Pennsylvania Real Estate Investment Trust (PEI)

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The analysis below presents the sensitivity of the market value of our financial instruments and of our interest-related cash flows to selected changes in market interest rates. As of September 30, 2005, our consolidated debt portfolio consisted of $276.0 million borrowed under the Credit Facility and $1,346 million in fixed-rate mortgage notes, including $44.3 million of mortgage debt premium. Mortgage notes payable, which are secured by 28 of our wholly-owned properties including one property classified as held for sale, are due in installments over various terms extending to the year 2017 with interest at rates ranging from 4.95% to 8.70% with a weighted average interest rate of 6.76% at September 30, 2005. Mortgage notes payable for properties classified as discontinued operations are accounted for in liabilities related to assets held-for-sale on the consolidated balance sheet.

The table below presents the principal amounts of the expected annual maturities and the weighted average interest rates for the principal payments in the specified period:

The preceding table includes scheduled maturities for properties that are classified as held-for-sale. There is one held-for-sale property that has a mortgage with an outstanding balance of $17.1 million and an interest rate of 7.25% at September 30, 2005.

To manage interest rate risk, we may employ options, forwards, interest rate swaps, caps and floors or a combination thereof, depending on the underlying exposure. We undertake a variety of borrowings, from lines of credit, to medium- and long-term financings. To limit overall interest cost, we may use interest rate instruments, typically interest rate swaps, to convert a portion of our variable-rate debt to fixed-rate debt, or a portion of our fixed-rate debt to variable-rate debt. Interest rate differentials that arise under these swap contracts are recognized in interest expense over the life of the contracts. The resulting cost of funds is expected to be lower than that which would have been available if debt with matching characteristics was issued directly. We may also employ forwards or purchased options to hedge qualifying anticipated transactions. Gains and losses are deferred and recognized in net income in the same period that the underlying transaction occurs, expires or is otherwise terminated. See also Note 10 of the notes to our consolidated financial statements.

In May 2005, the Company entered into three forward starting interest rate swap agreements that have a blended 10-year swap rate of 4.6858% on an aggregate notional amount of $120.0 million settling no later than October 31, 2007. The Company also entered into seven forward starting interest rate swap agreements in May 2005 that have a blended 10-year swap rate of 4.8047% on an aggregate notional amount of $250.0 million settling no later than December 10, 2008. A forward starting interest rate swap is an agreement that effectively hedges future base rates on debt for an established period of time. The Company entered into these swap agreements in order to hedge the expected interest payments associated with a portion of the Company’s anticipated future issuances of long term debt. The Company assessed the effectiveness of these swaps as hedges at inception and on September 30, 2005 and considers these swaps to be completely effective cash flow hedges under SFAS No. 133.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

     The analysis below presents the sensitivity of the market value of our financial instruments and of our interest-related cash flows to selected changes in market interest rates. As of June 30, 2005, our consolidated debt portfolio consisted of $431.0 million borrowed under the Credit Facility and $1,178.6 million in fixed-rate mortgage notes, including $49.2 million of mortgage debt premium.

     To manage interest rate risk, we may employ options, forwards, interest rate swaps, caps and floors or a combination thereof depending on the underlying exposure. We undertake a variety of borrowings, from lines of credit, to medium- and long-term financings. To limit overall interest cost, we may use interest rate instruments, typically interest rate swaps, to convert a portion of our variable-rate debt to fixed-rate debt, or even a portion of our fixed-rate debt to variable-rate debt. Interest rate differentials that arise under these swap contracts are recognized in interest expense over the life of the contracts. The resulting cost of funds is expected to be lower than that which would have been available if debt with matching characteristics was issued directly. We may also employ forwards or purchased options to hedge qualifying anticipated transactions. Gains and losses are deferred and recognized in net income in the same period that the underlying transaction occurs, expires or is otherwise terminated. See also Note 10 of the notes to our consolidated financial statements.

     In May 2005, the Company entered into three forward starting interest rate swap agreements that have a blended 10-year swap rate of 4.6858% on an aggregate notional amount of $120.0 million settling no later than October 31, 2007. The Company also entered into seven forward starting interest rate swap agreements that have a blended 10-year swap rate of 4.8047% on an aggregate notional amount of $250.0 million settling no later than December 10, 2008. A forward starting interest rate swap is an agreement that effectively hedges future base rates on debt for an established period of time. The Company entered into these swap agreements in order to hedge the expected interest payments associated with a portion of the Company’s anticipated future issuances of long term debt. The Company assessed the effectiveness of these swaps as hedges at inception and on June 30, 2005 and considers these swaps to be completely effective cash flow hedges under SFAS No. 133.

     Changes in market interest rates have different impacts on the fixed and variable portions of our debt portfolio. A change in market interest rates on the fixed portion of the debt portfolio impacts the fair value, but it has no impact on interest incurred or cash flows. A change in market interest rates on the variable portion of the debt portfolio impacts the interest incurred and cash flows, but does not impact the fair value. The sensitivity analysis related to the fixed debt portfolio, which includes the effects of the forward starting interest rate swap agreements described above, assumes an immediate 100 basis point change in interest rates from their actual June 30, 2005 levels, with all other variables held constant. A 100 basis point increase in market interest rates would result in a decrease in the net financial instrument position of $11.5 million at June 30, 2005. A 100 basis point decrease in market interest rates would result in an increase in the net financial instrument position of $9.2 million at June 30, 2005. The hypothetical changes in the net financial instrument position are less than the hypothetical changes as of December 31, 2004 because of the swap agreements. Based on the variable-rate debt included in our debt portfolio as of June 30, 2005, a 100 basis point increase in interest rates would result in an additional $4.3 million in interest annually. A 100 basis point decrease would reduce interest incurred by $4.3 million annually. The changes in hypothetical interest expense from the hypothetical expense for the year ended December 31, 2004 resulted from the higher amount outstanding under the Credit Facility.

     Mortgage notes payable, which are secured by 28 of our wholly-owned properties including one property classified as held for sale, are due in installments over various terms extending to the year 2017 with interest at rates ranging from 4.95% to 10.60% with a weighted average interest rate of 7.36% at June 30, 2005. Mortgage notes payable for properties classified as discontinued operations are accounted for in liabilities related to assets held-for-sale on the consolidated balance sheet.

     Our interest rate risk is monitored using a variety of techniques. The table below presents the principal amounts of the expected annual maturities and the weighted average interest rates for the principal payments in the specified period (in thousands of dollars):

⁽¹⁾ The Credit Facility has a term that expires in November 2007, with an additional 14 month extension provided that there is no event of default at that time.

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