WITH THIS, OUR TENTH ANNUAL REPORT, CAP REIT PROUDLY MARKS A DECADE OF GROWTH, PROFITABILITY AND SATISFIED RESIDENTS

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1 10 WITH THIS, OUR TENTH ANNUAL REPORT, CAP REIT PROUDLY MARKS A DECADE OF GROWTH, PROFITABILITY AND SATISFIED RESIDENTS CAP REIT 2006 ANNUAL REPORT

2 CAP REIT: A GREAT STORY OF SOLID, LONG-TERM VALUE Ten years of steady, stable and consistent growth have resulted in a strong average annual return for Unitholders. ASSETS ($ Thousands) We re enhancing value This is a people business This is about making money Apartments make money Canada s Landlord of Choice 2,000,000 1,750,000 1,500,000 1,250,000 A number of milestones were reached, including meeting and exceeding the financial forecast set out in the prospectus accompanying our Initial Public Offering in May At CAP REIT we have assembled one of the best property management teams in the industry, because providing our residents with attractive, comfortable and secure communities is our top priority. CAP REIT has consistently exceeded its forecasted performance since becoming a publicly held investment trust. Increased cash distributions by 13.8%, added 1,872 rental suites to portfolio (increase of 33%), entered Ottawa and Kitchener markets, increased average monthly rents by 4%, maintaining 99% occupancy, completed two public financings. Achieved total annual return of 24.9%, expanded portfolio by 19%, strengthened position as Landlord of Choice, grew revenues by 30% improved NOI margin by 4% to 54.1%, raised $38.6 million through public offering, introduced new services to residents, launched Distribution Reinvestment Plan ( DRIP ) for Unitholders. Expanded portfolio by 16%, increased revenues by 27%, grew Distributable Income per Unit by 5%, raised $45 million through a successful public offering, improved payout ratio to 88.7%. 1,000, , , ,000

3 HIGHLIGHTS No Vacancy Achieved 85% target payout ratio, expanded portfolio by 22.5%, entered Quebec City and Calgary markets, achieved 98.3% occupancy exceeded NOI margin target of 53% for the fifth consecutive year. It all adds up to experience Implemented eighth increase in monthly cash distributions since IPO, expanded portfolio with accretive acquisition of 867 suites, purchased properties in Halifax, Quebec City, Montreal and London, 97.6% occupancy, exceeded target NOI margin for sixth consecutive year, maintained payout ratio at 85% target level. We re Canada s Landlord of Choice Portfolio doubles with ResREIT Acquisition to 24,132 suites, properties span Canada from coast to coast, added new high quality downtown properties in Toronto and Vancouver became one of Canada s largest owner and operators of apartment properties. We re real estate people 29% increase in revenues, acquired 2,239 suites, average occupancy of 97.4%, sale of non-core properties generated $0.204 per Unit gain, reduced overall leverage ratio and strengthened balance sheet. acquisition and cost controls generate solid accretive growth NOI margin improves to 52% strong 2% NOI growth in stabilized portfolio industry fundamentals continue to improve. CAP REIT 2006 ANNUAL REPORT 1

4 FINANCIAL PERFORMANCE 2006 was another year of solid and accretive growth as we met our expansion and geographic diversification objectives. Year ended December 31, ($ Thousands, except per Unit amounts) Operating Revenues $ 283,704 $ 258,666 Net Operating Income ( NOI ) $ 147,289 $ 133,300 NOI Margin 51.9% 51.5% Discontinued Operations (1) $ $ 11,470 Gain on Property Dispositions $ $ 10,867 Net Income $ 722 $ 12,809 Net Income per Unit Basic $ $ Distributable Income (2) $ 66,160 $ 61,827 Distributable Income per Unit Basic (2) $ $ Distributions Declared per Unit $ $ Payout Ratio 94.1% 93.1% Effective Payout Ratio (2) 81.4% 78.8% Funds From Operations ( FFO ) (2) $ 65,443 $ 61,360 Funds From Operations per Unit Basic (2) $ $ Distributable Income ( DI ) Including Gain on Disposition (2) $ 66,160 $ 72,694 DI per Unit Basic Including Gain on Disposition (2) $ $ Funds From Operations Including Gain on Disposition (2) $ 65,443 $ 72,227 FFO per Unit Basic Including Gain on Disposition (2) $ $ Number of Suites 26,498 25,252 Income Properties (3) $ 1,983,072 $ 1,908,083 Weighted Average Number of Units Basic 56,564,616 53,254,636 (1) Includes gain on discontinued operations of $10,867 in (2) 2005 has been restated to include amortization on tenant improvements. (3) 2005 has been restated to include tenant improvements. 2 CAP REIT 2006 ANNUAL REPORT

5 2005 $ $ $ $ $124.7 Operating Revenues ($ millions) $ $ $52.3 PROFILE 2002 $34.4 $36.0 Canadian Apartment Properties Real Estate Investment Trust ( CAP REIT ) $1.236 $1.257 $1.251 $1.161 $1.170 is a growth-oriented investment trust owning freehold interests in multiunit residential complexes, including apartment buildings and townhouses, located in major urban centres across Canada. Distributable Income (excl. gain) ($ millions) (per Unit) $62.2 OBJECTIVES 2002 $ $ $45.1 $57.6 To provide Unitholders with long-term, stable and predictable monthly cash distributions. To grow Distributable Income, distributions and Unit value through active management of our properties, accretive acquisitions and strong financial management. $1.08 $1.08 $1.08 $1.08 $1.055 Cash Distributions ($ millions) (per Unit) CAP REIT 2006 ANNUAL REPORT 3

6 QUALITY BUILDINGS IN SUPERIOR LOCATIONS CAP REIT s high-quality portfolio is well positioned in major markets from coast to coast. Affordable Mid-tier Luxury 1, VANCOUVER CALGARY EDMONTON REGINA & SASKATOON OTTAWA LONDON / KITCHENER WATERLOO Total suites 879 Total suites 931 Total suites 310 Total suites 241 Total suites 1,527 Total suites 1,482 Occupancy 99.1% Occupancy 98.4% Occupancy 98.7% Occupancy 97.1% Occupancy 99.9% Occupancy 94.9% Average monthly rent $885 Average monthly rent $856 Average monthly rent $830 Average monthly rent $564 Average monthly rent $778 Average monthly rent $762 4 CAP REIT 2006 ANNUAL REPORT

7 TWO NEW ADDITIONS TO THE CAP REIT PORTFOLIO 13, % Faubourg de la Pointe 3793 Rue Le Marie Ste. Foy, Quebec West Park Village 186 Kingsview Blvd. Etobicoke, Ontario The acquisition of a portfolio of luxury apartment buildings in Quebec City containing 607 suites further enhanced our presence in one of Canada s strongest rental markets. The purchase of six apartment buildings and six townhouse complexes in Etobicoke, Ontario totalling 464 suites provides the opportunity to reduce operating costs through operating synergies and economies of scale. 8, % 5,929 4,786 4, % 2,631 2,071 1,600 1, , OUTSIDE GTA GREATER TORONTO AREA ( GTA ) MONTREAL QUEBEC CITY HALIFAX TOTAL Total suites 1,933 Total suites 13,346 Total suites 3,465 Total suites 1,301 Total suites 1,083 Total suites 26,498 Occupancy 97.6% Occupancy 97.0% Occupancy 97.0% Occupancy 97.2% Occupancy 94.8% Occupancy 97.2% Average monthly rent $858 Average monthly rent $1,004 Average monthly rent $641 Average monthly rent $654 Average monthly rent $902 Average monthly rent $886 CAP REIT 2006 ANNUAL REPORT 5

8 REPORT TO UNITHOLDERS 2006 was another year of solid and accretive growth as we met our expansion and geographic diversification objectives. With strengthening fundamentals in our markets, a strong balance sheet and our well-positioned and high-quality property portfolio, we are confident in our ability to generate sustained growth in revenues and cash flows for our Unitholders over the long term. Solid Performance We were pleased with our financial and operating performance in Our growth in revenues and cash flows was primarily due to strategic acquisitions made during the year as we met our growth objectives, strengthening our presence in Montreal, Quebec City and the Greater Toronto Area ( GTA ) and further diversifying the portfolio. We were also very successful in applying our hands-on approach to the apartment business for the benefit of our Unitholders. Our successful sales and marketing strategies, combined with the investments made in improving our properties, resulted in enhanced occupancies and increased average monthly rents across all segments of the portfolio compared to last year. In addition, effective portfolio management and a focus on cost efficiency resulted in an increase in our net operating income margin. Importantly, we produced four consecutive quarters of positive growth in same property net operating income in 2006, a real improvement over the prior two years. These were considerable accomplishments, and a testament to the significant industry experience, hard work and dedication of all our people. Strong Growth With the acquisitions completed during and subsequent to the end of 2006, we further enhanced our strong and diversified asset base and increased our presence in most major Canadian markets. Our focus over the past few years has been, and going forward, will be, on expanding our presence in targeted areas in British Columbia, Alberta and Quebec where we can achieve higher than average net operating income margins than in other regions of the country. We expect to see a full year s positive impact on our cash flows from our recent acquisitions in these higher margin markets in 2007 and in the years ahead. Our strong position in Ontario and the GTA is also a considerable advantage. Ontario remains the heartland of the Canadian economy with a broad economic base that is not tied to any one cyclical industry. In addition, Ontario and the GTA are the destinations of choice for new Canadians, and recent government initiatives to boost immigration will increase demand for rental accommodation in these key markets. 6 CAP REIT 2006 ANNUAL REPORT

9 SOLID PERFORMANCE Strategic acquisitions and solid performance resulted in another strong year in 2006.

10 With the acquisitions completed during and subsequent to the end of 2006, we further enhanced our strong and diversified asset base and increased our presence in most major Canadian markets. Looking ahead, we will continue to grow and enhance the diversification of our portfolio through additional accretive acquisitions that meet our strict criteria. Our goal is to purchase between 1,500 and 2,000 suites per year, and we remain confident that we will achieve this objective again in Strong Operating Platform To support our growth, during 2006 we added significant depth and expertise to our senior management team. In addition, we have designed and are deploying a stateof-the-art information technology and property management platform that will help us manage and monitor our future growth. We believe we now have an operating platform capable of managing the considerable growth we expect to generate in the years ahead. Importantly, with the investments made over the past two years in our people and infrastructure, we believe we can now expand our portfolio with only minor incremental increases in our costs. Strong Markets Following almost three years of weak demand in the Canadian apartment rental industry, we began to experience strengthening fundamentals through the last half of 2005 and continuing into Rising interest rates are reducing the affordability of home ownership, one of the key factors that has been negatively impacting the performance of our affordable property portfolio. Looking ahead, the forecasted decline in single family housing starts should contribute to ongoing strong demand for rental accommodation in this segment of our business. The youth job market is also steadily improving, driven by the strong Canadian economy and resulting in increased demand for apartments and townhouses from this traditionally strong demographic group. As a result of these factors, the cost gap between owning and renting a home in Canada is widening in favour of rental accommodation. The estimate of the difference between a typical monthly mortgage payment and rent is now more than $800, up significantly from $575 in 2005 and only $250 in The current trend toward increased affordability of rental accommodation compared with ownership has not been seen since the early 1990s. Strong Financial Position Our solid financial performance in 2006, combined with our aggressive capital market activities and innovative debt transactions, have resulted in what we believe is one of the strongest balance sheets in our industry. With a conservative debt leverage ratio at year-end, we had the resources and flexibility to acquire more than $621 million in new properties without the dilutive impact of accessing the equity markets. During the year, including the impact of interest rate forward contracts, we also further reduced the weighted average interest rate on our mortgage portfolio to 5.33% at December 31, 2006 from 5.38% at the same time last year, lowering the cost of our debt. In addition, we smoothed out the maturity schedule of our overall mortgage portfolio by 8 CAP REIT 2006 ANNUAL REPORT

11 PRIME LOCATIONS We enhanced the diversification of our property portfolio in 2006, extending our presence in high-growth rental markets.

12 These were considerable accomplishments, and a testament to the significant industry experience, hard work and dedication of all our people. hedging our exposure for maturities in 2009, resulting in an effective weighted average term to maturity of 7.5 years. In a rising interest rate environment, this extended term to maturity mitigates our exposure to potential future increases in interest costs. Most importantly, our strong balance sheet underpins our ability to deliver stable and sustainable cash distributions to our Unitholders over the long term. Strong Future Looking ahead, we see a number of positive trends that should generate improved performance in 2007 and beyond. Average monthly rents and occupancies should continue to increase, driven by improving market fundamentals and higher rent guidelines in the majority of regions in which we operate. We experienced positive increases in average monthly rents on renewals and on suite turnovers through the last three quarters of 2006, and expect this trend to continue going forward. We also expect that tenant inducements and insuite maintenance costs will continue to decline as market conditions strengthen and demand increases. As we enter our 10th full year as a publicly traded REIT, we are very proud of all we have accomplished in the past decade. Strategic acquisitions have grown our portfolio to where we now own interests in 27,105 suites with a net book value of approximately $2 billion. With this growth, operating revenues and net operating income have increased significantly since 1997, resulting in solid accretive growth for our Unitholders. Most importantly, Unitholders have achieved a very strong average total annual return since 1997, with a 23% total return in These Unitholder returns are supported by a continuing strong tax deferral. At 96% in 2006, CAP REIT s tax deferral was one of the highest among all Canadian REITs. In conclusion, we would like to thank everyone at CAP REIT for their tireless efforts over the past year. It is this dedication that has led to one of our best years ever, and the reinforcement of our brand as Canada s Landlord of Choice. With a solid balance sheet, the necessary financial resources and flexibility, a growing and high-quality portfolio, and a strengthened operating and management platform, we are well positioned to capitalize on the improving fundamentals in our industry to deliver enhanced value for our Unitholders for many years to come. Thomas Schwartz President and Chief Executive Officer Michael Stein Chairman 10 CAP REIT 2006 ANNUAL REPORT

13 WELL BUILT & MAINTAINED With more than $189 million invested in our portfolio over the last 10 years, we continue to meet the needs of residents across the country. CAP REIT 2006 ANNUAL REPORT 00

14 MANAGEMENT S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION Section I Forward-Looking Disclaimer 12 Overview 12 Objectives 13 Business Strategy 13 Key Performance Measures 14 Property Portfolio 15 Section II Results of Operations 19 Net Income 21 Stabilized Portfolio Performance 22 Capital Expenditures 23 Section III Distributable Income, Distributions and Payout Ratio 26 Funds from Operations 28 Unitholder Taxation 28 Liquidity and Financial Condition 29 Section IV Quarterly Results 32 Section V Critical Accounting Policies and Estimates 33 Future Changes in Accounting Policies 34 Section VI Risks and Uncertainties 34 Related Party Transactions 36 Contingencies 36 Controls and Procedures 36 Section VII Subsequent Event 37 Section VIII Future Outlook 37 Section I Forward-Looking Disclaimer The following management s discussion and analysis ( MD&A ) of the results of operations and financial condition for the years ended December 31, 2006 and 2005 should be read in conjunction with Canadian Apartment Properties Real Estate Investment Trust s ( CAP REIT ) audited consolidated financial statements. Certain statements in this MD&A could be considered as forward-looking information. This forward-looking information is subject to certain risks and uncertainties that could result in actual results differing materially from these forward-looking statements. These risks and uncertainties are more fully described in this document and in regulatory filings that can be obtained on SEDAR at The information in this MD&A is based on information available to management as at February 20, Overview CAP REIT is an unincorporated closed-end real estate investment trust created by a declaration of trust (the Declaration of Trust ) dated February 3, 1997 under the laws of the Province of Ontario, as recently amended on May 25, CAP REIT owns interests in multi-unit residential rental properties, including apartments and townhouses, located in major urban centres across Canada. As at December 31, 2006, CAP REIT had ownership interests in a portfolio that included 26,498 residential suites (CAP REIT s share 25,735 suites) well diversified by geographic location and asset class. The following outlines the per Unit (basic) net income, Distributable Income, funds from operations and the cash distributions per Unit for each calendar year and the closing price per Unit and market capitalization on the Toronto Stock Exchange on the last trading day of the period. CAP REIT currently pays monthly cash distributions of $0.09 per Unit to its Unitholders. Since its inception, CAP REIT has increased monthly cash distributions eight times and approximately 51%. 12 CAP REIT 2006 ANNUAL REPORT

15 YEARS ENDED DECEMBER 31, (PER UNIT INFORMATION, UNLESS NOTED) Net Income (1) $ $ Distributable Income ( DI ) (2) (4) $ $ Funds From Operations ( FFO ) (3) (4) $ $ Cash Distributions (5) $ $ Payout Ratio 94.1% 93.1% Effective Payout Ratio (6) 81.4% 78.8% Closing Price $ $ Market Value of Equity ($ millions) (7) $ 1,115 $ 897 (1) 2005 includes income from properties disposed of during the year in the amount of $0.215 per Unit. (2) Non-GAAP measure and excludes gain on property dispositions (see page 13 for a reconciliation to Net Income and page 14 for a reconciliation to Cash from Operating Activities). (3) Non-GAAP measure and excludes gain on property dispositions (see page 15 for a reconciliation to Net Income). (4) 2005 has been adjusted to include amortization of tenant improvements. (5) Includes distributions declared in December but paid in January. (6) Excludes from distributions cash reinvested by Unitholders through the Distribution Reinvestment Plan ( DRIP ). (7) Defined as the closing price of Units on the last trading day of the year times the number of Units outstanding on that date. Objectives CAP REIT s objectives are: > To provide Unitholders with long-term, stable and predictable monthly cash distributions. > To grow Distributable Income, distributions and Unit value through the active management of its properties, accretive acquisitions and strong financial management. > To continue the realization and reinvestment of capital within the property portfolio in order to maximize earnings and cash flow potential. Business Strategy To meet its objectives, CAP REIT has defined the following strategies: Customer Service CAP REIT recognizes that it is in a people business, and strives to be the recognized Landlord of Choice in all its chosen markets by providing its residents with safe, secure and comfortable homes. It takes a hands-on approach to managing its properties stressing open, frequent and consistent communications to ensure residents needs are met efficiently and effectively. Numerous initiatives such as newsletters, special events, resident committees and others help to build a true sense of community in its properties. In addition, CAP REIT has significantly strengthened its sales and marketing team, which is implementing innovative and highly effective strategies to help attract and retain residents. CAP REIT 2006 ANNUAL REPORT 13

16 Cost Controls While ensuring the needs of its residents are met, CAP REIT also carefully monitors operating costs to ensure it is delivering services to its residents both efficiently and cost effectively. As the portfolio has grown, CAP REIT has also strived to capture available economies of scale and cost synergies. Capital Investments CAP REIT acquires properties at prices significantly below their current replacement costs. It invests in capital expenditures in its property portfolio to attract and retain residents while ensuring the portfolio value is enhanced and maximum operating efficiencies are achieved. Building improvement costs are included in the acquisition analysis to ensure the acquisition is accretive to Unitholders, and that the appropriate investments are made over the ensuing years to improve the economic life of the properties. CAP REIT s suite improvement programs are market specific and aimed at attracting and retaining residents while enhancing revenues. Finally, portfolio-wide capital improvement programs help to enhance operating efficiencies and profitability while increasing the value of the property portfolio. Portfolio Growth CAP REIT will grow its portfolio over the long term through accretive acquisitions while capturing economies of scale and cost synergies, thereby increasing distributable income per Unit. As a component of this growth strategy, CAP REIT will monitor its portfolio and, from time to time, identify certain non-core properties for disposition. The funds from these dispositions will be used to acquire additional strategic assets better suited to CAP REIT s portfolio composition and property management objectives. Management believes the continued realization and reinvestment of capital is a fundamental component of its growth strategies, and demonstrates the success of its past investment programs and its ability to maximize and manage the earnings and cash flow potential of its property portfolio. Financial Management CAP REIT takes a long-term, conservative approach and strives to manage its exposure to interest rate volatility by proactively managing its mortgage debt portfolio to fix and, where possible, reduce average interest rates, extend the average term to maturity and stagger maturity dates. Key Performance Measures To achieve its objectives, CAP REIT has defined a number of key operating and performance measurements to measure the success of its operating and financial strategies: Occupancy Management strives, through its focused hands-on approach to its business, to achieve occupancies that are in line with, or higher than, market conditions in each of the geographic regions in which it operates. Average Rents Through its active property management strategies and proactive capital investment programs, CAP REIT strives to implement a yield management strategy in order to achieve the highest possible average rents in accordance with local market conditions. 14 CAP REIT 2006 ANNUAL REPORT

17 Net Operating Income This is defined as operating revenues less operating expenses. As a measure of its operating performance, CAP REIT strives to achieve an annual net operating income margin that is approximately 52% of operating revenues. Distributable Income and Funds From Operations CAP REIT also strives to increase Distributable Income and Funds from Operations annually, on a per Unit basis. Payout Ratio To ensure it retains sufficient cash to meet its capital investment objectives, CAP REIT targets an annual payout ratio of between 85% and 90%. Portfolio Growth Management s objective is to acquire between 1,500 and 2,000 suites on an annual basis. Financing CAP REIT takes a very proactive approach with its mortgage portfolio, ensuring it is properly positioned to manage interest expense volatility risk by achieving the lowest possible average interest rates while mitigating refinancing risk by extending the portfolio s average term to maturity and staggering the maturity dates. Property Portfolio CAP REIT s property portfolio continues to be well diversified by geography and balanced among asset types and demographic segments. Management intends to further enhance the geographic diversification through future acquisitions of properties and portfolios in regions primarily outside the Greater Toronto Area. Portfolio by Asset Type AS AT DECEMBER 31, 2006 % 2005 (1) % Affordable 4, , Mid-Tier 13, , Luxury 8, , Total Suites 26, , (1) One property has been reclassified among asset type. CAP REIT 2006 ANNUAL REPORT 15

18 Portfolio by Geography AS AT DECEMBER 31, 2006 % 2005 % ONTARIO Greater Toronto Area 13, , Ottawa 1, , London/Kitchener Waterloo 1, , Other Ontario 1, , , , QUEBEC Montreal 3, , Quebec City 1, , , , NOVA SCOTIA Halifax 1, , ALBERTA Edmonton Calgary , , SASKATCHEWAN Saskatoon Regina BRITISH COLUMBIA Greater Vancouver Area Total Suites 26, , Through accretive acquisitions and non-core property dispositions, CAP REIT has enhanced the geographic diversification of its property portfolio. In 2006, CAP REIT targeted increasing its presence in strong markets in the Province of Quebec, growing its Quebec portfolio by 553 suites. In total, CAP REIT acquired 30 apartment buildings and townhouse complexes during 2006 totalling 1,246 suites, located in Etobicoke, Ontario, Orangeville, Ontario, Toronto, Ontario, Longueuil, Quebec, and Quebec City, Quebec, for total acquisition costs of approximately $96.2 million. On December 15, 2005, CAP REIT disposed of its interest in 13 small apartment complexes in Ontario aggregating 797 suites. 16 CAP REIT 2006 ANNUAL REPORT

19 Portfolio Occupancy and Average Monthly Rents (By Asset Type) Properties Owned Prior to Properties Acquired Since Total Portfolio December 31, 2005 December 31, Average Average Average Average Average Monthly Monthly Monthly Monthly Monthly Rents Occ. Rents Occ. Rents Occ. Rents Occ. Rents Occ. Affordable $ % $ % $ % $ % $ % Mid-Tier $ % $ % $ % $ % $ % Luxury $ 1, % $ % $ 1, % $ % Average $ % $ % $ % $ % $ % Average monthly rents are defined as actual residential rents, net of vacancies, divided by the total number of suites in the property, and do not include revenues from parking, laundry or other sources. Average monthly rents for the overall portfolio increased as at December 31, 2006 to $886 compared to $877 last year, despite acquisitions made in Montreal and Quebec City, where rents are generally lower than the national averages. Average monthly rents for the properties owned prior to December 31, 2005 increased as at December 31, 2006 compared to December 31, 2005 with solid gains of between 1.4% and 1.9% in all segments of the portfolio due to CAP REIT s successful sales and marketing strategies and improving fundamentals in the majority of CAP REIT s markets. Suite turnovers (excluding co-ownerships) increased in 2006 to 9,106 suites, or 36.5% of the portfolio, from 7,680 suites or 33.3% of the total portfolio last year. During 2006, CAP REIT generated higher increases in average monthly rents on suite turnovers than in the prior year. CAP REIT 2006 ANNUAL REPORT 17

20 Portfolio Occupancy and Average Monthly Rents (By Geography) AS AT DECEMBER 31, Average Occupancy Average Occupancy Monthly Rents % Monthly Rents % ONTARIO Greater Toronto Area $ 1, $ Ottawa London/Kitchener Waterloo Other Ontario $ $ QUEBEC Montreal $ $ Quebec City $ $ NOVA SCOTIA Halifax $ $ ALBERTA Edmonton $ $ Calgary $ $ SASKATCHEWAN Saskatoon $ $ Regina $ $ BRITISH COLUMBIA Greater Vancouver Area $ $ Total $ $ Overall occupancies remained stable in 2006 as steady performance in most Ontario, Quebec and British Columbia markets was offset by soft market conditions in Halifax and the London/Kitchener Waterloo markets compared to last year. Average monthly rents were higher in all geographic regions except Halifax, which experienced a slight decline due to higher than anticipated vacancies. Sales and marketing programs combined with rental incentives have been targeted at these properties to reduce vacancies. Management believes that overall occupancies can be maintained in the 97% to 98% range which, combined with steady increases in overall average monthly rents, will provide the basis for sustained revenue growth in the future. 18 CAP REIT 2006 ANNUAL REPORT

21 Section II Results of Operations YEAR ENDED DECEMBER 31, ($ THOUSANDS) 2006 % 2005 % Operating Revenues $ 283, $ 258, Operating Expenses Realty Taxes 39, , Utilities 41, , Repairs and Maintenance 20, , Other Operating Expenses 35, , Total Operating Expenses 136, , Net Operating Income $ 147, $ 133, Net Operating Income ( NOI ) is not a measure defined by Canadian generally accepted accounting principles ( GAAP ). NOI is a key measure of operating performance in the real estate industry and includes all rental revenues generated at the property level, less related direct costs such as utilities, realty taxes, insurance, repairs and maintenance and on-site wages and salaries. It may not, however, be comparable to similar measures presented by other real estate trusts or companies. Operating Revenues Total operating revenues increased in 2006 compared to the prior year due primarily to acquisitions completed over the last 12 months and the full impact of 2005 acquisitions. Average monthly rents for the total portfolio also increased at December 31, 2006 compared to the same period last year. As a result of CAP REIT s effective sales and marketing programs and other initiatives, vacancies, bad debts and tenant inducements as a percentage of operating revenues were reduced to 3.5% for the year ended December 31, 2006 compared to 4.1% for the year ended December 31, The unamortized balance of tenant inducements was $0.4 million at December 31, 2006 and Operating Expenses Operating expenses for the year ended December 31, 2006 rose primarily due to the increase in the size of the property portfolio resulting from acquisitions completed over the last 12 months and the full impact of 2005 acquisitions. Overall operating expenses as a percentage of operating revenues were slightly lower in 2006 primarily due to the following factors: > Realty taxes as a percentage of revenues in 2006 reduced compared to 2005 due to the enhanced diversification of the portfolio in regions with lower taxation policies, as well as successful tax appeals. > Energy costs as a percentage of revenues remained stable compared to the prior year due to CAP REIT s energy management strategies, which include locking in future prices where possible, as well as lower consumption. CAP REIT 2006 ANNUAL REPORT 19

22 > Repairs and maintenance expenses increased as a percentage of revenues in 2006 and aggregated to $819 per suite in 2006 as compared to $778 per suite in 2005, primarily due to higher turnover related costs. Insuite maintenance costs for regular suite turnovers from normal wear and tear by residents including costs for painting, sanding and flooring, which are expensed as incurred, increased from $5.8 million (or an average of $246 per suite in 2005) to $7.2 million (or an average of $284 per suite in 2006). Management believes that as markets continue to strengthen and turnovers stabilize, insuite maintenance costs will reduce in the future. > Other operating expenses rose in 2006 due to the increased size of the portfolio, as well as higher advertising costs compared to In addition, costs for on-site wages and benefits increased to $657 per suite in 2006 compared to $610 per suite in As we continue to increase the quality and level of service to our residents and extend the office hours at our properties, these costs have risen. Net Operating Income YEAR ENDED DECEMBER 31, ($ THOUSANDS) NOI as % % of NOI as % % of NOI of Revenue Total NOI NOI of Revenue Total NOI Ontario $ 105, $ 101, Quebec 18, , Alberta 8, , British Columbia 5, , Nova Scotia 7, , Saskatchewan Total $ 147, $ 133, CAP REIT s portfolio diversification programs have successfully expanded its presence in markets with generally higher NOI margins. NOI margins remained stable in Ontario in 2006 compared with the prior year, and increased in Alberta, British Columbia and Saskatchewan, resulting in the overall NOI margin for the year improving to 51.9% of total revenues compared to 51.5% last year. Management believes that as a result of the rollout of the new Lease Administration System, which enables enhanced control on rent setting, the NOI margin will continue to further improve in CAP REIT 2006 ANNUAL REPORT

23 Net Income YEAR ENDED DECEMBER 31, ($ THOUSANDS, EXCEPT PER UNIT AMOUNTS) Net Operating Income $ 147,289 $ 133,300 Less: Trust Expenses 9,097 7,803 Mortgage Interest 65,196 60,508 Other Interest Net 5,690 4,642 Subtotal 67,306 60,347 Less: Depreciation 59,563 52,582 Amortization 7,021 6,426 Net Income from Continuing Operations 722 1,339 Add: Discontinued Operations 11,470 Net Income $ 722 $ 12,809 Net Income per Unit Basic and Diluted $ $ Weighted Average Number of Units (000s) Basic 56,565 53,255 Depreciation and Amortization CAP REIT depreciates its properties on a straight-line basis over their estimated useful lives, not exceeding 40 years, compared to the industry average of between 40 and 50 years. Depreciation expense increased in 2006 due to new acquisitions as well as capital expenditures incurred for the property portfolio. The increase in amortization expense in 2006 is due to increased deferred financing costs related to CMHC mortgage insurance premiums for mortgage refinancings aimed at taking advantage of low interest rates, as well as new mortgages for acquired properties. Trust Expenses Trust expenses increased in 2006 mainly due to the increased size of the portfolio. Overall compensation costs were higher resulting from the implementation of the strategic review conducted in early 2005 and new initiatives to enhance CAP REIT s marketing and information technology platforms. As a result of the increase in staff, management believes it now has built an operating platform sufficient to manage the strong growth it expects to generate in the future. In addition, CAP REIT also incurred increased legal and compliance costs in 2006 to conform to new securities regulations. Compensation costs related to CAP REIT s Long-Term Incentive Plan ( LTIP ) were $0.750 million in the first quarter of 2006 compared to $0.554 million in the first quarter of CAP REIT 2006 ANNUAL REPORT 21

24 Mortgage and Other Interest Mortgage interest expense increased in 2006 due to new debt associated with the acquisition of properties and top-up mortgage financings, offset by a slight decrease in the weighted average interest rate. Mortgage interest expense as a percentage of operating revenues reduced to 23.0% in 2006 from 23.4% in the prior year primarily due to the lower weighted average interest rate for the portfolio. Other interest costs relate to borrowings under CAP REIT s acquisition and operating facilities. The increase in other interest costs for the year ended December 31, 2006 was due to increased borrowings on the acquisition facility as a result of acquisitions completed during the year, and higher interest rates on floating rate debt, which rose to a weighted average interest rate of 5.93% in 2006 compared to 4.81% in During 2007, management will continue its financing plan to top up existing mortgages and generate funds to reduce its acquisition and operating facilities, thereby lowering interest costs and its cost of capital. The interest coverage ratio (defined as income from continuing operations before interest, depreciation, amortization and LTIP compensation cost divided by interest expense) improved to 1.96 times for the year ended December 31, 2006, from 1.94 times for the same period in Stabilized Portfolio Performance YEAR ENDED DECEMBER 31, Stabilized Suites 22,250 22,250 Operating Revenues ($ millions) $ $ Net Operating Income ($ millions) $ $ Net Operating Income Margin 51.6% 51.5% Change in Operating Revenues 1.8% Change in NOI 2.0% Stabilized properties for the year ended December 31, 2006 are defined as all properties owned by CAP REIT as at December 31, 2004 and, therefore, do not take into account the impact on performance of acquisitions completed during 2006 and For the stabilized portfolio, which represents 86.5% of the total 25,735 suites owned as at December 31, 2006, operating revenues increased by 1.8%. CAP REIT s operating costs increased by 1.7% due to higher repairs and maintenance costs (primarily regular suite turnover costs), payroll and advertising costs. These increased operating costs were partially offset by lower realty taxes due to enhanced portfolio diversification and tax refunds. In addition, higher rental incentives were offered during the third and fourth quarters of 2006 aimed at successfully increasing occupancies at specific properties. As a result, NOI for the year ended December 31, 2006 increased by 2.0% compared to the prior year. As of the fourth quarter of 2006, CAP REIT has generated four consecutive quarters of positive stabilized NOI growth. For new properties acquired since December 31, 2004, the net operating income margin increased to 54.8% in 2006, from 52.9% in CAP REIT 2006 ANNUAL REPORT

25 Capital Expenditures CAP REIT believes it acquires properties at prices significantly below current replacement costs and is committed to improving its operating performance by incurring appropriate capital expenditures in order to replace and maintain the productive capacity of its property portfolio, so as to sustain its rental income generating potential over its useful life. Since its IPO in May 1997, CAP REIT has invested approximately $189 million in capital expenditures aimed at upgrading its properties to increase future operating cash flows and enhance the long-term value of its portfolio. These investments have also improved the quality of life for residents and enhanced CAP REIT s brand as the Landlord of Choice. CAP REIT capitalizes all costs related to the acquisition and improvement of its properties as they increase the value and extend the useful life of its assets. Over the last three years, despite the substantial increase in the size of the property portfolio, (including the ResREIT portfolio acquired in June 2004), annual capital expenditures have been in the range of $30 to $40 million. Maintenance capital expenditures that do not extend the useful life of the assets are expensed as incurred. During the last three years, CAP REIT has incurred repairs and maintenance costs (including operating contracts, common area maintenance and regular suite turnover costs) in the range of $750 to $850 per suite annually. The regular suite turnover costs, which include painting, sanding and flooring due to normal wear and tear by residents, are in the range of $200 to $350 per suite annually. Maintenance capital expenditures vary with market conditions and are directly related to suite turnover. CAP REIT classifies its capital expenditures under the following general headings: Building Improvements are those expenditures identified by building condition audits completed prior to acquisition, identified by CMHC at the time of refinancings or are upgrades required to comply with current operational building codes and performance levels for properties acquired. The nature of these expenditures, which include improvements to major building structures, parking garages and balconies, is as follows: > primarily related to acquisitions completed over the last few years > estimated at the time of acquisition and included in the acquisition analysis to ensure the transaction is accretive to Unitholders > funded periodically over several years from mortgage advances or refinancings and equity > improve the economic life and value of the properties, and > are long-term, permanent improvements and generally non-recurring. Suite Improvement programs are aimed at increasing revenues by enhancing the interiors of suites, and range from complete suite renovations to kitchen, bathroom, flooring and electrical upgrades. The nature of these expenditures is as follows: > targeted to specific properties and markets to enhance average rents and occupancies > tailored to market trends, currently requiring smaller, lower cost and faster turnaround renovations > increasingly utilizing subcontractors to reduce costs, downtime and enhance efficiency, and > are medium-term and amortized over five to 10 years. CAP REIT 2006 ANNUAL REPORT 23

26 Capital Improvement programs are designed to replace and upgrade major components, and include boiler replacements, window replacements, elevator modernizations, mechanical and electrical systems upgrades and common area enhancements. The nature of these expenditures is as follows: > enhance operating efficiencies and profitability or reduce costs to improve NOI > increase the useful lives of the properties > improve safety and living conditions for residents, and > are mainly non-recurring and long-term. Intensification programs construct new suites on surplus land or in vacant or unutilized space within existing buildings without incurring any incremental land costs. These expenditures are considered to be non-recurring and long-term in nature. A breakdown of capital expenditures by program, portfolio and type (including accrued capital expenditures) is as follows: Capital Expenditures by Program YEAR ENDED DECEMBER 31, ($ THOUSANDS) (2) Building Improvements $ 13,408 $ 16,690 Capital Improvements 14,226 12,352 Suite Improvements 8,873 12,501 Intensification Total (1) $ 36,522 $ 41,621 (1) Excludes capital expenditures for head office assets and properties disposed. (2) 2005 has been reclassified to conform to the current year s classifications. Capital Expenditures by Portfolio YEAR ENDED DECEMBER 31, ($ THOUSANDS) 2006 % 2005 (2) % Acquisitions ResREIT $ 16, $ 22, Other Remaining Portfolio 19, , Total (1) $ 36, $ 41, (1) Excludes capital expenditures for head office assets and properties disposed. (2) 2005 has been reclassified to conform to the current year s classifications. 24 CAP REIT 2006 ANNUAL REPORT

27 Capital Expenditures by Type YEAR ENDED DECEMBER 31, ($ THOUSANDS) (2) Building Improvements $ 13,408 $ 16,690 Capital Improvements Boilers and Elevators 2,976 2,918 Windows 54 1,029 Appliances 1,316 1,248 Common Area Upgrades 5,785 4,931 Equipment 2,916 2,033 Signage 551 Other Subtotal 14,226 12,352 Suite Improvements Suite Improvements 6,024 10,431 Kitchens/Baths/Floors 2,849 2,070 Subtotal 8,873 12,501 Intensification Total (1) $ 36,522 $ 41,621 (1) Excludes capital expenditures for head office assets and properties disposed. (2) 2005 has been reclassified to conform to the current year s classifications. Total capital expenditures were lower in 2006 than in the prior year despite the increase in the portfolio due to acquisitions. Management is increasingly subcontracting its capital improvement and suite improvement projects to capture the benefits of lower costs. In addition, with the improvement in many of the markets in which CAP REIT operates, the average cost per suite for suite improvements has declined compared to the prior year as CAP REIT is doing smaller renovation packages. Included in the total expenditures for the year ended December 31, 2006 is $0.6 million (December 31, 2005 $0.4 million) of direct labour costs capitalized for capital and suite improvement programs. Management expects spending on capital expenditures for its total portfolio will be in the range of $40 million in CAP REIT funds its capital improvement programs through a combination of retained income, funds generated from its mortgage refinancing activities and cash distributions reinvested from its Distribution Reinvestment Plan ( DRIP ). Management believes these sources will be sufficient to fund current and future capital expenditure programs. CAP REIT 2006 ANNUAL REPORT 25

28 Section III Distributable Income, Distributions and Payout Ratio Distributable Income ( DI ) is not a measure defined by GAAP, nor does it have a standard definition, and as such may not be comparable to other trusts that use similar terms. Management considers DI to be a key performance indicator for determining CAP REIT s capacity to pay cash distributions to its Unitholders, one of CAP REIT s key objectives. CAP REIT calculates DI as defined in its Declaration of Trust, which requires CAP REIT to declare distributions to Unitholders each year not less than the greater of: (i) 85% of its DI, (or a lesser amount at the discretion of the trustees); or (ii) an amount calculated to ensure CAP REIT will not be subject to tax on its income and capital gains. A reconciliation of Net Income to distributions to Unitholders is as follows: Net Income $ 722 $ 12,809 Depreciation (1) 59,563 54,131 Amortization of tenant improvements Amortization of intangibles: (2) Value of tenant in-place leases 4,712 4,776 Value of tenant relationships Value of above and below market leases (50) 175 Straight-line rent adjustment (33) (87) Compensation component of the LTIP awards granted Less: Gain on Property Dispositions (10,867) Distributable Income $ 66,160 $ 61,827 Retention of DI 3,932 4,275 Distributions to Unitholders $ 62,228 $ 57,552 Distributable Income per Unit $ $ Retention of DI per Unit $ (0.090) $ (0.081) Distributions to Unitholders per Unit $ $ (1) Includes depreciation on discontinued operations (see note 13 to Consolidated Financial Statements). (2) Includes amortization on discontinued operations (see note 14 to Consolidated Financial Statements). 26 CAP REIT 2006 ANNUAL REPORT

29 Pursuant to the Ontario Securities Commission s Revised CSA Staff Notice , the Commission recommends that distributable cash (which we believe to be synonymous with DI) be reconciled to cash from operating activities as presented in the Consolidated Financial Statements. The following table outlines the reconciliation of cash from operating activities to DI. YEAR ENDED DECEMBER 31, ($ THOUSANDS) Cash from Operating Activities $ 68,406 $ 63,654 Less: Changes in Non-Cash Operating Assets and Liabilities (433) (357) Amortization of Deferred Financing Costs (1,739) (1,398) Amortization of Leasehold Improvements (74) (72) Distributable Income (DI) (1) $ 66,160 $ 61,827 Retention of DI $ 3,932 $ 4,275 Distributions to Unitholders $ 62,228 $ 57,552 (1) 2005 has been adjusted to include amortization of tenant improvements. The increase in Distributable Income in 2006 compared to the prior year is primarily due to the contributions from acquisitions completed during the year, as well as higher overall occupancies and average monthly rents resulting from management s sales and marketing programs. YEAR ENDED DECEMBER 31, ($ THOUSANDS, EXCEPT WHERE NOTED) Distributions Declared $ 62,228 $ 57,552 Distributions Declared per Unit $ $ Retention of DI (1) $ 3,932 $ 4,275 Payout Ratio 94.1% 93.1% Distributions Reinvested (2) $ 8,347 $ 8,849 % Reinvested 13.4% 15.4% Effective Payout Ratio (3) 81.4% 78.8% (1) Defined as Distributable Income less distributions declared. (2) Cash reinvested by Unitholders through the DRIP. (3) Excludes from distributions cash reinvested by Unitholders through the DRIP. Total distributions declared in 2006 were higher than the prior year due to the issuance of 3.6 million Units through a successful bought-deal equity offering on August 22, The effective payout ratio excludes from distributions the cash reinvested by investors through the DRIP and excludes from Distributable Income gains from property dispositions. DRIP participation as at December 31, 2006 was 20.0% compared to 17.0% as at December 31, CAP REIT 2006 ANNUAL REPORT 27

30 Funds From Operations Funds From Operations ( FFO ) is a measure of the operating performance based on the funds generated from the business before reinvestment or provision for other capital needs. FFO is not a measure defined by GAAP. FFO as presented is in accordance with the recommendations of the Real Property Association of Canada ( RealPac ). It may not, however, be comparable to similar measures presented by other trusts or companies in similar or different industries. Management considers FFO to be an important measure of CAP REIT s operating performance and is an indicative measure of CAP REIT s cash generating activities. YEAR ENDED DECEMBER 31, ($ THOUSANDS, EXCEPT PER UNIT AMOUNTS) Net Income $ 722 $ 12,809 Less: Gain on Property Dispositions (10,867) 722 1,942 Add: Depreciation (1) 59,563 54,131 Amortization of Tenant Improvements Amortization of Intangibles (2) 5,047 5,055 Value of Above and Below Market Leases (50) 175 FFO (3) $ 65,443 $ 61,360 FFO per Unit Basic $ $ (1) Includes depreciation on discontinued operations (see note 13 to Consolidated Financial Statements). (2) Includes amortization on discontinued operations (see note 14 to Consolidated Financial Statements). (3) 2005 has been adjusted to include amortization of tenant improvements. FFO increased in 2006 due primarily to acquisitions completed during the year as well as higher overall occupancies and average monthly rents resulting from management s sales and marketing programs. Unitholder Taxation For taxable Canadian resident Unitholders, the distributions are treated as follows for tax purposes: Taxable to Unitholders as Other Income 3.93% 11.03% Taxable to Unitholders as Capital Gain Income 28.39% Tax Deferral 96.07% 60.58% Total % % Total Effective Non-taxable Portion of Distributions 96.07% 74.77% 28 CAP REIT 2006 ANNUAL REPORT

31 Liquidity and Financial Condition CAP REIT finances its operations through three sources of capital: (i) mortgage debt secured by its income properties; (ii) secured short-term debt financing with two Canadian chartered banks; and (iii) equity. AS AT DECEMBER 31, ($ THOUSANDS, EXCEPT WHERE NOTED) Mortgage Debt to Gross Book Value (%) Total Debt to Gross Book Value (%) Total Debt to Total Capitalization (%) Debt Coverage Ratio (times) Interest Coverage Ratio (times) Weighted Average Mortgage Interest Rate (%) (1) Weighted Average Mortgage Term to Maturity (years) (1) Operating and Acquisition Line Availability $ 62,024 $ 75,782 (1) Including the effect of the interest rate forward contracts, which assumes mortgage renewals will match the term of the interest rate forward contracts as discussed in the Mortgages Payable section below, the weighted average mortgage interest rate is 5.33% and the weighted average mortgage term to maturity is 7.5 years as at December 31, 2006, compared to 5.38% and 8.1 years, respectively, as at December 31, Mortgages Payable CAP REIT takes a long-term, conservative approach and actively manages its mortgage portfolio to reduce interest costs while ensuring it is not overly exposed to interest rate volatility risk. Management takes a portfolio approach to its mortgage debt, proactively staggering maturities and interest rates to reduce risk while taking advantage of low interest rate environments. AS AT DECEMBER 31, ($ THOUSANDS) Balance, beginning of year $ 1,215,256 $ 1,145,256 Add: New Borrowings 46,576 84,085 Assumed 13,293 12,789 Refinanced 92,194 54, , ,916 Less: Mortgage Repayments (38,860) (34,940) Mortgages Matured (53,248) (18,714) Dispositions (27,262) Balance, end of year $ 1,275,211 $ 1,215,256 CAP REIT 2006 ANNUAL REPORT 29

32 During 2006, total financings of $152.1 million were completed, including $59.9 million of new and assumed CMHC insured mortgage financings for newly acquired properties, at an effective weighted average interest rate of 4.47%. Existing mortgages aggregating to approximately $92.2 million were also refinanced or topped up to fund CAP REIT s acquisition and capital expenditure programs at an effective weighted average interest rate of 4.81%. During the second quarter of 2005, CAP REIT entered into interest rate forward contracts to hedge its exposure to rising interest rates for mortgages maturing in These contracts, aggregating to $145.7 million, assume mortgage renewals will match the terms of the interest rate forward contracts, are for terms ranging from five to 13 years and extend the mortgage terms to between 2014 to These contracts provide for a fixed rate on the contract settlement date in 2009 which, after including estimated funding spreads for lenders, will result in estimated interest rates ranging from 5.69% to 5.87%. Including the impact of the interest rate forward contracts, the effective weighted average interest rate for the total mortgage portfolio was 5.33% as at December 31, 2006 and the average term to maturity was extended to 7.5 years, compared to 5.38% and 8.1 years, respectively, as at December 31, To ensure CAP REIT is not overly exposed to interest rate volatility risk, management has also been successful in staggering the maturity dates of its mortgage portfolio. During 2007 and 2008, total debt repayments (including maturing mortgages), will be approximately 5.7% and 7.8% of the total mortgage portfolio, respectively. To reduce its interest cost and cost of capital, management will leverage its balance sheet strength and the stability of its property portfolio to implement a financing plan during 2007 to further top up existing mortgages to reduce its acquisition and operating facilities. To date, additional financing of approximately $11.8 million has been completed and the funds applied to further reduce the acquisition facility. The debt coverage ratio (defined as earnings from continuing operations before interest, depreciation and amortization and the add-back of LTIP compensation cost divided by principal and interest repayments) was unchanged at 1.27 times as at December 31, 2006 from December 31, As at December 31, 2006, the ratio of mortgage debt to gross book value was 57.4% compared to 58.5% as at December 31, The total debt to total capitalization (defined as total debt divided by the sum of total debt plus market value of equity) was 55.1% as at December 31, 2006, compared to 59.2% as at December 31, CAP REIT 2006 ANNUAL REPORT

33 The breakdown of future principal repayments, including mortgage maturities and the weighted average interest rates as at December 31, 2006, is as follows: Weighted Principal Mortgage % of Avg. Interest ($ THOUSANDS, EXCEPT WHERE NOTED) Repayments Maturities Total Debt Total Debt Rate (%) (1) 2007 $ 40,985 $ 31,533 $ 72, ,531 57,736 99, , , , , , , , , , ,718 99, , ,485 72,008 90, ,572 86, , ,683 18,080 29, ,407 17,878 27, ,276 60,639 97, onwards 14,373 13,752 28, $ 305,042 $ 970,169 $ 1,275, Portfolio weighted average term to maturity 6.1 years. (1) Rates for maturing mortgages only. Bank Indebtedness Bank indebtedness includes borrowings on CAP REIT s Acquisition and Operating Facilities. On June 30, 2006, the Acquisition Facility was renewed and amended to $140 million from $150 million, and the Operating Facility was increased to $30 million from $20 million. As at December 31, 2006, $77.3 million was outstanding on the Acquisition Facility and $17.1 million on the Operating Facility after paying down $57.3 million from funds raised through the equity offering in August Unitholders Equity On August 22, 2006, CAP REIT completed its seventh equity issue of 3.6 million Units at $16.90 per Unit on a bought-deal basis for aggregate gross proceeds of $60.3 million. The net proceeds of approximately $57.3 million were used to repay floating interest rate borrowings on the Acquisition Facility. Unitholders equity as at December 31, 2006 was $594.5 million compared to $588.4 million as at December 31, The increase from December 31, 2005 is mainly due to the issuance of the 3.6 million Units on August 22, 2006 for net proceeds of $57.3 million as mentioned above. Since its Initial Public Offering in May 1997, the total market value of CAP REIT s equity as at December 31, 2006 has risen to $1.1 billion. As at December 31, 2006, officers and trustees owned approximately 4.3% of CAP REIT s issued and outstanding Units. CAP REIT 2006 ANNUAL REPORT 31

34 Liquidity Net operating income generated from the income properties is the primary source of liquidity to fund CAP REIT s financing expenses, trust expenses and distributions to Unitholders. CAP REIT expects to generate sufficient cash flow from its operating activities to be able to fund its current level of distributions. In addition, management is of the opinion that funds generated from its mortgage refinancing program, the available borrowing capacity under the credit facilities, funds from its DRIP and retained income will be sufficient to fund mortgage principal repayments and its ongoing capital expenditures. As at December 31, 2006, amounts available on our existing Operating and Acquisition Facilities aggregated to $62 million. The ratio of total indebtedness to gross book value was 61.6% as at December 31, 2006, compared to 62.7% as at December 31, The maximum ratio allowable under CAP REIT s Declaration of Trust is 70%. Section IV Quarterly Results ($ THOUSANDS, EXCEPT PER UNIT AMOUNTS) Q4 06 Q3 06 Q2 06 Q1 06 Q4 05 (1) Q3 05 (1) Q2 05 (1) Q1 05 (1) Operating Revenues $ 73,002 $ 71,526 $ 69,859 $ 69,317 $ 67,934 $ 64,453 $ 63,010 $ 63,269 NOI 37,212 39,558 37,919 32,600 33,949 35,787 34,407 29,157 (Loss) Income from Continuing Operations (209) 2,900 1,457 (3,426) (983) 3,162 2,070 (2,910) Income (Loss) from Discontinued Operations 10, (21) Net (Loss) Income (209) 2,900 1,457 (3,426) 9,973 3,477 2,290 (2,931) DI (2) (4) 16,378 19,310 17,469 13,003 14,887 18,362 16,641 11,937 FFO (3) (4) 16,399 19,311 17,470 12,263 14,927 18,369 16,661 11,403 Net (Loss) Income from Continuing Operations per Unit Basic and Diluted $ (0.004) $ $ $ (0.062) $ (0.018) $ $ $ (0.057) Net (Loss) Income per Unit Basic and Diluted $ (0.004) $ $ $ (0.062) $ $ $ $ (0.057) DI per Unit Basic $ $ $ $ $ $ $ $ FFO per Unit Basic $ $ $ $ $ $ $ $ Weighted Avg. Units (000s) Basic 59,014 56,890 55,220 55,672 55,517 54,454 51,707 51,280 (1) Reclassified for discontinued operations. (2) Excludes gains on property dispositions (see page 13 for reconciliation to Net Income and page 14 for reconciliation to Cash from Operating Activities). (3) Excludes gains on property dispositions (see page 15 for reconciliation to Net Income). (4) 2005 has been adjusted to include amortization of tenant improvements. 32 CAP REIT 2006 ANNUAL REPORT

35 CAP REIT has steadily grown revenues over the past two years as a result of new acquisitions and stable average rents and occupancies. The weighted average number of Units increased in the fourth quarters of 2005 and 2006 due to the equity offerings completed on August 4, 2005 and August 22, 2006, respectively. The third and fourth quarters of 2005 were impacted by the inclusion of certain transitional costs related to the integration of the ResREIT portfolio and other costs. Per Unit amounts in the fourth quarter of 2005 and third quarter of 2006 were impacted by the increase in the weighted average number of Units outstanding from the equity offerings in 2005 and During the first two quarters of 2005, CAP REIT experienced weakening demand in its markets due to higher vacancies and lower average monthly rents. Commencing in the second quarter of 2006, fundamentals in the residential rental industry gradually began to improve. The third and fourth quarters of 2006 reflect the impact of increased operating costs (primarily higher suite turnover costs), increased payroll, rental incentives and advertising costs targeted at specific properties to improve occupancies. The fourth and first quarters of each year tend to generate weaker performance due to increased energy consumption during the winter months. Section V Critical Accounting Policies and Estimates CAP REIT s management believes the accounting policies outlined below are those most subject to estimation and management s judgement. For a detailed description of these policies, please refer to note 2 to the Consolidated Financial Statements. Depreciation On the acquisition of a property, a significant portion of the cost of each property is allocated to buildings. The depreciation recorded on buildings is based on the straight-line basis over 40 years as compared to the industry average of between 40 and 50 years. The allocation of the acquisition cost to buildings and the determination of the useful life are based on management s estimates. In the event the allocation to buildings is inappropriate or the estimated useful life of the buildings proves incorrect, the computation of depreciation will not be appropriately recorded over future accounting periods. Intangible Costs on Acquisitions The Canadian Institute of Chartered Accountants ( CICA ) has issued guidelines with respect to purchase price allocation for acquisitions initiated subsequent to September 12, These guidelines require that a portion of the purchase price be allocated to intangible amounts for the fair value of tenant in-place leases, above and below market leases and tenant relationships. These estimates, which are subject to variability based on the assumptions used, will impact amortization expense recorded. CAP REIT 2006 ANNUAL REPORT 33

36 Fair Value CAP REIT reports the fair value of the financial instruments in the annual consolidated financial statements. The rents receivable, loans receivable, cash and short-term investments and accounts payable and other liabilities are carried at cost, which approximates their fair value. In determining the fair values of the mortgages and interest rate forward contracts, CAP REIT utilizes internally developed models that incorporate market conditions. Future Changes in Accounting Policies The CICA released Section 3855, Financial Instruments Recognition and Measurement, Section 1530, Comprehensive Income and Section 3865 Hedges, which standards are applicable to CAP REIT commencing January 1, These standards provide more comprehensive guidance on how to recognize financial instruments on the balance sheet, how to measure them and how to account for gains and losses, and provides criteria for application of hedge accounting in the future. CAP REIT has assessed the impact of these new standards on the Consolidated Financial Statements and the highlights are summarized below: > The impact of changes in net unrealized gains or losses as a result of mark-to-market valuations for interest rate forward contracts entered into, which continue to qualify for hedge accounting treatment, will be disclosed in the Accumulated Other Comprehensive Income ( AOCI ) section in the Consolidated Statement of Unitholders Equity. > Deferred financing costs (currently disclosed separately as Assets on the Consolidated Balance Sheet) will be netted against Mortgages Payable and amortized to the Consolidated Statement of Income through the adoption of the effective interest rate method, over the expected life of the debt instrument. > The transition adjustments relating to the above standards will be reflected in AOCI as at January 1, 2007 and are not expected to be material to the Consolidated Financial Statements. Section VI Risks and Uncertainties CAP REIT has been structured and is operated in adherence to the stringent investment restrictions and operating policies, as set out in its Declaration of Trust. These policies cover such matters as the type and location of properties that CAP REIT can acquire, the maximum leverage allowed, environmental matters and investment restrictions. Operating Risk The major operating risk affecting financial performance arises from CAP REIT s ability to maintain stable or increasing average rental rates combined with acceptable occupancy levels. Management has developed a focused program to build its brand as Landlord of Choice in its markets to increase resident loyalty for CAP REIT s properties. As a result, CAP REIT believes it is increasingly recognized as the preferred landlord in all its markets. CAP REIT s diversification by geographic location and by asset type minimizes exposure to any one region or demographic sector. 34 CAP REIT 2006 ANNUAL REPORT

37 CAP REIT operates under rent control legislation in most of its major markets. In January 2007, the Province of Ontario passed new legislation to govern landlord and tenant relations. CAP REIT has operated successfully in periods of legislated rent control in the past, and believes its strategies to foster resident loyalty and build its brand will continue to result in CAP REIT being considered a preferred landlord in its chosen markets. CAP REIT s growth in the past has come from its focused acquisition program. Management has demonstrated an ability to locate and complete property purchases at accretive capitalization rates. There is a risk that continuing increased competition for apartment and townhouse acquisitions may increase purchase prices to levels that are not accretive to distributable income for Unitholders. Interest Rate Risk CAP REIT seeks to minimize its refinancing risk on the maturity dates of its mortgages by ensuring that it has government-backed mortgage insurance through the National Housing Act, which is administered by the Canada Mortgage and Housing Corporation ( CMHC ). As at December 31, 2006, 93.2% of CAP REIT s mortgages were CMHC insured. Interest rate risk is managed by ensuring that debt maturities are staggered over a number of years and by taking advantage of low interest rate environments to refinance mortgages to extend the average term to maturity. This strategy helps protect Unitholders from future significant increases in interest rates. In addition, the amount of floating rate debt incurred by CAP REIT is restricted to less than 10% of total indebtedness by its Declaration of Trust. To reduce its exposure to increases in interest rates, management may also employ hedging strategies from time to time. As at December 31, 2006, $12.3 million of mortgages (1.0% of total indebtedness) and $94.4 million of bank indebtedness represented by borrowings on the Operating and Acquisition Facilities were on a floating rate basis. Capital Risk A residential rental business, like any other real estate enterprise, is capital intensive. Since its Initial Public Offering, CAP REIT has invested approximately $189 million in capital expenditures to enhance its properties. CAP REIT is exposed to the risk of being unable to fund its capital expenditure and repair and refurbishment programs to upgrade its properties. Management is also focused on ensuring that sufficient mortgage debt capacity and unutilized credit facilities are available. Environmental Risk CAP REIT is subject to various laws relating to the protection of the environment. Management attempts to reduce any potential environmental risks by ensuring comprehensive Phase 1 environmental audits are completed prior to any property acquisition. In addition, ongoing environmental training programs ensure continued compliance with all laws and regulations governing environmental and related matters. Commitments CAP REIT has entered into commitments for fixed price natural gas, hydro and land leases as outlined in note 19 to the Consolidated Financial Statements. Taxation of Income Trusts On December 21, 2006, the Federal Minister of Finance announced draft legislation regarding the taxation of distributions for publicly traded income trusts. For existing trusts, the new taxation regime will not apply until the Trust s 2011 taxation year, subject to certain conditions. In addition, trusts commonly referred to as real estate investment trusts are expected to be exempt from the new taxation rules if they meet certain conditions. At this time, management believes that these proposed changes should not affect CAP REIT but it will be necessary to assess CAP REIT s position once final legislation is enacted. CAP REIT 2006 ANNUAL REPORT 35

38 Related Party Transactions For the year ended December 31, 2006, CAP REIT paid construction management fees of $1.0 million (based on 4.5% of construction costs up to $20 million and 3.0% thereafter) in consideration for construction management services provided by a company owned by two trustees and officers of CAP REIT in connection with the capital improvement programs for the properties. For the year ended December 31, 2006, CAP REIT paid rent for head office space in the amount of $0.6 million to a company in which one of the trustees and officers has an 18% beneficial interest. The lease for the head office space expires October 31, 2009 and provides for yearly minimum rental payments of $0.3 million. For the year ended December 31, 2006, CAP REIT paid consulting fees of $0.2 million to a company controlled by a trustee and officer. Contingencies CAP REIT is contingently liable under guarantees that are issued in the normal course of business and with respect to litigation and claims that arise from time to time. In the opinion of management, any liability that may arise from such contingencies would not have a material adverse effect on the consolidated financial statements of CAP REIT. Controls and Procedures During the last quarter of 2006, CAP REIT successfully implemented a Lease Administration System, which has significantly changed the design of internal controls as they relate to the management of resident leases. Under the new system, CAP REIT has enhanced controls on rent setting for every suite in the portfolio and increased functionality at the sites to manage leases, make changes and update resident records, thereby improving the overall internal controls over the lease billing and administration process. In addition, CAP REIT maintains appropriate information systems, procedures and controls to ensure new information disclosed externally is complete, reliable and timely. Pursuant to the requirements of Multilateral Instrument of the Canadian Securities Administrator, the Chief Executive Officer and the Chief Financial Officer have satisfied themselves that as at December 31, 2006, the design of disclosure controls and procedures and the design of internal controls over financial reporting are appropriate. Furthermore, the Chief Executive Officer and the Chief Financial Officer have evaluated the effectiveness of CAP REIT s disclosure controls and procedures and have concluded that these controls and procedures were operating effectively as at December 31, CAP REIT 2006 ANNUAL REPORT

39 Section VII Subsequent Event On February 1, 2007, CAP REIT completed the acquisition of 17 apartment buildings comprising 607 suites located in three luxury multi-building portfolios in Quebec City, Quebec. The purchase price was $60.0 million. On closing, CAP REIT arranged new CMHC insured, 10-year financing of approximately $39.3 million at an interest rate of 4.71%. After this new financing, CAP REIT s ratio of total debt to gross book value was a conservative 62.7%. With the completion of this acquisition, CAP REIT s Quebec portfolio now aggregates 5,373 suites or approximately 19.8% of the total portfolio. Section VIII Future Outlook Market conditions in the multi-unit residential rental market have begun to demonstrate positive trends due to a number of factors: > Rising average home prices are causing mortgage carrying costs to rise and are reducing the affordability of home ownership, while increasing the demand for high-quality rental accommodation. As a result, the gap between owning and renting a home has been widening in favour of renting. > Housing starts are declining in Canada after two years of significant increases, with the largest declines expected to be in Ontario and Quebec. This will drive increased demand for apartment and townhouse rentals. > Due to the strong Canadian economy, youth job growth has begun to improve, increasing demand for rental suites from this traditionally strong demographic group. > New immigration policies in Canada propose a 40% increase in the number of new Canadians, another traditionally strong market for rental accommodation. As a result of the positive trends being experienced in the majority of the markets in which it operates, CAP REIT expects to see steady increases in overall average monthly rents on lease renewals and turnovers. CAP REIT believes it is well positioned in the right markets to benefit from these improving trends. Management is confident that its strong presence in Ontario will also benefit Unitholders going forward. Ontario remains the heartland of the Canadian economy and, with a broad economic base, is not tied to any single cyclical industry. CAP REIT also has a dominant presence in the Greater Toronto Area, the financial engine of the Canadian economy. The proposed increases in immigration to Canada will also increase demand in CAP REIT s key markets. CAP REIT 2006 ANNUAL REPORT 37

40 Looking ahead, CAP REIT has defined a number of strategies to capitalize on these improving market fundamentals and achieve its objectives of providing Unitholders with stable and predictable monthly cash distributions while growing Distributable Income and Unit value over the long term. First, management will maintain its focus on maximizing occupancy rates in accordance with local conditions in each of its markets. Since its inception in May 1997, CAP REIT s hands-on management style, focus on resident communications and capital improvement programs aimed at increasing the long-term value of its properties have contributed to a strong track record of stable portfolio occupancy. Second, management will continue to direct its efforts on its program to upgrade properties, including suite renovations, in a number of specific properties across the portfolio to stabilize and enhance rental revenues. Third, CAP REIT will continue to increase the size of the portfolio over the long term through accretive acquisitions that meet its strategic criteria and enhance CAP REIT s geographic diversification while capturing economies of scale and cost synergies to increase Distributable Income per Unit. Management believes the realization and reinvestment of capital is a fundamental component of its growth strategies and demonstrates the success of its investment programs. The proceeds from these dispositions will assist in funding the acquisition of properties more aligned with CAP REIT s goals. Fourth, CAP REIT will continue to take advantage of the current low interest rate environment to refinance and top up its mortgage portfolio to reduce interest costs while appropriately staggering the maturity dates of its mortgage portfolio to ensure it is not exposed in any one year to a refinancing risk. In addition, CAP REIT will continue to manage its overall cost of capital and leverage ratios by raising equity at appropriate Unit prices as compared to net asset value and also to reduce its exposure to floating interest rates on its acquisition and credit facilities. Management believes its successful equity financing and mortgage refinancing programs have resulted in CAP REIT possessing one of the strongest balance sheets in its industry, well suited to delivering consistent, stable and secure monthly cash distributions over the long term. 38 CAP REIT 2006 ANNUAL REPORT

41 MANAGEMENT S RESPONSIBILITY FOR FINANCIAL STATEMENTS The accompanying consolidated financial statements and information included in this Annual Report have been prepared by the management of CAP REIT in accordance with Canadian generally accepted accounting principles, and include amounts based on management s informed judgements and estimates. Management is responsible for the integrity and objectivity of these consolidated financial statements. To fulfill this responsibility, CAP REIT maintains an appropriate system of internal controls, policies and procedures to reasonably ensure that its reporting practices and accounting and administrative procedures provide reliable and accurate financial information, and that assets are adequately safeguarded. The financial information presented elsewhere in this Annual Report is consistent with that in the consolidated financial statements in all material respects. PricewaterhouseCoopers LLP, the auditors appointed by the Unitholders, have examined the consolidated financial statements in accordance with Canadian generally accepted auditing standards to enable them to express to the Unitholders their opinion on the consolidated financial statements. Their report as auditors is set forth herein. The consolidated financial statements have been further reviewed and approved by the Board of Trustees and its Audit Committee. This committee meets regularly with management and the auditors, who have full and free access to the Audit Committee. February 20, 2007 Thomas Schwartz President and Chief Executive Officer Yazdi Bharucha Chief Financial Officer and Secretary CAP REIT 2006 ANNUAL REPORT 39

42 AUDITORS REPORT To the Unitholders of Canadian Apartment Properties Real Estate Investment Trust We have audited the consolidated balance sheets of Canadian Apartment Properties Real Estate Investment Trust ( CAP REIT ) as at December 31, 2006 and 2005 and the consolidated statements of income, unitholders equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of CAP REIT s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with Canadian generally accepted auditing standards. Those standards require that we plan and perform an audit to obtain reasonable assurance whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. In our opinion, these consolidated financial statements present fairly, in all material respects, the financial position of CAP REIT as at December 31, 2006 and 2005 and the results of its operations and its cash flows for the years then ended in accordance with Canadian generally accepted accounting principles. Toronto, Ontario February 20, 2007 Chartered Accountants, Licensed Public Accountants 40 CAP REIT 2006 ANNUAL REPORT

43 CONSOLIDATED BALANCE SHEETS AS AT DECEMBER 31, ($ THOUSANDS) Assets (note 4) Income properties Cost $ 2,162,487 $ 2,027,774 Less: Accumulated depreciation (179,415) (119,691) Net book value 1,983,072 1,908,083 Deposits and sundry assets (note 5) 17,609 11,342 Deferred financing costs (note 6) 19,966 18,547 Intangible assets (note 7) 2,193 6,505 $ 2,022,840 $ 1,944,477 Liabilities and Unitholders Equity Liabilities Mortgages payable (note 8) $ 1,275,211 $ 1,215,256 Bank indebtedness (note 9) 94,415 87,758 Accounts payable and other liabilities 34,838 30,457 Security deposits 18,191 17,262 Distributions payable 5,399 4,998 Intangible liabilities (note 7) ,428,357 1,356,121 Unitholders Equity 594, ,356 $ 2,022,840 $ 1,944,477 See accompanying notes to consolidated financial statements. Signed on behalf of the Trustees: Thomas Schwartz Trustee Michael Stein Trustee CAP REIT 2006 ANNUAL REPORT 41