Form: 10-Q

Quarterly report pursuant to Section 13 or 15(d)

November 4, 2014


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended September 30, 2014
 
Commission file number 1-12672
 
AVALONBAY COMMUNITIES, INC.
(Exact name of registrant as specified in its charter)
 
Maryland
 
77-0404318
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
 
Ballston Tower
671 N. Glebe Rd, Suite 800
Arlington, Virginia  22203
(Address of principal executive offices, including zip code)
 
(703) 329-6300
(Registrant’s telephone number, including area code) 
 
(Former name, if changed since last report) 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve (12) months (or 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 ninety (90) days.
Yes ý                    No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes ý                    No o
Indicate by check mark whether the Exchange registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer x
Accelerated filer o
Non-accelerated filer (Do not check if a smaller reporting company) o
Smaller reporting company o
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes o                    No ý
APPLICABLE ONLY TO CORPORATE ISSUERS
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date:

132,008,021 shares of common stock, par value $0.01 per share, were outstanding as of October 31, 2014


Table of Contents

AVALONBAY COMMUNITIES, INC.
FORM 10-Q
INDEX
 
 
PAGE
PART I - FINANCIAL INFORMATION
 
 
 
ITEM 1.
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 



Table of Contents



AVALONBAY COMMUNITIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)
 
9/30/2014
 
12/31/2013
 
(unaudited)
 
 
ASSETS
 

 
 

Real estate:
 

 
 

Land
$
3,436,853

 
$
3,262,616

Buildings and improvements
12,098,294

 
11,059,001

Furniture, fixtures and equipment
388,566

 
340,461

 
15,923,713

 
14,662,078

Less accumulated depreciation
(2,799,679
)
 
(2,476,729
)
Net operating real estate
13,124,034

 
12,185,349

Construction in progress, including land
1,343,157

 
1,582,906

Land held for development
176,484

 
300,364

Operating real estate assets held for sale, net
80,624

 
215,590

Total real estate, net
14,724,299

 
14,284,209

 
 
 
 
Cash and cash equivalents
440,028

 
281,355

Cash in escrow
95,664

 
98,564

Resident security deposits
29,604

 
26,672

Investments in unconsolidated real estate entities
304,795

 
367,866

Deferred financing costs, net
39,329

 
40,677

Deferred development costs
36,945

 
31,592

Prepaid expenses and other assets
210,514

 
197,208

Total assets
$
15,881,178

 
$
15,328,143

 
 
 
 
LIABILITIES AND EQUITY
 

 
 

Unsecured notes, net
$
2,695,299

 
$
2,594,709

Variable rate unsecured credit facility

 

Mortgage notes payable
3,546,469

 
3,539,642

Dividends payable
153,125

 
138,476

Payables for construction
98,095

 
94,632

Accrued expenses and other liabilities
250,440

 
240,606

Accrued interest payable
28,857

 
43,175

Resident security deposits
49,425

 
44,823

Liabilities related to real estate assets held for sale
1,590

 
15,033

Total liabilities
6,823,300

 
6,711,096

 
 
 
 
Redeemable noncontrolling interests
12,596

 
17,320

 
 
 
 
Equity:
 

 
 

Preferred stock, $0.01 par value; $25 liquidation preference; 50,000,000 shares authorized at both September 30, 2014 and December 31, 2013; zero shares issued and outstanding at both September 30, 2014 and December 31, 2013

 

Common stock, $0.01 par value; 280,000,000 shares authorized at both September 30, 2014 and December 31, 2013; 132,006,835 and 129,416,695 shares issued and outstanding at September 30, 2014 and December 31, 2013, respectively
1,320

 
1,294

Additional paid-in capital
9,344,198

 
8,988,723

Accumulated earnings less dividends
(256,162
)
 
(345,254
)
Accumulated other comprehensive loss
(44,074
)
 
(48,631
)
Total stockholders' equity
9,045,282

 
8,596,132

Noncontrolling interests

 
3,595

Total equity
9,045,282

 
8,599,727

Total liabilities and equity
$
15,881,178

 
$
15,328,143

 
See accompanying notes to Condensed Consolidated Financial Statements.

1

Table of Contents

AVALONBAY COMMUNITIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF
COMPREHENSIVE INCOME
(unaudited)
(Dollars in thousands, except per share data)
 
For the three months ended
 
For the nine months ended
 
9/30/2014
 
9/30/2013
 
9/30/2014
 
9/30/2013
Revenue:
 

 
 

 
 
 
 
Rental and other income
$
428,022

 
$
386,175

 
$
1,236,154

 
$
1,060,554

Management, development and other fees
2,503

 
3,014

 
8,253

 
8,198

Total revenue
430,525

 
389,189

 
1,244,407

 
1,068,752

 
 
 
 
 
 
 
 
Expenses:
 

 
 

 
 
 
 
Operating expenses, excluding property taxes
105,212

 
96,857

 
304,812

 
256,549

Property taxes
44,996

 
42,184

 
131,920

 
115,096

Interest expense, net
46,376

 
43,945

 
132,631

 
127,772

Loss on extinguishment of debt, net

 

 
412

 

Loss on interest rate contract

 
53,484

 

 
51,000

Depreciation expense
111,836

 
159,873

 
328,598

 
455,410

General and administrative expense
11,290

 
9,878

 
30,745

 
31,262

Expensed acquisition, development and other pursuit costs
406

 
2,176

 
3,139

 
46,041

Total expenses
320,116

 
408,397

 
932,257

 
1,083,130

 
 
 
 
 
 
 
 
Equity in income (loss) of unconsolidated real estate entities
130,592

 
3,260

 
143,527

 
(16,244
)
Gain on sale of land

 

 

 
240

Gain on sale of communities

 

 
60,945

 

 
 
 
 
 
 
 
 
Income (loss) from continuing operations
241,001

 
(15,948
)
 
516,622

 
(30,382
)
 
 
 
 
 
 
 
 
Discontinued operations:
 

 
 

 
 
 
 
Income from discontinued operations

 
5,063

 
310

 
12,890

Gain on sale of discontinued operations

 

 
37,869

 
118,173

Total discontinued operations

 
5,063

 
38,179

 
131,063

 
 
 
 
 
 
 
 
Net income (loss)
241,001

 
(10,885
)
 
554,801

 
100,681

Net loss (income) attributable to noncontrolling interests
99

 
170

 
(13,872
)
 
248

 
 
 
 
 
 
 
 
Net income (loss) attributable to common stockholders
$
241,100

 
$
(10,715
)
 
$
540,929

 
$
100,929

 
 
 
 
 
 
 
 
Other comprehensive income:
 

 
 

 
 
 
 
Cash flow hedge losses reclassified to earnings
1,546

 
54,948

 
4,557

 
57,913

Comprehensive income
$
242,646

 
$
44,233

 
$
545,486

 
$
158,842

 
 
 
 
 
 
 
 
Earnings per common share - basic:
 

 
 

 
 
 
 
Income (loss) from continuing operations attributable to common stockholders
$
1.83

 
$
(0.12
)
 
$
3.86

 
$
(0.24
)
Discontinued operations attributable to common stockholders

 
0.04

 
0.29

 
1.04

 
 
 
 
 
 
 
 
Net income (loss) attributable to common stockholders
$
1.83

 
$
(0.08
)
 
$
4.15

 
$
0.80

 
 
 
 
 
 
 
 
Earnings per common share - diluted:
 

 
 

 
 
 
 
Income (loss) from continuing operations attributable to common stockholders
$
1.83

 
$
(0.12
)
 
$
3.85

 
$
(0.24
)
Discontinued operations attributable to common stockholders

 
0.04

 
0.29

 
1.04

 
 
 
 
 
 
 
 
Net income (loss) attributable to common stockholders
$
1.83

 
$
(0.08
)
 
$
4.14

 
$
0.80

 
 
 
 
 
 
 
 
Dividends per common share
$
1.16

 
$
1.07

 
$
3.48

 
$
3.21


See accompanying notes to Condensed Consolidated Financial Statements.

2

Table of Contents

AVALONBAY COMMUNITIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(Dollars in thousands)
 
For the nine months ended
 
9/30/2014
 
9/30/2013
Cash flows from operating activities:
 
 
 
Net income
$
554,801

 
$
100,681

Adjustments to reconcile net income to cash provided by operating activities:
 
 
 
Depreciation expense
328,598

 
455,410

Depreciation expense from discontinued operations

 
13,154

Amortization of deferred financing costs
4,763

 
5,067

Amortization of debt premium
(26,271
)
 
(20,898
)
Loss on extinguishment of debt, net
412

 

Amortization of stock-based compensation
10,354

 
8,720

Equity in (income) loss of, and return on, unconsolidated real estate entities and noncontrolling interests, net of eliminations
2,911

 
45,215

Abandonment of development pursuits
1,455

 

Cash flow hedge losses reclassified to earnings
4,557

 
57,913

Gain on sale of real estate assets
(98,814
)
 
(118,413
)
Gain on sale of joint venture real estate assets
(130,386
)
 
(12,667
)
Decrease (increase) in cash in operating escrows
771

 
(12,883
)
Increase in resident security deposits, prepaid expenses and other assets
(12,808
)
 
(66,709
)
Increase in accrued expenses, other liabilities and accrued interest payable
1,086

 
15,333

Net cash provided by operating activities
641,429

 
469,923

 
 
 
 
Cash flows from investing activities:
 
 
 
Development/redevelopment of real estate assets including land acquisitions and deferred development costs
(861,466
)
 
(908,215
)
Acquisition of real estate assets, including partnership interest

 
(749,275
)
Capital expenditures - existing real estate assets
(33,324
)
 
(10,527
)
Capital expenditures - non-real estate assets
(5,776
)
 
(7,286
)
Proceeds from sale of real estate, net of selling costs
186,651

 
432,380

Mortgage note receivable repayment
21,748

 

Increase in payables for construction
3,463

 
31,124

Decrease in investments in unconsolidated real estate entities
192,209

 
16,788

Net cash used in investing activities
(496,495
)
 
(1,195,011
)
 
 
 
 
Cash flows from financing activities:
 
 
 
Issuance of common stock
340,091

 
2,874

Dividends paid
(440,632
)
 
(387,658
)
Issuance of mortgage notes payable
53,000

 
71,210

Repayments of mortgage notes payable, including prepayment penalties
(28,718
)
 
(1,789,399
)
Settlement of interest rate contract

 
(51,000
)
Issuance of unsecured notes
250,000

 
400,000

Repayment of unsecured notes
(150,000
)
 
(100,000
)
Payment of deferred financing costs
(3,414
)
 
(6,093
)
Acquisition of joint venture partner equity interest

 
(1,965
)
Distributions to DownREIT partnership unitholders
(26
)
 
(24
)
Distributions to joint venture and profit-sharing partners
(262
)
 
(238
)
Redemption of preferred interest obligation
(6,300
)
 
(33,327
)
Net cash provided by (used in) financing activities
13,739

 
(1,895,620
)
 
 
 
 
Net increase (decrease) in cash and cash equivalents
158,673

 
(2,620,708
)
Cash and cash equivalents, beginning of period
281,355

 
2,733,618

Cash and cash equivalents, end of period
$
440,028

 
$
112,910

Cash paid during the period for interest, net of amount capitalized
$
154,653

 
$
137,081

 
See accompanying notes to Condensed Consolidated Financial Statements.

3

Table of Contents

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
Supplemental disclosures of non-cash investing and financing activities:
During the nine months ended September 30, 2014:
As described in Note 4, “Equity,” 113,822 shares of common stock were issued as part of the Company's stock based compensation plan, of which 16,209 shares related to the conversion of restricted stock units to restricted shares, and the remaining 97,613 shares valued at $12,605,000 were issued in connection with new stock grants; 1,868 shares valued at $250,000 were issued through the Company’s dividend reinvestment plan; 53,983 shares valued at $4,701,000 were withheld to satisfy employees’ tax withholding and other liabilities; and 200 restricted shares as well as restricted stock units with an aggregate value of $1,826,000 previously issued in connection with employee compensation were canceled upon forfeiture.
Common dividends declared but not paid totaled $153,125,000.
The Company recorded a decrease of $4,088,000 in redeemable noncontrolling interest with a corresponding increase to accumulated earnings less dividends to adjust the redemption value associated with the put options held by joint venture partners and DownREIT partnership units.  For further discussion of the nature and valuation of these items, see Note 11, “Fair Value.”
The Company reclassified $4,557,000 of cash flow hedge losses from other comprehensive income to interest expense, net, to record the impact of the Company’s derivative and hedge accounting activity.
The Company derecognized $17,816,000 in noncontrolling interest in conjunction with the deconsolidation of a Fund I subsidiary.
During the nine months ended September 30, 2013:
The Company issued 14,889,706 shares of common stock valued at $1,875,210,000 as partial consideration for the Archstone Acquisition (as defined in this Form 10-Q); 123,977 shares of common stock valued at $16,019,000 were issued in connection with stock grants; 1,465 shares valued at $200,000 were issued through the Company’s dividend reinvestment plan; 44,750 shares valued at $5,706,000 were withheld to satisfy employees’ tax withholding and other liabilities; and 5,214 shares and options valued at $780,000 previously issued in connection with employee compensation were forfeited. In addition, the Company granted 215,230 options for common stock at a value of $5,768,000.
The Company reclassified $4,429,000 of deferred cash flow hedge losses from other comprehensive income to interest expense, net, and $53,484,000 to loss on interest rate contract, to record the impact of the Company's derivative and hedge accounting activity.
Common dividends declared but not paid totaled $138,459,000.
The Company recorded $13,262,000 in redeemable noncontrolling interests associated with the acquisition of consolidated joint ventures as part of the Archstone Acquisition.  The Company also recorded an increase of $441,000 in redeemable noncontrolling interest with a corresponding decrease to accumulated earnings less dividends to adjust the redemption value associated with the put option held by a joint venture partner and DownREIT partnership units.
The Company assumed secured indebtedness with a principal amount of $3,512,202,000 in conjunction with the Archstone Acquisition.  The Company also assumed an obligation related to outstanding preferred interests of approximately $67,500,000, included in accrued expenses and other liabilities.

4

Table of Contents

AVALONBAY COMMUNITIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)  
1.  Organization, Basis of Presentation and Significant Accounting Policies
Organization and Basis of Presentation
AvalonBay Communities, Inc. (the “Company,” which term, unless the context otherwise requires, refers to AvalonBay Communities, Inc. together with its consolidated subsidiaries), is a Maryland corporation that has elected to be taxed as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986 (the “Code”). The Company focuses on the development, acquisition, ownership and operation of apartment communities primarily in high barrier to entry markets of the United States. The Company’s primary markets are located in New England, the New York/New Jersey Metro area, the Mid-Atlantic, the Pacific Northwest and the Northern and Southern California regions of the United States.
At September 30, 2014, the Company owned or held a direct or indirect ownership interest in 247 operating apartment communities containing 73,182 apartment homes in 11 states and the District of Columbia, of which six communities containing 2,094 apartment homes were under reconstruction. In addition, the Company owned or held a direct or indirect ownership interest in 27 communities under construction that are expected to contain an aggregate of 9,151 apartment homes when completed. The Company also owned or held a direct or indirect ownership interest in land or rights to land on which the Company expects to develop an additional 39 communities that, if developed as expected, will contain an estimated 10,707 apartment homes.
The interim unaudited financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and in conjunction with the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements required by GAAP have been condensed or omitted pursuant to such rules and regulations. These unaudited financial statements should be read in conjunction with the financial statements and notes included in the Company’s 2013 Annual Report on Form 10-K. The results of operations for the three and nine months ended September 30, 2014 are not necessarily indicative of the operating results for the full year. Management believes the disclosures are adequate to ensure the information presented is not misleading.  In the opinion of management, all adjustments and eliminations, consisting only of normal, recurring adjustments necessary for a fair presentation of the financial statements for the interim periods, have been included.
Capitalized terms used without definition have meanings provided elsewhere in this Form 10-Q.
Earnings per Common Share
Basic earnings per share is computed by dividing net income attributable to common stockholders by the weighted average number of shares outstanding during the period. All outstanding unvested restricted share awards contain rights to non-forfeitable dividends and participate in undistributed earnings with common shareholders and, accordingly, are considered participating securities that are included in the two-class method of computing basic earnings per share (“EPS”). Both the unvested restricted shares and other potentially dilutive common shares, and the related impact to earnings, are considered when calculating earnings per share on a diluted basis. The Company’s earnings per common share are determined as follows (dollars in thousands, except per share data):

5

Table of Contents

 
For the three months ended
 
For the nine months ended
 
9/30/2014
 
9/30/2013
 
9/30/2014
 
9/30/2013
Basic and diluted shares outstanding
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Weighted average common shares - basic
131,330,078

 
129,208,839

 
130,165,873

 
126,057,793

 
 
 
 
 
 
 
 
Weighted average DownREIT units outstanding
7,500

 
7,500

 
7,500

 
7,500

 
 
 
 
 
 
 
 
Effect of dilutive securities (1)
568,417

 

 
554,627

 
411,821

 
 
 
 
 
 
 
 
Weighted average common shares - diluted
131,905,995

 
129,216,339

 
130,728,000

 
126,477,114

 
 
 
 
 
 
 
 
Calculation of Earnings per Share - basic
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Net income (loss) attributable to common stockholders
$
241,100

 
$
(10,715
)
 
$
540,929

 
$
100,929

Net income (loss) allocated to unvested restricted shares
(366
)
 
16

 
(858
)
 
(166
)
Net income (loss) attributable to common stockholders, adjusted
$
240,734

 
$
(10,699
)
 
$
540,071

 
$
100,763

 
 
 
 
 
 
 
 
Weighted average common shares - basic
131,330,078

 
129,208,839

 
130,165,873

 
126,057,793

 
 
 
 
 
 
 
 
Earnings (loss) per common share - basic
$
1.83

 
$
(0.08
)
 
$
4.15

 
$
0.80

 
 
 
 
 
 
 
 
Calculation of Earnings per Share - diluted
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
Net income (loss) attributable to common stockholders
$
241,100

 
$
(10,715
)
 
$
540,929

 
$
100,929

Add: noncontrolling interests of DownREIT unitholders in consolidated partnerships, including discontinued operations
9

 
8

 
26

 
24

 
 
 
 
 
 
 
 
Adjusted net income (loss) available to common stockholders
$
241,109

 
$
(10,707
)
 
$
540,955

 
$
100,953

 
 
 
 
 
 
 
 
Weighted average common shares - diluted
131,905,995

 
129,216,339

 
130,728,000

 
126,477,114

 
 
 
 
 
 
 
 
Earnings (loss) per common share - diluted
$
1.83

 
$
(0.08
)
 
$
4.14

 
$
0.80

 
____________________________
(1) Securities considered antidilutive for the three months ended September 30, 2013 due to the Company's recognition of a net loss.
Certain options to purchase shares of common stock in the amounts of 1,499 and 605,899 were outstanding at September 30, 2014 and 2013, respectively, but were not included in the computation of diluted earnings per share because such options were anti-dilutive for the respective quarters.
The Company is required to estimate the forfeiture of stock options and recognize compensation cost net of the estimated forfeitures.  The estimated forfeitures included in compensation cost are adjusted to reflect actual forfeitures at the end of the vesting period.  The forfeiture rate at September 30, 2014 is based on the average forfeiture activity over a period equal to the estimated life of the stock options, and was 1.4%. The application of estimated forfeitures did not materially impact compensation expense for the three and nine months ended September 30, 2014 or 2013.
Derivative Instruments and Hedging Activities
The Company enters into interest rate swap and interest rate cap agreements (collectively, “Hedging Derivatives”) for interest rate risk management purposes and in conjunction with certain variable rate secured debt to satisfy lender requirements.  The Company does not enter into Hedging Derivatives transactions for trading or other speculative purposes. The Company assesses both at inception, and on an on-going basis, the effectiveness of qualifying cash flow and fair value hedges. Hedge ineffectiveness is reported as a component of general and administrative expenses. The fair values of Hedging Derivatives that are in an asset position are recorded in prepaid expenses and other assets. The fair value of Hedging Derivatives that are in a liability position are included in accrued expenses and other liabilities. Fair value changes for derivatives that are not in qualifying hedge relationships are reported as a component of interest expense, net.  For Hedging Derivatives that the Company has determined qualify as effective

6

Table of Contents

cash flow hedges, the Company has recorded the effective portion of cumulative changes in the fair value of Hedging Derivatives in other comprehensive income.  Amounts recorded in other comprehensive income will be reclassified into earnings in the periods in which earnings are affected by the hedged cash flow. The effective portion of the change in fair value of Hedging Derivatives that the Company has determined qualified as effective fair value hedges is reported as an adjustment to the carrying amount of the corresponding debt being hedged.
Legal and Other Contingencies
The Company is involved in various claims and/or administrative proceedings that arise in the ordinary course of the Company’s business. While no assurances can be given, the Company does not believe that any of these outstanding litigation matters, individually or in the aggregate, will have a material adverse effect on the Company’s financial position or results of operations.
Acquisitions of Investments in Real Estate
The Company accounts for acquisitions of investments in real estate in accordance with the authoritative guidance for the initial measurement, which requires the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree to be recognized at fair value. Typical assets and liabilities acquired include land, building, furniture, fixtures, and equipment, and identified intangible assets and liabilities, consisting of the value of above or below market leases and in-place leases.  In making estimates of fair values for purposes of allocating purchase price, the Company utilizes various sources, including its own analysis of recently acquired and existing comparable properties in its portfolio and other market data.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make certain estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods.  Actual results could differ from those estimates.
Reclassifications
Certain reclassifications have been made to amounts in prior years’ financial statements to conform to current year presentations as a result of discontinued operations and changes in held for sale classification as described in Note 7, “Real Estate Disposition Activities.”
Recently Adopted Accounting Standards
In April 2014, the Financial Accounting Standards Board issued Accounting Standards Update (ASU) 2014-08, guidance updating the accounting and reporting for discontinued operations. Under the recently issued guidance, only disposals representing a strategic shift in operations (e.g., a disposal of a major geographic area, a major line of business or a major equity method investment) will be presented as discontinued operations. Additionally, the final standard requires expanded disclosures about dispositions that will provide financial statement users with more information about the assets, liabilities, income and expenses of discontinued operations, as well as disposals of a significant part of an entity that does not qualify for discontinued operations reporting. The final standard is effective in the first quarter of 2015 and allows for early adoption. The Company adopted the guidance as of January 1, 2014, as discussed in Note 7, “Real Estate Disposition Activities.”
In May 2014, the Financial Accounting Standards Board issued a revenue recognition standard that will result in companies recognizing revenue from contracts when control for the service or product that is the subject of the contract is transferred from the seller to the buyer. The Company will be required to apply the new standard in the first quarter of 2017 and is assessing whether the new standard will have a material effect on its financial position or results of operations.
2.  Interest Capitalized
The Company capitalizes interest during the development and redevelopment of real estate assets. Capitalized interest associated with the Company’s development or redevelopment activities totaled $15,989,000 and $17,205,000 for the three months ended September 30, 2014 and 2013, respectively, and $54,294,000 and $47,168,000 for the nine months ended September 30, 2014 and 2013, respectively.

7

Table of Contents

3.  Notes Payable, Unsecured Notes and Credit Facility
The Company’s mortgage notes payable, unsecured notes, Term Loan and Credit Facility, both as defined below, as of September 30, 2014 and December 31, 2013, are summarized below (dollars in thousands).  The following amounts and discussion do not include the mortgage notes related to the communities classified as held for sale, if any, as of September 30, 2014 and December 31, 2013, as shown in the Condensed Consolidated Balance Sheets (dollars in thousands) (see Note 7, “Real Estate Disposition Activities”).
 
9/30/2014
 
12/31/2013
 
 
 
 
Fixed rate unsecured notes (1)
$
2,450,000

 
$
2,600,000

Term Loan
250,000

 

Fixed rate mortgage notes payable - conventional and tax-exempt (2)
2,405,000

 
2,418,389

Variable rate mortgage notes payable - conventional and tax-exempt
1,048,118

 
1,011,609

 
 
 
 
Total mortgage notes payable and unsecured notes
6,153,118

 
6,029,998

 
 
 
 
Credit Facility

 

 
 
 
 
Total mortgage notes payable, unsecured notes and Credit Facility
$
6,153,118

 
$
6,029,998

_____________________________________
(1)
Balances at September 30, 2014 and December 31, 2013 exclude $4,701 and $5,291 of debt discount, respectively, as reflected in unsecured notes, net on the Company’s Condensed Consolidated Balance Sheets.
(2)
Balances at September 30, 2014 and December 31, 2013 exclude $93,351 and $120,684 of debt premium, respectively, as reflected in mortgage notes payable on the Company’s Condensed Consolidated Balance Sheets.
The following debt activity occurred during the nine months ended September 30, 2014:
In March 2014, the Company entered into a $300,000,000 variable rate unsecured term loan that matures in March 2021 (the “Term Loan”).  At September 30, 2014, the Company had drawn $250,000,000 of the available $300,000,000, with the option to draw the additional $50,000,000 until March 2015.
In April 2014, in conjunction with certain requirements associated with the development of an apartment community, the Company entered into a $53,000,000 secured mortgage loan maturing in 2019, with an option to extend the maturity to 2024.  The mortgage is comprised of a $15,000,000 fixed rate note with an interest rate of 2.99% and a $38,000,000 variable rate note at the London Interbank Offered Rate ("LIBOR") plus 2.00%.
Pursuant to its scheduled maturity in April 2014, the Company repaid $150,000,000 principal amount of unsecured notes with a stated coupon of 5.375%.
In June 2014, in conjunction with the disposition of an operating community, the Company repaid a fixed rate secured mortgage loan in the amount of $10,427,000 with an interest rate of 6.19% in advance of its November 2015 maturity date. In accordance with the requirements of the master credit agreement governing this and certain other secured borrowings, the Company repaid an additional $5,914,000 principal amount of secured borrowings for eight other operating communities. The Company incurred a charge for early debt extinguishment of $412,000.
The Company has a $1,300,000,000 revolving variable rate unsecured credit facility with a syndicate of banks (the “Credit Facility”) which matures in April 2017. The Company has the option to extend the maturity by up to one year under two, six month extension options for an aggregate fee of $1,950,000. The Credit Facility bears interest at varying levels based on the LIBOR rating levels achieved on the unsecured notes and on a maturity schedule selected by the Company. The current stated pricing is LIBOR plus 1.05% (1.20% at September 30, 2014), assuming a one month borrowing rate.  The annual facility fee is approximately $1,950,000 based on the $1,300,000,000 facility size and based on the Company’s current credit rating.
The Company had no borrowings outstanding under the Credit Facility and had $52,347,000 and $65,018,000 outstanding in letters of credit that reduced the borrowing capacity as of September 30, 2014 and December 31, 2013, respectively.
In the aggregate, secured notes payable mature at various dates from November 2015 through July 2066, and are secured by certain apartment communities and improved land parcels (with a net carrying value of $4,440,175,000 excluding communities classified as held for sale, as of September 30, 2014).

8

Table of Contents

As of September 30, 2014, the Company has guaranteed approximately $257,970,000 of mortgage notes payable held by wholly-owned subsidiaries; all such mortgage notes payable are consolidated for financial reporting purposes.  The weighted average interest rate of the Company’s fixed rate mortgage notes payable (conventional and tax-exempt) was 4.5% at both September 30, 2014 and December 31, 2013.  The weighted average interest rate of the Company’s variable rate mortgage notes payable (conventional and tax exempt), the Term Loan and its Credit Facility, including the effect of certain financing related fees, was 1.8% at both September 30, 2014 and December 31, 2013.
Scheduled payments and maturities of mortgage notes payable and unsecured notes outstanding at September 30, 2014 are as follows (dollars in thousands):
Year
 
Secured notes payments
 
Secured notes maturities
 
Unsecured notes maturities
 
Stated interest rate of unsecured notes
 
 
 
 
 
 
 
 
 
2014
 
$
4,641

 
$

 
$

 

 
 
 
 
 
 
 
 
 
2015
 
17,871

 
586,703

 

 

 
 
 
 
 
 
 
 
 
2016
 
19,036

 
16,255

 
250,000

 
5.750
%
 
 
 
 
 
 
 
 
 
2017
 
20,257

 
710,491

 
250,000

 
5.700
%
 
 
 
 
 
 
 
 
 
2018
 
19,646

 
76,930

 

 

 
 
 
 
 
 
 
 
 
2019
 
7,145

 
658,475

 

 

 
 
 
 
 
 
 
 
 
2020
 
6,205

 
50,824

 
250,000

 
6.100
%
 
 
 
 
 
 
 
 
 
 
 
 

 
 

 
400,000

 
3.625
%
 
 
 
 
 
 
 
 
 
2021
 
5,985

 
27,844

 
250,000

 
3.950
%
 
 
 
 
 
 
 
 
 
 
 
 

 
 

 
250,000

 
LIBOR + 1.45%

 
 
 
 
 
 
 
 
 
2022
 
6,352

 

 
450,000

 
2.950
%
 
 
 
 
 
 
 
 
 
2023
 
6,596

 

 
350,000

 
4.200
%
 
 
 
 
 
 
 
 
 
 
 
 

 
 

 
250,000

 
2.850
%
 
 
 
 
 
 
 
 
 
Thereafter
 
85,973

 
1,125,889

 

 

 
 
 
 
 
 
 
 
 
 
 
$
199,707

 
$
3,253,411

 
$
2,700,000

 
 

 
The Company was in compliance at September 30, 2014 with certain customary financial and other covenants under the Credit Facility, the Term Loan, and the Company’s fixed-rate unsecured notes.

9

Table of Contents

4.  Equity
The following summarizes the changes in equity for the nine months ended September 30, 2014 (dollars in thousands):
 
Common
stock
 
Additional
paid-in
capital
 
Accumulated
earnings
less
dividends
 
Accumulated
other
comprehensive
loss
 
Total
AvalonBay
stockholders’
equity
 
Noncontrolling
interests
 
Total
equity
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2013
$
1,294

 
$
8,988,723

 
$
(345,254
)
 
$
(48,631
)
 
$
8,596,132

 
$
3,595

 
$
8,599,727

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net income attributable to common stockholders

 

 
540,929

 

 
540,929

 

 
540,929

Cash flow hedge loss reclassified to earnings

 

 

 
4,557

 
4,557

 

 
4,557

Change in redemption value of redeemable noncontrolling interest

 

 
4,088

 

 
4,088

 

 
4,088

Noncontrolling interests income allocation

 

 

 

 

 
14,221

 
14,221

Noncontrolling interests derecognition

 

 

 

 

 
(17,816
)
 
(17,816
)
Dividends declared to common stockholders

 

 
(455,531
)
 

 
(455,531
)
 

 
(455,531
)
Issuance of common stock, net of withholdings
26

 
334,207

 
(394
)
 

 
333,839

 

 
333,839

Amortization of deferred compensation

 
21,268

 

 

 
21,268

 

 
21,268

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at September 30, 2014
$
1,320

 
$
9,344,198

 
$
(256,162
)
 
$
(44,074
)
 
$
9,045,282

 
$

 
$
9,045,282

As of September 30, 2014 and December 31, 2013, the Company’s charter had authorized for issuance a total of 280,000,000 shares of common stock and 50,000,000 shares of preferred stock.
During the nine months ended September 30, 2014, the Company:
(i)                                     issued 2,069,538 common shares through public offerings under CEP III, discussed below;
(ii) issued 454,728 common shares in connection with stock options exercised;
(iii)         issued 1,868 common shares through the Company’s dividend reinvestment plan;
(iv)                              issued 113,822 common shares in connection with stock grants and the conversion of restricted stock units to restricted
shares;
(v)                               issued 4,367 common shares through the Employee Stock Purchase Program;
(vi)                          withheld 53,983 common shares to satisfy employees’ tax withholding and other liabilities; and
(vii)        canceled 200 shares of restricted stock upon forfeiture.

Any deferred compensation related to the Company’s stock option and restricted stock grants during the nine months ended September 30, 2014 is not reflected on the Company’s Condensed Consolidated Balance Sheet as of September 30, 2014, and will not be reflected until earned as compensation cost.
In August 2012, the Company commenced a third continuous equity program (“CEP III”), under which the Company may sell up to $750,000,000 of shares of its common stock from time to time during a 36-month period.  Actual sales will depend on a variety of factors to be determined by the Company, including market conditions, the trading price of the Company’s common stock and determinations by the Company of the appropriate sources of funding for the Company. In conjunction with CEP III, the Company engaged sales agents who receive compensation of approximately 1.5% of the gross sales price for shares sold.  During the three and nine months ended September 30, 2014, the Company sold 650,579 and 2,069,538 shares at an average sales price of $153.68 and $144.95 per share, for net proceeds of $98,481,000 and $295,465,000, respectively. As of September 30, 2014, the Company had $346,304,000 of shares remaining authorized for issuance under this program.
On September 9, 2014, based on a market closing price of $155.83 per share on that date, the Company entered into a forward contract to sell 4,500,000 shares of common stock for an initial forward price of $151.74 per share, net of offering fees and discounts. The sales price and proceeds achieved by the Company will be determined on the date or dates of settlement, with adjustments during the term of the contract for the Company’s dividends as well as for a daily interest factor that varies with changes in the Fed Funds rate. The Company generally has the ability to determine the date(s) and method of settlement, subject

10

Table of Contents

to certain conditions and the right of the forward counterparty to accelerate settlement under certain circumstances. Settlement may be (i) physical sale of shares of our common stock for cash, (ii) net cash settlement, whereby the Company will either pay or receive the difference between the forward contract price and the weighted average market price for its common stock at the time of settlement, or (iii) net share settlement, whereby the Company will either receive or issue shares of its common stock, with the number of shares issued or received determined by the difference between the forward contract price and the weighted average market price for its common stock at the time of settlement. The forward contract price and the weighted average market price would in both cases by determined under the applicable terms of the forward contract. Under either of the net settlement provisions, the Company will pay to the counterparty either cash or shares of its common stock when the weighted average market price of its common stock at the time of settlement exceeds the forward contract price, and will receive either cash or issue shares of its common stock to the extent that the weighted average market price of its common stock at the time of settlement is less than the price under the forward contract. Settlement of the forward contract will occur on one or more dates not later than September 8, 2015.

5.  Archstone Acquisition
On February 27, 2013, pursuant to an asset purchase agreement (the “Purchase Agreement”) dated November 26, 2012, by and among the Company, Equity Residential and its operating partnership, ERP Operating Limited Partnership (together, “Equity Residential”), Lehman Brothers Holdings, Inc. (“Lehman,” which term is sometimes used in this report to refer to Lehman Brothers Holdings, Inc., and/or its relevant subsidiary or subsidiaries), and Archstone Enterprise LP (“Archstone,” which has since changed its name to Jupiter Enterprise LP), the Company, together with Equity Residential, acquired, directly or indirectly, all of Archstone’s assets, including all of the ownership interests in joint ventures and other entities owned by Archstone, and assumed Archstone’s liabilities, both known and unknown, with certain limited exceptions.
Under the terms of the Purchase Agreement, the Company acquired approximately 40% of Archstone’s assets and liabilities and Equity Residential acquired approximately 60% of Archstone’s assets and liabilities (the “Archstone Acquisition”). The Company accounted for the acquisition as a business combination and recorded the purchase price to acquired tangible assets consisting primarily of direct and indirect interests in land and related improvements, buildings and improvements and construction in progress and identified intangible assets and liabilities, consisting primarily of the value of above and below market leases, the value of in-places leases, and acquired management fees, at their fair values.
During the nine months ended September 30, 2013, the Company recognized $82,544,000 in acquisition related expenses associated with the Archstone Acquisition, with $37,295,000 reported as a component of equity in income (loss) of unconsolidated real estate entities, and the balance in expensed acquisition, development, and other pursuit costs on the accompanying Condensed Consolidated Statements of Comprehensive Income.
Consideration
Pursuant to the Purchase Agreement and separate arrangements between the Company and Equity Residential governing the allocation of liabilities assumed under the Purchase Agreement, the Company’s portion of consideration under the Purchase Agreement consisted of the following:
the issuance of 14,889,706 shares of the Company’s common stock, valued at $1,875,210,000 as of the market’s close on the closing date, February 27, 2013;
cash payment of approximately $760,000,000;
the assumption of consolidated indebtedness with a fair value of approximately $3,732,980,000, as of February 27, 2013, consisting of $3,512,202,000 principal amount of consolidated indebtedness and $220,777,000 representing the amount by which fair value of the aforementioned debt exceeded the principal face value, $70,479,000 of which excess related to debt the Company repaid concurrent with the Archstone Acquisition;
the acquisition with Equity Residential of interests in entities that have preferred units outstanding, some of which may be presented for redemption from time to time. The Company’s 40% share of the fair value of the collective obligations, including accrued dividends on these outstanding Archstone preferred units as of February 27, 2013, was approximately $67,500,000; and
the assumption with Equity Residential of all other liabilities, known or unknown, of Archstone, other than certain excluded liabilities. The Company shares 40% of the responsibility for these liabilities.

11

Table of Contents

The following table presents information for assets acquired in the Archstone Acquisition that are included in the Company’s Condensed Consolidated Statement of Comprehensive Income from the closing date of the acquisition, February 27, 2013, through September 30, 2013 (in thousands):
 
For the period including
February 28, 2013
through September 30, 2013
Revenues
$
246,969

Loss attributable to common shareholders (1)
$
(128,542
)
________________________________________
(1) Amounts exclude acquisition costs for the Archstone Acquisition.
Pro Forma Information
The following table presents the Company’s supplemental consolidated pro forma information for the nine months ended September 30, 2013, as if the acquisition had occurred on January 1, 2012 (unaudited) (in thousands):
 
For the nine months
ended September 30, 2013
Revenues
$
1,152,418

Income from continuing operations
$
242,647

Earnings per common share - diluted (from continuing operations)
$
1.87

The pro forma consolidated results are prepared for informational purposes only, and are based on assumptions and estimates considered appropriate by the Company’s management.  However, they are not necessarily indicative of what the Company’s consolidated financial condition or results of operations actually would have been assuming the Archstone Acquisition had occurred on January 1, 2012, nor do they purport to represent the consolidated financial position or results of operations for future periods.
6.  Investments in Real Estate Entities
Investment in unconsolidated real estate entities
As of September 30, 2014, the Company had investments in seven unconsolidated real estate entities, excluding an interest in the Residual JV (as defined in this Form 10-Q), with ownership interest percentages ranging from 15.2% to 31.3%. As discussed below, two of these entities disposed of their investments in real estate during the nine months ended September 30, 2014. The Company accounts for its investments in unconsolidated real estate entities under the equity method of accounting. The significant accounting policies of the Company’s unconsolidated real estate entities are consistent with those of the Company in all material respects.
During the nine months ended September 30, 2014, AvalonBay Value Added Fund I, L.P. ("Fund I") sold its four final apartment communities.
Weymouth Place, located in Weymouth, MA, containing 211 apartment homes was sold for $25,750,000. The Company's share of the gain in accordance with GAAP for the disposition was $545,000.
South Hills Apartments, located in West Covina, CA, containing 85 apartment homes was sold for $21,800,000. The Company's share of the gain in accordance with GAAP for the disposition was $54,000.
The Springs, located in Corona, CA. containing 320 apartment homes was sold for $43,200,000. The Company's share of the gain in accordance with GAAP for the disposition was $2,373,000.
Avalon Rutherford Station, located in East Rutherford, NJ, containing 108 homes was sold for $34,250,000. The Company's share of the gain in accordance with GAAP for the disposition was $345,000.


12

Table of Contents

The net assets and results of operations of The Springs were consolidated for financial reporting purposes. As a result, 100% of the gain recognized of $16,656,000 is included in gain on sale of communities in the Condensed Consolidated Statements of Comprehensive Income, and the Company's joint venture partners' 84.8% interest in this gain of $14,132,000 is reported as a component of net (income) loss attributable to noncontrolling interests. Concurrent with the disposition of The Springs, Fund I repaid its obligation to the Company under a fixed rate secured mortgage loan in the amount of $21,748,000 with an interest rate of 6.06% in advance of its October 2014 maturity date. Upon repayment the Company deconsolidated the net assets of The Springs.
Fund I has a term that expires in March 2015.
During the nine months ended September 30, 2014, AvalonBay Value Added Fund II, L.P. ("Fund II") sold two communities.
Avalon Bellevue Park, located in Bellevue, WA, containing 220 apartment homes was sold for $58,750,000. The Company's share of the gain in accordance with GAAP for the disposition was $8,450,000.
Avalon Fair Oaks, located in Fairfax, VA, containing 491 apartment homes was sold for $108,200,000. The Company's share of the gain in accordance with GAAP for the disposition was $13,174,000.
During the three months ended September 30, 2014, CVP I, LLC, the entity that owned Avalon Chrystie Place, located in New York, NY containing 361 apartment homes and approximately 71,000 square feet of retail space, sold the community for $365,000,000. The Company owned a 20.0% interest in the entity, and its share of the gain in accordance with GAAP for the disposition was $50,478,000. In addition, the Company earned $57,489,000 for its promoted interest in CVP I, LLC, reported in equity in income (loss) of unconsolidated real estate entities on the accompanying Condensed Consolidated Statements of Comprehensive Income.
In conjunction with the disposition of these communities, the respective ventures repaid $198,961,000 of related secured indebtedness in advance of the scheduled maturity dates. This resulted in charges for prepayment penalties and a write off of deferred financing costs, of which the Company’s portion was approximately $2,339,000 and was reported as a reduction of equity in income (loss) of unconsolidated real estate entities on the accompanying Condensed Consolidated Statements of Comprehensive Income. In addition, during the three months ended September 30, 2014, Fund II repaid an outstanding mortgage note at par in the amount of $42,023,000, in advance of its November 2014 maturity date.

As of September 30, 2014, the Residual JV completed the disposition of substantially all of its direct and indirect interests in German multifamily real estate assets and the associated property management company.  The Company’s proportionate share of income from the Residual JV (including from gains from dispositions) from its interests in German multifamily real estate assets was $7,548,000 for the nine months ended September 30, 2014, recorded as a component of equity in income (loss) of unconsolidated real estate entities in the Condensed Consolidated Statements of Comprehensive Income. The Company received proceeds of $8,249,000 and $51,361,000, respectively, during the three and nine months ended September 30, 2014 from the Residual JV, for its proportionate share of the proceeds from operations and the dispositions of the venture's interest in German multifamily real estate assets.
The following is a combined summary of the financial position of the entities accounted for using the equity method as of the dates presented, excluding amounts associated with the Residual JV (dollars in thousands):
 
9/30/2014
 
12/31/2013
 
(unaudited)
 
(unaudited)
Assets:
 

 
 

Real estate, net
$
1,624,119

 
$
1,905,005

Other assets
92,521

 
164,183

 
 
 
 
Total assets
$
1,716,640

 
$
2,069,188

 
 
 
 
Liabilities and partners’ capital:
 

 
 

Mortgage notes payable and credit facility
$
982,246

 
$
1,251,067

Other liabilities
34,846

 
32,257

Partners’ capital
699,548

 
785,864

 
 
 
 
Total liabilities and partners’ capital
$
1,716,640

 
$
2,069,188

 

13

Table of Contents

The following is a combined summary of the operating results of the entities accounted for using the equity method for the periods presented, excluding amounts associated with the Residual JV (dollars in thousands):
 
For the three months ended
 
For the nine months ended
 
9/30/2014
 
9/30/2013
 
9/30/2014
 
9/30/2013
 
(unaudited)
 
(unaudited)
 
 
 
 
 
 
 
 
Rental and other income
$
49,388

 
$
56,613

 
$
154,034

 
$
157,938

Operating and other expenses
(19,989
)
 
(22,915
)
 
(61,680
)
 
(63,731
)
Gain on sale of communities
327,539

 
5,395

 
333,221

 
70,662

Interest expense, net
(22,922
)
 
(15,376
)
 
(50,335
)
 
(46,474
)
Depreciation expense
(11,934
)
 
(15,668
)
 
(40,214
)
 
(46,602
)
Net income
$
322,082

 
$
8,049

 
$
335,026

 
$
71,793

In conjunction with the formation of Fund I and Fund II, the Company incurred costs in excess of its equity in the underlying net assets of the respective investments. These costs represent $4,108,000 at September 30, 2014 and $5,439,000 at December 31, 2013 of the respective investment balances.
As part of the formation of Fund II, the Company provided a guarantee to one of the limited partners that provides if, upon final liquidation of Fund II, the total amount of all distributions to the guaranteed partner during the life of Fund II (whether from operating cash flow or property sales) does not equal the total capital contributions made by that partner, then the Company will pay the guaranteed partner an amount equal to the shortfall, but in no event more than 10% of the total capital contributions made by the guaranteed partner (maximum of approximately $8,910,000 for Fund II as of September 30, 2014).  As of September 30, 2014, the expected realizable value of the real estate assets owned by Fund II is considered adequate to cover the guaranteed distribution amount under a liquidation scenario.  The estimated fair value of, and the Company’s obligation under, this guarantee, both at inception and as of September 30, 2014, was not significant and therefore the Company has not recorded any obligation for this guarantee as of September 30, 2014.
Expensed Acquisition, Development and Other Pursuit Costs and Impairment of Long-Lived Assets
The Company capitalizes pre-development costs incurred in pursuit of new development opportunities for which the Company currently believes future development is probable (“Development Rights”). Future development of these Development Rights is dependent upon various factors, including zoning and regulatory approval, rental market conditions, construction costs and the availability of capital.  Initial pre-development costs incurred for pursuits for which future development is not yet considered probable are expensed as incurred.  In addition, if the status of a Development Right changes, making future development by the Company no longer probable, any capitalized pre-development costs are written off with a charge to expense.  The Company expensed costs related to the abandonment of Development Rights as well as costs incurred in pursuing the acquisition of assets or costs incurred pursuing the disposition of assets for which such disposition activity did not occur, in the amounts of $407,000 and $351,000 for the three months ended September 30, 2014 and 2013, respectively, and $3,138,000 and $792,000 for the nine months ended September 30, 2014 and 2013. Amounts for the three and nine months ended September 30, 2013 do not include costs associated with the Archstone Acquisition. For further discussion of these costs, see Note 5, “Archstone Acquisition.” These costs are included in expensed acquisition, development, and other pursuit costs on the accompanying Condensed Consolidated Statements of Comprehensive Income. These costs can vary greatly, and the costs incurred in any given period may be significantly different in future periods.
The Company evaluates its real estate and other long-lived assets for impairment when potential indicators of impairment exist. Such assets are stated at cost, less accumulated depreciation and amortization, unless the carrying amount of the asset is not recoverable. If events or circumstances indicate that the carrying amount of a long-lived asset may not be recoverable, the Company assesses its recoverability by comparing the carrying amount of the long-lived asset to its estimated undiscounted future cash flows. If the carrying amount exceeds the aggregate undiscounted future cash flows, the Company recognizes an impairment loss to the extent the carrying amount exceeds the estimated fair value of the long-lived asset. Based on periodic tests of recoverability of long-lived assets, the Company did not record any impairment losses for the three and nine months ended September 30, 2014 and 2013.
The Company assesses its portfolio of land held for both development and investment for impairment if the intent of the Company changes with respect to either the development of, or the expected holding period for, the land.  The Company did not recognize any impairment charges on its investment in land for the three and nine months ended September 30, 2014 and 2013.

14

Table of Contents

The Company also evaluates its unconsolidated investments for impairment, considering both the carrying value of the investment, estimated as the expected proceeds that it would receive if the entity were dissolved and the net assets were liquidated at their current GAAP basis, as well as the Company’s proportionate share of any impairment of assets held by unconsolidated investments. There were no impairment losses recognized by any of the Company’s investments in unconsolidated entities during the three and nine months ended September 30, 2014 and 2013, respectively.

7.  Real Estate Disposition Activities
During the nine months ended September 30, 2014, the Company sold three wholly-owned operating communities.
Avalon Valley, located in Danbury, CT containing 268 homes, was sold for $53,325,000. The Company's gain in accordance with GAAP for the disposition was $37,869,000, reported in gain on sale of discontinued operations on the accompanying Condensed Consolidated Statements of Comprehensive Income.
Oakwood Philadelphia, acquired as part of the Archstone Acquisition and located in Philadelphia, PA containing 80 homes, was sold for $28,875,000.  The Company’s gain in accordance with GAAP for the disposition was $3,268,000, reported in gain on sale of communities on the accompanying Condensed Consolidated Statements of Comprehensive Income.
Avalon Danvers, located in Danvers, MA containing 433 homes, was sold for $108,500,000.  The Company’s gain in accordance with GAAP for the disposition was $41,021,000, reported in gain on sale of communities on the accompanying Condensed Consolidated Statements of Comprehensive Income.
The results of operations for Oakwood Philadelphia and Avalon Danvers are included in income (loss) from continuing operations on the accompanying Condensed Consolidated Statements of Comprehensive Income.
The operations for any real estate assets sold from January 1, 2013 through September 30, 2014 (which includes Avalon Valley) and which were classified as held for sale and discontinued operations as of and for the period ended December 31, 2013, and thus not subject to the new guidance for discontinued operations presentation and disclosure, as discussed in Note 1, “Organization, Basis of Presentation and Significant Accounting Policies,” have been presented as income from discontinued operations in the accompanying Condensed Consolidated Statements of Comprehensive Income. Accordingly, certain reclassifications have been made to prior years to reflect discontinued operations consistent with current year presentation.
The following is a summary of income from discontinued operations for the periods presented (dollars in thousands):
 
 
For the three months ended
 
For the nine months ended
 
 
9/30/2014
 
9/30/2013
 
9/30/2014
 
9/30/2013
 
 
(unaudited)
 
(unaudited)
 
 
 
 
 
 
 
 
 
Rental income
 
$

 
$
11,114

 
$
579

 
$
37,040

Operating and other expenses
 

 
(3,516
)
 
(269
)
 
(10,996
)
Depreciation expense
 

 
(2,535
)
 

 
(13,154
)
Income from discontinued operations
 
$

 
$
5,063

 
$
310

 
$
12,890

During the nine months ended September 30, 2014, Fund I sold The Springs, which was consolidated for financial reporting purposes, as discussed in Note 6, "Investments in Real Estate Entities."
At September 30, 2014, the Company had one real estate asset that qualified as held for sale.


15

Table of Contents

8.  Segment Reporting
The Company’s reportable operating segments include Established Communities, Other Stabilized Communities, and Development/Redevelopment Communities.  Annually as of January 1st, the Company determines which of its communities fall into each of these categories and generally maintains that classification throughout the year for the purpose of reporting segment operations, unless disposition or redevelopment plans regarding a community change.  At April 1, 2014, the Company updated its reportable operating segments, primarily to include communities acquired as part of the Archstone Acquisition, as described in Note 5, “Archstone Acquisition,” in its Established Community portfolio.
In addition, the Company owns land for future development and has other corporate assets that are not allocated to an operating segment.
The Company’s segment disclosures present the measure(s) used by the chief operating decision maker for purposes of assessing each segment’s performance.  The Company’s chief operating decision maker is comprised of several members of its executive management team who use net operating income (“NOI”) as the primary financial measure for Established Communities and Other Stabilized Communities.  NOI is defined by the Company as total property revenue less direct property operating expenses, including property taxes, and excluding corporate-level income (including management, development and other fees), corporate-level property management and other indirect operating expenses, investments and investment management expenses, expensed acquisition, development and other pursuit costs, net interest expense, gain (loss) on extinguishment of debt, general and administrative expense, joint venture income (loss), depreciation expense, impairment loss on land holdings, gain on sale of real estate assets, income from discontinued operations and net operating income from real estate assets sold or held for sale, not classified as discontinued operations. Although the Company considers NOI a useful measure of a community’s or communities’ operating performance, NOI should not be considered an alternative to net income or net cash flow from operating activities, as determined in accordance with GAAP.  NOI excludes a number of income and expense categories as detailed in the reconciliation of NOI to net income.
A reconciliation of NOI to net income for the three and nine months ended September 30, 2014 and 2013 is as follows (dollars in thousands):
 
For the three months ended
 
For the nine months ended
 
9/30/2014
 
9/30/2013
 
9/30/2014
 
9/30/2013
 
 
 
 
 
 
 
 
Net income
$
241,001

 
$
(10,885
)
 
$
554,801

 
$
100,681

Indirect operating expenses, net of corporate income
13,173

 
10,780

 
36,333

 
30,673

Investments and investment management expense
1,079

 
1,043

 
3,195

 
3,154

Expensed acquisition, development and other pursuit costs
406

 
2,176

 
3,139

 
46,041

Interest expense, net (1)
46,376

 
43,945

 
132,631

 
127,772

Loss on extinguishment of debt, net

 

 
412

 

Loss on interest rate contract

 
53,484

 

 
51,000

General and administrative expense
11,290

 
9,878

 
30,745

 
31,262

Equity in (income) loss of unconsolidated real estate entities
(130,592
)
 
(3,260
)
 
(143,527
)
 
16,244

Depreciation expense (1)
111,836

 
159,873

 
328,598

 
455,410

Gain on sale of real estate assets

 

 
(60,945
)
 
(240
)
Gain on sale of discontinued operations

 

 
(37,869
)
 
(118,173
)
Income from discontinued operations

 
(5,063
)
 
(310
)
 
(12,890
)
Net operating income from real estate assets sold or held for sale, not classified as discontinued operations
(1,216
)
 
(3,535
)
 
(8,373
)
 
(9,587
)
Net operating income
$
293,353

 
$
258,436

 
$
838,830

 
$
721,347

__________________________________
(1) Includes amounts associated with assets sold or held for sale, not classified as discontinued operations.
The following is a summary of NOI from real estate assets sold or held for sale, not classified as discontinued operations, for the periods presented (dollars in thousands):

16

Table of Contents

 
For the three months ended
 
For the nine months ended
 
9/30/2014
 
9/30/2013
 
9/30/2014
 
9/30/2013
 
 
 
 
 
 
 
 
 Rental income from real estate assets sold or held for sale, not classified as discontinued operations
$
2,238

 
$
5,871

 
$
13,809

 
$
15,659

 Operating expenses real estate assets sold or held for sale, not classified as discontinued operations
(1,022
)
 
(2,336
)
 
(5,436
)
 
(6,072
)
Net operating income from real estate assets sold or held for sale, not classified as discontinued operations
$
1,216

 
$
3,535

 
$
8,373

 
$
9,587

The primary performance measure for communities under development or redevelopment depends on the stage of completion.  While under development, management monitors actual construction costs against budgeted costs as well as lease-up pace and rent levels compared to budget.
The following table provides details of the Company’s segment information as of the dates specified (dollars in thousands). The segments are classified based on the individual community’s status at either the beginning of the given calendar year, or April 1, 2014, when the Company updated its operating segments. Therefore, each year the composition of communities within each business segment is adjusted.  Accordingly, the amounts between years are not directly comparable. Segment information for the three and nine months ended September 30, 2014 and 2013 has been adjusted to exclude amounts for the real estate assets that were both sold between January 1, 2013 and September 30, 2014, or qualified as held for sale as of September 30, 2014, as described in Note 7, “Real Estate Disposition Activities.”

17

Table of Contents

 
For the three months ended
 
For the nine months ended
 
 
 
Total
revenue
 
NOI
 
% NOI  change from  prior year
 
Total
revenue
 
NOI
 
% NOI  change from  prior year
 
Gross
real estate (1)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
For the period ended September 30, 2014 (2)
 
 

 
 

 
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Established
 

 
 

 
 

 
 

 
 

 
 

 
 

New England
$
49,227

 
$
31,858

 
4.6
 %
 
$
140,891

 
$
89,693

 
0.7
 %
 
$
1,427,605

Metro NY/NJ
96,112

 
67,255

 
3.9
 %
 
237,732

 
165,867

 
2.4
 %
 
2,376,493

Mid-Atlantic
47,122

 
32,284

 
(2.2
)%
 
73,964

 
51,947

 
(3.3
)%
 
645,872

Pacific Northwest
16,744

 
11,668

 
9.4
 %
 
40,437

 
28,104

 
6.3
 %
 
499,611

Northern California
64,120

 
48,805

 
12.2
 %
 
129,560

 
99,030

 
7.8
 %
 
1,401,286

Southern California
63,126

 
41,655

 
6.8
 %
 
103,919

 
71,054

 
4.5
 %
 
1,224,729

Total Established
336,451

 
233,525

 
5.5
 %
 
726,503

 
505,695

 
3.0
 %
 
7,575,596

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other Stabilized
45,023

 
31,838

 
N/A

 
370,627

 
255,085

 
N/A

 
6,008,289

Development / Redevelopment
44,310

 
27,990

 
N/A

 
125,215

 
78,050

 
N/A

 
3,639,770

Land Held for Future Development
N/A

 
N/A

 
N/A

 
N/A

 
N/A

 
N/A

 
176,484

Non-allocated (3)
2,503

 
N/A

 
N/A

 
8,253

 
N/A

 
N/A

 
43,215

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total
$
428,287

 
$
293,353

 
13.5
 %
 
$
1,230,598

 
$
838,830

 
16.3
 %
 
$
17,443,354

 
 
 
 
 
 
 
 
 
 
 
 
 
 
For the period ended September 30, 2013
 
 

 
 

 
 

 
 

 
 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Established
 

 
 

 
 

 
 

 
 

 
 

 
 

New England
$
42,853

 
$
27,221

 
(0.6
)%
 
$
126,239

 
$
81,882

 
2.1
 %
 
$
1,286,876

Metro NY/NJ
63,103

 
43,327

 
3.4
 %
 
186,897

 
129,215

 
4.6
 %
 
1,919,151

Mid-Atlantic
25,262

 
17,652

 
(1.0
)%
 
75,608

 
54,169

 
1.1
 %
 
632,102

Pacific Northwest
11,773

 
7,752

 
1.7
 %
 
34,752

 
23,539

 
7.4
 %
 
443,812

Northern California
35,850

 
28,009

 
15.3
 %
 
104,794

 
79,914

 
13.1
 %
 
1,232,724

Southern California
30,001

 
20,165

 
4.7
 %
 
88,873

 
60,640

 
5.7
 %
 
1,057,512

Total Established
208,842

 
144,126

 
4.2
 %
 
617,163

 
429,359

 
5.4
 %
 
6,572,177

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Other Stabilized
139,093

 
92,856

 
N/A

 
348,028

 
237,846

 
N/A

 
6,539,176

Development / Redevelopment
32,369

 
21,454

 
N/A

 
79,704

 
54,142

 
N/A

 
2,676,384

Land Held for Future Development
N/A

 
N/A

 
N/A

 
N/A

 
N/A

 
N/A

 
282,285

Non-allocated (3)
3,014

 
N/A

 
N/A

 
8,198

 
 N/A

 
N/A

 
47,921

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total
$
383,318

 
$
258,436

 
49.3
 %
 
$
1,053,093

 
$
721,347

 
45.4
 %
 
$
16,117,943

__________________________________
(1)
Does not include gross real estate assets held for sale of $87,393 and $654,729 as of September 30, 2014 and 2013, respectively.
(2)
Results for the three months ended September 30, 2014 reflect the operating segments updated as of April 1, 2014, which include most stabilized communities acquired as part of the Archstone Acquisition in the Established Communities segment. Results for the nine months ended September 30, 2014 reflect the operating segments determined as of January 1, 2014, which include stabilized communities acquired as part of the Archstone Acquisition in the Other Stabilized segment.
(3)
Revenue represents third party management, asset management and developer fees and miscellaneous income which are not allocated to a reportable segment.

18

Table of Contents

9.  Stock-Based Compensation Plans
Information with respect to stock options granted under the Company’s 1994 Stock Option and Incentive Plan (the “1994 Plan”) and its 2009 Stock Option and Incentive Plan (the “2009 Plan”) are as follows (dollars in thousands, other than per share amounts):
 
 
2009 Plan
shares
 
Weighted average
exercise price
per share
 
1994 Plan
shares
 
Weighted average
exercise price
per share
 
 
 
 
 
 
 
 
 
Options Outstanding, December 31, 2013
 
501,568

 
$
120.77

 
691,526

 
$
106.19

Exercised
 
(144,750
)
 
116.06

 
(309,978
)
 
97.00

Forfeited
 
(4,052
)
 
131.05

 
(76,381
)
 
142.66

Options Outstanding, September 30, 2014
 
352,766

 
$
122.58

 
305,167

 
$
106.39

Options Exercisable September 30, 2014
 
197,931

 
$
116.93

 
305,167

 
$
106.39

The Company granted 131,980 restricted stock units net of forfeitures, with an estimated aggregate compensation cost of $15,522,000, as part of its stock-based compensation plan, during the nine months ended September 30, 2014. The amount of restricted stock ultimately earned is based on the total shareholder return metrics related to the Company’s common stock for 58,206 restricted stock units and financial metrics related to operating performance and leverage metrics of the Company for 73,774 restricted stock units. For the portion of the grant for which the award is determined by the total shareholder return of the Company’s common stock, the Company used a Monte Carlo model to assess the compensation cost associated with the restricted stock units.  The estimated compensation cost was derived using the following assumptions: baseline share value of $128.97; dividend yield of approximately 3.6%; estimated volatility figures ranging from 17.6% to 18.6% over the life of the plan for the Company using 50% historical volatility and 50% implied volatility; and risk free rates over the life of the plan ranging from 0.04% to 0.72%, resulting in an average estimated fair value per restricted stock unit of $103.20. For the portion of the grant for which the award is determined by financial metrics, the estimated compensation cost was based on the baseline share value of $128.97 and the Company's estimate of corporate achievement for the financial metrics.

During the nine months ended September 30, 2014, the Company also issued 113,822 shares of restricted stock, of which 16,209 shares related to the conversion of restricted stock units to restricted shares, and the remaining 97,613 shares were new grants with a fair value of $12,605,000.

At September 30, 2014, the Company had 190,589 outstanding unvested restricted shares granted under the Company's equity compensation plans. Restricted stock vesting during the nine months ended September 30, 2014 totaled 97,346 shares of which 4,622 shares related to the conversion of restricted stock units and 92,724 shares related to restricted stock awards which had fair values at the grant date ranging from $74.20 to $149.05 per share. The total grant date fair value of shares vested under restricted stock awards was $11,143,000 and $13,857,000 for the nine months ended September 30, 2014 and 2013, respectively.

Total employee stock-based compensation cost recognized in income was $9,897,000 and $16,768,000 for the nine months ended September 30, 2014 and 2013, respectively, and total capitalized stock-based compensation cost was $4,635,000 and $5,911,000 for the nine months ended September 30, 2014 and 2013, respectively.  At September 30, 2014, there was a total unrecognized compensation cost of $1,483,000 for unvested stock options and $22,681,000 for unvested restricted stock and restricted stock units, which does not include estimated forfeitures. The unrecognized compensation cost for unvested stock options, and restricted stock and restricted stock units is expected to be recognized over a weighted average period of 1.2 years and 3.7 years, respectively.


19

Table of Contents

10.  Related Party Arrangements
Unconsolidated Entities
The Company manages unconsolidated real estate entities for which it receives asset management, property management, development and redevelopment fee revenue.  From these entities, the Company earned fees of $2,503,000 and $3,014,000 during the three months ended September 30, 2014 and 2013, respectively, and $8,253,000 and $8,198,000 during the nine months ended September 30, 2014 and 2013, respectively.  These fees are included in management, development and other fees on the accompanying Condensed Consolidated Statements of Comprehensive Income. In addition, the Company has outstanding receivables associated with its management role of $5,458,000 and $7,004,000 as of September 30, 2014 and December 31, 2013, respectively.
Director Compensation
The Company recorded non-employee director compensation expense relating to restricted stock grants and deferred stock awards in the amount of $250,000 in both the three months ended September 30, 2014 and 2013, and $750,000 and $743,000, in the nine months ended September 30, 2014 and 2013, respectively, as a component of general and administrative expense.  Deferred compensation relating to restricted stock grants and deferred stock awards to non-employee directors was $667,000 and $417,000 on September 30, 2014 and December 31, 2013, respectively.
11.  Fair Value
Financial Instruments Carried at Fair Value
Derivative Financial Instruments
Currently, the Company uses interest rate cap agreements to manage its interest rate risk.  These instruments are carried at fair value in the Company’s financial statements.  In adjusting the fair value of its derivative contracts for the effect of counterparty nonperformance risk, the Company has considered the impact of its net position with a given counterparty, as well as any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees. The Company minimizes its credit risk on these transactions by dealing with major, creditworthy financial institutions which have an A or better credit rating by the Standard & Poor’s Ratings Group. As part of its on-going control procedures, the Company monitors the credit ratings of counterparties and the exposure of the Company to any single entity, thus reducing credit risk concentration. The Company believes the likelihood of realizing losses from counterparty nonperformance is remote. Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives use Level 3 inputs, such as estimates of current credit spreads, to evaluate the likelihood of default by itself and its counterparties. As of September 30, 2014, the Company assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined it is not significant.  As a result, the Company has determined that its derivative valuations are classified in Level 2 of the fair value hierarchy.
Hedge ineffectiveness did not have a material impact on earnings of the Company for the three months ended September 30, 2014, or any prior period, and the Company does not anticipate that it will have a material effect in the future.
The following table summarizes the consolidated Hedging Derivatives at September 30, 2014, excluding derivatives executed to hedge debt on communities classified as held for sale (dollars in thousands):
 
Non-designated
Hedges
 
Cash Flow
Hedges
 
 
 
 
Notional balance
$
606,274

 
$
171,302

Weighted average interest rate (1)
1.7
%
 
2.5
%
Weighted average capped interest rate
5.9
%
 
5.1
%
Earliest maturity date
Jan 2015

 
Apr 2015

Latest maturity date
Aug 2018

 
Apr 2019

____________________________________
(1)
Represents the weighted average interest rate on the hedged debt.

20

Table of Contents

Excluding derivatives executed to hedge secured debt on communities classified as held for sale, the Company had four derivatives designated as cash flow hedges and 14 derivatives not designated as hedges at September 30, 2014. Fair value changes for derivatives not in qualifying hedge relationships for the three and nine months ended at September 30, 2014 were not material. Excluding the forward interest rate protection agreement discussed further below, fair value changes for derivatives not in qualifying hedge relationships for the three and nine months ended September 30, 2013 were not material. During the three and nine months ended September 30, 2014, the Company reclassified $1,546,000 and $4,557,000, respectively, of deferred losses from accumulated other comprehensive income as a component of interest expense, net. During the three and nine months ended September 30, 2013, the Company reclassified $54,948,000 and $57,913,000 of deferred losses from accumulated other comprehensive income as a charge to earnings, primarily associated with the forward interest rate protection agreement discussed below.  The Company anticipates reclassifying approximately $5,493,000 of hedging losses from accumulated other comprehensive income into earnings within the next 12 months to offset the variability of cash flows of the hedged items during this period.
In 2013, the Company was party to a $215,000,000 forward interest rate protection agreement, which was entered into in 2011 to reduce the impact of variability in interest rates on a portion of its expected debt issuance activity in 2013. The Company settled this position at its maturity in May 2013 with a payment to the counterparty of $51,000,000, the fair value at the time of settlement. Based on changes in the Company’s capital markets outlook for 2013, the Company deemed it was probable that it would not issue the anticipated debt for which the interest rate protection agreement was transacted. During the three and nine months ended September 30, 2013, the Company recognized the deferred losses of $53,484,000 and $51,000,000, respectively, for the forward interest rate protection agreement in loss on interest rate contract on the accompanying Condensed Consolidated Statements of Comprehensive Income.

Redeemable Noncontrolling Interests
The Company provided redemption options (the “Puts”) that allow joint venture partners of the Company to require the Company to purchase their interests in the investment at a guaranteed minimum amount related to three ventures.  The Puts are payable in cash. The Company determines the fair value of the Puts based on unobservable inputs considering the assumptions that market participants would make in pricing the obligations, applying a guaranteed rate of return to the joint venture partners’ net capital contribution balances as of period end. Given the significance of the unobservable inputs, the valuations are classified in Level 3 of the fair value hierarchy.
The Company issued units of limited partnership interest in DownREITs which provide the DownREIT limited partners the ability to present all or some of their units for redemption for cash as determined by the partnership agreement.  Under the DownREIT agreements, for each limited partnership unit, the limited partner is entitled to receive cash in the amount equal to the fair value of the Company’s common stock on or about the date of redemption.  In lieu of cash redemption, the Company may elect to exchange such units for an equal number of shares of the Company’s common stock. The limited partnership units in the DownREITs are valued using the market price of the Company’s common stock, a Level 1 price under the fair value hierarchy.
Financial Instruments Not Carried at Fair Value
Cash and Cash Equivalents
Cash and cash equivalent balances are held with various financial institutions within principal protected accounts.  The Company monitors credit ratings of these financial institutions and the concentration of cash and cash equivalent balances with any one financial institution and believes the likelihood of realizing material losses related to cash and cash equivalent balances is remote.  Cash and cash equivalents are carried at their face amounts, which reasonably approximate their fair values and are Level 1 within the fair value hierarchy.
Other Financial Instruments
The Company values its unsecured notes using quoted market prices, a Level 1 price within the fair value hierarchy. The Company values its notes payable and outstanding amounts under the Credit Facility and Term Loan using a discounted cash flow analysis on the expected cash flows of each instrument. This analysis reflects the contractual terms of the instrument, including the period to maturity, and uses observable market-based inputs, including interest rate curves. Th