PS BUSINESS PARKS INC/CA, 10-K405, 1999-03-11

PS BUSINESS PARKS INC/CA
10-K405, 1999-03-11
REAL ESTATE INVESTMENT TRUSTS

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K

[X] Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act
of 1934
For the fiscal year ended December 31, 1998.

or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934

For the transition period from to
---------- ----------

Commission File Number 1-10709
-------

PS BUSINESS PARKS, INC.
-----------------------
(Exact name of registrant as specified in its charter)

CALIFORNIA 95-4300881
- ---------------------------------- -----------------------------
(State or Other Jurisdiction (I.R.S. Employer
of Incorporation or Organization) Identification Number)

701 WESTERN AVENUE, GLENDALE, CALIFORNIA 91201-2397
---------------------------------------------------
(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: (818) 244-8080
--------------

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

Common Stock, $0.01 par value American Stock Exchange
- ----------------------------- -----------------------
(Title of each class) (Name of each exchange on which registered)

Securities registered pursuant to Section 12(g) of the Act
None
----
(Title of class)

Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days.

Yes X No
---

Indicate by check mark 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 Company's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]

The aggregate market value of the voting stock held by non-affiliates of the
registrant as of March 5, 1999:

Common Stock, $0.01 par value, $279,389,255 (computed on the basis of $22.9375
per share which was the reported closing sale price of the Company's Common
Stock on the American Stock Exchange as of March 5, 1999).

Number of shares outstanding of the registrant's class of common stock, as of
March 5, 1999:

Common Stock, $0.01 par value, 23,637,410 shares.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the proxy statement to be filed in connection with the annual
shareholders' meeting to be held in 1999 are incorporated by reference into Part
III.
<PAGE>

This Annual Report contains forward-looking statements. Actual results
could differ materially from those set forth in the forward-looking statements
as a result of various factors, including general real estate investment risks,
competition, risks associated with acquisition and development activities and
debt financing, environmental matters, general uninsured losses and seismic
activity.

PART I.

ITEM 1. BUSINESS

THE COMPANY
- -----------

PS Business Parks, Inc. (the "Company") is a self-advised and self-managed
real estate investment trust ("REIT") that acquires, develops, owns and operates
commercial properties, primarily multi-tenant office industrial or "flex" space.
The Company is the sole general partner of PS Business Parks, L.P. (the
"Operating Partnership") through which the Company conducts most of its
activities and owned, as of December 31, 1998, a 72.6% partnership interest.
Substantially all of the remaining partnership interest is owned by Public
Storage, Inc. ("PSI") and its affiliates. As of December 31, 1998, PSI owned
27.1% of the Operating Partnership.

In a March 17, 1998 merger (the "Merger") of American Office Park
Properties, Inc. ("AOPP") with and into the Company (formerly "Public Storage
Properties XI, Inc."), the Company acquired the commercial property business
previously operated by AOPP and was renamed "PS Business Parks, Inc." Concurrent
with the Merger, the Company exchanged 11 mini-warehouses and two properties
that combined mini-warehouse and commercial space for 11 commercial properties
owned by PSI.

As of December 31, 1998, the Company and the Operating Partnership owned
106 commercial properties in 11 states containing approximately 10.9 million
square feet of commercial space, representing an increase in commercial square
footage between December 31, 1997 and December 31, 1998 of 82%. In addition, the
Operating Partnership manages, on behalf of PSI and affiliated entities, an
additional 36 commercial properties (approximately 1.0 million net rentable
square feet) at December 31, 1998.

For financial accounting purposes, the Merger was accounted for as a
reverse acquisition whereby AOPP was deemed to have acquired Public Storage
Properties XI, Inc. However, PS Business Parks, Inc. (formerly Public Storage
Properties XI, Inc.) is the continuing legal entity and registrant for both
Securities and Exchange Commission filing purposes and income tax reporting
purposes.

AOPP was originally organized in 1986 as a California corporation to serve
as the manager of the commercial properties owned by PSI and its related
entities. In January 1997, AOPP was reorganized to succeed to the commercial
property business of PSI, becoming a fully integrated, self-advised and
self-managed REIT. AOPP conducted substantially all of its business as the sole
general partner of the Operating Partnership.

In January 1997, as part of a reorganization, PSI and its consolidated
partnerships transferred 35 commercial properties to AOPP and the Operating
Partnership. During April 1997, PSI transferred four additional commercial
properties to the Operating Partnership. During the remainder of 1997, AOPP
acquired six properties containing approximately 2 million square feet of
commercial space from the Acquiport Corporations, subsidiaries of the New York
State Common Retirement Fund, and four properties containing approximately 0.6
million square feet of commercial space from other third parties. At December
31, 1997, AOPP and the Operating Partnership owned 49 properties located in 10
states. The Operating Partnership also managed an additional 49 properties owned
by PSI and its related entities (including the 13 properties acquired in the
Merger). As of December 31, 1997, AOPP owned a 35.4% partnership interest in the
Operating Partnership. The balance of the Operating Partnership was owned by
PSI, its consolidated partnerships and certain third parties.

During 1998, The Company completed the Merger and acquired approximately
4.9 million square feet of commercial space, including 2.3 million square feet
of space located in Oregon and Texas from Principal Mutual Life Insurance
Company in May 1998 and 1.8 million square feet of commercial space located in
California, Maryland, Virginia and Texas from other unaffiliated third parties.

2
<PAGE>

The Company has elected to be taxed as a REIT under the Internal Revenue
Code of 1986, as amended (the "Code"), commencing with its taxable year ended
December 31, 1990. To the extent that the Company continues to qualify as a
REIT, it will not be taxed, with certain limited exceptions, on the net income
that is distributed currently to its shareholders.

The Company's principal executive offices are located at 701 Western
Avenue, Glendale, California 91201-2397. Its telephone number is (818) 244-8080.

The commercial properties owned by the Company and the Operating
Partnership generally include both business park (industrial/"flex" space) and
office space. The industrial space is used for, among other things, light
manufacturing and assembly, storage and warehousing, distribution and research
and development activities. Tenants who are also renting industrial space occupy
most of the office space. The commercial properties typically consist of one to
ten one-story buildings located on three to 20 acres and contain from
approximately 10,000 to 500,000 square feet of rentable space (more than 50,000
square feet in the case of the freestanding properties). A property is typically
divided into units ranging in size from 500 to 10,000 square feet. Leases
generally range from one to five years and some tenants have options to extend
the original terms of their leases. The larger facilities have on-site
management. Parking is open or covered, and the ratio of spaces to rentable
square feet ranges from two to five per thousand square feet, depending upon the
use of the property and its location. Office space generally requires a greater
parking ratio than most industrial uses. The Company may acquire properties that
do not have these characteristics.

The Company intends to continue to acquire commercial properties located
throughout the United States. The Company's policy of acquiring commercial
properties may be changed by its Board of Directors without shareholder
approval. However, the Board of Directors has no intention to change this policy
at this time. Although the Company currently operates properties in 13 states,
it may expand its operations to other states. Properties are acquired both for
income and potential capital appreciation; there is no limitation on the amount
that can be invested in any specific property. Although there is no limitation
on mortgage debt, the Company has no current intention to incur significant debt
(other than short-term borrowings from time to time (including from PSI) to fund
acquisitions). The Company may acquire land on which it develops commercial
properties, particularly land that is adjacent to existing commercial properties
that the Company acquires. The Company currently has four facilities under
development.

OPERATING PARTNERSHIP
- ---------------------

The properties in which the Company has an equity interest generally will
be owned by the Operating Partnership. This structure enables the Company to
acquire interests in additional properties in transactions that could defer the
contributors' tax consequences. This structure also enabled PSI and its
consolidated partnerships to contribute interests in their properties and to
defer until a later date the tax liabilities that they otherwise would have
incurred if they had received Common Stock.

As the general partner of the Operating Partnership, the Company has the
exclusive power under the Operating Partnership Agreement to manage and conduct
the business of the Operating Partnership. The Board of Directors directs the
affairs of the Operating Partnership by managing the Company's affairs. The
Operating Partnership will be responsible for, and pay when due, its share of
all administrative and operating expenses of the properties it owns under the
terms of a cost sharing and administrative services agreement with an affiliate
of PSI. See "Cost Allocation and Administrative Services."

The Company's interest in the Operating Partnership entitles it to share in
cash distributions from, and the profits and losses of, the Operating
Partnership in proportion to the Company's economic interest in the Operating
Partnership (apart from tax allocations of profits and losses to take into
account pre-contribution property appreciation or depreciation). Substantially
all of the economic interest in the Operating Partnership that is not held by
the Company is held by PSI and its consolidated partnerships as limited
partners.

3
<PAGE>

SUMMARY OF THE OPERATING PARTNERSHIP AGREEMENT
- ----------------------------------------------

The following summary of the Operating Partnership Agreement is qualified
in its entirety by reference to the Operating Partnership Agreement, which has
been filed as an exhibit with the Securities and Exchange Commission.

ISSUANCE OF ADDITIONAL PARTNERSHIP INTERESTS: As the general partner of the
Operating Partnership, the Company is authorized to cause the Operating
Partnership from time to time to issue to partners of the Operating Partnership
or to other persons additional partnership units in one or more classes, and in
one or more series of any of such classes, with such designations, preferences
and relative, participating, optional, or other special rights, powers and
duties (which may be senior to the existing partnership units), as will be
determined by the Company, in its sole and absolute discretion. No such
additional partnership units, however, will be issued to the Company unless (i)
the agreement to issue the additional partnership interests arises in connection
with the issuance of shares of the Company, which shares have designations,
preferences and other rights, such that the economic interests are substantially
similar to the designations, preferences and other rights of the additional
partnership units that would be issued to the Company and (ii) the Company
agrees to make a capital contribution to the Operating Partnership in an amount
equal to the proceeds raised in connection with the issuance of such shares of
the Company.

CAPITAL CONTRIBUTIONS: No partner is required to make additional capital
contributions to the Operating Partnership, except the Company as the general
partner is required to contribute the net proceeds of the sale of equity
interests in the Company to the Operating Partnership. A limited partner may be
required to pay to the Operating Partnership any taxes paid by the Operating
Partnership on behalf of that limited partner. No partner is required to pay to
the Operating Partnership any deficit or negative balance, which may exist in
its capital account.

DISTRIBUTIONS: The Company, as general partner, is required to distribute
at least quarterly the "available cash" (as defined in the Operating Partnership
Agreement) generated by the Operating Partnership for such quarter.
Distributions are to be made (i) first, with respect to any class of partnership
interests having a preference over other classes of partnership interests; and
(ii) second, in accordance with the partners' respective percentage interests on
the "partnership record date" (as defined in the Operating Partnership
Agreement). Commencing in 1998, the Operating Partnership's policy is to make
distributions per unit that are equal to the per share distributions made by the
Company with respect to its Common Stock, and in any case the per unit and per
share distributions will be equal during partnership years 1999 and 2000.

REDEMPTION OF PARTNERSHIP INTERESTS: Subject to certain limitations
described below, each limited partner other than the Company has the right to
require the redemption of such limited partner's unit. This right may be
exercised on at least 10 days notice at any time or from time to time, beginning
on the date that is one year after the date on which such limited partner is
admitted to the Operating Partnership (unless otherwise contractually agreed by
the general partner).

Unless the Company, as general partner, elects to assume and perform the
Operating Partnership's obligation with respect to a redemption right, as
described below, a limited partner that exercises its redemption right will
receive cash from the Operating Partnership in an amount equal to the
"redemption amount" (as defined in the Operating Partnership Agreement generally
to reflect the average trading price of the Common Stock of the Company over a
specified 10 day period) for the units redeemed. In lieu of the Operating
Partnership redeeming the partner for cash, the Company, as the general partner,
has the right to elect to acquire the units directly from a limited partner
exercising its redemption right, in exchange for cash in the amount specified
above as the "redemption amount" or by issuance of the "shares amount" (as
defined in the Operating Partnership Agreement generally to mean the issuance of
one share of the Company Common Stock for each unit of limited partnership
interest redeemed).

A limited partner cannot exercise its redemption right if delivery of
shares of Common Stock would be prohibited under the applicable articles of
incorporation or if the general partner believes that there is a risk that
delivery of shares of Common Stock would cause the general partner to no longer
qualify as a REIT, would cause a violation of the applicable securities or
certain antitrust laws, or would result in the Operating Partnership no longer
being treated as a partnership for federal income tax purposes.

4
<PAGE>

MANAGEMENT: The Operating Partnership is organized as a California limited
partnership. The Company, as the sole general partner of the Operating
Partnership has full, exclusive and complete responsibility and discretion in
managing and controlling the Operating Partnership, except as provided in the
Operating Partnership Agreement and by applicable law. The limited partners of
the Operating Partnership have no authority to transact business for, or
participate in the management activities or decisions of, the Operating
Partnership except as provided in the Operating Partnership Agreement and as
permitted by applicable law. However, the consent of the limited partners
holding a majority of the interests of the limited partners (including limited
partnership interests held by the Company) generally will be required to amend
the Operating Partnership Agreement. Further, the Operating Partnership
Agreement cannot be amended without the consent of each partner adversely
affected if, among other things, the amendment would alter the partner's rights
to distributions from the Operating Partnership (except as specifically
permitted in the Operating Partnership Agreement), alter the redemption right,
or impose on the limited partners an obligation to make additional capital
contributions. The consent of all limited partners will be required to (i) take
any action that would make it impossible to carry on the ordinary business of
the Operating Partnership, except as otherwise provided in the Operating
Partnership Agreement; or (ii) possess Operating Partnership property, or assign
any rights in specific Operating Partnership property, for other than an
Operating Partnership purpose except as otherwise provided in the Operating
Partnership Agreement. In addition, without the consent of any adversely
affected limited partner, the general partner may not perform any act that would
subject a limited partner to liability as a general partner in any jurisdiction
or any other liability except as provided in the Operating Partnership Agreement
or under California law.

EXTRAORDINARY TRANSACTIONS: The Operating Partnership Agreement provides
that the Company may not engage in any business combination, defined to mean any
merger, consolidation or other combination with or into another person or sale
of all or substantially all of its assets, any reclassification, any
recapitalization (other than certain stock splits or stock dividends) or change
of outstanding shares of common stock, unless (i) the limited partners of the
Operating Partnership will receive, or have the opportunity to receive, the same
proportionate consideration per unit in the transaction as shareholders of the
Company (without regard to tax considerations); or (ii) limited partners of the
Operating Partnership (other than the general partner) holding at least 60% of
the interests in the Operating Partnership held by limited partners (other than
the general partner) vote to approve the business combination. In addition, the
Company, as general partner of the Operating Partnership, has agreed in the
Operating Partnership Agreement with the limited partners of the Operating
Partnership that it will not consummate a business combination in which the
Company conducted a vote of shareholders unless the matter is also submitted to
a vote of the partners. The foregoing provision of the Operating Partnership
Agreement would under no circumstances enable or require the Company to engage
in a business combination which required the approval of shareholders if the
shareholders of the Company did not in fact give the requisite approval. Rather,
if the shareholders did approve a business combination, the Company would not
consummate the transaction unless the Company as general partner first conducts
a vote of partners of the Operating Partnership on the matter. For purposes of
the Operating Partnership vote, the Company shall be deemed to vote its
partnership interest in the same proportion as the shareholders of the Company
voted on the matter (disregarding shareholders who do not vote). The Operating
Partnership vote will be deemed approved if the votes recorded are such that if
the Operating Partnership vote had been a vote of shareholders, the business
combination would have been approved by the shareholders. As a result of these
provisions of the Operating Partnership, a third party may be inhibited from
making an acquisition proposal that it would otherwise make, or the Company,
despite having the requisite authority under its articles of incorporation, may
not be authorized to engage in a proposed business combination.

TAX PROTECTION PROVISIONS: The Operating Partnership Agreement provides
that, until 2007, the Operating Partnership may not sell any of 13 designated
properties in a transaction that will produce taxable gain for the contributing
partner without the prior written consent of PSI. The Operating Partnership is
not required to obtain PSI's consent if PSI and its affiliated partnerships do
not continue to hold at the time of the sale at least 30% of their original
interest in the Operating Partnership. Since PSI's consent is required only in
connection with a taxable sale of one of the 13 designated properties, the
Operating Partnership will not be required to obtain PSI's consent in connection
with a "like-kind" exchange or other nontaxable transaction involving one of
these properties.

INDEMNIFICATION: The Operating Partnership Agreement provides that the
Company and its officers and directors will be indemnified and held harmless by
the Operating Partnership for any act performed for, or on behalf of, the
Operating Partnership, or in furtherance of the Operating Partnership's business
unless it is established that (i) the act or omission of the indemnified person
was material to the matter giving rise to the proceeding and either was

5
<PAGE>

committed in bad faith or was the result of active and deliberate dishonesty;
(ii) the indemnified person actually received an improper personal benefit in
money, property or services; or (iii) in the case of any criminal proceeding,
the indemnified person had reasonable cause to believe that the act or omission
was unlawful. The termination of any proceeding by judgment, order or settlement
does not create a presumption that the indemnified person did not meet the
requisite standards of conduct set forth above. The termination of any
proceeding by conviction or upon a plea of nolo contendere or its equivalent, or
an entry of an order of probation prior to judgment, creates a rebuttable
presumption that the indemnified person did not meet the requisite standard of
conduct set forth above. Any indemnification so made shall be made only out of
the assets of the Operating Partnership.

DUTIES AND CONFLICTS: The Operating Agreement allows the Company to operate
the Operating Partnership in a manner that will enable the Company to satisfy
the requirements for being classified as a REIT. The Company intends to conduct
all of its business activities, including all activities pertaining to the
acquisition, management and operation of properties, through the Operating
Partnership. However, the Company may own, directly or through subsidiaries,
interest in Operating Partnership properties that do not exceed 1% of the
economic interest of any property, and if appropriate for regulatory, tax or
other purposes, the Company also may own, directly or through subsidiaries,
interests in assets that the Operating Partnership otherwise could acquire, if
the Company grants to the Operating Partnership the option to acquire the assets
within a period not to exceed three years in exchange for the number of
partnership units that would be issued if the Operating Partnership had acquired
the assets at the time of acquisition by the Company.

TERM: The Operating Partnership will continue in full force and effect
until December 31, 2096 or until sooner dissolved upon the withdrawal of the
general partner (unless the limited partners elect to continue the Operating
Partnership), or by the election of the general partner (with the consent of the
holders of a majority of the partnerships interests if such vote is held before
January 1, 2056), in connection with a merger, by the sale or other disposition
of all or substantially all of the assets of the Operating Partnership, or by
judicial decree.

COST ALLOCATION AND ADMINISTRATIVE SERVICES
- -------------------------------------------

Pursuant to a cost sharing and administrative services agreement, PSCC,
Inc. ("PSCC") has been formed to serve as a cooperative cost allocation and
administrative services clearing house that performs centralized administrative
services for the Company, PSI and other property owners affiliated with PSI.
These services include accounting and finance, employee relations, management
information systems, legal, office services, marketing, administration and
property management training. In addition, to take advantage of economies of
scale, PSCC purchases supplies and services for the benefit of multiple property
owners and allocates the costs of these supplies and services to the benefited
property owners and employs and administers the payroll for employees required
for the operation of the properties and the ownership entities. As to the
Company, this agreement is not terminable until January 2002. The Company has no
intention to terminate this agreement. The Company, PSI and certain other
property owners own the capital stock of PSCC. Since the Company owns less than
10% of the capital stock of PSCC, the Company does not control the operations
and activities of PSCC. Under this agreement, PSCC allocates costs to the
Company in accordance with a methodology that is intended to fairly allocate
charges among participating entities.

COMMON OFFICERS AND DIRECTORS
- -----------------------------

Harvey Lenkin, the President of PSI, is a Director of both the Company and
PSI. Ronald L. Havner, Jr., the Chairman and Chief Executive Officer of the
Company, was Senior Vice President and Chief Financial Officer of PSI until
December 1996 and is currently an employee of PSI. Mary Jayne Howard, the
Executive Vice President of the Company, was a Senior Vice President of PSI
until December 1996. The Company engages additional executive personnel who
render services exclusively for the Company. However, it is expected that
officers of PSI will continue to render services for the Company as requested.

MANAGEMENT AGREEMENT
- --------------------

The Company continues to manage commercial properties owned by PSI and
affiliates, which are generally adjacent to mini-warehouses, for a fee of 5% of
the gross revenues of such properties in addition to reimbursement of direct
costs. The property management contract with PSI is for a seven-year term with

6
<PAGE>

the term extended one-year each anniversary. The property management contracts
with affiliates of PSI are cancelable by either party upon sixty days notice.

MANAGEMENT
- ----------

Ronald L. Havner, Jr. (41), President, Chairman and Chief Executive Officer
heads the Company's senior management team. Mr. Havner has been President and
Chief Executive Officer of the Company or AOPP since December 1996. He became
Chairman of the Company in March 1998. He was Senior Vice President and Chief
Financial Officer of PSI from 1992 until December 1996. The Company's executive
management includes: Mary Jayne Howard (53), Executive Vice President and
President-Property Operations; Jack Corrigan (38), Vice President and Chief
Financial Officer; and Michael Lynch (46), Vice President-Acquisitions and
Development.

REIT STRUCTURE
- --------------

If certain detailed conditions imposed by the Code and the related Treasury
Regulations are met, an entity, such as PS Business Parks, Inc., that invests
principally in real estate and that otherwise would be taxed as a corporation
may elect to be treated as a REIT. The most important consequence to PS Business
Parks, Inc. of being treated as a REIT for federal income tax purposes is that
this enables PS Business Parks, Inc. to deduct dividend distributions to its
shareholders, thus effectively eliminating the "double taxation" (at the
corporate and shareholder levels) that typically results when a corporation
earns income and distributes that income to shareholders in the form of
dividends.

INVESTMENT OBJECTIVE - GROWTH IN FUNDS FROM OPERATIONS PER SHARE
- ----------------------------------------------------------------

The Company's primary objective is to maximize shareholder value by
achieving long term growth in funds from operations per share. The Company
intends to continue achieving this objective through internal growth of existing
facilities combined with acquisitions of quality commercial properties in growth
markets and submarkets. The Company intends to continue investing in properties
and markets that have characteristics which enable them to be competitive in the
short and long term. The Company seeks markets with above average population
growth, education levels and personal income. In addition, the Company targets
properties in those markets where it believes supply is constrained and where
properties are close to important services and have easy access to major
transportation arteries.

The Company attempts to limit the risk in its portfolio through attracting
a diversified tenant base, both in size and industry focus. The Company's focus
is on properties that are easily divisible and therefore appeal to a wide range
of potential tenants. Such property flexibility also allows the Company to
better serve existing tenants by accommodating their inevitable expansion and
contraction needs. In addition, the Company's experience is that such property
flexibility helps it maintain high occupancy rates particularly when market
conditions are less favorable.

By focusing on divisible properties and a wide range of tenants, the
Company seeks to control capital expenditures associated with re-leasing space.
The Company also attempts to limit tenant improvement expenditures to those that
are appropriate for a high number of users.

The Company seeks to provide a superior level of service to its tenants in
order to achieve high occupancy and rental rates, as well as low turnover. The
Company's property management offices are located on-site, providing tenants
with convenient access to management. On-site staff enables the Company's
properties to be well maintained and to convey a sense of quality, order and
security. The Company has significant experience in acquiring properties managed
by others and thereafter improving tenant satisfaction, occupancy levels,
renewal rates and rental income by implementing the Company's tenant service
programs.

COMPETITION
- -----------

SIGNIFICANT COMPETITION AMONG COMMERCIAL PROPERTIES: Competition in the
market areas in which many of the Company's properties are located is
significant and has reduced the occupancy levels and rental rates of, and
increased the operating expenses of, certain of these properties. Competition

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<PAGE>

may be accelerated by any increase in availability of funds for investment in
real estate. Barriers to entry are relatively low for those with the necessary
capital and the Company will be competing for property acquisition and tenants
with entities that have greater financial resources than the Company. Recent
increases in development of commercial properties are expected to further
intensify competition among operators in certain market areas in which the
Company operates.

The Company believes that the significant operating and financial
experience of its executive officers and directors combined with the Company's
capital structure, national investment scope, geographic diversity and economies
of scale should enable the Company to continue to compete effectively with other
entities.

BUSINESS ATTRIBUTES
- -------------------

The Company believes it possesses several distinguishing characteristics
that enable it to compete effectively in the Office/Warehouse, "flex" space
industry. The Company's facilities are part of a comprehensive system
encompassing standardized procedures and integrated reporting and information
networks. The Company believes it possesses the most experienced property
operations group within this industry. The Company has a strong track record of
growing revenues and net operating income for the properties it has operated for
at least seven years. The Company is diversified geographically and by tenant.
In addition, the Company has a consistent record of acquiring properties in
selected markets at prices believed to be below replacement costs and which
enables the Company to execute its growth strategies.

Financially, the Company has adopted a conservative policy characterized by
a low payout ratio and minimal debt levels. These attributes are complemented by
sponsorship from PSI, a widely known and respected REIT.

GROWTH STRATEGIES
- -----------------

The Company's growth strategies focus on improving the operating
performance of its existing properties and on increasing its ownership of
"flex" space facilities through additional investments. Major elements of these
strategies are as follows:

INCREASE NET CASH FLOW OF EXISTING PROPERTIES: The Company seeks to
increase the net cash flow generated by its existing properties by (i)
increasing average occupancy rates and (ii) achieving higher levels of realized
monthly rents per occupied square foot and (iii) reducing its operating cost
structure by improving operating efficiencies and economies of scale. The
Company believes that its proactive property management personnel and systems
combined with strong markets and increasing economies of scale will enhance the
Company's ability to meet these goals.

ACQUIRE PROPERTIES OWNED OR OPERATED BY OTHERS: The Company believes its
presence in and knowledge of its markets enhances its ability to identify
attractive acquisition opportunities and capitalize on the overall fragmentation
in the "flex" space industry. The Company maintains local market information on
rates, occupancy and competition in each of the markets in which it operates. Of
the more than 800 million square feet of "flex" space facilities in the United
States noted by Torto Wheaton Research, the Company believes that the ten
largest operators manage less than 15% of the total space. During 1998, the
Company acquired 44 "flex" space facilities from unaffiliated third parties.
Similar to 1998, the Company expects third party acquisitions to be its most
significant growth area during fiscal 1999, if attractive investment
opportunities continue to be available.

DEVELOP PROPERTIES IN EXISTING MARKETS: The Company's development strategy
is to selectively construct new properties next to existing business parks. In
accordance with that strategy, the Company commenced construction of office and
"flex" space adjacent to facilities in Beaverton, Oregon and Las Colinas, Texas,
in 1998. These developments are expected to be complete in June 1999. The
Company plans to keep development activities below 10% of its portfolio.

FINANCING OF THE COMPANY'S GROWTH STRATEGIES
- --------------------------------------------

RETAIN OPERATING CASH FLOW: The Company seeks to retain significant funds
(after funding its distributions and capital improvements) for additional

8
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investments and debt reduction. During the year ended December 31, 1998, the
Company distributed 51% of its funds from operations ("FFO") allocable to common
stock and retained $19.7 million which was available for principal payments on
debt and reinvestment into real estate assets. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations-Liquidity and Capital
Resources."

REVOLVING LINE OF CREDIT: The Company currently has a $100 million
unsecured credit facility with Wells Fargo Bank, which the Company uses as a
temporary source of acquisition financing. The Company seeks to ultimately
finance all acquisitions with permanent capital to eliminate refinancing and
interest rate risk. As of December 31, 1998, there was $12.5 million outstanding
on this credit facility.

ACCESS TO ACQUISITION CAPITAL: The Company believes that its strong
financial position enables it to access capital to finance its growth. In 1998,
the Company issued approximately $322 million of common equity and Operating
Partnership units to finance its acquisitions. The Company's debt as a
percentage of total capitalization was 7% at December 31, 1998. The Company
targets a 40% leverage ratio, which is defined as debt and preferred stock as a
percentage of its total capitalization (shareholders' equity plus debt plus
minority interest). In addition, the Company targets a ratio of FFO to fixed
charges (FFO plus interest expense divided by fixed charges) of 3.0 to 1.0.
Fixed charges include interest expense, capitalized interest and preferred
dividends. The FFO to fixed charges ratio was 22.74 to 1.0 at December 31, 1998.
The Company plans to add leverage in its capital structure primarily through the
use of preferred stock, but may assume debt in connection with acquisitions.
This policy is subject to change depending upon market conditions.

INVESTMENTS IN REAL ESTATE FACILITIES
- -------------------------------------

As of December 31, 1998, the Company had a total of 106 (10,930,000 square
feet) real estate facilities compared to 49 (6,009,000 square feet) facilities
at December 31, 1997. The increase in the number of facilities was due to
acquisitions of facilities from third parties in addition to the Merger.

RESTRICTIONS ON TRANSACTIONS WITH AFFILIATES
- --------------------------------------------

The Company's Bylaws provide that the Company may engage in transactions
with affiliates provided that a purchase or sale transaction with an affiliate
is (i) approved by a majority of the Company's independent directors and (ii)
fair to the Company based on an independent appraisal or fairness opinion.

BORROWINGS
- ----------

The Company has an unsecured $100 million credit facility ("Credit
Facility") with Wells Fargo Bank which expires on August 5, 2000. The expiration
date may be extended by one year on each anniversary of the Credit Facility.
Interest on outstanding borrowings on the Credit Facility is payable monthly. At
the option of the Company, the rate of interest charged on borrowings is equal
to (i) the prime rate or (ii) a rate ranging from the London Interbank Offered
Rate ("LIBOR") plus 0.55% to LIBOR plus 0.95% depending on the Company's credit
rating and coverage ratios, as defined. In addition, the Company is required to
pay a commitment fee of 0.25% (per annum) of the revolving Credit Facility.

Under covenants of the Credit Facility, the Company is required to (i)
maintain a balance sheet leverage ratio (as defined) of less than 0.50 to 1.00,
(ii) maintain interest and fixed charge coverage ratios (as defined) of not less
than 2.25 to 1.0 and 2.0 to 1.0, respectively, (iii) maintain a minimum total
shareholder's equity (as defined) and (iv) limit distributions to 95% of funds
from operations. In addition, the Company is limited in its ability to incur
additional borrowings (the Company is required to maintain unencumbered assets
with an aggregate book value equal to or greater than two times the Company's
unsecured recourse debt) or sell assets. The Company was in compliance with the
covenants of the Credit Facility at December 31, 1998.

As of December 31, 1998, the Company had outstanding mortgage notes payable
balances of approximately $38 million and $12.5 million outstanding on the
Credit Facility. See Notes 6 and 7 to the consolidated financial statements for
a summary of the Company's borrowings at December 31, 1998.

9
<PAGE>

The Company has broad powers to borrow in furtherance of the Company's
objectives. The Company has incurred in the past, and may incur in the future,
both short-term and long-term indebtedness to increase its funds available for
investment in real estate, capital expenditures and distributions.

EMPLOYEES
- ---------

As of December 31, 1998, the Company employed 95 individuals, primarily
personnel engaged in property operations. The Company believes that its
relationship with its employees is good and none of the employees are
represented by a labor union.

FEDERAL INCOME TAX
- ------------------

The Company believes that it has operated, and intends to continue to
operate, in such a manner as to qualify as a REIT under the Internal Revenue
Code of 1986, but no assurance can be given that it will at all times so
qualify. To the extent that the Company continues to qualify as a REIT, it will
not be taxed, with certain limited exceptions, on the taxable income that is
distributed to its shareholders.

INSURANCE
- ---------

The Company believes that its properties are adequately insured. Facilities
operated by the Company have historically carried comprehensive insurance,
including fire, earthquake, liability and extended coverage from nationally
recognized carriers.

IMPACT OF YEAR 2000
- -------------------

See "Management's Discussion and Analysis of Financial Condition and
Results of Operations-Impact of Year 2000."

10
<PAGE>

ITEM 2. PROPERTIES

As of December 31, 1998, the Company's portfolio of properties consisted
primarily of "flex" space and suburban office buildings located principally in
five major markets including Southern and Northern California,
Virginia/Maryland, Texas and Oregon. The Company owned approximately 1.2 million
square feet of suburban office space and 9.7 million square feet of "flex" space
as of December 31, 1998 and the average occupancy rate of the properties was
96%.

The following table contains information as of December 31, 1998 about
properties owned by the Company and the Operating Partnership:
<TABLE>
<CAPTION>

Rentable Square Footage
Number of ---------------------------------------------------------- Occupancy at
City Properties Business Park Office Total December 31, 1998
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
ARKANSAS
Little Rock........... 1 91,100 - 91,100 83%
----------------------------------------------------------------------------------------------------
1 91,100 - 91,100 83%
----------------------------------------------------------------------------------------------------
ARIZONA
Mesa.................. 1 78,000 - 78,000 100%
Tempe................. 3 291,300 - 291,300 99%
----------------------------------------------------------------------------------------------------
4 369,300 - 369,300 100%
----------------------------------------------------------------------------------------------------
NORTHERN CALIFORNIA
Monterey.............. 1 - 12,000 12,000 100%
Hayward............... 1 406,700 - 406,700 100%
Sacramento............ 1 153,600 - 153,600 89%
San Jose.............. 2 386,800 - 386,800 89%
San Ramon............. 2 24,600 27,500 52,100 100%
So. San Francisco..... 2 93,800 - 93,800 100%
----------------------------------------------------------------------------------------------------
9 1,065,500 39,500 1,105,000 95%
----------------------------------------------------------------------------------------------------
SOUTHERN CALIFORNIA
Buena Park............ 1 317,300 - 317,300 100%
Carson................ 1 77,600 - 77,600 91%
Cerritos.............. 2 394,600 31,300 425,900 92%
Culver City........... 1 145,400 - 145,400 97%
Laguna Hills.......... 2 613,900 - 613,900 99%
Lake Forest........... 1 296,600 - 296,600 92%
Lakewood.............. 1 - 56,900 56,900 96%
Monterey Park......... 1 199,100 - 199,100 92%
San Diego............. 7 372,000 232,800 604,800 99%
Signal Hill........... 2 178,200 - 178,200 99%
Studio City........... 1 22,100 - 22,100 100%
Torrance.............. 2 147,200 - 147,200 85%
----------------------------------------------------------------------------------------------------
22 2,764,000 321,000 3,085,000 96%
----------------------------------------------------------------------------------------------------
KANSAS
Overland Park......... 1 61,800 - 61,800 99%
----------------------------------------------------------------------------------------------------
1 61,800 - 61,800 99%
----------------------------------------------------------------------------------------------------
</TABLE>

11
<PAGE>
<TABLE>
<CAPTION>
Rentable Square Footage
Number of ---------------------------------------------------------- Occupancy at
City Properties Business Park Office Total December 31, 1998
- ------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
MARYLAND
Baltimore (1)......... 1 - 240,900 240,900 90%
Beltsville............ 1 307,800 - 307,800 96%
Gaithersburg.......... 1 - 29,000 29,000 73%
Landover (2).......... 2 379,700 - 379,700 95%
Largo................. 1 149,900 - 149,900 100%
----------------------------------------------------------------------------------------------------
6 837,400 269,900 1,107,300 94%
----------------------------------------------------------------------------------------------------
OKLAHOMA
Broken Arrow.......... 1 87,900 - 87,900 92%
Tulsa................. 1 56,600 - 56,600 84%
----------------------------------------------------------------------------------------------------
2 144,500 - 144,500 89%
----------------------------------------------------------------------------------------------------
OREGON
Beaverton............. 14 879,700 121,000 1,000,700 99%
Milwaukee............. 2 101,600 - 101,600 90%
----------------------------------------------------------------------------------------------------
16 981,300 121,000 1,102,300 98%
----------------------------------------------------------------------------------------------------
TENNESSEE
Nashville............. 2 138,000 - 138,000 98%
----------------------------------------------------------------------------------------------------
2 138,000 - 138,000 98%
----------------------------------------------------------------------------------------------------
TEXAS
Austin (2)............ 7 525,100 - 525,100 92%
Dallas................ 2 237,900 - 237,900 96%
Garland............... 1 36,500 - 36,500 92%
Houston............... 1 - 130,600 130,600 100%
Las Colinas (1)....... 10 725,100 - 725,100 100%
Mesquite.............. 1 56,500 - 56,500 97%
Missouri City......... 1 66,000 - 66,000 98%
Pasadena.............. 1 154,000 - 154,000 99%
Plano................. 1 184,800 - 184,800 72%
Richardson............ 3 173,900 - 173,900 97%
San Antonio........... 2 - 199,300 199,300 88%
----------------------------------------------------------------------------------------------------
30 2,159,800 329,900 2,489,700 94%
----------------------------------------------------------------------------------------------------
VIRGINIA
Alexandria............ 3 154,700 53,700 208,400 100%
Herndon............... 1 193,600 - 193,600 97%
Lorton (2)............ 1 246,500 - 246,500 100%
Springfield........... 2 59,800 90,500 150,300 94%
Sterling (2).......... 4 295,600 - 295,600 99%
Woodbridge............ 1 113,600 - 113,600 96%
----------------------------------------------------------------------------------------------------
12 1,063,800 144,200 1,208,000 98%
----------------------------------------------------------------------------------------------------
WASHINGTON
Renton................ 1 27,900 - 27,900 77%
----------------------------------------------------------------------------------------------------
1 27,900 - 27,900 77%
----------------------------------------------------------------------------------------------------

Totals - 11 states.... 106 9,704,400 1,225,500 10,929,900 96%
====================================================================================================
</TABLE>

(1) The Company owns two properties that are subject to a ground lease in
Baltimore, Maryland and Las Colinas, Texas.

(2) Eleven commercial properties serve as collateral to mortgage notes payable.
See detailed listing in Schedule III.

12
<PAGE>

Each of these properties will continue to be used for its current purpose.
Competition exists in the market areas in which these properties are located.
Barriers to entry are relatively low for competitors with the necessary capital
and the Company will be competing for properties and tenants with entities that
have greater financial resources than the Company. However, the Company believes
that the current overall demand for commercial space is strong.

The Company has risks that tenants will default on leases and declare
bankruptcy. Management believes these risks are mitigated through its geographic
diversity and its diverse tenant base. As of December 31, 1998, tenants
occupying approximately 50,000 square feet of commercial space have delcared
bankruptcy. However, all of the bankrupt tenants remain current on their monthly
rental payments. In the Company's opinion, risk of loss due to property damage
is adequately covered by insurance.

As of December 31, 1998, none of these properties have a book value of more
than 10% of the Company's current total assets or accounts for more than 10% of
its current aggregate gross revenues.

The following table sets forth the lease expirations for the properties
owned as of December 31, 1998:
<TABLE>
<CAPTION>
Percentage of Total
Annual Base Rents
Rentable Square Footage Annual Base Rents Under Represented by Expiring
Year of Lease Expiration Subject to Expiring Leases Expiring Leases Leases
- ------------------------ -------------------------- ----------------------- -----------------------
<S> <C> <C> <C>
1999 2,641,000 $ 25,722,000 25.5%
2000 2,618,000 25,497,000 25.2%
2001 1,788,000 17,415,000 17.2%
2002 1,316,000 12,821,000 12.7%
2003 1,016,000 9,899,000 9.8%
Thereafter 996,000 9,704,000 9.6%
- ------------------------ -------------------------- ----------------------- -----------------------
Total 10,375,000 $101,058,000 100.0%
======================== ========================== ======================= =======================
</TABLE>

ENVIRONMENTAL MATTERS: Compliance with laws and regulations relating to the
protection of the environment, including those regarding the discharge of
material into the environment, has not had any material effects upon the capital
expenditures, earnings or competitive position of the Company.

The properties contributed by PSI and affiliates during 1997 and 1998 were
each subject to environmental audits within the two-year period ended December
31, 1995. In addition, for each of the properties acquired subsequent to
December 31, 1995, and for each parcel of land purchased for development, an
environmental investigation was conducted as part of the acquisition due
diligence process. The environmental investigations have not revealed any
environmental liability that the Company believes would have a material adverse
effect on the Company's business, assets or results of operations, nor is the
Company aware of any potentially material environmental liability, except as
discussed below.

The Company acquired a property in Beaverton, Oregon ("Creekside Corporate
Park") in May 1998. A property adjacent to Creekside Corporate Park is currently
the subject of an environmental remedial investigation/feasibility study that is
being conducted by the current and past owners of the property, pursuant to an
order issued by the Oregon Department of Environmental Quality ("ODEQ"). As part
of that study, ODEQ ordered the property owners to sample soil and groundwater
on the Company's property to determine the nature and extent of contamination
resulting from past industrial operations at the property subject to the study.
The Company, which is not a party of the Order on Consent, executed separate
Access Agreements with the property owners to allow access to its property to
conduct the required sampling and testing. The sampling and testing is ongoing,
and preliminary results from one area indicate that the contamination from the
property subject to the study may have migrated onto a portion of Creekside
Corporate Park owned by the Company.

There is no evidence that any past or current use of the Creekside
Corporate Park property contributed in any way to the contamination that is the
subject of the current investigation. Nevertheless, upon completion of the
study, it is likely that removal or remedial measures will be required to
address any contamination detected during the current investigation, including
any contamination on or under the Creekside Corporate Park property. Because of

13
<PAGE>

the preliminary nature of the investigation, the Company cannot predict the
outcome of the investigation, nor can it estimate the costs of any remediation
or removal activities that may be required.

The Company believes that it bears no responsibility or liability for the
contamination. In the event the Company is ultimately deemed responsible for any
costs relating to this matter, the Company believes that the party from whom the
property was purchased will be responsible for any expenses or liabilities that
the Company may incur as a result of this contamination.

Although the environmental investigations conducted to date have not
revealed any environmental liability that the Company believes would have a
material adverse effect on the Company's business, assets or results of
operations, and the Company is not aware of any such liability, it is possible
that these investigations did not reveal all environmental liabilities or that
there are material environmental liabilities of which the Company is unaware. No
assurances can be given that (i) future laws, ordinances, or regulations will
not impose any material environmental liability, or (ii) the current
environmental condition of the Properties has not been, or will not be, affected
by tenants and occupants of the Properties, by the condition of properties in
the vicinity of the Properties, or by third parties unrelated to the Company.

PROPERTIES UNDER DEVELOPMENT: The Company plans to develop office and
"flex" properties that are located within or adjacent to existing parks. The
properties will be developed using the expertise of local development companies
on a fee basis. The development program is designed to enhance the Company's
existing portfolio. There are two projects currently under development.

The following table sets forth certain information regarding the Company's
properties under development as of December 31, 1998:

<TABLE>
<CAPTION>
Estimated Completion Rentable Square
Property Name Location Date Feet Amount Invested
- ------------- --------------- -------------------- ---------------- ---------------
<S> <C> <C> <C> <C>
Royal Tech 16 Las Colinas, TX May 1999 61,000 $ 1,261,000
Woodside Beaverton, OR June 1999 70,000 5,617,000
Creekside Beaverton, OR TBD 23,000 838,000
---------------- ---------------
154,000 $ 7,716,000
================ ===============
</TABLE>

The Royal Tech 16 project will have dock loading capabilities and an above
standard parking ratio of five cars per thousand square feet. The Company
currently has approximately 725,000 square feet of rentable space in Las
Colinas, Texas. The project is expected to cost approximately $6,364,000.

The Woodside project will be a three-story brick and glass structure and is
adjacent to Nike's world headquarters. The Company currently has approximately
one million square feet in Beaverton, Oregon. The project is expected to cost
approximately $10,951,000.

Both of these existing construction projects are expected to be completed
in the second quarter of 1999 with rent stabilization projected within six to
nine months of completion.

14
<PAGE>

ACQUISITIONS COMPLETED SUBSEQUENT TO DECEMBER 31, 1998: The following table
sets forth certain information regarding properties acquired between January 1,
1999 and March 5, 1999.

<TABLE>
<CAPTION>
Total Rentable Amount
Property Name Location Date Acquired Square Feet Invested
- ------------- -------------------- ---------------- -------------- ------------
<S> <C> <C> <C> <C>
Waterford A Austin, Texas January 6, 1999 30,000 $ 3,300,000
McNeil 6 Austin, Texas January 6, 1999 28,000 2,412,000
Rutland 11 Austin, Texas January 6, 1999 40,000 1,797,000
Rutland 12 Austin, Texas January 6, 1999 59,000 2,957,000
Rutland 13 Austin, Texas January 6, 1999 52,000 2,593,000
Rutland 19 Austin, Texas January 6, 1999 21,000 870,000
Lafayette (1) Chantilly, Virginia January 29, 1999 57,000 4,768,000
Monroe II Herndon, Virginia January 29, 1999 51,000 5,665,000
-------------- ------------
338,000 $ 24,362,000
============== ============
</TABLE>

(1) Does not include additional costs of land parcels acquired for future
development of $1 million on which the Company estimates 136,000 square
feet can be developed.

15
<PAGE>

ITEM 3. LEGAL PROCEEDINGS

There are no material proceedings pending against the Company or any of its
subsidiaries.

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

The Company did not submit any matter to a vote of security holders in the
fourth quarter of the fiscal year ended December 31, 1998.

ITEM 4A. EXECUTIVE OFFICERS

The following is a biographical summary of the executive officers of the
Company:

Ronald L. Havner, Jr., age 41, became a director of the Company on March
16, 1998 and Chairman of the Company on March 17, 1998. Mr. Havner has been
President and Chief Executive Officer of the Company or AOPP since December
1996. He was Senior Vice President and Chief Financial Officer of PSI and Vice
President of the Company and certain other REITs affiliated with PSI until
December 1996.

Mary Jayne Howard, age 53, became Executive Vice President and
President-Property Operations of the Company on March 17, 1998 with overall
responsibility for property operations. Ms. Howard has been a senior officer of
the Company or AOPP since December 1985 with overall responsibility for
commercial property operations and was a Senior Vice President of PSI from
November 1985 until December 1996.

Jack E. Corrigan, age 38, a certified public accountant, became Vice
President, Chief Financial Officer and Secretary of the Company on June 8, 1998.
From February 1991 until June 1998, Mr. Corrigan was a partner of LaRue,
Corrigan & McCormick with responsibility for the audit and accounting practice.
He was Vice President and Controller of PSI (formerly Storage Equities, Inc.)
from 1989 until February 1991.

J. Michael Lynch, age 46, became Vice President-Director of Acquisitions
and Development of the Company on June 8, 1998. Mr. Lynch was Vice President of
Acquisitions and Development of Nottingham Properties, Inc. from 1995 until May
1998. He has 16 years of real estate experience, primarily in acquisitions and
development. From 1988 until 1995, Mr. Lynch was a development project manager
for The Parkway Companies. From 1983 until 1988, he was an Assistant Vice
President, Real Estate Investment Department of First Wachovia Corporation.

16
<PAGE>

PART II

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

a. Market Price of the Registrant's Common Equity:

The Common Stock (formerly Common Stock Series A) of the Company (then
known as Public Storage Properties XI, Inc.) began trading on the American Stock
Exchange on March 27, 1991 under the symbol PSM. In connection with the March
1998 merger of AOPP into the Company, the Company changed its name from Public
Storage Properties XI, Inc. to PS Business Parks, Inc. and the Company's Common
Stock Series A was reclassified as Common Stock and began trading on the
American Stock Exchange under the symbol PSB.

The following table sets forth the high and low sales prices of the Common
Stock (formerly Common Stock Series A) on the American Stock Exchange for the
applicable periods:
<TABLE>
<CAPTION>
Range
-----------------------------------
Year Quarter High Low
----------------- ----------------- ----------------- --------------
<S> <C> <C> <C>
1997 1st $20-3/8 $19-3/8
2nd 20-1/8 19-3/8
3rd 21-7/16 19-5/16
4th 23-1/2 20-1/2

1998 1st 24-1/2 20-1/2
2nd 25-3/4 22-5/16
3rd 26-5/8 18-7/16
4th 24-3/8 18
</TABLE>

As of March 5, 1999, there were approximately 794 holders of record of the
Common Stock.

b. Dividends

Holders of Common Stock are entitled to receive distributions when and if
declared by the Company's Board of Directors out of any funds legally available
for that purpose. The Company is required to distribute at least 95% of its net
taxable ordinary income prior to the filing of the Company's tax return and 85%,
subject to certain adjustments, during the calendar year, to maintain its REIT
status for federal income tax purposes. It is management's intention to pay
distributions of not less than this required amount.

Distributions paid per share of Common Stock for 1998 and 1997 amounted to
$1.10 and $0.68, respectively (distributions paid prior to March 17, 1998 refer
to distributions paid on the AOPP common stock).

Since the second quarter of 1998, the Company has declared regular
quarterly dividends of $0.25 per common share. This reflects a decrease from the
quarterly dividend of $0.34 per common share which was paid to the previous
shareholders of Public Storage Properties XI, Inc. through the first quarter of
1998. The Board of Directors has established a distribution policy to maximize
the retention of operating cash flow and only distribute the minimum amount
required for the Company to maintain its tax status as a REIT.

17
<PAGE>

ITEM 6. SELECTED FINANCIAL DATA (1)
<TABLE>
<CAPTION>
For the Year
Ended
December 31, For the Periods (2) For the Years Ended December 31,
--------------- ----------------------------- ----------------------------------------------
April 1, 1997 January 1, 1997
through through
December 31, March 31,
1998 1997 1997 1996 1995 1994
------------- ------------- --------------- ------------- ------------- -------------
(In thousands, except per share data)
<S> <C> <C> <C> <C> <C> <C>
Revenues:
Rental income................ $ 88,320 $ 24,364 $ 5,805 $ - $ - $ -
Facility management fees..... 529 709 247 2,133 2,044 1,973
Interest income.............. 1,411 424 29 43 37 40
------------- ------------- --------------- ------------- ------------- -------------
90,260 25,497 6,081 2,176 2,081 2,013
------------- ------------- --------------- ------------- ------------- -------------
Expenses:
Cost of operations........... 26,073 9,837 2,493 - - -
Cost of facility management.. 77 129 60 514 570 523
Depreciation and amortization 18,908 4,375 820 - - -
General and administrative... 2,233 1,248 213 1,143 319 245
Interest expense............. 2,361 1 - - - -
------------- ------------- --------------- ------------- ------------- -------------
49,652 15,590 3,586 1,657 889 768
------------- ------------- --------------- ------------- ------------- -------------
Income before minority
interest..................... 40,608 9,907 2,495 519 1,192 1,245
Minority interest in income.. (11,208) (6,753) (1,813) - - -
------------- ------------- --------------- ------------- ------------- -------------

Income before income taxes... 29,400 3,154 682 519 1,192 1,245
Income tax expense (2)....... - - - (216) (472) (488)
------------- ------------- --------------- ------------- ------------- -------------

Net income................... $ 29,400 $ 3,154 $ 682 $ 303 $ 720 $ 757
============= ============= =============== ============= ============= =============
- -----------------------------------------------------------------------------------------------------------------------------------
PER COMMON SHARE:
- -----------------
Distribution................. $ 1.10 $ 0.68 $ 0.00 $ 0.43 $ 0.90 $ 0.64

Net income - Basic........... $ 1.52 $ 0.92 $ 0.31 $ 0.32 $ 0.80 $ 0.84
Net income - Diluted......... $ 1.51 $ 0.92 $ 0.31 $ 0.32 $ 0.80 $ 0.84

Weighted average common
shares-Basic................. 19,361 3,414 2,193 947 905 900
Weighted average common
shares-Diluted............... 19,429 3,426 2,193 947 905 900
- -----------------------------------------------------------------------------------------------------------------------------------
BALANCE SHEET DATA
- ------------------
Total assets................. $ 709,414 $ 323,454 $ 136,922 $ 1,941 $ 1,110 $ 326
Total debt................... 50,541 3,500 - - - -
Minority interest............ 153,015 168,665 97,180 - - -
Shareholders' equity......... $ 489,905 $ 142,958 $ 36,670 $ 1,734 $ 1,041 $ 343
- -----------------------------------------------------------------------------------------------------------------------------------
OTHER DATA
- ----------
Net cash provided by
operating activities......... $ 60,228 $ 13,597 $ 5,840 $ 413 $ 950 $ 571
Net cash used in investing
activities................... (308,646) (47,105) (582) - - -
Net cash provided by (used in)
financing activities..... 250,602 31,443 (228) (378) (84) (563)
Funds from operations (3).... $ 57,430 $ 14,282 $ 3,315 $ 303 $ 720 $ 757

Square footage owned at end
of period.................... 10,930 6,009 3,014 - - -
</TABLE>

(1) The selected financial data for periods prior to March 17, 1998 refers to
AOPP.
(2) See Note 2 of the Notes to Consolidated Financial Statements.
(3) Funds from operations ("FFO") is defined as net income, computed in
accordance with generally accepted accounting principles ("GAAP") before
depreciation, amortization, minority interest in income, straight line rent
adjustments and extraordinary or non-recurring items.

18
<PAGE>

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS

The following discussion and analysis of the results of operation and
financial condition of PS Business Parks, Inc. (the "Company") should be read in
conjunction with the selected financial data and the Company's financial
statements included elsewhere in the form 10-K. References to the Company for
periods prior to March 17, 1998 refer to AOPP.

COMPARISON OF 1998 TO 1997
- --------------------------

OVERVIEW: During 1998, the Company identified and completed strategic
acquisition transactions and focused on increasing cash flow from its existing
core portfolio of properties. In addition, the Company began limited development
in two of its core markets. The Company strengthened its balance sheet primarily
through common equity offerings and a conservative distribution policy that
maximizes cash flow retention. The Company also established a capital structure
that allows it to take advantage of attractive growth opportunities.

During 1998, the Company added 4.9 million square feet to its portfolio.
The cost of these acquisitions was approximately $378 million. The acquisitions
added square footage to each of the Company's existing core markets. The Company
acquired 1,687,000 square feet in Texas at an aggregate cost of approximately
$102 million; 1,001,000 square feet in Portland, Oregon at an aggregate cost of
approximately $115 million; 1,442,000 square feet in the Northern
Virginia/Maryland market at an aggregate cost of approximately $108 million;
422,000 square feet in Southern California at an aggregate cost of approximately
$25 million and 307,000 square feet in Northern California at an aggregate cost
of approximately $25 million. In addition, the Company acquired 62,000 square
feet in the Merger at an aggregate cost of approximately $3 million in a market
the Company does not consider a core market.

The Company was also able to increase rents and maintain expenses at a
stable level at its "Same Park" facilities during 1998. Revenue increased 5.9%,
while expenses remained flat resulting in a 9.5% increase in NOI. The Company
defines "Same Park" facilities as those facilities owned or operated by the
Company since January 1, 1996.

Net income for the year ended December 31, 1998 was $29,400,000 compared to
$3,836,000 for the same period in 1997. Net income per common share on a diluted
basis was $1.51 (based on weighted average diluted shares outstanding of
19,429,000) for the year ended December 31, 1998 compared to net income per
common share on a diluted basis of $1.23 (based on diluted weighted average
shares outstanding of 3,129,000) for the year ended December 31, 1997,
representing an increase of 22.7%. The increases in net income and net income
per share reflects the Company's significant growth in its asset base through
the acquisition of commercial properties and increase in net operating income
from the consistent group of properties.

COMPARISON WITH 1997 RESULTS: On March 31, 1997, PSI exchanged its
non-voting preferred stock for voting common stock of AOPP in a transaction
accounted for as a purchase of AOPP by PSI. As a result of PSI attaining a 95%
ownership interest in AOPP voting common stock, the financial results for 1997
are presented separately for the period prior to the exchange transaction
(January 1, 1997 to March 31, 1997) and subsequent to the exchange transaction
(April 1, 1997 to December 31, 1997). To properly compare the operating results
for the year ended December 31, 1997 to the same period in the current year, the
amounts for 1997 have been combined as follows:

19
<PAGE>

EXPENSES:
Cost of operations......................................... 9,837,000 2,493,000 12,330,000
Cost of facility management................................ 129,000 60,000 189,000
Depreciation and amortization.............................. 4,375,000 820,000 5,195,000
General and administrative................................. 1,248,000 213,000 1,461,000
Interest expense.......................................... 1,000 - 1,000
------------- --------------- -------------
15,590,000 3,586,000 19,176,000
------------- --------------- -------------

Income before minority interest.............................. 9,907,000 2,495,000 12,402,000

Minority interest in income................................ (6,753,000) (1,813,000) (8,566,000)
------------- --------------- -------------

Net income................................................... $ 3,154,000 $ 682,000 $ 3,836,000
============= =============== =============
</TABLE>

RESULTS OF OPERATIONS: The Company's property operations account for almost
all of the net operating income earned by the Company. The following table
presents the pre-depreciation operating results of the properties for the years
ended December 31, 1998 and 1997:
<TABLE>
<CAPTION>

1998 1997 Change
------------- --------------- -------------
<S> <C> <C> <C>
Rental income:
Facilities owned throughout each period (35 facilities, 3.0
million net rentable square feet)...................... $ 25,045,000 $ 23,936,000 4.6%
Facilities acquired between March 31, 1997 and December
31, 1998 (71 facilities, 7.9 million net rentable square
feet).................................................. 63,275,000 6,233,000 915.2%
------------- --------------- -------------
Total rental income......................................... $ 88,320,000 $ 30,169,000 192.8%
============= =============== =============

Cost of operations (excluding depreciation):
Facilities owned throughout each period..................... $ 10,023,000 $ 10,073,000 (0.5%)
Facilities acquired between March 31, 1997 and
December 31, 1998...................................... 16,050,000 2,257,000 611.1%
------------- --------------- -------------
Total cost of operations.................................... $ 26,073,000 $ 12,330,000 111.5%
============= =============== =============

Net operating income (rental income less cost of operations):
Facilities owned throughout each period..................... $ 15,022,000 $ 13,863,000 8.4%
Facilities acquired between March 31, 1997 and December 31,
1998................................................... 47,225,000 3,976,000 1,087.8%
------------- --------------- -------------
Total net operating income.................................. $ 62,247,000 $ 17,839,000 248.9%
============= =============== =============
</TABLE>

20
<PAGE>
Rental income and rental income less cost of operations or net operating
income ("NOI") prior to depreciation are summarized for the year ended December
31, 1998 by major geographic regions below:
<TABLE>
<CAPTION>
Square Percent of Rental Percent of Percent of
Region Footage Total Income Total NOI Total
- ------------------------- ----------- ---------- ----------- ---------- ------------ ----------
<S> <C> <C> <C> <C> <C> <C>
Southern California...... 3,085,000 28.2% $28,930,000 32.7% $20,803,000 33.4%
Northern California...... 1,105,000 10.1% 7,557,000 8.6% 5,513,000 8.9%
Virginia/Maryland........ 2,315,300 21.2% 22,710,000 25.7% 15,864,000 25.5%
Texas.................... 2,489,700 22.8% 13,927,000 15.8% 8,865,000 14.2%
Oregon................... 1,102,300 10.0% 9,725,000 11.0% 7,652,000 12.3%
Other.................... 832,600 7.6% 5,471,000 6.2% 3,550,000 5.7%
----------- ---------- ----------- ---------- ----------- -----------
Total.................... 10,929,900 100.0% $88,320,000 100.0% $62,247,000 100.0%
=========== ========== =========== ========== =========== ===========
</TABLE>

SUPPLEMENTAL PROPERTY DATA AND TRENDS: In order to evaluate how the
Company's overall portfolio has performed, management analyzes the operating
performance of a consistent group of 51 properties (4.2 million net rentable
square feet). These 51 properties represent a mature group of properties that
have been managed by the Company for at least three years and, as of March 17,
1998, were owned by the Company. The table below summarizes the historical
operations of the 51 properties for 1998 and 1997; however, the Company did not
own all of the properties throughout the periods presented and therefore, such
operations are not all reflected in the Company's historical operating results.

The following table summarizes the pre-depreciation historical operating
results of these "Same Park" facilities for the year ended December 31, 1998 and
1997:

<TABLE>
<CAPTION>
1998 (1) 1997 (1) Change
----------- ----------- ------
<S> <C> <C> <C>
Rental income (2).......................................... $38,927,000 $36,760,000 5.9%
Cost of operations......................................... 14,718,000 14,655,000 0.4%
----------- ----------- ------
Net operating income.................................... $24,209,000 $22,105,000 9.5%
=========== =========== ======
Gross margin (3)...................................... 62.2% 60.1% 2.1%

Annualized realized rent per occupied square foot (4)...... $9.74 $9.24 5.4%
Weighted average occupancy for the period.................. 95.1% 94.6% 0.5%
</TABLE>

(1) Operations for the year ended December 31, 1998 represent the historical
operations of the 51 properties; however, the Company did not own all of
the properties throughout all periods presented and therefore such
operations are not reflected in the Company's historical operating results.
All such properties were owned effective March 17, 1998.

(2) Rental income does not include the effect of straight-line accounting.

(3) Gross margin is computed by dividing property net operating income by
rental income.

(4) Realized rent per square foot represents the actual revenue earned per
occupied square foot.

The following table summarizes the operating results displayed above by
major geographic regions:

<TABLE>
<CAPTION>
Revenues Revenues Percentage NOI NOI Percentage
1998 1997 Increase 1998 1997 Increase
----------- ----------- ---------- ----------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
Southern California....... $14,965,000 $14,362,000 4.2% $ 9,639,000 $ 9,075,000 6.2%
Northern California....... 5,668,000 5,227,000 8.4% 3,836,000 3,472,000 10.5%
Virginia/Maryland......... 5,271,000 4,953,000 6.4% 3,314,000 2,854,000 16.1%
Texas..................... 6,649,000 6,394,000 4.0% 3,407,000 3,206,000 6.3%
Arizona................... 2,728,000 2,477,000 10.1% 1,731,000 1,488,000 16.3%
Other..................... 3,646,000 3,347,000 8.9% 2,282,000 2,010,000 13.5%
----------- ----------- ---------- ----------- ----------- ----------
Total..................... $38,927,000 $36,760,000 5.9% $24,209,000 $22,105,000 9.5%
=========== =========== ========== =========== =========== ==========
</TABLE>

21
<PAGE>

The increases noted above reflect the performance of the Company's existing
markets. All major markets reflected increases in rental rates without
corresponding increases in expenses.

FACILITY MANAGEMENT OPERATIONS: The Company's net operating income from
facility management accounts for a small portion of the Company's net operating
income. During the year ended December 31, 1998, $452,000 in net operating
income was recognized from facility management operations compared to $767,000
for the same period in 1997. Facility management fees have decreased due to the
Company's acquisition of properties previously managed.

INTEREST INCOME: Interest income reflects earnings on cash balances.
Interest income was $1,411,000 for the year ended December 31, 1998 compared to
$453,000 for the same period in 1997. The increase is attributable to increased
average cash balances primarily due to the Company's issuance of common stock in
January and May 1998 and the timing of investing these funds in newly acquired
real estate facilities. Average cash balances for the year ended December 31,
1998 were approximately $28 million, compared to $9 million for the same period
in 1997.

COST OF OPERATIONS: Cost of operations for the year ended December 31, 1998
was $26,073,000 compared to $12,330,000 for the same period in 1997. The
increase is due primarily to the growth in the total square footage of the
Company's portfolio of properties. Cost of operations as a percentage of rental
income decreased from 40.9% for the year ended December 31, 1997 to 29.5% for
the year ended December 31, 1998 as a result of economies of scale achieved
through the acquisition of properties in existing markets. Cost of operations
consists primarily of property taxes ($6,967,000), property maintenance
($4,643,000), utilities ($4,558,000) and direct payroll ($3,981,000) for the
year ended December 31, 1998.

DEPRECIATION AND AMORTIZATION EXPENSE: Depreciation and amortization
expense for the year ended December 31, 1998 was $18,908,000 compared to
$5,195,000 for the same period in 1997. The increase is due to the acquisitions
of real estate facilities in 1997 and 1998.

GENERAL AND ADMINISTRATIVE EXPENSE: General and administrative expense was
$2,233,000 for the year ended December 31, 1998 compared to $1,461,000 for the
same period in 1997. The increase is due to the increased size and acquisition
activities of the Company. Included in general and administrative costs are
acquisition costs and abandoned transaction costs. Acquisition expenses for 1998
and 1997 were $844,000 and $177,000 respectively. Abandoned transaction costs
for 1998 and 1997 were $65,000 and $5,000, respectively.

INTEREST EXPENSE: Interest expense was $2,361,000 for the year ended
December 31, 1998 compared to $1,000 for the same period in 1997. The increase
is attributable to mortgage notes assumed in connection with the acquisition of
real estate facilities totaling approximately $38 million ($1.5 million in
interest expense), temporary financing in connection with acquisitions ($0.5
million in interest expense), costs to establish the line of credit ($0.5
million) and commitment fees ($0.1 million) net of $268,000 of interest expense
capitalized to ongoing construction projects.

MINORITY INTEREST IN INCOME: Minority interest in income reflects the
income allocable to equity interests in the Operating Partnership that are not
owned by the Company. Minority interest in income for the year ended December
31, 1998 was $11,208,000 compared to $8,566,000 for the same period in 1997. The
increase in minority interest in income is due to improved operating results and
the issuance of additional Operating Partnership units, primarily in connection
with the acquisition of real estate facilities on April 1, 1997.

22
<PAGE>

COMPARISON OF 1997 TO 1996
- --------------------------

OVERVIEW: During 1997, the Company identified and completed strategic
acquisition transactions and focused on increasing cash flow from its existing
core portfolio of properties. The Company strengthened its balance sheet
primarily through issuance of common stock and Operating Partnership units for
real estate. By maintaining low leverage, the Company facilitated future growth.

During 1997, the Company acquired 6.0 million square feet. The cost of
these acquisitions was approximately $308 million. The Company acquired 39
properties (3.4 million square feet) from PSI, which the Company had been
managing. In addition, the Company acquired 10 properties (2.6 million square
feet) from third parties, primarily in the Southern California and the
Maryland/Northern Virginia markets.

The Company did not own properties during 1996; however, it managed all 51
of the "Same Park" facilities that year. The Company was able to increase rents
and maintain expenses at a stable level at its "Same Park" facilities during
1997. Revenue increased 5.4%, while expenses remained flat resulting in a 7.8%
increase in NOI. The Company defines "Same Park" facilities as those facilities
owned or operated by the Company since January 1, 1996.

Net income for the year ended December 31, 1997 was $3,836,000 compared to
$303,000 for the same period in 1996. Net income per common share on a diluted
basis was $1.23 (based on weighted average diluted shares outstanding of
3,129,000) for the year ended December 31, 1997 compared to net income per
common share on a diluted basis of $0.32 (based on diluted weighted average
shares outstanding of 947,000) for the year ended December 31, 1996. The
increases in net income and net income per share reflect the Company's
significant growth in its asset base through the acquisition of commercial
properties.

<TABLE>
<CAPTION>
April 1, 1997 January 1, 1997 For the Year
through through Ended
December 31, March 31, December 31,
1997 1997 1997
------------- --------------- ---------------
<S> <C> <C> <C>
REVENUES:
Rental income............................................. $ 24,364,000 $ 5,805,000 $ 30,169,000
Facility management fees from affiliates.................. 709,000 247,000 956,000
Interest income........................................... 424,000 29,000 453,000
------------- -------------- ---------------
25,497,000 6,081,000 31,578,000
------------- -------------- ---------------
EXPENSES:
Cost of operations......................................... 9,837,000 2,493,000 12,330,000
Cost of facility management................................ 129,000 60,000 189,000
Depreciation and amortization.............................. 4,375,000 820,000 5,195,000
General and administrative................................. 1,248,000 213,000 1,461,000
Interest expense.......................................... 1,000 - 1,000
------------- -------------- ---------------
15,590,000 3,586,000 19,176,000
------------- -------------- ---------------

Income before minority interest.............................. 9,907,000 2,495,000 12,402,000

Minority interest in income................................ (6,753,000) (1,813,000) (8,566,000)
------------- -------------- ---------------

Net income................................................... $ 3,154,000 $ 682,000 $ 3,836,000
============= ============== ===============
</TABLE>

23
<PAGE>

RESULTS OF OPERATIONS: The Company's property operations account for almost
all of the net operating income earned by the Company.

Rental income and NOI are summarized for the year ended December 31, 1997
by major geographic regions below:
<TABLE>
<CAPTION>

Square Percent Rental Percent Percent
Region Footage of Total Income of Total NOI of Total
- -------------------------- --------- --------- ----------- -------- ----------- --------
<S> <C> <C> <C> <C> <C> <C>
Southern California....... 2,669,000 44.1% $10,240,000 33.9% $ 6,284,000 35.2%
Northern California....... 798,000 13.2% 3,229,000 10.7% 2,155,000 12.1%
Virginia/Maryland......... 873,000 14.4% 5,122,000 17.0% 3,243,000 18.2%
Texas..................... 843,000 13.9% 6,394,000 21.2% 3,076,000 17.2%
Arizona................... 369,000 6.1% 2,477,000 8.2% 1,455,000 8.2%
Other..................... 503,000 8.3% 2,707,000 9.0% 1,626,000 9.1%
---------- --------- ----------- -------- ------------ --------
Total..................... 6,055,000 100.0% $30,169,000 100.0% $17,839,000 100.0%
========= ========= =========== ======== =========== ========
</TABLE>

SUPPLEMENTAL PROPERTY DATA AND TRENDS: In order to evaluate how the
Company's overall portfolio has performed, management analyzes the operating
performance of a consistent group of 51 properties (4.2 million net rentable
square feet). These 51 properties represent a mature group of properties that
have been managed by the Company for at least three years and, as of March 17,
1998, were owned by the Company. The table below summarizes the historical
operations of the 51 properties for years ended December 31, 1997 and 1996;
however, the Company did not own all of the properties throughout the periods
presented and therefore, such operations are not all reflected in the Company's
historical operating results.

The following table summarizes the pre-depreciation historical operating
results of these "Same Park" facilities for the years ended December 31, 1997
and 1996:

<TABLE>
<CAPTION>
1997 (1) 1996 (1) Change
----------- ----------- ------
<S> <C> <C> <C>
Rental income (2)........................................... $36,760,000 $34,891,000 5.4%
Cost of operations.......................................... 14,655,000 14,381,000 1.9%
----------- ----------- ------
Net operating income..................................... $22,105,000 $20,510,000 7.8%
=========== =========== ======
Gross margin (3)....................................... 60.1% 58.8% 1.3%

Annualized realized rent per occupied square foot (4)....... $9.24 $8.74 5.7%
Weighted average occupancy for the period................... 94.6% 94.9% (0.3)%
</TABLE>

(1) Operations for the year ended December 31, 1997 represent the historical
operations of the 51 properties; however, the Company did not own all of
the properties throughout all periods presented and therefore such
operations are not reflected in the Company's historical operating results.
All such properties were owned effective March 17, 1998.

(2) Rental income does not include the effect of straight-line accounting.

(3) Gross margin is computed by dividing property net operating income by
rental income.

(4) Realized rent per square foot represents the actual revenue earned per
occupied square foot.

24
<PAGE>

The following table summarizes the operating results displayed above by
major geographic regions:

<TABLE>
<CAPTION>
Revenues Revenues Percentage NOI NOI Percentage
1997 1996 Increase 1997 1996 Increase
----------- ----------- ----------- ----------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C>
Southern California $14,362,000 $13,441,000 6.9% $ 9,075,000 $ 8,306,000 9.3%
Northern California 5,227,000 4,911,000 6.4% 3,472,000 3,187,000 8.9%
Virginia/Maryland 4,953,000 4,808,000 3.0% 2,854,000 2,657,000 7.4%
Texas 6,394,000 6,231,000 2.6% 3,206,000 3,049,000 5.1%
Arizona 2,477,000 2,232,000 11.0% 1,488,000 1,295,000 14.9%
Other 3,347,000 3,268,000 2.4% 2,010,000 2,016,000 (0.3)%
----------- ----------- ----------- ----------- ----------- ----------
Total $36,760,000 $34,891,000 5.4% $22,105,000 $20,510,000 7.8%
=========== =========== =========== =========== =========== ==========
</TABLE>

The increases noted above reflect the performance of the Company's existing
markets. All major markets reflected increases in rental rates without
corresponding increases in expenses.

FACILITY MANAGEMENT OPERATIONS: The Company's facility management accounts
for a small portion of the Company's net operating income during 1997 and the
majority of its income during 1996. During the year ended December 31, 1997,
$767,000 in net operating income was recognized from facility management
operations compared to $1,619,000 for the same period in 1996. Facility
management fees have decreased due to the Company's acquisition of properties
previously managed.

INTEREST INCOME: Interest income reflects earnings on cash balances.
Interest income was $453,000 for the year ended December 31, 1997 compared to
$43,000 for the same period in 1996. The increase is attributable to increased
average cash balances primarily due to the Company's increased cash flow.
Average cash balances for the year ended December 31, 1997 were approximately $9
million, compared to $1 million for the same period in 1996.

COST OF OPERATIONS: Cost of operations for the year ended December 31, 1997
was $12,330,000 compared to none in the same period in 1996. The increase is due
to the acquisition of real estate facilities in 1997. The Company did not own
real estate facilities prior to 1997 and served as a manager of commercial
properties owned by PSI and its related entities. Cost of operations consists
primarily of property taxes ($2,653,000), property maintenance ($1,882,000),
utilities ($2,156,000) and direct payroll ($2,648,000) for the year ended
December 31, 1997.

DEPRECIATION AND AMORTIZATION EXPENSE: Depreciation and amortization
expense for the year ended December 31, 1997 was $5,195,000 compared to none for
the same period in 1996. The increase is due to the acquisition of real estate
facilities in 1997.

GENERAL AND ADMINISTRATIVE EXPENSE: General and administrative expense was
$1,461,000 for the year ended December 31, 1997 compared to $1,143,000 for the
same period in 1996. The increase is due to the increased size and acquisition
activities of the Company. Included in general and administrative costs are
acquisition costs and abandoned transaction costs. Acquisition expenses for 1997
were $177,000 and none in 1996. Abandoned transaction costs for 1997 were $5,000
and none in 1996.

MINORITY INTEREST IN INCOME: Minority interest in income reflects the
income allocable to equity interests in the Operating Partnership that are not
owned by the Company. Minority interest in income for the year ended December
31, 1997 was $8,566,000 compared to none for the same period in 1996. The
increase in minority interest in income is due to the issuance of Operating
Partnership units, primarily in connection with the acquisition of real estate
facilities on January 2, 1997 and April 1, 1997.

LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------

Net cash provided by operating activities for the year ended December 31,
1998 and 1997 was $60,228,000 and $19,437,000, respectively. Management believes
that its internally generated net cash provided by operating activities will
continue to be sufficient to enable it to meet its operating expenses, capital
improvements, debt service requirements and maintain the current level of
distributions to shareholders.

25
<PAGE>

The following table summarizes the Company's ability to make capital
improvements to maintain its facilities through the use of cash provided by
operating activities. The remaining cash flow is available to the Company to pay
distributions to shareholders and acquire property interests.

<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
Net income............................................................ $29,400,000 $ 3,836,000
Depreciation and amortization......................................... 18,908,000 5,195,000
Change in working capital............................................. 712,000 1,840,000
Minority interest in income........................................... 11,208,000 8,566,000
------------ ------------
Net cash provided by operating activities............................. 60,228,000 19,437,000
Maintenance capital expenditures...................................... (3,376,000) (1,442,000)
Tenant improvements................................................... (5,258,000) (1,415,000)
Capitalized lease commissions......................................... (1,979,000) (359,000)
------------ ------------
Funds available for distribution to shareholders, minority interests,
acquisitions and other corporate purposes.......................... 49,615,000 16,221,000
Cash distributions to shareholders and minority interests............. (29,904,000) (6,992,000)
------------ ------------
Excess funds available for acquisitions and other corporate purposes.. $19,711,000 $ 9,229,000
============ ============
</TABLE>

The Company's capital structure is characterized by a low level of
leverage. As of December 31, 1998, the Company had seven fixed rate mortgage
notes payable totaling $38,041,000 and $12,500,000 drawn on its line of credit
which represented 7% of its total capitalization (based on book value, including
minority interests and debt). The weighted average interest rate for the
mortgages is 7.82%. The line of credit currently bears interest at LIBOR plus
0.80% (5.93% at December 31, 1998).

On August 6, 1998, The Company entered into an unsecured line of credit
(the "Credit Agreement") with Wells Fargo Bank. The Credit Agreement has a
borrowing limit of $100 million and an expiration date of August 5, 2000. The
expiration date may be extended by one year on each anniversary of the Credit
Agreement. Interest on outstanding borrowings is payable monthly. At the option
of the Company, the rate of interest charged is equal to (i) the prime rate or
(ii) a rate ranging from the London Interbank Offered Rate ("LIBOR") plus 0.55%
to LIBOR plus 0.95% depending on the Company's credit ratings and interest
coverage ratios, as defined (currently LIBOR plus 0.80%). In addition, the
Company is required to pay a commitment fee of 0.25% (per annum).

The Company expects to fund its growth strategies with cash on hand,
internally generated retained cash flows and temporary borrowings from its line
of credit. The Company intends to repay amounts borrowed under the credit
facility from undistributed cash flow or, as market conditions permit and as
determined to be advantageous, from the public or private placement of preferred
and common stock or formation of joint ventures. The Company targets a leverage
ratio of 40% and a FFO to fixed charges ratio of 3.0 to 1.0. As of December 31,
1998 and for the year then ended, the leverage ratio was 7% and the FFO to fixed
charges coverage ratio was 22.74 to 1.0.

In January 1998, the Company entered into an agreement with institutional
investors whereby the Company agreed to issue 6,774,072 shares of its common
stock for cash ($155 million) in separate tranches. The first tranche,
representing 2,185,187 share or $50 million, was issued in January 1998. The
Company incurred $2.4 million in costs associated with the issuance. The
remainder of the common shares (4,588,885) was issued on May 6, 1998 and the net
proceeds ($105 million) were used to repay short-term borrowings.

In May 1998, the Company completed two common stock offerings, raising net
proceeds totaling $118.9 million. In the first offering, the Company sold
4,000,000 shares of common stock to an underwriter, resulting in approximately
$95.2 million of net proceeds. These shares were resold to various institutional
investors. A portion of the proceeds was used to retire debt incurred as a
result of a $190 million property portfolio acquisition. In the second common
stock offering, the Company sold 1,025,800 common shares to an underwriter,
resulting in net proceeds of $23.7 million. These proceeds were used for
subsequent acquisitions.

FUNDS FROM OPERATIONS: Funds from operations ("FFO") is defined as net
income, computed in accordance with generally accepted accounting principles
("GAAP"), before depreciation, amortization, minority interest in income,

26
<PAGE>

straight line rent adjustments and extraordinary or non-recurring items. FFO is
presented because the Company considers FFO to be a useful measure of the
operating performance of a REIT which, together with net income and cash flows
provides investors with a basis to evaluate the operating and cash flow
performances of a REIT. FFO does not represent net income or cash flows from
operations as defined by GAAP. FFO does not take into consideration scheduled
principal payments on debt and capital improvements. Accordingly, FFO is not
necessarily a substitute for cash flow or net income as a measure of liquidity
or operating performance or ability to make acquisitions and capital
improvements or ability to pay distributions or debt principal payments. Also,
FFO as computed and disclosed by the Company may not be comparable to FFO
computed and disclosed by other REITs.

Funds from operations for the Company is computed as follows:

<TABLE>
<CAPTION>
1998 1997
------------ ------------
<S> <C> <C>
Net income............................................................... $29,400,000 $ 3,836,000
Depreciation and amortization............................................ 18,908,000 5,195,000
Minority interest in income.............................................. 11,208,000 8,566,000
Effects of straight line rents........................................... (2,086,000) -
------------ ------------
Subtotal.............................................................. 57,430,000 17,597,000
FFO allocated to minority interests...................................... (15,852,000) (12,153,000)
------------ ------------
Funds from operations allocated to shareholders.......................... $41,578,000 $ 5,444,000
============ ============
</TABLE>

CAPITAL EXPENDITURES: During 1998, the Company incurred $10.6 million in
maintenance capital expenditures, tenant improvements and capitalized leasing
commissions. In addition, the Company made $0.5 million of renovation
expenditures. On a recurring annual basis, the Company expects $0.90 to $1.20
per square foot in recurring capital expenditures in 1999 ($10 - $13 million
based on current square footage). In addition, the Company expects to make $3
million in expenditures to continue renovation on two properties in Texas.

DISTRIBUTIONS: The Company has elected and intends to qualify as a REIT for
federal income tax purposes. As a REIT, the company must meet, among other
tests, sources of income, share ownership and certain asset tests. In addition,
the Company is not taxed on that portion of its taxable income that is
distributed to its shareholders provided that at least 95% of its taxable income
is so distributed to its shareholders prior to filing of its tax return.

On February 3, 1999, the Company declared a regular dividend of $0.25 per
share payable on March 31, 1999 to shareholders of record on March 15, 1999. The
Board of Directors has established a distribution policy to maximize the
retention of operating cash flow and only distribute the minimum amount required
for the Company to maintain its tax status as a REIT.

IMPACT OF YEAR 2000
- -------------------

The Company utilizes PSI's information systems in connection with a cost
sharing and administrative services agreement. The Company and PSI have
completed an assessment of all of its hardware and software applications
including those affecting the Company to identify susceptibility to what is
commonly referred to as the "Y2K Issue" whereby certain computer programs have
been using two digits rather than four to define the applicable year. Certain
computer programs or hardware with the Y2K Issue have date-sensitive
applications or embedded chips that may recognize a date using "00" as the year
1900 rather than the year 2000, resulting in miscalculations or system failure
causing disruptions to operations.

The Company in conjunction with PSI has an implementation in process for
critical applications, including its general ledger and related systems, that
are believed to have Y2K issues. PSI and the Company expect the implementation
to be complete by June 1999. Contingency plans have been developed for use in
case the implementations are not completed on a timely basis. The Company
presently believes that the impact of the Y2K Issue on its system can be
mitigated. However, if the plan for ensuring Y2K compliance and the related
contingency plans were to fail, be insufficient, or not be implemented on a
timely basis, operations of the Company could be materially impacted.

27
<PAGE>

Certain of the Company's other non-computer related systems that may be
impacted by the Y2K Issue, such as security systems, are currently being
evaluated, and the Company expects the evaluation to be complete by June 1999.
The Company expects the implementation of any required solutions to be complete
in advance of December 31, 1999. The Company has not fully evaluated the impact
of lack of Y2K compliance on these systems, but has no reason to believe that
lack of compliance would materially impact its operations.

The Company exchanges electronic data with certain outside vendors in the
banking and payroll processing areas. The Company has been advised by these
vendors that their systems are or will be Y2K compliant and has requested a Y2K
compliance certification from these entities. The Company is not aware of any
other vendors, suppliers, or other external agents with a Y2K Issue that would
materially impact the Company's results of operations, liquidity, or capital
resources. However, the Company has no means of ensuring that external agents
will be Y2K compliant, and there can be no assurance that the Company has
identified all such external agents. The inability of external agents to
complete their Year 2000 compliance process in a timely fashion could materially
impact the Company. The effect of non-compliance by external agents is not
determinable.

The total cost of PSI's Y2K compliance activities (which primarily consists
of the costs of implementing new systems) will be allocated to all entities that
use the PSI computer systems. The amount to be allocated to the Company is
estimated at approximately $250,000.

The costs of the projects and the date on which PSI and the Company believe
that it will be Y2K compliant are based upon management's best estimates, and
were derived utilizing numerous assumptions of future events. There can be no
assurance that these estimates will be achieved, and actual results could differ
materially from those anticipated. There can be no assurance that PSI and the
Company have identified all potential Y2K Issues either within the Company or at
external agents. In addition, the impact of the Y2K issue on governmental
entities and utility providers and the resultant impact on the Company, as well
as disruptions in the general economy, may be material but cannot be reasonably
determined or quantified.

RISK FACTORS
- ------------

The Company's business is subject to a number of risks and uncertainties.
Our business operating results and financial condition could be adversely
affected by any one of the following risks or any of the risks described under
the caption "Risk Factors" in our Registration Statement on Form S-3 (file no.
333-50463) which risks are attached hereto as Exhibit 99.1 and incorporated
herein by reference.

OUR BUSINESS COULD BE SUBJECT TO ENVIRONMENTAL LIABILITIES

Federal, state and local environmental laws impose liability on an owner or
operator of real estate interests for the costs of cleaning up past or present
releases of hazardous or toxic substances on or from a property for damages
resulting from these releases. Some of these laws impose liability without
regard to whether the owner knew of, or was responsible for, the presence of
hazardous or toxic wastes at or from a property. Some of these laws also impose
liability on an owner or operator of real estate interests for air and water
pollution and the improper handling and disposal of hazardous or toxic wastes.
This liability may exceed the value of the property. The presence of hazardous
or toxic wastes, or the failure to properly remedy any resulting contamination,
may make it more difficult for the owner or operator to sell, lease or operate
its property or to borrow money using its property as collateral. There can be
no assurance that any future environmental laws that may be enacted will not
impose material liabilities on us.

We acquired a property in Beaverton, Oregon known as Creekside Corporate
Park in May of 1998. A property owned by Mattel Corporation adjacent to
Creekside Corporate Park is currently the subject of an environmental remedial
investigation that is being conducted by the current and past owners of the
property, pursuant as part of a consent order issued by the Oregon Department of
Environmental Quality ("ODEQ"). We are not a party to the consent order. As part
of the consent order, the ODEQ ordered the property owners to sample soil and
groundwater on our property to determine the nature and extent of contamination
resulting from past industrial operations at the Mattel property. We executed
access agreements with the current and former property owners to allow access to

28
<PAGE>

our property to conduct the required sampling and testing. The sampling and
testing is ongoing, and preliminary results from one area indicate that the
contamination from the Mattel property may have migrated onto a portion of the
Creekside Corporate Park that we own.

There is no evidence that any past or current use of the Creekside
Corporate Park property contributed in any way to the contamination that is the
subject of the ODEQ's investigation. Nevertheless, upon completion of the
remedial study it is likely that removal or remedial measures will be required
to address any contamination detected during the remedial study, including any
contamination on or under the Creekside Corporate Park property. Because of the
preliminary nature of the investigation, we cannot predict the outcome of the
investigation, nor can we estimate the costs of any remediation or removal
activities that may be required.

We believe that we bear no responsibility or liability for the
contamination, but there can be no assurance that we will not be held liable for
costs and expenses incurred with respect to this matter. If we are ultimately
deemed responsible for any costs or expenses relating to this matter, however,
we believe that we have a claim against the party from which we purchased
Creekside Corporate Park for any liabilities that we may incur as a result of
this contamination.

We have conducted preliminary environmental assessments of most of our
properties (and we intend to conduct preliminary environmental assessments in
connection with future property acquisitions) to evaluate the environmental
condition of our properties and the potential environmental liabilities
associated with our properties. Our assessments generally consist of an
investigation of environmental conditions at the property (not including soil or
groundwater sampling or analysis), as well as a review of available information
regarding the site and publicly available data regarding conditions at other
sites in the vicinity.

When preliminary environmental assessments have revealed any potential
environmental liability, we have obtained an indemnification from entities which
we deem to be creditworthy (including Public Storage Inc.) or established
escrows with funds that would otherwise be payable to sellers of property to
remedy the environmental matter. Nevertheless, the preliminary environmental
assessments may not reveal all environmental liabilities and there may be
material environmental liabilities of which we are unaware. The current
environmental condition of our properties may be affected by tenants, by the
condition of land or operations in the vicinity of the properties (such as the
presence of underground storage tanks) or by third parties unrelated to us.

YEAR 2000 PROBLEMS COULD HAVE AN ADVERSE EFFECT ON OUR BUSINESS

We use Public Storage's information systems in connection with a cost
sharing and administrative services agreement. Both PS Business Parks, Inc. and
Public Storage have completed an assessment of all of their hardware and
software applications including those affecting us to identify susceptibility to
what is commonly referred to as the "Y2K Issue" whereby certain computer
programs have been written using two digits rather than four to define the
applicable year. Certain computer programs or hardware with the Y2K Issue have
date-sensitive applications or embedded chips that may recognize a date using
"00" as the year 1900 rather than the year 2000, resulting in miscalculations or
system failure causing disruption to operations.

PS Business Parks in conjunction with Public Storage have an implementation
in process for critical applications, including its general ledger and related
systems, that are believed to have Y2K issues. PS Business Parks and Public
Storage expect the implementation to be complete by June 1999. Contingency plans
have been developed for use in case the implementations are not completed on a
timely basis. We presently believe that the impact of the Y2K Issue on our
systems can be mitigated. However, if the plan for ensuring Year 2000 compliance
and the related contingency plans were to fail, be insufficient, or not be
implemented on a timely basis, our operations could be materially impacted.

Certain of our other non-computed related systems that may be impacted by
the Y2K Issue, such as security systems, are currently being evaluated, and we
expect an evaluation to be completed by June 1999. We expect the implementation
of any required solutions to be completed in advance of December 31, 1999. We
have not fully evaluated the impact of lack of Year 2000 compliance on these
systems, but have no reason to believe that lack of compliance would materially
impact our operations.

29
<PAGE>

We exchange electronic data with certain outside vendors in the banking and
payroll processing areas. We have been advised by these vendors that their
systems are or will be Year 2000 compliant and have requested a Year 2000
compliance certification from these entities. We are not aware of any other
vendors, suppliers, or other external agents with a Y2K Issue that would
materially impact our results of operations, liquidity, or capital resources.
However, we have no means of ensuring that external agents will be Year 2000
compliant, and there can be no assurance that we have identified all such
external agents. The inability of external agents to complete their Year 2000
compliance process in a timely fashion could materially impact our business,
financial condition and results of operations. The effect of non-compliance by
external agents is not determinable.

The total cost of Public Storage's Year 2000 compliance activities (which
primarily consists of the costs of new systems) will be allocated to all
entities that use Public Storage's computer systems. The amount to be allocated
to us is estimated at approximately $250,000.

The costs of the projects and the date on which PS Business Parks and
Public Storage believe that it will be Year 2000 compliant are based upon
management's best estimates, and were derived utilizing numerous assumptions of
future events. There can be no assurance that these estimates will be achieved,
and actual results could differ materially from those anticipated. There can be
no assurance that PS Business Parks and Public Storage have identified all
potential Y2K Issues either within PS Business Parks or at external agents. In
addition, the impact of the Y2K Issue on governmental entities and utility
providers and the resultant impact on PS Business Parks, as well as disruptions
in the general economy, may be material but cannot be reasonably determined or
quantified.

30
<PAGE>

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
----------------------------------------------------------

To limit the Company's exposure to market risk, the Company principally
finances its operations and growth with permanent equity capital consisting
either of common or preferred stock. At December 31, 1998, the Company's debt as
a percentage of shareholders' equity (based on book values) was 10.3%.

The Company's market risk sensitive instruments include mortgage notes
payable which totaled $50,541,000 at December 31, 1998 (including $12,500,000 of
borrowings on the Company's revolving line of credit which were subsequently
repaid). Substantially all of the Company's mortgage notes payable bear interest
at fixed rates. See Note 7 of the Notes to Consolidated Financial Statements for
terms, valuations and approximate principal maturities of the mortgage notes
payable as of December 31, 1998. Based on borrowing rates currently available to
the Company, the carrying amount of debt approximates fair value.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
-------------------------------------------

The financial statements of the Company (AOPP for periods prior to March
17, 1998) at December 31, 1998 and December 31, 1997 and for the year ended
December 31, 1998, the period from April 1, 1997 through December 31, 1997, the
period from January 1, 1997 through March 31, 1997 and the year ended December
31, 1996 and the report of Ernst & Young LLP, Independent Auditors, thereon and
the related financial statement schedule, are included elsewhere herein.
Reference is made to the Index of Financial Statements and Schedule in Item 14.

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

Not Applicable.

31
<PAGE>

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
--------------------------------------------------

The information required by this item with respect to directors is hereby
incorporated by reference to the material appearing in the Company's definitive
proxy statement to be filed in connection with the annual shareholders' meeting
to be held in 1999 (the "Proxy Statement") under the caption "Proposal No. 1-
Election of Directors." Information required by this item with respect to
executive officers is provided in Item 4A of this report. See "Executive
Officers."

ITEM 11. EXECUTIVE COMPENSATION
----------------------

The information required by this item is hereby incorporated by reference
to the material appearing in the Proxy Statement under the captions
"Compensation" and "Compensation Committee Interlocks and Insider
Participation."

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
--------------------------------------------------------------

The information required by this item is hereby incorporated by reference
to the material appearing in the Proxy Statement under the captions "Proposal
No. 1-Election of Directors-Security Ownership of Certain Beneficial Owners" and
"-Security Ownership of Management."

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
----------------------------------------------

The information required by this item is hereby incorporated by reference
to the material appearing in the Proxy Statement under the caption "Compensation
Committee Interlocks and Insider Participation-Certain Relationships and Related
Transactions."

32
<PAGE>

PART IV

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

a. 1. Financial Statements

The financial statements listed in the accompanying Index to Financial
Statements and Schedule hereof are filed as part of this report.

2. Financial Statements Schedule

The financial statements schedule listed in the accompanying Index to
Financial Statements and Schedule are filed as part of this report.

3. Exhibits

See Index to Exhibits contained herein.

b. Reports on Form 8-K

The Company filed a Current Report on Form 8-K dated September 30, 1998
(filed October 13, 1998), as amended by Form 8-K/A dated September 30, 1998
(filed November 13, 1998) pursuant to Item 5, which filed Combined
Statements of Revenues and Certain Expenses for the Northpointe D and G
Properties for the six months ended June 30, 1998 and for the year ended
December 31, 1997, Statements of Revenues and Certain Expenses for the
Gunston Property for the six months ended June 30, 1998 and for the year
ended December 31, 1997, and Statements of Revenues and Certain Operating
Expenses for the Spectrum 95 Property for the six month ended June 30, 1998
and for the year ended December 31, 1997.

The Company filed a Current Report on Form 8-K dated December 31, 1998
(filed January 13, 1999), as amended by Form 8-K/A dated December 31, 1998
(filed February 17, 1999) pursuant to Item 5, which filed Combined
Statements of Revenues and Certain Expenses for Hill Properties for the
nine months ended September 30, 1998 and for the year ended December 31,
1997 and Statements of Revenues and Certain Operating Expenses for the Las
Plumas Property for the nine months ended September 30, 1998 and for the
year ended December 31, 1997.

c. Exhibits

See Index to Exhibits contained herein.

d. Financial Statement Schedules

Not applicable.

33
<PAGE>

PS BUSINESS PARKS, INC.
EXHIBIT INDEX
(Item 14(c))

2.1 Amended and Restated Agreement and Plan of Reorganization among
Registrant, American Office Park Properties, Inc. ("AOPP") and Public
Storage, Inc. ("PSI") dated as of December 17, 1997. Filed with
Registrant's Registration Statement No. 333-45405 and incorporated
herein by reference.

3.1 Restated Articles of Incorporation. Filed with Registrant's Current
Report on Form 8-K dated March 17, 1998 and incorporated herein by
reference.

3.2 Restated Bylaws. Filed with Registrant's Current Report on Form 8-K
dated March 17, 1998 and incorporated herein by reference.

10.1 Amended Management Agreement between Storage Equities, Inc. and Public
Storage Commercial Properties Group, Inc. dated as of February 21,
1995. Filed with PSI's Annual Report on Form 10-K for the year ended
December 31, 1994 and incorporated herein by reference.

*10.2 Registrant's 1997 Stock Option and Incentive Plan. Filed with
Registrant's Registration Statement No. 333-48313 and incorporated
herein by reference.

10.3 Agreement of Limited Partnership of PS Business Parks, L.P. Filed with
Registrant's Quarterly Report on Form 10-Q for the quarterly period
ended June 30, 1998 and incorporated herein by reference.

10.4 Merger and Contribution Agreement dated as of December 23, 1997 among
Acquiport Two Corporation, Acquiport Three Corporation, New York State
Common Retirement Fund, American Office Park Properties, L.P., AOPP and
AOPP Acquisition Corp. Three. Filed with Registrant's Registration
Statement No. 333-45405 and incorporated herein by reference.

10.5 Agreement Among Shareholders and Company dated as of December 23, 1997
among Acquiport Two Corporation, AOPP, American Office Park Properties,
L.P. and PSI. Filed with Registrant's Registration Statement No.
333-45405 and incorporated herein by reference.

10.6 Amendment to Agreement Among Shareholders and Company dated as of
January 21, 1998 among Acquiport Two Corporation, AOPP, American Office
Park Properties, L.P. and PSI. Filed with Registrant's Registration
Statement No. 333-45405 and incorporated herein by reference.

10.7 Non-Competition Agreement dated as of December 23, 1997 among PSI,
AOPP, American Office Park Properties, L.P. and Acquiport Two
Corporation. Filed with Registrant's Registration Statement No.
333-45405 and incorporated herein by reference.

**10.8 Employment Agreement between AOPP and Ronald L. Havner, Jr. dated as of
December 23, 1997. Filed with Registrant's Registration Statement No.
333-45405 and incorporated herein by reference.

**10.9 Employment Agreement between AOPP and Mary Jayne Howard dated as of
December 23, 1997. Filed with Registrant's Registration Statement No.
333-45405 and incorporated herein by reference.

**10.10 Employment Agreement between Registrant and J. Michael Lynch dated as
of May 20, 1998. Filed with Registrant's Quarterly Report on Form 10-Q
for the quarterly period ended June 30, 1998 and incorporated herein by
reference.

10.11 Common Stock Purchase Agreement dated as of January 23, 1998 among AOPP
and the Investors signatory thereto. Filed with Registrant's
Registration Statement No. 333-45405 and incorporated herein by
reference.

10.12 Registration Rights Agreement dated as of January 30, 1998 among AOPP
and the Investors signatory thereto. Filed with Registrant's
Registration Statement No. 333-45405 and incorporated herein by
reference.

34
<PAGE>

10.13 Registration Rights Agreement dated as of March 17, 1998 between
Registrant and Acquiport Two Corporation ("Acquiport Registration
Rights Agreement"). Filed with Registrant's Quarterly Report on Form
10-Q for the quarterly period ended June 30, 1998 and incorporated
herein by reference.

10.14 Letter dated May 20, 1998 relating to Acquiport Registration Rights
Agreement. Filed with Registrant's Quarterly Report on Form 10-Q for
the quarterly period ended June 30, 1998 and incorporated herein by
reference.

10.15 Revolving Credit Agreement dated August 6, 1998 among PS Business
Parks, L.P., Wells Fargo Bank, National Association, as Agent, and the
Lenders named therein. Filed with Registrant's Quarterly Report on Form
10-Q for the quarterly period ended June 30, 1998 and incorporated
herein by reference.

10.16 Form of Indemnity Agreement. Filed with Registrant's Quarterly Report
on Form 10-Q for the quarterly period ended March 31, 1998 and
incorporated herein by reference.

10.17 Cost Sharing and Administrative Services Agreement dated as of November
16, 1995 by and among PSCC, Inc. and the owners listed therein. Filed
with Registrant's Quarterly Report on Form 10-Q for the quarterly
period ended March 31, 1998 and incorporated herein by reference.

10.18 Amendment to Cost Sharing and Administrative Services Agreement dated
as of January 2, 1997 by and among PSCC, Inc. and the owners listed
therein. Filed with Registrant's Quarterly Report on Form 10-Q for the
quarterly period ended March 31, 1998 and incorporated herein by
reference.

10.19 Accounts Payable and Payroll Disbursement Services Agreement dated as
of January 2, 1997 by and between PSCC, Inc. and American Office Park
Properties, L.P. Filed with Registrant's Quarterly Report on Form 10-Q
for the quarterly period ended March 31, 1998 and incorporated herein
by reference.

11 Statement re: Computation of Earnings per Share. Filed herewith.

12 Statement re: Computation of Ratio of Earnings to Fixed Charges. Filed
herewith.

23 Consent of Independent Auditors. Filed herewith.

27 Financial Data Schedule. Filed herewith.

99.1 Risk factors included under the section entitled "Risk Factors" on
pages 4 through 9 of the Registrant's prospectus dated May 15, 1998.
Filed herewith.

- ---------------
* Compensatory benefit plan.

** Management contract.

35
<PAGE>

SIGNATURES

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

Dated: March 10, 1999

PS BUSINESS PARKS, INC.

BY: /s/ Ronald L. Havner, Jr.
--------------------------------
Ronald L. Havner, Jr.
President, Chairman of the Board
and Chief Executive Officer

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.

<TABLE>
<CAPTION>
Signature Title Date
- ---------------------------------------------------------------------------------------------------------
<S> <C> <C>
/s/ Ronald L. Havner, Jr. President, Chairman of the Board and
- ------------------------- Chief Executive Officer (principal
Ronald L. Havner, Jr. executive officer) March 10, 1999

/s/ Jack E. Corrigan Vice President and Chief Financial
- -------------------- Officer (principal financial officer
Jack E. Corrigan and principal accounting officer) March 10, 1999

/s/ Harvey Lenkin
- -----------------
Harvey Lenkin Director March 10, 1999

/s/ Vern O. Curtis
- ------------------
Vern O. Curtis Director March 10, 1999

/s/ James H. Kropp
- ------------------
James H. Kropp Director March 10, 1999

/s/ Jack D. Steele
- ------------------
Jack D. Steele Director March 10, 1999

/s/ Alan K. Pribble
- -------------------
Alan K. Pribble Director March 10, 1999

/s/ Arthur M. Friedman
- ----------------------
Arthur M. Friedman Director March 10, 1999
</TABLE>

36
<PAGE>
<TABLE>
<CAPTION>

PS BUSINESS PARKS, INC.

INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES

(Item 14(a)(3) and Item 14(c))

Page
----
<S> <C>
Report of Independent Auditors.............................................................. F-1

Consolidated balance sheets as of December 31, 1998 and 1997................................ F-2

Consolidated statements of income for the year ended December 31, 1998, the period from April
1, 1997 through December 31, 1997, the period from January 1, 1997 through March 31, 1997 and
the year ended December 31, 1996............................................................ F-3

Consolidated statement of shareholders' equity for the year ended December 31, 1998, the
period from April 1, 1997 through December 31, 1997, the period from January 1, 1997 through
March 31, 1997 and the year ended December 31, 1996......................................... F-4

Consolidated statements of cash flows for the year ended December 31, 1998, the period from
April 1, 1997 through December 31, 1997, the period from January 1, 1997 through March 31,
1997 and the year ended December 31, 1996................................................... F-5

Notes to consolidated financial statements.................................................. F-7

SCHEDULE:

III - Real estate and accumulated depreciation.............................................. F-20
</TABLE>

All other schedules have been omitted since the required information is not
present or not present in amounts sufficient to require submission of the
schedule, or because the information required is included in the consolidated
financial statements or notes thereto.

37
<PAGE>

REPORT OF INDEPENDENT AUDITORS

To the Board of Directors and Shareholders
PS Business Parks, Inc.

We have audited the accompanying consolidated balance sheets of PS Business
Parks, Inc. as of December 31, 1998 and 1997, and the related consolidated
statements of income, shareholders' equity and cash flows for the year ended
December 31, 1998, the period from April 1, 1997 through December 31, 1997, the
period from January 1, 1997 through March 31, 1997 and the year ended December
31, 1996. Our audits also included the financial statement schedule listed in
the Index at Item 14(a). These financial statements and financial statement
schedule are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements and financial statement
schedule based on our audits.

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

In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of PS
Business Parks, Inc. at December 31, 1998 and 1997, and the consolidated results
of its operations and its cash flows for the year ended December 31, 1998, the
period from April 1, 1997 through December 31, 1997, the period from January 1,
1997 through March 31, 1997 and the year ended December 31, 1996 in conformity
with 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.

/s/ ERNST & YOUNG LLP

Los Angeles, California
February 2, 1999

F-1
<PAGE>

<TABLE>
<CAPTION>
PS BUSINESS PARKS, INC.
CONSOLIDATED BALANCE SHEETS

December 31, December 31,
1998 1997
------------- -------------
ASSETS
------
<S> <C> <C>
Cash and cash equivalents........................................ $ 6,068,000 $ 3,884,000

Real estate facilities, at cost:
Land........................................................ 176,241,000 91,754,000
Buildings and equipment..................................... 536,697,000 226,466,000
------------- -------------
712,938,000 318,220,000
Accumulated depreciation.................................... (22,517,000) (3,982,000)
------------- ------------
690,421,000 314,238,000
Construction in progress......................................... 7,716,000 -
------------- -------------
698,137,000 314,238,000

Intangible assets, net........................................... 1,583,000 3,272,000
Other assets..................................................... 3,626,000 2,060,000
------------- -------------
Total assets....................................... $709,414,000 $323,454,000
============= =============

LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------

Accrued and other liabilities.................................... $ 15,953,000 $ 8,331,000
Line of credit................................................... 12,500,000 -
Mortgage notes payable........................................... 38,041,000 -
Note payable to affiliate........................................ - 3,500,000
------------- -------------
Total liabilities.......................................... 66,494,000 11,831,000

Minority interest................................................ 153,015,000 168,665,000

Shareholders' equity:
Preferred stock, $0.01 par value, 50,000,000 shares
authorized, none outstanding at December 31, 1998 and
December 31, 1997....................................... - -
Common stock, $0.01 par value, 100,000,000 shares
authorized, 23,635,650 shares issued and outstanding at
December 31, 1998 (7,728,309 shares issued and
outstanding at December 31, 1997)....................... 236,000 77,000
Paid-in capital............................................. 482,471,000 143,277,000
Cumulative net income....................................... 32,554,000 3,154,000
Cumulative distributions.................................... (25,356,000) (3,550,000)
------------- -------------
Total shareholders' equity.............................. 489,905,000 142,958,000
------------- -------------
Total liabilities and shareholders' equity......... $709,414,000 $323,454,000
============= =============
</TABLE>

See accompanying notes.
F-2
<PAGE>

PS BUSINESS PARKS, INC.
CONSOLIDATED STATEMENTS OF INCOME

For the Periods (Note 2)
----------------------------------
For the Year April 1, 1997 January 1, 1997 For the Year
Ended December 31, through through Ended December 31,
1998 December 31, 1997 March 31, 1997 1996
------------------ ----------------- --------------- ------------------
<S> <C> <C> <C> <C>
Revenues:
Rental income........................... $ 88,320,000 $ 24,364,000 $ 5,805,000 $ -
Facility management fees from affiliates 529,000 709,000 247,000 2,133,000
Interest income......................... 1,411,000 424,000 29,000 43,000
----------------- ----------------- --------------- ------------------
90,260,000 25,497,000 6,081,000 2,176,000
----------------- ----------------- --------------- ------------------

Expenses:
Cost of operations....................... 26,073,000 9,837,000 2,493,000 -
Cost of facility management.............. 77,000 129,000 60,000 514,000
Depreciation and amortization............ 18,908,000 4,375,000 820,000 -
General and administrative............... 2,233,000 1,248,000 213,000 1,143,000
Interest expense......................... 2,361,000 1,000 - -
----------------- ------------------ --------------- ------------------
49,652,000 15,590,000 3,586,000 1,657,000
----------------- ------------------ --------------- ------------------

Income before minority interest............ 40,608,000 9,907,000 2,495,000 519,000

Minority interest in income.............. (11,208,000) (6,753,000) (1,813,000) -
----------------- ------------------ --------------- ------------------

Income before income taxes................. 29,400,000 3,154,000 682,000 519,000

Income tax expense....................... - - - (216,000)
----------------- ------------------ --------------- ------------------

Net income................................. $ 29,400,000 $ 3,154,000 $ 682,000 $ 303,000
================= ================== =============== ==================

Net income per share:
Basic.................................... $ 1.52 $ 0.92 $ 0.31 $ 0.32
================= ================== =============== ==================
Diluted.................................. $ 1.51 $ 0.92 $ 0.31 $ 0.32
================= ================== =============== ==================

Weighted average shares outstanding:
Basic.................................... 19,361,000 3,414,000 2,193,000 947,000
================= ================== =============== ==================
Diluted.................................. 19,429,000 3,426,000 2,193,000 947,000
================= ================== =============== ==================
</TABLE>

See accompanying notes.
F-3
<PAGE>
<TABLE>
<CAPTION>

PS BUSINESS PARKS, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY

Preferred Stock Common Stock
------------------------------- ------------------------------
Shares Amount Shares Amount
---------------- -------------- ----------------- ------------
<S> <C> <C> <C> <C>
BALANCES AT DECEMBER 31, 1995................. 899,608 $ 9,000 47,348 $ 1,000
Issuance of common stock for cash.......... - - 47,349 -
Net income................................. - - - -
Distributions paid......................... - - - -
--------------------------------------------------------------
BALANCES AT DECEMBER 31, 1996................. 899,608 9,000 94,697 1,000
Issuance of preferred stock in exchange for
real estate facilities................... 1,198,680 12,000 - -
Net income................................. - - - -
Issuance of common stock for cash.......... - - 4,797 -
Adjustment to reflect cost of PSI's
investment in PSB ....................... - - - -
Exchange of preferred stock for common stock (2,098,288) (21,000) 2,098,288 21,000
Adjustment to reflect minority interest to
underlying ownership interest .......... - - - -
--------------------------------------------------------------
BALANCES AT MARCH 31, 1997.................... - - 2,197,782 22,000
Issuance of common stock for cash.......... - - 2,025,769 20,000
Issuance of common stock in exchange for
real estate facilities................... - - 3,504,758 35,000
Net income................................. - - - -
Distributions paid......................... - - - -
Adjustment to reflect minority interest to
underlying ownership interest............ - - - -
--------------------------------------------------------------
BALANCES AT DECEMBER 31, 1997................. - - 7,728,309 77,000
Issuance of common stock:
Conversion of OP units................. - - 1,785,007 18,000
Private offerings, net of costs........ - - 6,774,072 68,000
Exercise of stock options.............. - - 39,024 -
In connection with a business combination - - 2,283,438 23,000
Public offerings, net of costs......... - - 5,025,800 50,000
Net income................................. - - - -
Distributions paid......................... - - - -
Adjustment to reflect minority interest to
underlying ownership interest............ - - - -
---------------- -------------- ----------------- -------------
BALANCES AT DECEMBER 31, 1998................. - $ - 23,635,650 $ 236,000
================ ============== ================= =============
</TABLE>
<TABLE>
<CAPTION>
PS BUSINESS PARKS, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY

Cumulative Cumulative Shareholders'
Paid-in Capital Net Income Distributions Equity
---------------- -------------- ----------------- ---------------
<S> <C> <C> <C> <C>
BALANCES AT DECEMBER 31, 1995................. $ 783,000 $ 248,000 $ - $ 1,041,000
Issuance of common stock for cash.......... 790,000 - - 790,000
Net income................................. - 303,000 - 303,000
Distributions paid......................... - (400,000) - (400,000)
------------------------------------------------------------------
BALANCES AT DECEMBER 31, 1996................. 1,573,000 151,000 - 1,734,000
Issuance of preferred stock in exchange for
real estate facilities................... 19,988,000 - - 20,000,000
Net income................................. - 682,000 - 682,000
Issuance of common stock for cash.......... 80,000 - - 80,000
Adjustment to reflect cost of PSI's
investment in PSB ....................... 13,194,000 (833,000) - 12,361,000
Exchange of preferred stock for common stock - - - -
Adjustment to reflect minority interest to
underlying ownership interest .......... 1,813,000 - - 1,813,000
---------------------------------------------------------------------
BALANCES AT MARCH 31, 1997.................... 36,648,000 - - 36,670,000
Issuance of common stock for cash.......... 33,780,000 - - 33,800,000
Issuance of common stock in exchange for
real estate facilities................... 75,939,000 - - 75,974,000
Net income................................. - 3,154,000 - 3,154,000
Distributions paid......................... - - (3,550,000) (3,550,000)
Adjustment to reflect minority interest to
underlying ownership interest............ (3,090,000) - - (3,090,000)
---------------------------------------------------------------------
BALANCES AT DECEMBER 31, 1997................. 143,277,000 3,154,000 (3,550,000) 142,958,000
Issuance of common stock:
Conversion of OP units................. 33,005,000 - - 33,023,000
Private offerings, net of costs........ 152,533,000 - - 152,601,000
Exercise of stock options.............. 651,000 - - 651,000
In connection with a business combination 46,787,000 - - 46,810,000
Public offerings, net of costs......... 118,810,000 - - 118,860,000
Net income................................. - 29,400,000 - 29,400,000
Distributions paid......................... - - (21,806,000) (21,806,000)
Adjustment to reflect minority interest to
underlying ownership interest............ (12,592,000) - - (12,592,000)
---------------- -------------- ----------------- ----------------
BALANCES AT DECEMBER 31, 1998................. $482,471,000 $ 32,554,000 $ (25,356,000) $489,905,000
================ ============== ================= ================
</TABLE>
See accompanying notes.
F-4
<PAGE>
<TABLE>
<CAPTION>
PS BUSINESS PARKS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS

Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization expense................... 18,908,000 4,375,000 820,000 -
Minority interest in income............................. 11,208,000 6,753,000 1,813,000 -
Increase in other assets................................ (1,913,000) (1,465,000) (400,000) (28,000)
Increase in accrued and other liabilities............... 2,625,000 780,000 2,925,000 138,000
--------------- -------------- --------------- --------------
Total adjustments.................................. 30,828,000 10,443,000 5,158,000 110,000
--------------- -------------- --------------- --------------

Net cash provided by operating activities............. 60,228,000 13,597,000 5,840,000 413,000
--------------- -------------- --------------- --------------

Cash flows from investing activities:
Acquisition of real estate facilities................... (289,415,000) (44,122,000) - -
Acquisition cost of business combination................ (424,000) - - -
Construction in progress................................ (7,716,000) - - -
Capital improvements to real estate facilities.......... (11,091,000) (2,983,000) (582,000) -
--------------- -------------- --------------- --------------
Net cash used in investing activities................. (308,646,000) (47,105,000) (582,000) -
--------------- -------------- --------------- --------------

Cash flows from financing activities:
Borrowings from an affiliate............................ 179,000,000 3,500,000 - -
Borrowings from line of credit.......................... 12,500,000 - - -
Repayment of borrowings from an affiliate............... (182,500,000) - - -
Principal payments on mortgage notes payable............ (606,000) - - -
Decrease (increase) in receivable from affiliate........ - 1,135,000 (308,000) (768,000)
Net proceeds from the issuance of common stock.......... 272,112,000 33,800,000 80,000 790,000
Distributions paid to shareholders...................... (21,806,000) (3,550,000) - (400,000)
Distributions paid to minority interests................ (8,098,000) (3,442,000) - -
--------------- -------------- --------------- --------------
Net cash provided by (used in) financing activities... 250,602,000 31,443,000 (228,000) (378,000)
--------------- -------------- --------------- --------------

Net increase (decrease) in cash and cash equivalents......... 2,184,000 (2,065,000) 5,030,000 35,000

Cash and cash equivalents at the beginning of the period..... 3,884,000 5,949,000 919,000 884,000
--------------- -------------- --------------- --------------

Cash and cash equivalents at the end of the period........... $ 6,068,000 $ 3,884,000 $ 5,949,000 $ 919,000
=============== ============== =============== ==============

Supplemental disclosures:
Interest paid........................................... $ 2,629,000 $ 1,000 $ - $ -
=============== ============== =============== ==============
</TABLE>

See accompanying notes.
F-5
<PAGE>

<TABLE>
<CAPTION>
PS BUSINESS PARKS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS

For the Periods (Note 2)
--------------------------------
For the Year April 1, 1997 January 1, 1997 For the Year
Ended through through Ended
December 31, December 31, March 31, December 31,
1998 1997 1997 1996
--------------- -------------- --------------- --------------
<S> <C> <C> <C> <C>
SUPPLEMENTAL SCHEDULE OF NON CASH INVESTING AND FINANCIAL
ACTIVITIES:
Acquisitions of real estate facilities and associated assets
and liabilities in exchange for preferred stock, minority
interests, and mortgage notes payable:
Real estate facilities.................................. $ (44,592,000) $(146,207,000) $ (117,180,000) $ -
Other assets (deposits on real estate acquisitions)..... 800,000 - -
Accrued and other liabilities........................... 3,531,000 4,419,000 - -
Minority interest....................................... 1,614,000 65,084,000 97,180,000 -
Preferred stock......................................... - - 12,000 -
Common stock............................................ - 35,000 - -
Paid in capital......................................... - 75,939,000 19,988,000 -
Mortgage notes payable.................................. 38,647,000 - - -
Intangible assets....................................... - 730,000 - -

Business combination:
Real estate facilities.................................. (48,305,000) - - -
Other assets............................................ (452,000) - - -
Accrued and other liabilities........................... 1,523,000 - - -
Common stock............................................ 23,000 - - -
Paid in capital......................................... 46,787,000 - - -

Conversion of OP units into shares of common stock:
Minority interest....................................... (33,023,000) - - -
Common stock............................................ 18,000 - - -
Paid in capital......................................... 33,005,000 - - -

Adjustment to reflect minority interest to underlying ownership
interest:
Minority interest....................................... 12,592,000 3,090,000 (1,813,000) -
Paid in capital......................................... (12,592,000) (3,090,000) 1,813,000 -

Exchange of preferred stock for common stock:
Preferred stock......................................... - - (21,000) -
Common stock............................................ - - 21,000 -

Adjustment to acquisition cost (see Note 2):
Real estate facilities.................................. (1,315,000) - (7,146,000) -
Accumulated depreciation................................ - - (820,000) -
Intangible assets....................................... 1,315,000 - (4,395,000) -
Paid in capital......................................... - - 13,194,000 -
Cumulative net income................................... - - (833,000) -
</TABLE>

See accompanying notes.
F-6
<PAGE>

PS BUSINESS PARKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998

1. ORGANIZATION AND DESCRIPTION OF BUSINESS

ORGANIZATION

PS Business Parks, Inc. ("PSB" or the "Company"), a California corporation,
is the success1r to American Office Park Properties, Inc. ("AOPP") which
merged with and into Public Storage Properties XI, Inc. ("PSP 11") on March
17, 1998 (the "Merger"). The name of the Company was changed to "PS
Business Parks, Inc." in connection with the Merger. See Note 3 for a
description of the Merger and its terms.

Based upon the terms of the Merger, the transaction for financial reporting
and accounting purposes has been accounted for as a reverse acquisition
whereby AOPP is deemed to have acquired PSP11. However, PSP11 is the
continuing legal entity and registrant for both Securities and Exchange
filing purposes and income tax reporting purposes. All subsequent
references to PSB or the Company for periods prior to March 17, 1998 shall
refer to AOPP.

PSB was organized in California in 1986 as a wholly owned subsidiary of
Public Storage Management, Inc. ("PSMI"), a privately owned company of B.
Wayne Hughes and his family (collectively "Hughes").

On November 16, 1995, Public Storage, Inc. ("PSI") acquired PSMI in a
business combination accounted for using the purchase method. In connection
with the transaction, PSI exchanged its common stock for all of the
non-voting participating preferred stock of PSB, representing a 95%
economic interest, and Hughes purchased all the voting common stock of PSB,
representing the remaining 5% economic interest. During December 1996,
Ronald L. Havner, Jr. (then an executive officer of PSI) acquired all of
Hughes' common stock in PSB.

On January 2, 1997, in connection with the reorganization of the commercial
property operations of PSI and affiliated entities, PSB formed a
partnership (the "Operating Partnership") whereby PSB became the general
partner. Concurrent with the formation of the Operating Partnership, PSI
and affiliated entities contributed commercial properties to the Operating
Partnership in exchange for limited partnership units ("OP units"). In
addition, PSI contributed commercial properties to PSB in exchange for
shares of non-voting participating preferred stock, and such properties
were immediately contributed by PSB along with its commercial property
management operations and cash to the Operating Partnership for OP units.

Subject to certain limitations as described in Note 8, holders of OP units,
other than PSB, have the right to require PSB to redeem such holders' OP
units at any time or from time to time beginning on the date that is one
year after the date on which such limited partner is admitted to the
Operating Partnership.

DESCRIPTION OF BUSINESS

PSB is a fully integrated, self-managed real estate investment trust
("REIT") that acquires, owns, operates and develops commercial properties
containing commercial and industrial rental space. From 1986 through 1996,
PSB's sole business activity consisted of the management of commercial
properties owned primarily by PSI and affiliated entities.

Commencing in 1997, PSB began to own and operate commercial properties for
its own behalf. At December 31, 1998, PSB and the Operating Partnership
collectively owned and operated 106 commercial properties (approximately
10.9 million net rentable square feet) located in 11 states. In addition,
the Operating Partnership managed, on behalf of PSI and affiliated
entities, 36 commercial properties (approximately 1.0 million net rentable
square feet).

F-7
<PAGE>

PS BUSINESS PARKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF PRESENTATION

The financial statements for 1996 include only the accounts of PSB. The
consolidated financial statements for 1998 and 1997 include the accounts of
PSB and the Operating Partnership. At December 31, 1998, PSB owned
approximately 73% of the OP units of the Operating Partnership. PSB, as the
sole general partner of the Operating Partnership, has full, exclusive and
complete responsibility and discretion in managing and controlling the
Operating Partnership. Historical financial data of PSP11 have not been
included in the historical financial statements of PSB.

On March 31, 1997, PSB and PSI agreed to exchange the non-voting
participating preferred stock held by PSI for 2,098,288 shares of voting
common stock of PSB. After the exchange, PSI owned in excess of 95% of the
outstanding common voting common stock of PSB and PSB accounted for the
transaction as if PSI acquired PSB in a transaction accounted for as a
purchase. Accordingly, PSB reflected PSI's cost of its investment in PSB in
accordance with Accounting Principles Board Opinion No. 16. As a result of
PSI attaining control of PSB, the carrying value of PSB's assets and
liabilities were adjusted to reflect PSI's acquisition cost of its
controlling interest in PSB of approximately $35 million. As a result, the
carrying value of real estate facilities was increased approximately $8.0
million, intangible assets increased approximately $4.4 million and paid in
capital increased approximately $12.4 million.

Prior to March 31, 1997, control of PSB was held by entities other than
PSI. As a result of PSI acquiring a majority of the voting common stock and
control of PSB on March 31, 1997, the 1997 consolidated financial
statements are presented separately for the period prior to March 31, 1997
(January 1, 1997 through March 31, 1997) and the period subsequent to March
31, 1997 (April 1, 1997 through December 31, 1997) when control was held by
PSI.

USE OF ESTIMATES

The preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management to make
estimates and assumptions that affect the amounts reported in the
consolidated financial statements and accompanying notes. Actual results
could differ from those estimates.

CASH AND CASH EQUIVALENTS

PSB considers all highly liquid investments with an original maturity of
three months or less at the date of purchase to be cash equivalents. The
carrying amount of cash and cash equivalents approximates fair value.

REAL ESTATE FACILITIES

Costs related to the improvements of properties are capitalized.
Expenditures for repairs and maintenance are charged to expense when
incurred. Buildings and equipment are depreciated on the straight-line
method over the estimated useful lives, which are generally 30 and 5 years,
respectively.

Interest cost incurred during the period of construction of real estate
facilities is capitalized. Construction in progress includes $268,000 of
interest costs capitalized in 1998.

F-8
<PAGE>

PS BUSINESS PARKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998

INTANGIBLE ASSETS

Intangible assets consist of property management contracts for properties
managed, but not owned, by PSB. The intangible assets are being amortized
over seven years. As properties managed are subsequently acquired by PSB,
the unamortized basis of intangible assets related to such property is
included in the cost of acquisition of such property. During April 1997,
PSB acquired four properties from PSI and included in the cost of real
estate facilities for such properties is $730,000 of cost previously
classified as intangible assets. In connection with the Merger, PSB
acquired 13 properties and included in the cost of such properties is
$1,315,000 (which was net of accumulated amortization of $194,000) of costs
previously classified as intangible assets. Intangible assets are net of
accumulated amortization of $573,000 and $393,000 at December 31, 1998 and
1997, respectively.

EVALUATION OF ASSET IMPAIRMENT

PSB evaluates its assets used in operations, by identifying indicators of
impairment and by comparing the sum of the estimated undiscounted future
cash flows for each asset to the asset's carrying amount. When indicators
of impairment are present and the sum of the undiscounted future cash flows
is less than the carrying value of such asset, an impairment loss is
recorded equal to the difference between the asset's current carrying value
and its value based on discounting its estimated future cash flows. At
December 31, 1998, no such indicators of impairment have been identified.

NOTE PAYABLE TO AND BORROWINGS FROM AFFILIATE

Note payable to affiliate at December 31, 1997 of $3,500,000 reflects
amounts borrowed from PSI on that date. The note bore interest at 6.97% and
was repaid on January 31, 1998. On May 4, 1998, PSB borrowed $179,000,000
from PSI to fund a portion of the acquisition cost of real estate
facilities. On May 6, 1998, $105,000,000 was repaid and the remaining
balance of $74,000,000 was repaid on May 27, 1998. The borrowings bore
interest at 6.91% (per annum).

STOCK-BASED COMPENSATION

PSB has elected to adopt the disclosure requirements of Statement of
Financial Accounting Standards ("SFAS") No. 123, "Accounting for
Stock-Based Compensation," but will continue to account for stock-based
compensation under Accounting Principles Board Opinion No. 25, "Accounting
for Stock Issued to Employees."

STOCK SPLIT AND STOCK DIVIDEND

On January 1, 1997, the number of outstanding shares of preferred and
common stock increased as a result of a 10 for 1 stock split. In March
1997, the preferred stock of PSB was converted into common stock on a share
for share basis. In December 1997, PSB declared a common stock dividend at
a rate of .01583 shares for each common share outstanding. Similarly, the
Operating Partnership's outstanding OP units were adjusted to reflect the
stock dividend. No adjustment was made to the outstanding OP units for the
January 1997 stock split, as the issuance of OP units during 1997 already
reflected the stock split.

On March 17, 1998, in connection with the merger, PSB's common shares were
converted into 1.18 shares of PSP11. Similarly, holders of OP units
received an additional 0.18 OP units for each outstanding OP unit held at
the time of the merger.

References in the consolidated financial statements and notes thereto with
respect to shares of preferred stock, common stock, stock options, and OP

F-9
<PAGE>

PS BUSINESS PARKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998

units and the related per share/per unit amounts have been retroactively
adjusted to reflect the January 1997 stock split, the December 1997 stock
dividend and the March 1998 conversion in connection with the Merger.

REVENUE AND EXPENSE RECOGNITION

All leases are classified as operating leases. Rental income is recognized
on a straight-line basis over the terms of the leases. Reimbursements from
tenants for real estate taxes and other recoverable operating expenses are
recognized as revenue in the period the applicable costs are incurred.

Costs incurred in connection with leasing (primarily tenant improvements
and leasing commissions) are capitalized and amortized over the lease
period.

Property management fees are recognized in the period earned.

GENERAL AND ADMINISTRATIVE EXPENSE

General and administrative expense includes legal and office expense, state
income taxes, executive salaries, cost of acquisition personnel and other
such administrative items. Such amounts include amounts incurred by PSI on
behalf of PSB, which were subsequently charged to PSB in accordance with
the allocation methodology pursuant to the cost allocation and
administrative service agreement between PSB and PSI.

ACQUISITION COSTS

Internal acquisition costs are expensed as incurred.

INCOME TAXES

In 1996, income taxes were accounted for under SFAS No. 109, "Accounting
for Income Taxes," which requires income taxes to be recorded using the
liability method. Under the liability method, deferred taxes are provided
for temporary differences between the financial reporting and income tax
bases of assets and liabilities, applying presently enacted tax rates and
laws.

The income tax provision for 1996 is as follows:

<TABLE>
<S> <C>
Federal........................... $166,000
State............................. 50,000
--------
$216,000
========
</TABLE>

The income tax provision is different from that which would be computed by
applying the Federal income tax rate to income before taxes as follows:

<TABLE>
<S> <C>
Tax at statutory rate............. $177,000
State income taxes................ 33,000
Other............................. 6,000
--------
$216,000
========
</TABLE>

During 1997, PSB qualified and intends to continue to qualify as a real
estate investment trust ("REIT"), as defined in Section 856 of the Internal
Revenue Code. As a REIT, PSB is not subject to federal income tax to the
extent that it distributes at least 95% of its taxable income to its
shareholders. In addition, REITs are subject to a number of organizational
and operating requirements. If the Company fails to qualify as a REIT in

F-10
<PAGE>

PS BUSINESS PARKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998

any taxable year, the Company will be subject to federal income tax
(including any applicable alternative minimum tax) based on its taxable
income using corporate income tax rates. Even if the Company qualifies for
taxation as a REIT, the Company may be subject to certain state and local
taxes on its income and property and to federal income and excise taxes on
its undistributed taxable income. PSB believes it met all organizational
and operating requirements to maintain its REIT status during 1998 and
1997. In addition, PSP11 (the legal entity for income tax reporting
purposes subsequent to the March 17, 1998 merger) believes it has also met
these requirements during 1998, 1997 and 1996. Accordingly, no provision
for income taxes has been made in the accompanying financial statements.

The difference between book income and taxable income primarily results
from timing differences consisting of depreciation expense and unearned
rental income.

NET INCOME PER COMMON SHARE

Per share amounts are computed using the weighted average common shares
outstanding. "Diluted" weighted average common shares outstanding include
the dilutive effect of stock options under the treasury stock method.
"Basic" weighted average common shares outstanding excludes such effect.
Earnings per share has been calculated as follows:

<TABLE>
<CAPTION>
For the Period For the Period
For the Year April 1 January 1 For the Year
Ended through through Ended
December 31, December 31, March 31, December 31,
--------------- -------------- -------------- --------------
1998 1997 1997 1996
--------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Net income and net income allocable to common
shareholders (same for Basic and Diluted computations)... $ 29,400,000 $ 3,154,000 $ 682,000 $ 303,000
=============== ============== ============== ==============
Weighted average common shares outstanding:

Basic weighted average common shares outstanding......... 19,361,000 3,414,000 2,193,000 947,000
Net effect of dilutive stock options - based on treasury
stock method using average market price............. 68,000 12,000 - -
--------------- -------------- -------------- --------------
Diluted weighted average common shares outstanding....... 19,429,000 3,426,000 2,193,000 947,000
=============== ============== ============== ==============
Basic earnings per common share............................... $ 1.52 $ 0.92 $ 0.31 $ 0.32
=============== ============== ============== ==============
Diluted earnings per common share............................. $ 1.51 $ 0.92 $ 0.31 $ 0.32
=============== ============== ============== ==============
</TABLE>

COMPREHENSIVE INCOME

Effective January 1, 1998, PSB adopted SFAS No. 130, "Reporting
Comprehensive Income." SFAS No. 130 requires a separate statement to report
the components of comprehensive income for each period reported. The
adoption of SFAS No. 130 did not have an impact on PSB's reporting
presentation.

F-11
<PAGE>

PS BUSINESS PARKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998

SEGMENT REPORTING

Effective January 1, 1998, PSB adopted SFAS No. 131, "Disclosures about
Segments of an Enterprise and Related Information." SFAS No. 131
established standards for the way public business enterprises report
information about operating segments in annual financial statements and
requires that those enterprises report selected information about operating
segments in interim financial reports. SFAS 131 also establishes standards
for related disclosures about products and services, geographic areas, and
major customers. As management views the Company as operating in a single
segment as described in Note 1, the adoption of SFAS No. 131 did not affect
PSB's disclosure of segment information.

RECLASSIFICATIONS

Certain reclassifications have been made to the consolidated financial
statements for 1997 in order to conform to the 1998 presentation.

3. BUSINESS COMBINATION

On March 17, 1998, AOPP merged into PSP11, a publicly traded real estate
investment trust and an affiliate of PSI. Upon consummation of the Merger
of AOPP into PSP11, the surviving corporation was renamed "PS Business
Parks, Inc." (PSB as defined in Note 1). In connection with the Merger:

* Each outstanding share of PSP11 common stock, which did not elect
cash, continued to be owned by current holders. A total of 106,155
PSP11 common shares elected to receive cash of $20.50 per share.

* Each share of PSP11 common stock Series B and each share of PSP11
common stock Series C converted into .8641 shares of PSP11 common
stock.

* Each share of AOPP common stock converted into 1.18 shares of PSP11
common stock.

* Concurrent with the Merger, PSP11 exchanged 11 mini-warehouses and two
properties that combine mini-warehouse and commercial space for 11
commercial properties owned by PSI. The fair value of each group of
real estate facilities was approximately $48 million.

The Merger has been accounted for as a reverse merger whereby PSB is
treated as the accounting acquirer using the purchase method. This has been
determined based upon the following: (i) the former shareholders and
unitholders of PSB owned in excess of 80% of the merged companies and (ii)
the business focus post-Merger will continue to be that of PSB's which
includes the acquisition, ownership and management of commercial
properties. Prior to the Merger, PSP11's business focus has been primarily
on the ownership and operation of its self-storage facilities which
represented approximately 81% of its portfolio.

F-12
<PAGE>

PS BUSINESS PARKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998

Allocations of the total acquisition cost to the net assets acquired were
made based upon the fair value of PSP11's assets and liabilities as of the
date of the Merger. The acquisition cost and the fair market values of the
assets acquired and liabilities assumed in the Merger are summarized as
follows:

<TABLE>
<S> <C>
ACQUISITION COST:
-----------------
Issuance of common stock.......... $46,810,000
Cash.............................. 424,000
-------------
Total acquisition cost........ $47,234,000
=============

ALLOCATION OF ACQUISITION COST:
-------------------------------
Real estate facilities............ $48,305,000
Other assets...................... 452,000
Accrued and other liabilities..... (1,523,000)
-------------
Total allocation.............. $47,234,000
=============
</TABLE>

The historical operating results of PSP11 prior to the Merger have not been
included in PSB's historical operating results. Pro forma data for the year
ended December 31, 1998 and 1997 as though the Merger and related exchange
of properties have been effective at the beginning of fiscal 1997 are as
follows:

<TABLE>
<CAPTION>
For the Years Ended December 31,
1998 1997
---------------- ----------------
<S> <C> <C>
Revenues................................ $ 92,137,000 $ 40,615,000
Net income.............................. $ 30,159,000 $ 7,042,000
Net income per share - basic............ $ 1.52 $ 1.30
Net income per share - diluted.......... $ 1.52 $ 1.30
</TABLE>

The pro forma data does not purport to be indicative either of the results
of operations that would have occurred had the Merger occurred at the
beginning of fiscal 1997 or of the future results of PSB.

4. REAL ESTATE FACILITIES

The activity in real estate facilities for the year ended December 31, 1998
is as follows:

<TABLE>
<CAPTION>
Accumulated
Land Buildings Depreciation Total
------------- ------------- ---------------- ---------------
<S> <C> <C> <C> <C>
Balances at December 31, 1997....... $ 91,754,000 $ 226,466,000 $ (3,982,000) $ 314,238,000
Property acquisitions............... 70,087,000 263,920,000 - 334,007,000
Acquired in connection with the
Merger......................... 14,400,000 33,905,000 - 48,305,000
Adjustment from intangible assets... - 1,315,000 - 1,315,000
Capital improvements................ - 11,091,000 - 11,091,000
Depreciation expense................ - - (18,535,000) (18,535,000)
------------- ------------- ---------------- ---------------
Balances at December 31, 1998....... $ 176,241,000 $ 536,697,000 $ (22,517,000) $ 690,421,000
============= ============= ================ ===============
</TABLE>

F-13
<PAGE>

PS BUSINESS PARKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998

At December 31, 1998, real estate facilities for Federal income tax
purposes were approximately $676,186,000 (unaudited), net of accumulated
depreciation of $159,842,000 (unaudited).

5. LEASING ACTIVITY

The Company leases space in its real estate facilities to tenants under
non-cancelable leases generally ranging from one to seven years. Future
minimum rental revenues excluding recovery of expenses as of December 31,
1998 under these leases are as follows:

<TABLE>
<S> <C>
1999.............................. $ 83,980,000
2000.............................. 60,969,000
2001.............................. 40,812,000
2002.............................. 26,451,000
2003.............................. 15,260,000
Thereafter........................ 24,333,000
--------------
$ 251,805,000
==============
</TABLE>

In addition to minimum rental payments, tenants pay reimbursements for
their pro rata share of specified operating expenses, which amounted to
$10,357,000, $3,106,000 and none for the years ended December 31, 1998,
1997 and 1996, respectively. These amounts are included as rental income
and cost of operations in the accompanying statements of income.

6. REVOLVING LINE OF CREDIT

The Company has an unsecured line of credit (the "Credit Facility") with
Wells Fargo Bank. The Credit Facility has a borrowing limit of $100 million
and an expiration date of August 5, 2000. The expiration date may be
extended by one year on each anniversary of the Credit Facility. Interest
on outstanding borrowings is payable monthly. At the option of the Company,
the rate of interest charged is equal to (i) the prime rate or (ii) a rate
ranging from the London Interbank Offered Rate ("LIBOR") plus 0.55% to
LIBOR plus 0.95% depending on the Company's credit ratings and coverage
ratios, as defined (currently LIBOR plus 0.80%). In addition, the Company
is required to pay a commitment fee of 0.25% (per annum). As of December
31, 1998, the Company had $12.5 million outstanding on the line of credit
at an interest rate of 5.93%.

Under covenants of the Credit Facility, the Company is required to (i)
maintain a balance sheet leverage ratio (as defined) of less than 0.50 to
1.00, (ii) maintain interest and fixed charge coverage ratios (as defined)
of not less than 2.25 to 1.0 and 2.0 to 1.0, respectively, (iii) maintain a
minimum total shareholder's equity (as defined) and (iv) limit
distributions to 95% of funds from operations. In addition, the Company is
limited in its ability to incur additional borrowings (the Company is
required to maintain unencumbered assets with an aggregate book value equal
to or greater than two times the Company's unsecured recourse debt) or sell
assets. The Company was in compliance with the covenants of the Credit
Facility at December 31, 1998.

F-14
<PAGE>

PS BUSINESS PARKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998

7. MORTGAGE NOTES PAYABLE

Mortgage notes at December 31, 1998 consist of the following:

<TABLE>
<S> <C>
7.625% mortgage note, secured by one commercial property with an
approximate carrying amount of $21,507,000, principal and
interest payable monthly, due May 2004........................ $11,418,000
7.125% mortgage note, secured by one commercial property with an
approximate carrying amount of $19,794,000, principal and
interest payable monthly, due May 2006........................ 8,905,000
8.4% mortgage note, secured by six commercial properties with
approximate carrying amounts totaling $21,014,000, principal
and interest payable monthly, due November 2001............... 8,672,000
8.125% mortgage note, secured by one commercial property with an
approximate carrying amount of $12,557,000, principal and
interest payable monthly, due July 2005....................... 5,416,000
8.5% mortgage note, secured by one commercial property with an
approximate carrying amount of $3,701,000, principal and
interest payable monthly, due July 2007....................... 1,939,000
8% mortgage note, secured by one commercial property with an
approximate carrying amount of $3,576,000, principal and
interest payable monthly, due April 2003...................... 1,691,000
-----------
$38,041,000
===========
</TABLE>

At December 31, 1998, approximate principal maturities of mortgage notes
payable are as follows:

<TABLE>
<S> <C>
1999.............................. $ 1,237,000
2000.............................. 1,364,000
2001.............................. 9,624,000
2002.............................. 1,387,000
2003.............................. 2,909,000
Thereafter........................ 21,520,000
----------------
$ 38,041,000
================
</TABLE>

The mortgage notes have a weighted average interest rate of 7.82% and an
average maturity of 5.6 years. Based on borrowing rates currently available
to the Company, the carrying amount of debt approximates fair value.

8. MINORITY INTERESTS

The Company presents the accounts of PSB and the Operating Partnership on a
consolidated basis. Ownership interests in the Operating Partnership, other
than PSB's interest, are classified as minority interest in the
consolidated financial statements. Minority interest in income consists of
the minority interests' share of the consolidated operating results.

Beginning one year from the date of admission as a limited partner and
subject to certain limitations described below, each limited partner other
than PSB has the right to require the redemption of its partnership
interest.

A limited partner that exercises its redemption right will receive cash
from the Operating Partnership in an amount equal to the market value (as
defined in the Operating Partnership Agreement) of the partnership interest

F-15
<PAGE>

PS BUSINESS PARKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998

redeemed. In lieu of the Operating Partnership redeeming the partner for
cash, PSB, as general partner, has the right to elect to acquire the
partnership interest directly from a limited partner exercising its
redemption right, in exchange for cash in the amount specified above or by
issuance of one share of PSB common stock for each unit of limited
partnership interest redeemed.

A limited partner cannot exercise its redemption right if delivery of
shares of PSB common stock would be prohibited under the applicable
articles of incorporation, if the general partner believes that there is a
risk that delivery of shares of common stock would cause the general
partner to no longer qualify as a REIT, would cause a violation of the
applicable securities laws, or would result in the Operating Partnership no
longer being treated as a partnership for federal income tax purposes.

At December 31, 1998, there were 7,400,951 OP units owned by minority
interests (7,305,355 were owned by PSI and affiliated entities and 95,596
were owned by unaffiliated third parties). On a fully converted basis,
assuming all 7,400,951 minority interest OP units were converted into
shares of common stock of PSB at December 31, 1998, the minority interests
would own approximately 23.8% of the common shares outstanding. At the end
of each reporting period, PSB determines the amount of equity (book value
of net assets) which is allocable to the minority interest based upon the
ownership interest and an adjustment is made to the minority interest, with
a corresponding adjustment to paid-in capital, to reflect the minority
interests' equity in the Company.

9. PROPERTY MANAGEMENT CONTRACTS

The Operating Partnership manages industrial, office and retail facilities
for PSI and entities affiliated with PSI and third party owners. These
facilities, all located in the United States, operate under the "Public
Storage" or "PS Business Parks" name.

The property management contracts provide for compensation of five percent
of the gross revenue of the facilities managed. Under the supervision of
the property owners, the Operating Partnership coordinates rental policies,
rent collections, marketing activities, the purchase of equipment and
supplies, maintenance activities, and the selection and engagement of
vendors, suppliers and independent contractors. In addition, the Operating
Partnership assists and advises the property owners in establishing
policies for the hire, discharge and supervision of employees for the
operation of these facilities, including property managers, leasing,
billing and maintenance personnel.

The property management contract with PSI is for a seven year term with the
term being extended one year each anniversary. The property management
contracts with affiliates of PSI are cancelable by either party upon sixty
days notice.

10. SHAREHOLDERS' EQUITY

In addition to common and preferred stock, PSB is authorized to issue
100,000,000 shares of Equity Stock. The Articles of Incorporation provide
that the Equity Stock may be issued from time to time in one or more series
and gives the Board of Directors broad authority to fix the dividend and
distribution rights, conversion and voting rights, redemption provisions
and liquidation rights of each series of Equity Stock.

On January 7, 1998, a holder of OP units exercised its option and converted
its 1,785,007 OP units into an equal number of shares of PSB common stock.
The conversion resulted in an increase in shareholders' equity and a
corresponding decrease in minority interest of approximately $33,023,000
representing the book value of the OP units at the time of conversion.

F-16
<PAGE>

PS BUSINESS PARKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998

In January 1998, PSB entered into an agreement with a group of
institutional investors under which PSB agreed to issue up to 6,774,072
shares of common stock at $22.88 per share in cash (an aggregate of $155
million) in separate tranches. The first tranche, representing 2,185,187
shares or $50 million, was issued in January 1998. PSB incurred $2.4
million in costs associated with the issuance. The remainder of the common
shares (4,588,885 common shares) was issued on May 6, 1998 and the net
proceeds ($105 million) were used to fund a portion of the cost to acquire
commercial properties in May 1998.

In May 1998, PSB completed two common stock offerings, raising net proceeds
in aggregate totaling $118.9 million through the issuance of 5,025,800
common shares. A portion of the net proceeds was used in connection with a
$190 million property portfolio acquisition.

The Company paid distributions to its shareholders totaling $1.10, $0.68
and $0.43 per share in 1998, 1997 and 1996, respectively. Pursuant to
restrictions on the line of credit agreement, distributions may not exceed
95% of funds from operations (as defined in the Credit Facility Agreement).

11. STOCK OPTIONS

PSB has a 1997 Stock Option Plan (the "Plan"). Under the Plan, PSB has
granted non-qualified options to certain directors, officers and key
employees to purchase shares of PSB's common stock at a price no less than
the fair market value of the common stock at the date of grant. Generally,
options under the Plan vest over a three-year period from the date of grant
at the rate of one third per year and expire ten years after the date of
grant.

At December 31, 1998, there were 1,500,000 options authorized to grant.
Information with respect to the Plan is as follows:

<TABLE>
<CAPTION>
Weighted
Number of Exercise Average
Options Price Exercise Price
---------- --------------- --------------
<S> <C> <C> <C>
Outstanding at December 31, 1996........... - - -
Granted............................... 305,570 $16.69 - $22.88 $16.80
Exercised............................. - - -
Canceled.............................. - - -
---------- --------------- --------------
Outstanding at December 31, 1997........... 305,570 16.69 - 22.88 16.80
Granted............................... 222,500 22.88 - 25.00 24.01
Exercised............................. (39,024) 16.69 16.69
Canceled.............................. - - -
---------- --------------- --------------
Outstanding at December 31, 1998........... 489,046 $16.69 - $25.00 $20.09
========== =============== ==============

Exercisable at:
December 31, 1998..................... 62,828 $16.69 - $22.88 $16.87
</TABLE>

PSB adopted the disclosure requirement provision of SFAS No. 123 in
accounting for stock-based compensation issued to employees. As of December
31, 1998 and 1997, there were 489,046 and 305,570 options outstanding,
respectively, that were subject to SFAS No. 123 disclosure requirements.
The fair value of these options was estimated utilizing prescribed
valuation models and assumptions as of each respective grant date. Based on
the results of such estimates, management determined that there was no
material effect on net income or earnings per share for the years ended
December 31, 1998 and 1997. The remaining contractual lives were 8.9 and
9.1 years, respectively at December 31, 1998 and 1997.

F-17
<PAGE>

PS BUSINESS PARKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998

12. RECENT ACCOUNTING PRONOUNCEMENTS

In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," which is
required to be adopted in years beginning after June 15, 1999. Management
anticipates that the adoption of SFAS No. 133 will have no effect on
earnings or the financial position of PSB since no derivatives are
currently being used.

13. SUPPLEMENTARY QUARTERLY FINANCIAL DATA (UNAUDITED)

<TABLE>
<CAPTION>
Three Months Ended
------------------------------------------------------------------------
March 31, June 30, September 30, December 31,
1997 1997 1997 1997
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Revenues................. $ 6,081,000 $ 7,316,000 $ 8,660,000 $ 9,521,000
Net income............... $ 682,000 $ 795,000 $ 1,182,000 $ 1,177,000

Basic.................... $0.31 $0.36 $0.33 $0.26
Diluted.................. $0.31 $0.36 $0.33 $0.26

Three Months Ended
------------------------------------------------------------------------
March 31, June 30, September 30, December 31,
1998 1998 1998 1998
-------------- -------------- -------------- --------------
Revenues................. $ 14,788,000 $ 21,911,000 $ 26,277,000 $ 27,284,000
Net income............... $ 4,330,000 $ 7,046,000 $ 9,748,000 $ 8,276,000

Basic.................... $0.38 $0.38 $0.41 $0.35
Diluted.................. $0.38 $0.38 $0.41 $0.35
</TABLE>

14. COMMITMENTS AND CONTINGENCIES

PSB is subject to the risks inherent in the ownership and operation of
commercial real estate. These include, among others, the risks normally
associated with changes in the general economic climate, trends in the real
estate industry, creditworthiness of tenants, competition, changes in tax
laws, interest rate levels, the availability of financing and potential
liability under environmental and other laws.

Substantially all of the properties have been subjected to Phase I
environmental reviews. Such reviews have not revealed, nor is management
aware of, any probable or reasonably possible environmental costs that
management believes would be material to the consolidated financial
statements except as discussed below.

The Company acquired a property in Beaverton, Oregon ("Creekside Corporate
Park") in May 1998. A property adjacent to Creekside Corporate Park is
currently the subject of an environmental remedial
investigation/feasibility study that is being conducted by the current and
past owners of the property, pursuant to an order issued by the Oregon
Department of Environmental Quality ("ODEQ"). As part of that study, ODEQ
ordered the property owners to sample soil and groundwater on the Company's
property to determine the nature and extent of contamination resulting from
past industrial oeprations at the property subject to the study. The
Company, which is not a party of the Order on Consent, executed separate
Access Agreements with the property owners to allow access to its property
to conduct the required sampling and testing. The smapling and testing is
ongoing, and preliminary results from one area indicate that the
contamination from the property subject to the study may have migrated onto
a portion of Creekside Corporate Park owned by the Company.

F-18
<PAGE>

PS BUSINESS PARKS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998

the study, it is likely that removal or remedial measures will be required
to address any contamination detected during the current investigation,
including any contamination on or under the Creekside Corporate Park
property. Because of the preliminary nature of the investigation, the
Company cannont predict the outcome of the investigation, nor can it
estimate the costs of any remediation or removal activities that may be
required.

The Company believes that it bears no responbility or liability for the
contamination. In the event the Company is ultimately deemed responsible
for any costs relating to this matter, the Company believes that the party
from whom the property was purchased will be responsible for any expenses
or liabilites that the Company may incur as a result of this contamination.

PSB currently is neither subject to any other material litigation nor, to
management's knowledge, is any material litigation currently threatened
against PSB other than routine litigation and administrative proceedings
arising in the ordinary course of business. Based on consultation with
counsel, management believes that these items will not have a material
adverse impact on the Company's consolidated financial position or results
of operations.

15. SUBSEQUENT EVENTS

On January 6, 1999, six commercial properties were acquired in Austin,
Texas (approximately 230,000 net rentable square feet) from an unaffiliated
third party for an aggregate cost of approximately $13.9 million in cash.
The Company obtained the funds to acquire the facilities from its existing
cash balances and borrowings of $14 million from its unsecured line of
credit.

On January 19, 1999, PSB temporarily borrowed $26.5 million from PSI to pay
off its line of credit at a rate below its borrowing rate under the line of
credit

On January 29, 1999, two commercial properties (approximately 108,000 net
rentable square feet) and a parcel of vacant land (approximately 402,000
square feet) were acquired in Northern Virginia from unaffiliated third
parties for an aggregate cost of approximately $11.4 million, consisting of
cash totaling approximately $8.9 million, the issuance of 13,669 OP units
having a value of approximately $0.3 million and the assumption of an
existing mortgage note payable of $2.2 million. The Company obtained the
funds to acquire the facilities from its existing cash balances and
additional borrowings of $6 million from PSI.

F-19
<PAGE>

PS BUSINESS PARKS, INC.
SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION
DECEMBER 31, 1998
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
Cost
Capitalized
Subsequent to
Initial Cost to Company Acquisition
---------------------------------------
Buildings Buildings
and and
Description Location Encumbrances Land Improvements Improvements
- ------------------------ ---------------- -------------- ----------- ------------- -------------
<S> <C> <C> <C> <C> <C>
I-435.................. Overland Park, KS $- $ 890 $ 2,176 $129
Produce................ San Francisco, CA - 771 1,886 9
Crenshaw II............ Torrance, CA - 1,861 4,938 253
Airport................ San Francisco, CA - 897 2,387 56
Christopher Ave........ Gaithersburg, MD - 466 1,203 70
Monterey Park.......... Monterey Park, CA - 3,078 7,862 148
Calle Del Oaks......... Monterey, CA - 282 706 75
Milwaukie I............ Milwaukie, OR - 690 1,754 173
Edwards Road........... Cerritos, CA - 450 1,217 224
Milwaukie II........... Milwaukie, OR - 435 1,103 168
Rainier................ Renton, WA - 330 889 125
Lusk................... San Diego, CA - 1,500 3,738 257
Eisenhower............. Alexandria, VA - 1,440 3,635 189
McKellips.............. Tempe, AZ - 195 522 45
Crenshaw............... Torrance, CA - 450 1,131 78
Old Oakland Rd......... San Jose, CA - 3,458 8,765 227
Junipero............... Signal Hill, CA - 900 2,510 221
Watson Plaza........... Lakewood, CA - 930 2,360 65
Northgate Blvd......... Sacramento, CA - 1,710 4,567 504
Camino Del Rio S....... San Diego, CA - 930 2,388 218
Uplander............... Culver City, CA - 3,252 8,157 892
University............. Tempe, AZ - 2,160 5,454 370
E. 28th Street......... Signal Hill, CA - 1,500 3,749 123
W. Main................ Mesa, AZ - 675 1,692 55
S. Edward.............. Tempe, AZ - 645 1,653 168
Leapwood Ave........... Carson, CA - 990 2,496 387
Downtown Center........ Nashville, TN - 660 1,681 254
Airport South.......... Nashville, TN - 660 1,657 96
Great Oaks............. Woodbridge, VA - 1,350 3,398 109
W. Concord Cir......... Broken Arrow, OK - 840 2,174 95
John Barrow............ Little Rock, AR - 780 1,998 67
S. Peoria.............. Tulsa, OK - 375 962 15
Ventura Blvd. II....... Studio City, CA - 621 1,530 162
Largo 95............... Largo, MD - 3,085 7,332 389
Gunston................ Lorton, VA 11,418 4,146 17,872 8
</TABLE>
<TABLE>
<CAPTION>
Gross Amount at Which Carried at
December 31, 1998
---------------------------------------
Buildings Depreciable
and Accumulated Date Lives
Description Location Land Improvements Totals Depreciation Acquired (Years)
- ------------------------ ---------------- --------- -------------- ----------- ------------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
I-435.................. Overland Park, KS $ 890 $ 2,305 $ 3,195 $ 66 3/17/98 5-30
Produce................ San Francisco, CA 771 1,895 2,666 51 3/17/98 5-30
Crenshaw II............ Torrance, CA 1,861 5,191 7,052 333 4/12/97 5-30
Airport................ San Francisco, CA 897 2,443 3,340 163 4/12/97 5-30
Christopher Ave........ Gaithersburg, MD 466 1,273 1,739 83 4/12/97 5-30
Monterey Park.......... Monterey Park, CA 3,078 8,010 11,088 512 1/1/97 5-30
Calle Del Oaks......... Monterey, CA 282 781 1,063 55 1/1/97 5-30
Milwaukie I............ Milwaukie, OR 690 1,927 2,617 157 1/1/97 5-30
Edwards Road........... Cerritos, CA 450 1,441 1,891 106 1/1/97 5-30
Milwaukie II........... Milwaukie, OR 435 1,271 1,706 110 1/1/97 5-30
Rainier................ Renton, WA 330 1,014 1,344 65 1/1/97 5-30
Lusk................... San Diego, CA 1,500 3,995 5,495 252 1/1/97 5-30
Eisenhower............. Alexandria, VA 1,440 3,824 5,264 247 1/1/97 5-30
McKellips.............. Tempe, AZ 195 567 762 38 1/1/97 5-30
Crenshaw............... Torrance, CA 450 1,209 1,659 83 1/1/97 5-30
Old Oakland Rd......... San Jose, CA 3,458 8,992 12,450 576 1/1/97 5-30
Junipero............... Signal Hill, CA 900 2,731 3,631 187 1/1/97 5-30
Watson Plaza........... Lakewood, CA 930 2,425 3,355 156 1/1/97 5-30
Northgate Blvd......... Sacramento, CA 1,710 5,071 6,781 323 1/1/97 5-30
Camino Del Rio S....... San Diego, CA 930 2,606 3,536 168 1/1/97 5-30
Uplander............... Culver City, CA 3,252 9,049 12,301 594 1/1/97 5-30
University............. Tempe, AZ 2,160 5,824 7,984 407 1/1/97 5-30
E. 28th Street......... Signal Hill, CA 1,500 3,872 5,372 261 1/1/97 5-30
W. Main................ Mesa, AZ 675 1,747 2,422 116 1/1/97 5-30
S. Edward.............. Tempe, AZ 645 1,821 2,466 139 1/1/97 5-30
Leapwood Ave........... Carson, CA 990 2,883 3,873 184 1/1/97 5-30
Downtown Center........ Nashville, TN 660 1,935 2,595 118 1/1/97 5-30
Airport South.......... Nashville, TN 660 1,753 2,413 111 1/1/97 5-30
Great Oaks............. Woodbridge, VA 1,350 3,507 4,857 228 1/1/97 5-30
W. Concord Cir......... Broken Arrow, OK 840 2,269 3,109 138 1/1/97 5-30
John Barrow............ Little Rock, AR 780 2,065 2,845 136 1/1/97 5-30
S. Peoria.............. Tulsa, OK 375 977 1,352 63 1/1/97 5-30
Ventura Blvd. II....... Studio City, CA 621 1,692 2,313 109 1/1/97 5-30
Largo 95............... Largo, MD 3,085 7,721 10,806 349 9/24/97 5-30
Gunston................ Lorton, VA 4,146 17,880 22,026 519 6/17/98 5-30
</TABLE>

F-20
<PAGE>

PS BUSINESS PARKS, INC.
SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION
DECEMBER 31, 1998
(DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>
Cost
Capitalized
Subsequent to
Initial Cost to Company Acquisition
---------------------------------------

Buildings Buildings
and and
Description Location Encumbrances Land Improvements Improvements
- ------------------------ ---------------- -------------- ----------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Canada................. Lake Forest, CA - 2,037 19,562 177
Ridge Route............ Laguna Hills, CA - 16,261 34,587 308
Lake Forest Commerce... Laguna Hills, CA - 5,508 2,364 49
Park...................
Buena Park Industrial.. Buena Park, CA - 3,245 9,599 491
Center.................
Cerritos Business Cerritos, CA - 4,218 11,628 146
Center.................
Parkway Commerce Center Hayward, CA - 4,398 9,062 174
Northpointe E.......... Sterling, VA - 1,156 2,957 58
Ammendale.............. Beltsville, MD - 4,278 18,380 355
Centrepointe........... Landover, MD 8,905 3,801 16,708 46
Shaw Road.............. Sterling, VA 5,416 2,969 10,008 86
Creekside-Phase 1...... Beaverton, OR - 4,519 13,651 9
Creekside-Phase 2 Beaverton, OR - 832 2,542 2
Bldg-4.................
Creekside-Phase 2 Beaverton, OR - 521 1,603 -
Bldg-5.................
Creekside-Phase 2 Beaverton, OR - 1,326 4,035 3
Bldg-1.................
Creekside-Phase 3...... Beaverton, OR - 1,353 4,101 2
Creekside-Phase 5...... Beaverton, OR - 1,741 5,301 16
Creekside-Phase 6...... Beaverton, OR - 2,616 7,908 27
Creekside-Phase 7...... Beaverton, OR - 3,293 9,938 6
Creekside-Phase 8...... Beaverton, OR - 1,140 3,644 2
Woodside-Phase 1....... Beaverton, OR - 2,987 8,982 39
Woodside-Phase 2 Bldg-6 Beaverton, OR - 255 785 22
Woodside-Phase 2 Beaverton, OR - 2,102 6,387 20
Bldg-7&8...............
Woodside-Sequent 1..... Beaverton, OR - 2,890 8,672 13
Woodside-Sequent 5..... Beaverton, OR - 3,093 9,280 1
Northpointe G.......... Sterling, VA 1,939 824 2,965 -
Spectrum 95............ Landover, MD - 1,610 7,129 127
Las Plumas............. San Jose, CA - 4,379 12,889 -
So. Shaver............. Pasadena, TX - 464 1,184 54
Lamar Boulevard........ Austin, TX - 2,528 6,596 741
N. Barker's Landing.... Houston, TX - 1,140 3,003 324
One Park Ten........... San Antonio, TX - 1,500 4,266 1,237
Park Terrace........... San Antonio, TX - 360 987 131
La Prada............... Mesquite, TX - 495 1,235 61
NW Highway............. Garland, TX - 480 1,203 29
</TABLE>
<TABLE>
<CAPTION>
Gross Amount at Which Carried at
December 31, 1998
-------------------------------------
Buildings Depreciable
and Accumulated Date Lives
Description Location Land Improvements Totals Depreciation Acquired (Years)
- ------------------------ ---------------- --------- -------------- ----------- ------------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Canada................. Lake Forest, CA 2,037 19,739 21,776 172 12/23/97 5-30
Ridge Route............ Laguna Hills, CA 16,261 34,895 51,156 1,334 12/23/97 5-30
Lake Forest Commerce... Laguna Hills, CA 5,508 2,413 7,921 437 12/23/97 5-30
Park...................
Buena Park Industrial.. Buena Park, CA 3,245 10,090 13,335 284 12/23/97 5-30
Center.................
Cerritos Business Cerritos, CA 4,218 11,774 15,992 344 12/23/97 5-30
Center.................
Parkway Commerce Center Hayward, CA 4,398 9,236 13,634 353 12/23/97 5-30
Northpointe E.......... Sterling, VA 1,156 3,015 4,171 114 12/10/97 5-30
Ammendale.............. Beltsville, MD 4,278 18,735 23,013 1,099 1/13/98 5-30
Centrepointe........... Landover, MD 3,801 16,754 20,555 761 3/20/98 5-30
Shaw Road.............. Sterling, VA 2,969 10,094 13,063 506 3/9/98 5-30
Creekside-Phase 1...... Beaverton, OR 4,519 13,660 18,179 534 5/4/98 5-30
Creekside-Phase 2 Beaverton, OR 832 2,544 3,376 98 5/4/98 5-30
Bldg-4.................
Creekside-Phase 2 Beaverton, OR 521 1,603 2,124 62 5/4/98 5-30
Bldg-5.................
Creekside-Phase 2 Beaverton, OR 1,326 4,038 5,364 157 5/4/98 5-30
Bldg-1.................
Creekside-Phase 3...... Beaverton, OR 1,353 4,103 5,456 160 5/4/98 5-30
Creekside-Phase 5...... Beaverton, OR 1,741 5,317 7,058 208 5/4/98 5-30
Creekside-Phase 6...... Beaverton, OR 2,616 7,935 10,551 313 5/4/98 5-30
Creekside-Phase 7...... Beaverton, OR 3,293 9,944 13,237 389 5/4/98 5-30
Creekside-Phase 8...... Beaverton, OR 1,140 3,646 4,786 142 5/4/98 5-30
Woodside-Phase 1....... Beaverton, OR 2,987 9,021 12,008 353 5/4/98 5-30
Woodside-Phase 2 Bldg-6 Beaverton, OR 255 807 1,062 34 5/4/98 5-30
Woodside-Phase 2 Beaverton, OR 2,102 6,407 8,509 254 5/4/98 5-30
Bldg-7&8...............
Woodside-Sequent 1..... Beaverton, OR 2,890 8,685 11,575 342 5/4/98 5-30
Woodside-Sequent 5..... Beaverton, OR 3,093 9,281 12,374 366 5/4/98 5-30
Northpointe G.......... Sterling, VA 824 2,965 3,789 88 6/11/98 5-30
Spectrum 95............ Landover, MD 1,610 7,256 8,866 110 9/30/98 5-30
Las Plumas............. San Jose, CA 4,379 12,889 17,268 - 12/31/98 5-30
So. Shaver............. Pasadena, TX 464 1,238 1,702 85 1/1/97 5-30
Lamar Boulevard........ Austin, TX 2,528 7,337 9,865 455 1/1/97 5-30
N. Barker's Landing.... Houston, TX 1,140 3,327 4,467 222 1/1/97 5-30
One Park Ten........... San Antonio, TX 1,500 5,503 7,003 311 1/1/97 5-30
Park Terrace........... San Antonio, TX 360 1,118 1,478 76 1/1/97 5-30
La Prada............... Mesquite, TX 495 1,296 1,791 87 1/1/97 5-30
NW Highway............. Garland, TX 480 1,232 1,712 83 1/1/97 5-30
</TABLE>
F-21
<PAGE>
PS BUSINESS PARKS, INC.
SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION
DECEMBER 31, 1998
(DOLLARS IN THOUSANDS)

<TABLE>
<CAPTION>
Cost
Capitalized
Subsequent to
Initial Cost to Company Acquisition
---------------------------------------

Buildings Buildings
and and
Description Location Encumbrances Land Improvements Improvements
- ------------------------ ---------------- -------------- ----------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Quail Valley........... Missouri City, TX - 360 918 53
Business Parkway I..... Richardson, TX - 759 3,371 42
The Summit............. Plano, TX - 1,536 6,654 116
Northgate II........... Dallas, TX - 1,274 5,505 548
Empire Commerce........ Dallas, TX - 305 1,545 -
Royal Tech - Digital... Las Colinas, TX - 319 1,393 1
Royal Tech - Springwood Las Colinas, TX - 894 3,824 -
Royal Tech - Regent.... Las Colinas, TX - 606 2,615 -
Royal Tech - Bldg 7.... Las Colinas, TX - 246 1,061 1
Royal Tech - NFTZ...... Las Colinas, TX - 1,517 6,499 1
Royal Tech - Olympus... Las Colinas, TX - 1,060 4,531 1
Royal Tech - Honeywell. Las Colinas, TX - 548 2,347 -
Royal Tech - Bldg 12... Las Colinas, TX - 1,466 6,263 1
Royal Tech - Bldg 13... Las Colinas, TX - 955 4,080 1
Royal Tech - Bldg 14... Las Colinas, TX - 2,010 10,242 -
Business Parkway II.... Richardson, TX - 40 196 1
Royal Tech - Bldg 15... Irving, TX - 1,307 5,600 163
Ben White 1............ Austin, TX 1,751 789 3,571 -
Ben White 5............ Austin, TX 1,673 761 3,444 -
McKalla 3.............. Austin, TX 1,701 662 2,994 -
McKalla 4.............. Austin, TX 1,479 749 3,390 -
Mopac 6................ Austin, TX 811 307 1,390 -
Rutland 14............. Austin, TX 1,257 535 2,422 -
Monroe Business Center. Herndon, VA - 5,926 13,944 460
B & O.................. Baltimore, MD - 4,067 9,522 547
Lusk II-R&D............ San Diego, CA - 1,081 2,644 59
Lusk II-Office......... San Diego, CA - 1,229 3,005 171
Norris Cn-Office....... San Ramon, CA - 792 1,938 82
Norris Cn-R&D.......... San Ramon, CA - 696 1,703 71
Northpointe D.......... Sterling, VA 1,691 787 2,883 -
Kearny Mesa-Office..... San Diego, CA - 790 1,933 104
Kearny Mesa-R&D........ San Diego, CA - 2,108 5,156 86
Bren Mar-Office........ Alexandria, VA - 573 1,401 323
Lusk III............... San Diego, CA - 1,906 4,662 160
Bren Mar-R&D........... Alexandria, VA - 1,627 3,979 44
Alban Road-Office...... Springfield, VA - 989 2,418 344
Alban Road-R&D......... Springfield, VA - 944 2,315 96

-------------- ----------- ------------- -------------
$38,041 $176,241 $522,041 $14,656
============== =========== ============= =============
</TABLE>
<TABLE>
<CAPTION>

Gross Amount at Which Carried at
December 31, 1998
-----------------------------------------
Buildings Depreciable
and Accumulated Date Lives
Description Location Land Improvements Totals Depreciation Acquired (Years)
- ------------------------ ---------------- ----------- -------------- ----------- ------------ ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Quail Valley........... Missouri City, TX 360 971 1,331 68 1/1/97 5-30
Business Parkway I..... Richardson, TX 759 3,413 4,172 136 5/4/98 5-30
The Summit............. Plano, TX 1,536 6,770 8,306 274 5/4/98 5-30
Northgate II........... Dallas, TX 1,274 6,053 7,327 240 5/4/98 5-30
Empire Commerce........ Dallas, TX 305 1,545 1,850 56 5/4/98 5-30
Royal Tech - Digital... Las Colinas, TX 319 1,394 1,713 53 5/4/98 5-30
Royal Tech - Springwood Las Colinas, TX 894 3,824 4,718 148 5/4/98 5-30
Royal Tech - Regent.... Las Colinas, TX 606 2,615 3,221 100 5/4/98 5-30
Royal Tech - Bldg 7.... Las Colinas, TX 246 1,062 1,308 41 5/4/98 5-30
Royal Tech - NFTZ...... Las Colinas, TX 1,517 6,500 8,017 250 5/4/98 5-30
Royal Tech - Olympus... Las Colinas, TX 1,060 4,532 5,592 175 5/4/98 5-30
Royal Tech - Honeywell. Las Colinas, TX 548 2,347 2,895 90 5/4/98 5-30
Royal Tech - Bldg 12... Las Colinas, TX 1,466 6,264 7,730 242 5/4/98 5-30
Royal Tech - Bldg 13... Las Colinas, TX 955 4,081 5,036 158 5/4/98 5-30
Royal Tech - Bldg 14... Las Colinas, TX 2,010 10,242 12,252 400 5/4/98 5-30
Business Parkway II.... Richardson, TX 40 197 237 6 5/4/98 5-30
Royal Tech - Bldg 15... Irving, TX 1,307 5,763 7,070 76 11/4/98 5-30
Ben White 1............ Austin, TX 789 3,571 4,360 - 12/31/98 5-30
Ben White 5............ Austin, TX 761 3,444 4,205 - 12/31/98 5-30
McKalla 3.............. Austin, TX 662 2,994 3,656 - 12/31/98 5-30
McKalla 4.............. Austin, TX 749 3,390 4,139 - 12/31/98 5-30
Mopac 6................ Austin, TX 307 1,390 1,697 - 12/31/98 5-30
Rutland 14............. Austin, TX 535 2,422 2,957 - 12/31/98 5-30
Monroe Business Center. Herndon, VA 5,926 14,404 20,330 877 8/1/97 5-30
B & O.................. Baltimore, MD 4,067 10,069 14,136 594 8/1/97 5-30
Lusk II-R&D............ San Diego, CA 1,081 2,703 3,784 73 3/17/98 5-30
Lusk II-Office......... San Diego, CA 1,229 3,176 4,405 89 3/17/98 5-30
Norris Cn-Office....... San Ramon, CA 792 2,020 2,812 57 3/17/98 5-30
Norris Cn-R&D.......... San Ramon, CA 696 1,774 2,470 49 3/17/98 5-30
Northpointe D.......... Sterling, VA 787 2,883 3,670 94 6/11/98 5-30
Kearny Mesa-Office..... San Diego, CA 790 2,037 2,827 57 3/17/98 5-30
Kearny Mesa-R&D........ San Diego, CA 2,108 5,242 7,350 141 3/17/98 5-30
Bren Mar-Office........ Alexandria, VA 573 1,724 2,297 54 3/17/98 5-30
Lusk III............... San Diego, CA 1,906 4,822 6,728 128 3/17/98 5-30
Bren Mar-R&D........... Alexandria, VA 1,627 4,023 5,650 106 3/17/98 5-30
Alban Road-Office...... Springfield, VA 989 2,762 3,751 81 3/17/98 5-30
Alban Road-R&D......... Springfield, VA 944 2,411 3,355 68 3/17/98 5-30

----------- ------------- ----------- -------------
$176,241 $536,697 $712,938 $22,517
=========== ============= =========== =============
</TABLE>

F-22
<PAGE>

PS BUSINESS PARKS, INC.
SCHEDULE III - REAL ESTATE AND ACCUMULATED DEPRECIATION
DECEMBER 31, 1998

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

<TABLE>
<CAPTION>
Reconciliation of real estate:

Years Ended December 31,
----------------------------------------------------
1998 1997 1996
------------- -------------- ----------------
<S> <C> <C> <C>
Balance at beginning of period...... $ 318,220,000 $ - $ -
Additions during period:
Acquisitions...................... 378,321,000 314,655,000 -
Additional costs relating to
prior year's acquisitions...... 5,306,000 - -
Improvements...................... 11,091,000 3,565,000 -
------------- -------------- ----------------
Balance at close of period.......... $ 712,938,000 $ 318,220,000 $ -
============= ============== ================

Reconciliation of accumulated depreciation:

Years Ended December 31,
---------------------------------------------------
1998 1997 1996
------------- -------------- ----------------
Balance at beginning of period...... $ 3,982,000 $ - $ -
Additions during period:
Depreciation...................... 18,535,000 3,982,000 -
------------- -------------- ----------------
Balance at close of period.......... $ 22,517,000 $ 3,982,000 $ -
============= ============== ================
</TABLE>

Real estate for Federal income tax purposes was approximately $676,186,000
(unaudited), net of accumulated depreciation of $159,842,000 (unaudited).

F-23

<TABLE>
<CAPTION>
For the Period For the Period
For the Year April 1 January 1 For the Year
Emded through through Ended
December 31, December 31, March 31, December 31,
-------------- -------------- --------------- --------------
BASIC AND DILUTED EARNINGS PER SHARE: 1998 1997 1997 1996
-------------- -------------- --------------- --------------
<S> <C> <C> <C> <C>
Net income and net income allocable to
common shareholders (same for Basic and
Diluted computations).................................. $ 29,400,000 $ 3,154,000 $ 682,000 $ 303,000
============== ============== =============== ==============

Weighted average common shares outstanding:

Basic weighted average common shares outstanding....... 19,361,000 3,414,000 2,193,000 947,000
Net effect of dilutive stock options - based on treasury
stock method using average market price.............. 68,000 12,000 - -
-------------- -------------- --------------- --------------

Diluted weighted average common shares outstanding..... 19,429,000 3,426,000 2,193,000 947,000
============== ============== =============== ==============

Basic earnings per common share........................... $ 1.52 $ 0.92 $ 0.31 $ 0.32
============== ============== =============== ==============
Diluted earnings per common share......................... $ 1.51 $ 0.92 $ 0.31 $ 0.32
============== ============== =============== ==============
</TABLE>

Years Ended December 31,
----------------------------------------------------------------------------
1998 1997 1996 1995 1994
------------ ------------- ------------- ------------- -------------
<S> <C> <C> <C> <C> <C>
Net income before taxes............ $ 29,400,000 $ 3,836,000 $ 519,000 $ 1,192,000 $ 1,245,000
Minority interest.................. 11,208,000 8,566,000 - - -
Interest expense................... 2,361,000 1,000 - - -
------------ ------------- ------------- ------------- -------------
Earnings available to cover fixed
charges......................... $ 42,969,000 $ 12,403,000 $ 519,000 $ 1,192,000 $ 1,245,000
============ ============= ============= ============= =============

Fixed charges (1).................. $ 2,629,000 $ 1,000 $ - $ - $ -
============ ============= ============= ============= =============

Ratio of earnings to fixed charges. 16.34 12,403 N/A N/A N/A
============ ============= ============= ============= =============

Supplemental disclosure of Ratio of Funds from Operations ("FFO") to fixed
charges:

Years Ended December 31,
----------------------------------------------------------------------------
1998 1997 1996 1995 1994
------------ ------------- ------------- ------------- -------------
FFO................................ $ 57,430,000 $ 17,597,000 $ 303,000 $ 720,000 $ 757,000
Interest expense................... 2,361,000 1,000 - - -
------------ ------------- ------------- ------------- -------------
Adjusted FFO available
to cover fixed charges.......... $ 59,791,000 $ 17,598,000 $ 303,000 $ 720,000 $ 757,000
============ ============= ============= ============= =============

Fixed charges (1).................. $ 2,629,000 $ 1,000 $ - $ - $ -
============ ============= ============= ============= =============

Ratio of FFO to fixed charges...... 22.74 17,598 N/A N/A N/A
============ ============= ============= ============= =============

(1) Fixed charges include interest expense plus capitalized interest.
</TABLE>

We consent to the incorporation by reference in the Registration Statement on
Form S-8 (No. 333-48313) of PS Business Parks, Inc. pertaining to the PS
Business Parks, Inc. 1997 Stock Option and Incentive Plan, and the Registration
Statement on Form S-3 (No. 333-50463) and the related prospectus of our report
dated February 2, 1999 with respect to the consolidated financial statement and
schedule of PS Business Parks, Inc. included in the Annual Report (Form 10-K)
for 1998 filed with the Securities and Exchange Commission.

/s/ ERNST & YOUNG LLP

Los Angeles, California
March 10, 1999

<ARTICLE> 5
<CIK> 0000866368
<NAME> PS Business Parks, Inc.
<MULTIPLIER> 1
<CURRENCY> U.S.$

<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-1-1998
<PERIOD-END> DEC-31-1998
<EXCHANGE-RATE> 1
<CASH> 6,068,000
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 6,068,000
<PP&E> 712,938,000
<DEPRECIATION> (22,517,000)
<TOTAL-ASSETS> 709,414,000
<CURRENT-LIABILITIES> 15,953,000
<BONDS> 0
0
0
<COMMON> 236,000
<OTHER-SE> 489,669,000
<TOTAL-LIABILITY-AND-EQUITY> 709,414,000
<SALES> 0
<TOTAL-REVENUES> 90,260,000
<CGS> 0
<TOTAL-COSTS> 26,150,000
<OTHER-EXPENSES> 21,141,000
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 2,361,000
<INCOME-PRETAX> 29,400,000
<INCOME-TAX> 0
<INCOME-CONTINUING> 29,400,000
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 29,400,000
<EPS-PRIMARY> 1.52
<EPS-DILUTED> 1.51

</TABLE>

EXHIBIT 99.1

RISK FACTORS

CONTROL AND INFLUENCE BY PSI

At May 15, 1998, PSI owned 26.4% of the outstanding shares of Common Stock
(47.2% upon conversion of PSI's interest in the Operating Partnership).
Consequently, PSI has the ability to effectively control all matters submitted
to a vote of Shareholders, including the election of directors, amendment of the
Company's articles of incorporation, dissolution and the approval of other
extraordinary transactions. In addition, this concentration of ownership may
have the effect of delaying or preventing a change in control of the Company.

PSI and an institutional Shareholder owning 28.4% of the Common Stock as of
May 15, 1998 have agreed to vote their respective shares of Common Stock to
support specified nominees to the Board of Directors until the expiration of the
voting agreement, which would not be earlier than December 2001. This voting
agreement will further enhance PSI's control of the Company.

OWNERSHIP LIMITATIONS AND ANTITAKEOVER PROVISIONS

The Company's articles of incorporation restrict the number of shares that
may be owned by any other person and the partnership agreement of the Operating
Partnership (the "Partnership Agreement") contains an anti-takeover provision.
Unless the restrictions in the articles of incorporation are waived by the Board
of Directors, no Shareholder (other than PSI and certain other specified, and
categories of, Shareholders) may own more than 2% of the outstanding shares of
Common Stock. The principal purpose of the foregoing limitations is to assist in
preventing, to the extent practicable, a concentration of ownership that might
jeopardize the ability of the Company to obtain the favorable tax benefits
afforded a qualified REIT. An incidental consequence of such provisions is to
make a change of control significantly more difficult (if not impossible) even
if it would be favorable to the interests of the public Shareholders. Such
provisions may prevent future takeover attempts which the Board of Directors has
not approved even if a majority of the Shareholders deem it to be in their best
interests or in which the Shareholders would receive a premium for their shares
over the then market value. See "Description of Common Stock-Ownership
Limitations".

The Board of Directors is authorized, without Shareholder approval, to
issue up to 50,000,000 shares of Preferred Stock and up to 100,000,000 shares of
Equity Stock, in each case in one or more series. Each series of Preferred Stock
or Equity Stock shall have such rights, preferences, privileges and restrictions
as may be determined by the Board of Directors. The Board would be authorized to
establish a class or series of shares that could delay, defer or prevent a
transaction or a change in control of the Company that might involve a price for
the Common Stock or other attributes which the Shareholders may consider to be
desirable. The articles of incorporation and bylaws of the Company also contain
other provisions that may have the effect of delaying, deferring or preventing a
transaction or a change in control of the Company that might involve a price for
the Common Stock or other attributes that the Shareholders may consider to be
desirable. The Company also may cause the Operating Partnership to offer
additional units in the Operating Partnership in exchange for property or
otherwise.

The Partnership Agreement provides that the Company may not generally
engage in a business consolidation unless the limited partners of the Operating
Partnership are entitled to receive the same proportionate consideration as
holders of Common Stock. In addition, the Company will not engage in a business
combination unless the transaction would have been approved had the limited
partners of the Operating Partnership been able to vote together with the
Shareholders. As a result of these provisions, the Company may be precluded from
engaging in a proposed business combination.

<PAGE>

RISKS RELATING TO THE OPERATING PARTNERSHIP

Limited partners of the Operating Partnership (including PSI and its
affiliates) have the right to vote on certain amendments to the Partnership
Agreement. These voting rights may be exercised in a manner that conflicts with
the interests of the Shareholders. Also, the Company, as the general partner of
the Operating Partnership, has fiduciary duties to the limited partners, the
discharge of which may conflict with interests of the Shareholders.

PSI'S CONSENT TO CERTAIN PROPERTY SALES

Prior to 2007, the Company is restricted from selling in a taxable
transaction any of 13 designated properties without PSI's consent. Since PSI
would incur adverse tax consequences upon a sale of these properties, there may
be a conflict between the interests of PSI and the other Shareholders as to the
optimum time to sell these properties.

CERTAIN INSTITUTIONAL INVESTORS HAVE SPECIAL RIGHTS

Certain institutional investors have rights in the Company, such as the
right to approve nominees to the Company's Board of Directors, the right to
purchase securities offered by the Company in certain circumstances and the
right to require registration of their shares, not available to public
Shareholders.

FEDERAL INCOME TAX RISKS

REDUCED CASH FLOW TO SHAREHOLDERS IF THE COMPANY FAILED TO QUALIFY AS A
REIT. The Company believes that commencing with its taxable year ended December
31, 1990, it has been organized and has operated in such a manner so as to
qualify for taxation as a REIT under the Code, and that its proposed method of
operation will enable it to continue to meet the requirements for qualification
and taxation as a REIT. The Company's qualification and taxation as a REIT
depend upon both (i) the satisfaction in the past by AOPP of the requirements
for qualification and taxation as a REIT and (ii) the Company's ability to meet
on a continuing basis, through actual annual operating and other results, the
various requirements under the Code with regard to, among other things, the
sources of its gross income, the composition of its assets, the level of its
distributions to Shareholders and the diversity of its stock ownership. Although
management believes that the Company has been and will continue to be organized
and has been and will continue to be operated in such a manner as to qualify as
a REIT, no assurance can be given that the actual results of the operations of
the Company and AOPP, the sources of their income, the nature of their assets,
the level of their distributions to Shareholders and the diversity of their
share ownership for any given taxable year in the past or in the future will
satisfy the requirements under the Code for qualification and taxation as a
REIT. In this regard, the stock ownership limits set forth in the Company's
articles of incorporation do not necessarily ensure that the Company will be
able to satisfy the requirement that it not be "closely held" for any given
taxable year. For any taxable year that the Company fails to qualify as a REIT
and the relief provisions do not apply, the Company would be taxed at the
regular corporate rates on all of its taxable income, whether or not it makes
any distributions to its Shareholders. Those taxes would reduce the amount of
cash available to the Company for distribution to its Shareholders or for
reinvestment. As a result, failure of the Company to qualify during any taxable
year as a REIT could have a material adverse effect upon the Company and its
Shareholders. Furthermore, unless certain relief provisions apply, the Company
would not be eligible to elect REIT status again until the fifth taxable year
that begins after the first year for which the Company fails to qualify.

REDUCED CASH FLOW TO SHAREHOLDERS IF AOPP FAILED TO QUALIFY AS A REIT. AOPP
elected to qualify for taxation as a REIT effective for its tax year ended 1997.
The Company and AOPP believe that AOPP was organized and operated until the time
of the Merger in conformity with the requirements for taxation as a REIT. If,
for any reason, the IRS were subsequently to determine that AOPP failed to meet
the requirements for REIT status, AOPP could lose its REIT qualification,
causing the Company to lose its REIT qualification for the year of the Merger
and for subsequent years. Among other requirements, a REIT is not permitted to
have at the end of any taxable year any undistributed earnings and profits that
are attributable to a "C corporation" taxable year. AOPP was taxable as a "C

<PAGE>

corporation" prior to 1997, and believes that at the end of 1996 it did not have
any undistributed "C corporation" earnings and profits. However, neither AOPP
nor the Company has sought an opinion of counsel or outside accountants to the
effect that there are no "C corporation earnings and profits" at that time or as
a result of the Merger or to the effect that AOPP otherwise qualified for
taxation as a REIT.

BORROWINGS MAY BE REQUIRED TO MEET REIT MINIMUM DISTRIBUTION REQUIREMENTS;
POSSIBLE INCURRENCE OF ADDITIONAL DEBT. In order to qualify as a REIT, the
Company generally will be required each year to distribute to the Shareholders
at least 95% of its net taxable income (excluding any net capital gain). In
addition, the Company will be subject to a 4% nondeductible excise tax on the
amount, if any, by which certain distributions paid by it with respect to any
calendar year are less than the sum of (i) 85% of its ordinary income for that
year, (ii) 95% of its capital gain net income for that year, and (iii) 100% of
its undistributed taxable income from prior years. The Company intends to make
distributions to the Shareholders to comply with the 95% distribution
requirement and to avoid the nondeductible excise tax. The Company's income will
consist primarily of its share of the income of the Operating Partnership, and
the cash available for distribution by the Company to its Shareholders will
consist primarily of its share of cash distributions from the Operating
Partnership. Differences in timing between the actual receipt of income and
actual payment of deductible expenses and the inclusion of such income and
deduction of such expenses in arriving at taxable income of the Company or the
possible need to make nondeductible payments, such as principal payments on any
indebtedness, could require the Company to borrow funds on a short-term (or
possibly long-term) basis to meet the 95% distribution requirement and to avoid
the nondeductible excise tax.

VALUE OF INVESTMENT REDUCED BY GENERAL RISKS OF REAL ESTATE OWNERSHIP

GENERAL REAL ESTATE RISKS. The Company owns and operates commercial
properties and is subject to the risks of ownership of real estate-related
assets generally and of ownership of commercial properties in particular. These
risks include (i) the national, state and local economic climate and real estate
conditions (such as oversupply of or reduced demand for space and changes in
market rental rates), (ii) the perceptions of prospective tenants of the
attractiveness, convenience and safety of the Company's properties, (iii) the
ability of the Company to provide adequate management, maintenance and
insurance, (iv) the Company's ability to collect all rent from tenants on a
timely basis, (v) the expense of periodically renovating, repairing and
reletting spaces and (vi) increasing operating costs (including real estate
taxes and utilities) to the extent that such increased costs cannot be passed
through to tenants, (vi) changes in tax, real estate and zoning laws. Certain
significant costs associated with investments in real estate (such as mortgage
payments, real estate taxes, insurance and maintenance costs) generally are not
reduced when circumstances cause a reduction in rental revenues from a property
and vacancies result in loss of the ability to receive tenant reimbursements of
operating costs customarily borne by commercial real estate tenants. In
addition, real estate values and income from properties are also affected by
such factors as compliance with laws applicable to real property, including
environmental and tax laws, interest rate levels and the availability of
financing. Furthermore, the amount of available rental square feet of commercial
property is often affected by market conditions and may therefore fluctuate over
time.

If the Company's properties do not generate revenue sufficient to meet
operating expenses, including any debt service, tenant improvements, leasing
commissions and other capital expenditures, the Company may have to borrow
additional amounts to cover fixed costs, and the Company's cash available for
distribution and ability to make expected distributions to its Shareholders will
be adversely affected.

RECENT ACQUISITIONS. The Company recently has acquired a significant
portion (at May 15, 1998, 41 properties containing approximately 5,600,000
square feet of space) of its overall portfolio. In addition, the Company
anticipates that it will continue to acquire commercial properties in the
future. Newly acquired properties may have characteristics or deficiencies
unknown to the Company affecting their valuation or revenue potential, and the
operating performance of these properties may therefore be less than anticipated
or may decline. As the Company acquires additional properties, the Company will
be subject to risks associated with managing new properties, including lease-up
and tenant retention. In addition, the Company's ability to manage its growth
effectively will require it to successfully integrate its new acquisitions into
its existing management structure.

<PAGE>

LEASE EXPIRATIONS. The Company is subject to the risk that, upon
expiration, leases may not be renewed, the space may not be relet, or the terms
of renewal or reletting (including the cost of required renovations) may be less
favorable than the current lease terms. Certain leases pertaining to the
Company's properties grant their tenants early termination rights upon payment
of a termination penalty. The Company has estimated the expenditures for new and
renewal leases for 1998 but no assurances can be given that the Company has
correctly estimated such expenses. Lease expirations will require the Company to
locate new tenants and negotiate replacement leases with such tenants.
Replacement leases typically require the Company to incur tenant improvements,
other tenant inducements and leasing commissions, in each case, which may be
higher than the costs relating to renewal leases. If the Company is unable to
promptly relet or renew leases for all or a substantial portion of expiring
space, if the rental rates upon such renewal or reletting are significantly
lower than expected or if the Company's reserves for these purposes prove
inadequate, the Company's cash available for distribution and ability to make
expected distributions to Shareholders could be adversely affected.

FINANCIALLY DISTRESSED TENANTS. In the event of any lease default by a
tenant, the Company may experience delays in enforcing its rights as a landlord
and may incur substantial costs in protecting its investment. In addition, at
any time, a tenant of one of the Company's properties may seek the protection of
bankruptcy laws, which could result in the rejection and termination of such
tenant's lease and thereby cause a reduction in cash available for distribution
to Shareholders.

SIGNIFICANT COMPETITION AMONG COMMERCIAL PROPERTIES. Numerous commercial
properties compete with the Company's properties in attracting tenants to lease
space and additional properties can be expected to be built in the markets in
which the Company's properties are located. The number and quality of
competitive commercial properties in a particular area will have a material
effect on the Company's ability to lease space at the properties or at newly
acquired properties and on the rents charged. Some of these competing properties
may be newer or better located than the Company's properties. In addition, the
commercial real estate market has become highly competitive. There are a
significant number of buyers of commercial properties, including other
publicly-traded commercial REITs, many of which have significant financial
resources. This has resulted in increased competition in acquiring attractive
commercial properties. Accordingly, it is possible that the Company may not be
able to meet its desired level of property acquisitions due to such competition
or other factors which may have an adverse effect on the Company's expected
growth in 1998 and subsequent years.

UNINSURED LOSSES

The Company carries insurance with respect to its properties with policy
terms and conditions customarily carried for similar properties. No assurance
can be given, however, that material losses in excess of insurance proceeds will
not occur in the future which would adversely affect the business of the Company
and its financial condition and results of operations. In addition, certain
types of losses are, or may become, uninsurable, not fully insurable or
economically insurable. Should an uninsured loss or a loss in excess of insured
limits occur, the Company could lose its capital invested in a property, as well
as the anticipated future revenue from such property, and would continue to be
obligated on any mortgage indebtedness or other obligations related to the
property.

POSSIBLE ADVERSE EFFECTS OF ILLIQUIDITY OF REAL ESTATE INVESTMENTS

Equity real estate investments are relatively illiquid. Such illiquidity
will tend to limit the ability of the Company to vary its portfolio promptly in
response to changes in economic or other conditions. In addition, the Code
limits the ability of a REIT to sell properties held for fewer than four years,
which may affect the Company's ability to sell properties without adversely
affecting returns to Shareholders.

REDUCED PROPERTY INCOME FROM CHANGES IN LAWS

Because increases in income and service taxes are generally not passed
through to tenants under leases, such increases may adversely affect the
Company's cash flow and its ability to make expected distributions to

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Shareholders. The Company's properties are also subject to various federal,
state, and local regulatory requirements, such as requirements of the state and
local fire and safety requirements. Failure to comply with these requirements
could result in the imposition of fines by governmental authorities or awards of
damages to private litigants. The Company believes that the Company's properties
are currently in material compliance with all such requirements. However, there
can be no assurance that these requirements will not change or that new
requirements will not be imposed which would require significant unanticipated
expenditures by the Company and could have an adverse effect on the Company's
cash flow and ability to make distributions.

ADVERSE EFFECT OF POSSIBLE ADDITIONAL COSTS OF COMPLIANCE WITH AMERICANS WITH
DISABILITIES ACT ON CASH FLOW AND DISTRIBUTIONS

Under the Americans with Disabilities Act of 1990 (the "ADA"), all public
accommodations and commercial facilities are required to meet certain federal
requirements related to access and use by disabled persons. Existing commercial
properties generally are exempt from the provisions of the ADA but may be
subject to provisions requiring that buildings be made accessible to people with
disabilities. Compliance with the ADA requirements could require removal of
access barriers, and non-compliance could result in imposition of fines by the
U.S. government or an award of damages to private litigants. While the amounts
of such compliance costs, if any, are not currently ascertainable, they are not
expected to have a material effect on the Company.

LACK OF CONTROL OF PROPERTIES BY THE COMPANY RESULTING FROM PARTNERSHIP AND
JOINT VENTURE PROPERTY OWNERSHIP STRUCTURES

The Company owns most of its properties through the Operating Partnership.
In addition, the Company may also participate with other entities in property
ownership through joint ventures or partnerships in the future. Partnership or
joint venture investments may, under certain circumstances, involve risks not
otherwise present, including the possibility that the Company's partners or
co-venturers might become bankrupt, that such partners or co-venturers might at
any time have economic or other business interests or goals which are
inconsistent with the business interests or goals of the Company and that such
partners or co-venturers may be in a position to take action contrary to the
Company's instructions or requests or contrary to the Company's policies or
objectives, including the Company's policy with respect to maintaining its
qualification as a REIT. The Company will, however, seek to maintain sufficient
control of such partnerships or joint ventures to permit the Company's business
objectives to be achieved. There is no limitation under the Company's
organizational documents as to the amount of funds that may be invested in
partnerships or joint ventures.

POSSIBLE ENVIRONMENTAL LIABILITIES

Under various federal, state and local environmental laws, regulations and
ordinances, an owner or operator of real estate interests may be liable for the
costs of cleaning up, as well as certain damages resulting from, past or present
spills, disposals or other releases of hazardous or toxic substances or wastes
on, in or from a property. Certain environmental laws impose such liability
without regard to whether the owner knew of, or was responsible for, the
presence of hazardous or toxic substances or wastes at or from a property. An
owner or operator of real estate or real estate interests also may be liable
under certain environmental laws that govern activities or operations at a
property having adverse environmental effects, such as discharges to air and
water as well as handling and disposal practices for solid and hazardous or
toxic wastes. In some cases, liability may not be limited to the value of the
property. The presence of such substances or wastes, or the failure to properly
remediate any resulting contamination, also may adversely affect the owner's or
operator's ability to sell, lease or operate its property or to borrow using its
property as collateral.

The Company has conducted preliminary environmental assessments of most of
its properties (and the Company intends to conduct such assessments in
connection with future property acquisitions) to evaluate the environmental
condition of, and potential environmental liabilities associated with, such
properties. Such assessments generally consist of an investigation of
environmental conditions at the subject property (not including soil or

<PAGE>

groundwater sampling or analysis), as well as a review of available information
regarding the site and publicly available data regarding conditions at other
sites in the vicinity. The preliminary environmental assessments, including
subsequent procedures where applicable, have not revealed any environmental
liability that the Company believes would have a material adverse effect on the
Company's business, assets or results of operations, nor is the Company aware of
any such material environmental liability. When preliminary environmental
assessments, including subsequent procedures where applicable, have revealed any
potential environmental liability, the Company has obtained an indemnification
from entities which it deems to be creditworthy (including PSI) or established
escrows with funds that would otherwise be payable to sellers of property to
remediate the environmental matter. Nevertheless, it is possible that the
preliminary environmental assessments, relating to the properties do not reveal
all environmental liabilities or that there are material environmental
liabilities of which the Company is unaware. Moreover, there can be no assurance
that (i) future laws, ordinances or regulations will not impose any material
environmental liability or (ii) the current environmental condition of the
properties will not be affected by tenants, by the condition of land or
operations in the vicinity of the properties (such as the presence of
underground storage tanks) or by third parties unrelated to the Company.

POSSIBLE CHANGES IN POLICIES WITHOUT SHAREHOLDER APPROVAL; NO LIMITATION ON DEBT

The Company's investment, financing and distribution policies, and its
policies with respect to all other activities, including growth, capitalization
and operations, will be determined by the Board of Directors. The organizational
documents of the Company do not contain any limitation on the amount of
indebtedness the Company may incur. The amount of indebtedness, and the
Company's other investment, financing and distribution policies, may be changed
by the Board of Directors without a vote of the Shareholders. A change in these
policies, including the Company's level of debt, could adversely affect the
Company's financial condition or results of operations or the market price of
the Common Stock.

DILUTION AND SUBORDINATION

The interest of Shareholders can be diluted through the issuance of
additional securities. If the Company issues Preferred Stock or Equity Stock,
the interest of Shareholders could be subordinated, and if the Company issues
additional Common Stock, the interest of Shareholders could be diluted.

POSSIBLE ADVERSE EFFECT OF MARKET INTEREST RATES ON PRICE OF COMMON STOCK

One of the factors that is expected to influence the market price of the
Common Stock is the annual distribution rate on the Common Stock. An increase in
market interest rates may lead prospective purchasers of the Common Stock to
demand a higher annual distribution rate for future distributions. Such an
increase in the required distribution rate may adversely affect the market price
of the Common Stock.

POSSIBLE ADVERSE EFFECT ON PRICE OF COMMON SHARES OF SHARES AVAILABLE FOR FUTURE
SALE

Sales of a substantial number of shares of Common Stock or other
Securities, or the perception that such sales could occur, could adversely
affect prevailing market prices of the Common Stock or other Securities. Certain
Shareholders hold significant numbers of shares of Common Stock and, subject to
compliance with applicable securities laws, could determine to reduce or
liquidate such holdings through sales in the public markets or otherwise.
Because certain of these shares of Common Stock were sold to the holders thereof
in offerings exempt from the registration provisions of the Securities Act,
resale is restricted for prescribed times and manners pursuant to Rule 144 under
the Securities Act. However, these restrictions lapse at the times and in the
manner specified in such Rule. In addition, certain of the Shareholders whose
shares of Common Stock are subject to restriction on resale under Rule 144 have
certain rights to require that the Company register such shares for offer or
sale to the public.

<PAGE>

DEPENDENCE ON KEY PERSONNEL

The Company is dependent on the efforts of its executive officers,
including Ronald L. Havner, Jr., the Company's chief executive officer and
president, and Mary Jayne Howard, the Company's chief operating officer and
executive vice president. The loss of either of their services may have an
adverse effect on the operations of the Company. The Company maintains no key
person insurance with respect to either of these individuals.