For Sql 2005 development, I do not use a local database server, I run VMWare on my desktop, with a 'proper' Sql Server 2005 instance running on that, apparently, however, it would seem that this environment isn't compatible with the Database Projects provided by the VS2008 Database Edition that comes in Team Suite.

I add a new project my solution, go down to the 'Database' node and select "Sql Server 2005" or "Sql Server 2005 Wizard".

In my current situation, the first will fail straight away, and the wizard will annoyingly  fail only after I've selected a source database, set options, and a target database for deployment.  The error is:

I wouldn't mind - but the databases that I select in the project setup are taken directly from Data Connections that are active inside the Server Explorer!

Clearly the project is trying to connect to a server that doesn't exist.

I've tried modifying the default instances used for validation and connections under Tools->Options->Data Tools, but to no avail.

The bad news 

After much research, the problem comes that VS2005 and VS2008 Database Editions, only local instances can be used for the design-time-validation database - which means if you use this development model you will be unable to use the Database Projects unless you're willing to switch to a local DB server as well.

The good news 

I stumbled across this however: http://blogs.msdn.com/gertd/archive/2008/06/03/vsts-2008-database-edition-gdr-june-ctp.aspx which lists the top enhancement as being the removal of this requirement.  I can't wait!