Form: 10-Q

Quarterly report pursuant to Section 13 or 15(d)

May 2, 2017

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 March 31, 2017
 
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 registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company.  See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
Accelerated filer o
Non-accelerated filer (Do not check if a smaller reporting company) o
Smaller reporting company o
Emerging growth company o
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  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:

137,786,073 shares of common stock, par value $0.01 per share, were outstanding as of April 28, 2017.


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)
 
3/31/2017
 
12/31/2016
 
(unaudited)
 
 
ASSETS
 

 
 

Real estate:
 

 
 

Land and improvements
$
3,981,847

 
$
3,941,250

Buildings and improvements
14,496,026

 
14,314,981

Furniture, fixtures and equipment
546,523

 
532,994

 
19,024,396

 
18,789,225

Less accumulated depreciation
(3,852,593
)
 
(3,743,632
)
Net operating real estate
15,171,803

 
15,045,593

Construction in progress, including land
1,791,134

 
1,882,262

Land held for development
103,954

 
84,293

Real estate assets held for sale, net

 
20,846

Total real estate, net
17,066,891

 
17,032,994

 
 
 
 
Cash and cash equivalents
121,705

 
214,994

Cash in escrow
247,015

 
114,983

Resident security deposits
32,167

 
32,071

Investments in unconsolidated real estate entities
183,403

 
175,116

Deferred development costs
40,110

 
40,179

Prepaid expenses and other assets
287,130

 
256,934

Total assets
$
17,978,421

 
$
17,867,271

 
 
 
 
LIABILITIES AND EQUITY
 

 
 

Unsecured notes, net
$
4,464,546

 
$
4,463,302

Variable rate unsecured credit facility

 

Mortgage notes payable, net
2,541,183

 
2,567,578

Dividends payable
195,657

 
185,397

Payables for construction
96,672

 
100,998

Accrued expenses and other liabilities
293,637

 
274,676

Accrued interest payable
54,143

 
38,307

Resident security deposits
57,183

 
57,023

Liabilities related to real estate assets held for sale

 
808

Total liabilities
7,703,021

 
7,688,089

 
 
 
 
Commitments and contingencies


 


 
 
 
 
Redeemable noncontrolling interests
8,778

 
7,766

 
 
 
 
Equity:
 

 
 

Preferred stock, $0.01 par value; $25 liquidation preference; 50,000,000 shares authorized at March 31, 2017 and December 31, 2016; zero shares issued and outstanding at March 31, 2017 and December 31, 2016

 

Common stock, $0.01 par value; 280,000,000 shares authorized at March 31, 2017 and December 31, 2016; 137,786,600 and 137,330,904 shares issued and outstanding at March 31, 2017 and December 31, 2016, respectively
1,378

 
1,373

Additional paid-in capital
10,160,183

 
10,105,654

Accumulated earnings less dividends
133,674

 
94,899

Accumulated other comprehensive loss
(28,613
)
 
(30,510
)
Total equity
10,266,622

 
10,171,416

Total liabilities and equity
$
17,978,421

 
$
17,867,271

 
See accompanying notes to Condensed Consolidated Financial Statements.

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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
 
3/31/2017
 
3/31/2016
Revenue:
 

 
 

Rental and other income
$
521,126

 
$
506,974

Management, development and other fees
1,200

 
1,524

Total revenue
522,326

 
508,498

 
 
 
 
Expenses:
 

 
 

Operating expenses, excluding property taxes
123,044

 
116,626

Property taxes
52,930

 
50,067

Interest expense, net
49,295

 
43,410

Depreciation expense
140,621

 
127,216

General and administrative expense
13,206

 
11,404

Expensed acquisition, development and other pursuit costs, net of recoveries
728

 
3,462

Casualty and impairment loss (gain), net
11,688

 
(2,202
)
Total expenses
391,512

 
349,983

 
 
 
 
Income before equity in income of unconsolidated real estate entities, gain on sale of communities and other real estate, and income taxes
130,814

 
158,515

 
 
 
 
Equity in income of unconsolidated real estate entities
16,672

 
27,969

Gain on sale of communities
87,949

 
51,430

Gain on sale of other real estate
366

 

 
 
 
 
Income before income taxes
235,801

 
237,914

Income tax expense
20

 
37

 
 
 
 
Net income
235,781

 
237,877

Net loss attributable to noncontrolling interests
94

 
54

 
 
 
 
Net income attributable to common stockholders
$
235,875

 
$
237,931

 
 
 
 
Other comprehensive income (loss):
 

 
 

(Loss) income on cash flow hedges
145

 
(47,757
)
Cash flow hedge losses reclassified to earnings
1,752

 
1,374

Comprehensive income
$
237,772

 
$
191,548

 
 
 
 
Earnings per common share - basic:
 

 
 

Net income attributable to common stockholders
$
1.72

 
$
1.73

 
 
 
 
Earnings per common share - diluted:
 

 
 

Net income attributable to common stockholders
$
1.72

 
$
1.73

 
 
 
 
Dividends per common share
$
1.42

 
$
1.35


See accompanying notes to Condensed Consolidated Financial Statements.

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Table of Contents

AVALONBAY COMMUNITIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(Dollars in thousands)
 
For the three months ended
 
3/31/2017
 
3/31/2016
Cash flows from operating activities:
 
 
 
Net income
$
235,781

 
$
237,877

Adjustments to reconcile net income to cash provided by operating activities:
 
 
 
Depreciation expense
140,621

 
127,216

Amortization of deferred financing costs
1,826

 
1,936

Amortization of debt premium
(4,621
)
 
(4,779
)
Amortization of stock-based compensation
4,319

 
3,835

Equity in (income) loss of, and return on, unconsolidated real estate entities and noncontrolling interests, net of eliminations
(5,768
)
 
6,438

Casualty and impairment loss (gain), net
11,688

 
(2,202
)
Abandonment of development pursuits
265

 

Cash flow hedge losses reclassified to earnings
1,752

 
1,374

Gain on sale of real estate assets
(97,012
)
 
(81,055
)
(Increase) decrease in cash in operating escrows
(6,433
)
 
3,009

Increase in resident security deposits, prepaid expenses and other assets
(10,630
)
 
(8,559
)
Increase (decrease) in accrued expenses, other liabilities and accrued interest payable
21,674

 
(7,308
)
Net cash provided by operating activities
293,462

 
277,782

 
 
 
 
Cash flows from investing activities:
 
 
 
Development/redevelopment of real estate assets including land acquisitions and deferred development costs
(259,573
)
 
(266,588
)
Acquisition of real estate assets, including partnership interest

 
(170,022
)
Capital expenditures - existing real estate assets
(8,015
)
 
(11,618
)
Capital expenditures - non-real estate assets
(2,429
)
 
(3,264
)
Proceeds from sale of real estate, net of selling costs
159,985

 
68,709

Increase in cash in deposit escrows
(126,467
)
 
(69,227
)
Insurance proceeds for property damage claims
4,095

 
8,702

Mortgage note receivable lending
(4,795
)
 

(Decrease) increase in payables for construction
(4,326
)
 
842

Distributions from unconsolidated real estate entities
11,952

 
58,652

Investments in unconsolidated real estate entities
(5,774
)
 
(913
)
Net cash used in investing activities
(235,347
)
 
(384,727
)
 
 
 
 
Cash flows from financing activities:
 
 
 
Issuance of common stock, net
56,817

 
1,102

Dividends paid
(185,192
)
 
(171,151
)
Repayments of mortgage notes payable, including prepayment penalties
(21,037
)
 
(19,682
)
Payment of deferred financing costs
(2,315
)
 
(6,176
)
Distributions to DownREIT partnership unitholders
(11
)
 
(10
)
Contributions from joint venture and profit-sharing partners
1,038

 

Distributions to joint venture and profit-sharing partners
(104
)
 
(104
)
Preferred interest obligation redemption and dividends
(600
)
 

Net cash used in financing activities
(151,404
)
 
(196,021
)
 
 
 
 
Net decrease in cash and cash equivalents
(93,289
)
 
(302,966
)
 
 
 
 
Cash and cash equivalents, beginning of period
214,994

 
400,507

Cash and cash equivalents, end of period
$
121,705

 
$
97,541

 
 
 
 
Cash paid during the period for interest, net of amount capitalized
$
34,503

 
$
46,011

 
See accompanying notes to Condensed Consolidated Financial Statements.

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Table of Contents

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

Supplemental disclosures of non-cash investing and financing activities:

During the three months ended March 31, 2017:

As described in Note 4, "Equity," 198,502 shares of common stock were issued as part of the Company's stock-based compensation plans, of which 128,482 shares related to the conversion of performance awards to restricted shares, and the remaining 70,020 shares valued at $12,538,000 were issued in connection with new stock grants; 1,165 shares valued at $205,000 were issued through the Company's dividend reinvestment plan; 57,172 shares valued at $10,149,000 were withheld to satisfy employees' tax withholding and other liabilities; and 236 restricted shares with an aggregate value of $41,000 previously issued in connection with employee compensation were canceled upon forfeiture.

Common stock dividends declared but not paid totaled $195,657,000.

The Company recorded an increase of $183,000 in redeemable noncontrolling interest with a corresponding decrease 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 10, "Fair Value."

The Company recorded an increase in prepaid expenses and other assets of $180,000 and an increase in accrued expenses and other liabilities of $102,000, and a corresponding adjustment to other comprehensive income, and reclassified $1,752,000 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.
 
As discussed in Note 5, "Investments in Real Estate Entities," the Company recognized a charge of $16,361,000 to write-off the net book value of the fixed assets destroyed by the fire that occurred in February 2017 at the Company's Avalon Maplewood Development Community ("Maplewood"), and a corresponding recovery of loss of $12,598,000 for expected property damage insurance proceeds for the Maplewood casualty loss not received during the period.

During the three months ended March 31, 2016:

The Company issued 193,171 shares of common stock as part of the Company's stock-based compensation plans, of which 115,618 shares related to the conversion of performance awards to restricted shares, and the remaining 77,553 shares valued at $12,529,000 were issued in connection with new stock grants; 576 shares valued at $101,000 were issued through the Company's dividend reinvestment plan; 48,189 shares valued at $8,164,000 were withheld to satisfy employees' tax withholding and other liabilities; and 499 restricted shares with an aggregate value of $76,000 previously issued in connection with employee compensation were canceled upon forfeiture.

Common stock dividends declared but not paid totaled $185,173,000.

The Company recorded an increase of $299,000 in redeemable noncontrolling interest with a corresponding decrease to accumulated earnings less dividends to adjust the redemption value associated with the put options held by joint venture partners and DownREIT partnership units.

The Company recorded a decrease in prepaid expenses and other assets of $5,422,000 and an increase in accrued expenses and other liabilities of $42,335,000, and a corresponding loss to other comprehensive income of $47,757,000, and reclassified $1,374,000 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 assumed fixed rate indebtedness with a principal amount of $67,904,000 in conjunction with the acquisition of Avalon Hoboken.


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 subsidiaries), is a Maryland corporation that has elected to be treated as a real estate investment trust ("REIT") for federal income tax purposes under the Internal Revenue Code of 1986 (the "Code"). The Company focuses on the development, redevelopment, acquisition, ownership and operation of multifamily communities primarily in New England, the New York/New Jersey metro area, the Mid-Atlantic, the Pacific Northwest, and Northern and Southern California.

At March 31, 2017, the Company owned or held a direct or indirect ownership interest in 260 operating apartment communities containing 74,952 apartment homes in 10 states and the District of Columbia, of which nine communities containing 4,075 apartment homes were under redevelopment. In addition, the Company owned or held a direct or indirect ownership interest in 24 communities under development that are expected to contain an aggregate of 7,581 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 28 communities that, if developed as expected, will contain an estimated 9,304 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 2016 Annual Report on Form 10-K. The results of operations for the three months ended March 31, 2017 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):

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Table of Contents

 
For the three months ended
 
3/31/2017
 
3/31/2016
Basic and diluted shares outstanding
 

 
 

Weighted average common shares - basic
137,068,874

 
136,785,880

Weighted average DownREIT units outstanding
7,500

 
7,500

Effect of dilutive securities
454,868

 
589,664

Weighted average common shares - diluted
137,531,242

 
137,383,044

 
 
 
 
Calculation of Earnings per Share - basic
 

 
 

Net income attributable to common stockholders
$
235,875

 
$
237,931

Net income allocated to unvested restricted shares
(652
)
 
(632
)
Net income attributable to common stockholders, adjusted
$
235,223

 
$
237,299

 
 
 
 
Weighted average common shares - basic
137,068,874

 
136,785,880

 
 
 
 
Earnings per common share - basic
$
1.72

 
$
1.73

 
 
 
 
Calculation of Earnings per Share - diluted
 

 
 

Net income attributable to common stockholders
$
235,875

 
$
237,931

Add: noncontrolling interests of DownREIT unitholders in consolidated partnerships
11

 
10

Adjusted net income attributable to common stockholders
$
235,886

 
$
237,941

 
 
 
 
Weighted average common shares - diluted
137,531,242

 
137,383,044

 
 
 
 
Earnings per common share - diluted
$
1.72

 
$
1.73

 

All options to purchase shares of common stock outstanding as of March 31, 2017 and 2016 are included in the computation of diluted earnings per share.

As discussed under "Recently Issued and Adopted Accounting Standards," as of January 1, 2017, the Company adopted the provision of ASU 2016-09 using the modified retrospective approach to recognize forfeitures as they occur. Prior to the adoption of this standard, the Company was required to estimate the forfeiture of stock options and recognized compensation cost net of the estimated forfeitures. The estimated forfeitures included in compensation cost were adjusted to reflect actual forfeitures at the end of the vesting period. The change in accounting principle had an immaterial effect on the Company's financial position and no adjustment to retained earnings or the Company's diluted shares outstanding, as prescribed under the modified retrospective approach, was required in the prior year period.

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 Derivative transactions for trading or other speculative purposes. The Company assesses the effectiveness of qualifying cash flow and fair value hedges, both at inception and on an on-going basis. 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. The Company does not present or disclose the fair value of Hedging Derivatives on a net basis. Fair value changes for derivatives that are not in qualifying hedge relationships are reported as a component of interest expense, net.  For the Hedging Derivative positions that the Company has determined qualify as effective cash flow hedges, the Company has recorded the effective portion of cumulative changes in the fair value of Hedging Derivatives in other comprehensive income (loss).  Amounts recorded in other comprehensive income (loss) 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 the 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. See Note 10, "Fair Value," for further discussion of derivative financial instruments.

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Legal and Other Contingencies

Maplewood Casualty Loss

In February 2017, a fire occurred at the Company's Avalon Maplewood Development Community, located in Maplewood, NJ, which was under construction and not yet occupied. The Company believes that liabilities to third parties resulting from the fire will not be material and will, in any event, be substantially covered by insurance subject to a deductible. The Company has commenced reconstruction of the damaged and destroyed portions of the community. See Note 5, "Investments in Real Estate Entities," for further discussion of the casualty gains and losses associated with the Maplewood casualty loss.

Edgewater Casualty Loss

In January 2015, a fire occurred at the Company's Avalon at Edgewater apartment community located in Edgewater, New Jersey ("Edgewater"). Edgewater consisted of two residential buildings. One building, containing 240 apartment homes, was destroyed. The second building, containing 168 apartment homes, suffered minimal damage and has been repaired.

The Company has established protocols for processing claims from third parties who suffered losses as a result of the fire, and many third parties have contacted the Company's insurance carrier and settled their claims. See Part II, Item 1, "Legal Proceedings," for further discussion of the lawsuits associated with the Edgewater casualty loss.

Three class action lawsuits have been filed against the Company on behalf of occupants of the destroyed building and consolidated in the United States District Court for the District of New Jersey. The Company has agreed with class counsel to the terms of a proposed settlement which would provide a claims process (with agreed upon protocols for instructing the adjuster as to how to evaluate claims) and, if needed, an arbitration process to determine damage amounts to be paid to individual claimants covered by the class settlement. In March 2017 the District Court granted preliminary approval of the class action settlement and in July 2017 a fairness hearing will be held to determine whether the settlement will receive final approval. A fourth class action, being heard in the same federal court, was filed against the Company on behalf of residents of the second Edgewater building that suffered minimal damage. Recently, a fifth class action lawsuit was filed against the Company seeking to certify a class on behalf of both buildings and other third parties. That action is currently stayed pending the decision by those plaintiffs either to be included in the class settlement or to formally opt-out. In addition to the class action lawsuits described above, 19 lawsuits representing approximately 146 individual plaintiffs have been filed and are currently pending in the Superior Court of New Jersey Bergen County - Law Division. All of these state court cases have been consolidated by the court. These plaintiffs, if eligible to be class members under the class settlement that has been preliminarily approved as described above, must formally opt-out of that class action settlement by May 17, 2017 if they want to continue their individual actions. The Company believes that it has meritorious defenses to the extent of damages claimed in all of the suits. There are also five subrogation lawsuits that have been filed against the Company by insurers of Edgewater residents who obtained renters insurance; it is the Company's position that in the majority of the applicable leases the residents waived subrogation rights. One of these lawsuits has been dismissed on that basis and the other four are currently pending in the United States District Court for the District of New Jersey. The District Court recently denied the Company's motions seeking dismissal on this basis. The Company will reassess the viability of this defense after conducting additional discovery.

Having settled many third party claims through the insurance claims process, the Company currently believes that any potential remaining liability to third parties (including any potential liability to third parties determined in accordance with the class settlement described above, if approved) will not be material to the Company and will in any event be substantially covered by the Company's insurance policies. However, the Company can give no assurances in this regard and continues to evaluate this matter. See Note 5, "Investments in Real Estate Entities," and Part II, Item 1, "Legal Proceedings," for further discussion of the casualty gains and losses and lawsuits associated with the Edgewater casualty loss.

Other Matters

The Company is involved in various other claims and/or administrative proceedings unrelated to the Edgewater casualty loss that arise in the ordinary course of its business. While no assurances can be given, the Company does not currently believe that any of these other outstanding litigation matters, individually or in the aggregate, will have a material adverse effect on its financial condition or results of operations.


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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, debt 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. Consideration for acquisitions is typically in the form of cash unless otherwise disclosed. For an acquisition of a business, the allocation of the purchase price is based on the fair value of the net assets, and for an asset acquisition, the allocation of the purchase price is based on the relative fair value of the net assets. Subsequent to the adoption of ASU 2017-01 on October 1, 2016, the Company expects that acquisitions of individual operating communities will generally be viewed as asset acquisitions.

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' notes to financial statements to conform to current year presentations as a result of changes in held for sale classification and disposition activity.

Recently Issued Accounting Standards

In February 2017, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2017-05, Other Income-Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets. This ASU clarifies the scope of the nonfinancial asset guidance and the derecognition of all businesses and nonprofit activities (except those related to conveyances of oil and gas mineral rights or contracts with customers). In addition, the amendments eliminate the exception in the financial asset guidance for transfers of investments (including equity method investments) in real estate entities and supersede the guidance in the Exchanges of a Nonfinancial Asset for a Noncontrolling Ownership Interest. The amendments also provide guidance on the accounting of partial sales of nonfinancial assets and contributions of nonfinancial assets to a joint venture or other noncontrolled investee. The new standard allows for either a retrospective or modified retrospective approach. The guidance will be effective in the first quarter of 2018 and allows for early adoption. The Company is assessing whether the new standard will have a material effect on its financial position or results of operations.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. This ASU addresses eight specific cash flow issues including debt prepayment or debt extinguishment costs, proceeds from the settlement of insurance claims, distributions received from equity method investees and separately identifiable cash flows and application of the predominance principle. The new standard requires a retrospective approach. The guidance will be effective in the first quarter of 2018 and allows for early adoption. The Company adopted this guidance as of January 1, 2017. The new standard did not have a material effect on the Company's Condensed Consolidated Statements of Cash Flows.

In March 2016, the FASB issued ASU 2016-09, Compensation-Stock Compensation: Improvements to Employee Share-Based Payment Accounting, which simplifies several aspects of share-based payment transactions, including income tax consequences, classification of awards as equity or liability, statement of cash flows classification and policy election options for forfeitures. Upon adoption of the standard, the Company elected to account for forfeitures when they occur instead of estimating the forfeitures. The Company adopted this guidance as of January 1, 2017, using the modified retrospective approach. The new standard did not have a material effect on the Company's financial position, results of operations or earnings per share as discussed in "Earnings per Common Share."

In February 2016, the FASB issued ASU 2016-02, Leases, amending the existing accounting standards for lease accounting, including requiring lessees to recognize most leases on their balance sheets and making targeted changes to lessor accounting. The guidance will be effective in the first quarter of 2019 and allows for early adoption. The new standard requires a modified retrospective transition approach for all leases existing at, or entered into after, the date of initial application, with an option to use certain transition relief.


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ASU 2016-02 provides for transition relief, which includes not electing to (i) reassess whether any expired or existing contract is a lease or contains a lease, (ii) reassess the lease classification of any expired or existing leases and (iii) expense any capitalized initial direct costs for any existing leases. The Company anticipates adoption of the standard to have a material impact on its financial position and results of operations resulting from the recognition of the right to use asset and corresponding lease obligation for its long-term ground leases, currently accounted for as operating leases. The Company will continue to assess the impact of the new standard.

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers and in August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers-Deferral of the Effective Date, which defers the effective date of the new revenue recognition standard until the first quarter of 2018. Subsequently, the FASB has issued multiple ASUs clarifying ASU 2014-09 and ASU 2015-14.

Under the new standard, revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed or determinable, and collectability is probable. Revenue is generally recognized net of allowances and any taxes collected from customers and subsequently remitted to governmental authorities. The majority of the Company's revenue is derived from rental income, which is scoped out from this standard and will be accounted for under ASU 2016-02, Leases, discussed above. The Company's other revenue streams, which are being evaluated under this ASU, include but are not limited to management fees, other income from residents determined not to be within the scope of ASU 2016-02 and gains and losses from real estate dispositions. The Company will continue to assess the impact of the new standard and anticipates adoption as of January 1, 2018 using the modified retrospective approach.

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 $17,821,000 and $20,609,000 for the three months ended March 31, 2017 and 2016, respectively.

3.  Mortgage Notes Payable, Unsecured Notes and Credit Facility

The Company's mortgage notes payable, unsecured notes, variable rate unsecured term loans ("Term Loans") and Credit Facility, as defined below, as of March 31, 2017 and December 31, 2016 are summarized below.  The following amounts and discussion do not include the mortgage notes related to the communities classified as held for sale, if any, as of March 31, 2017 and December 31, 2016, as shown in the accompanying Condensed Consolidated Balance Sheets (dollars in thousands) (see Note 6, "Real Estate Disposition Activities").
 
3/31/2017
 
12/31/2016
 
 
 
 
Fixed rate unsecured notes (1)
$
4,200,000

 
$
4,200,000

Term Loans (1)
300,000

 
300,000

Fixed rate mortgage notes payable - conventional and tax-exempt (2)
1,664,650

 
1,668,496

Variable rate mortgage notes payable - conventional and tax-exempt (2)
890,202

 
908,262

Total mortgage notes payable and unsecured notes
7,054,852

 
7,076,758

Credit Facility

 

Total mortgage notes payable, unsecured notes and Credit Facility
$
7,054,852

 
$
7,076,758

_____________________________________

(1)
Balances at March 31, 2017 and December 31, 2016 exclude $8,640 and $8,930, respectively, of debt discount, and $26,814 and $27,768, respectively, of deferred financing costs, as reflected in unsecured notes, net on the accompanying Condensed Consolidated Balance Sheets.
(2)
Balances at March 31, 2017 and December 31, 2016 exclude $3,044 of debt discount and $1,866 of debt premium, respectively, and $10,625 and $11,046, respectively, of deferred financing costs, as reflected in mortgage notes payable on the accompanying Condensed Consolidated Balance Sheets.

The following debt activity occurred during the three months ended March 31, 2017:

In February 2017, the Company repaid $17,300,000 of variable rate debt secured by Avalon Mountain View at par at its scheduled maturity date.


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In February 2017, the Company entered into a $250,000,000 variable rate unsecured term loan (the "$250 million Term Loan"), of which $100,000,000 matures in February 2022 with stated pricing of LIBOR plus 0.90%, and $150,000,000 matures in February 2024 with stated pricing of LIBOR plus 1.50%. As of March 31, 2017, the Company had not drawn any of the available $250,000,000 under the variable rate unsecured term loan. See Note 11, "Subsequent Events," for further discussion.

At March 31, 2017, the Company has a $1,500,000,000 revolving variable rate unsecured credit facility with a syndicate of banks (the "Credit Facility") which matures in April 2020. The Company may extend the maturity for up to nine months, provided the Company is not in default and upon payment of a $1,500,000 extension fee. The Credit Facility bears interest at varying levels based on the London Interbank Offered Rate ("LIBOR"), rating levels achieved on the Company's unsecured notes and on a maturity schedule selected by the Company. The current stated pricing is LIBOR plus 0.825% per annum (1.81% at March 31, 2017), assuming a one month borrowing rate. The annual facility fee is 0.125% (or approximately $1,875,000 annually based on the $1,500,000,000 facility size and based on the Company's current credit rating).

The Company had no borrowings outstanding under the Credit Facility and had $45,084,000 and $46,711,000 outstanding in letters of credit that reduced the borrowing capacity as of March 31, 2017 and December 31, 2016, respectively.

In the aggregate, secured notes payable mature at various dates from November 2017 through July 2066, and are secured by certain apartment communities (with a net carrying value of $3,405,173,000, excluding communities classified as held for sale, as of March 31, 2017).

As of March 31, 2017, the Company has guaranteed a $100,000,000 mortgage note payable held by a wholly-owned subsidiary; such mortgage note payable is consolidated for financial reporting purposes. The weighted average interest rate of the Company's fixed rate mortgage notes payable (conventional and tax-exempt) was 4.4% at both March 31, 2017 and December 31, 2016.  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 2.5% and 2.3% at March 31, 2017 and December 31, 2016, respectively.

Scheduled payments and maturities of mortgage notes payable and unsecured notes outstanding at March 31, 2017 are as follows (dollars in thousands):
Year
 
Secured notes payments
 
Secured notes maturities
 
Unsecured notes maturities
 
Stated interest rate of unsecured notes
2017
 
13,954

 
692,191

 

 
N/A

2018
 
17,789

 
76,667

 

 
N/A

2019
 
4,696

 
655,514

 

 
N/A

2020
 
3,624

 
118,729

 
250,000

 
6.100
%

 


 


 
400,000

 
3.625
%
2021
 
3,551

 
27,844

 
250,000

 
3.950
%

 


 


 
300,000

 
LIBOR + 1.450%

2022
 
3,795

 

 
450,000

 
2.950
%
2023
 
4,040

 

 
350,000

 
4.200
%

 


 


 
250,000

 
2.850
%
2024
 
4,310

 

 
300,000

 
3.500
%
2025
 
4,585

 
84,835

 
525,000

 
3.450
%
 
 
 
 
 
 
300,000

 
3.500
%
2026
 
4,894

 

 
475,000

 
2.950
%
 
 
 
 
 
 
300,000

 
2.900
%
Thereafter
 
213,754

 
620,080

 
350,000

 
3.900
%
 
 
$
278,992

 
$
2,275,860

 
$
4,500,000

 
 

 

The Company was in compliance at March 31, 2017 with customary financial and other covenants under the Credit Facility, the Term Loans and the Company's fixed rate unsecured notes.

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4.  Equity

The following summarizes the changes in equity for the three months ended March 31, 2017 (dollars in thousands):
 
Common
stock
 
Additional
paid-in
capital
 
Accumulated
earnings
less
dividends
 
Accumulated
other
comprehensive
loss
 
Total
equity
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2016
$
1,373

 
$
10,105,654

 
$
94,899

 
$
(30,510
)
 
$
10,171,416

Net income attributable to common stockholders

 

 
235,875

 

 
235,875

Gain on cash flow hedges, net

 

 

 
145

 
145

Cash flow hedge loss reclassified to earnings

 

 

 
1,752

 
1,752

Change in redemption value of redeemable noncontrolling interest

 

 
(183
)
 

 
(183
)
Dividends declared to common stockholders

 

 
(195,657
)
 

 
(195,657
)
Issuance of common stock, net of withholdings
5

 
47,962

 
(1,260
)
 

 
46,707

Amortization of deferred compensation

 
6,567

 

 

 
6,567

Balance at March 31, 2017
$
1,378

 
$
10,160,183

 
$
133,674

 
$
(28,613
)
 
$
10,266,622


As of March 31, 2017 and December 31, 2016, the Company's charter authorized a total of 280,000,000 shares of common stock and 50,000,000 shares of preferred stock for issuance.

During the three months ended March 31, 2017, the Company:

i.
issued 7,266 shares of common stock in connection with stock options exercised;
ii.
issued 1,165 common shares through the Company's dividend reinvestment plan;
iii.
issued 198,502 common shares in connection with restricted stock grants and the conversion of performance awards to restricted shares;
iv.
issued 306,177 shares under CEP IV as discussed below;
v.
withheld 57,172 common shares to satisfy employees' tax withholding and other liabilities; and
vi.
canceled 236 common shares of restricted stock upon forfeiture.

Any deferred compensation related to the Company's stock option, restricted stock and performance award grants during the three months ended March 31, 2017 is not reflected on the accompanying Condensed Consolidated Balance Sheet as of March 31, 2017, and will not be reflected until recognized as compensation cost.

In December 2015, the Company commenced a fourth continuous equity program ("CEP IV") under which the Company may sell up to $1,000,000,000 of its common stock from time to time. 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 IV, the Company engaged sales agents who will receive compensation of up to 2.0% of the gross sales price for shares sold. CEP IV also allows the Company to enter into forward sale agreements up to $1,000,000,000 in aggregate sales price of its common stock. The Company expects that it will physically settle each forward sale agreement on one or more dates specified by the Company on or prior to the maturity date of that particular forward sale agreement, in which case the Company will expect to receive aggregate net cash proceeds at settlement equal to the number of shares underlying the particular forward agreement multiplied by the relevant forward sale price. However, the Company may also elect to cash settle or net share settle a forward sale agreement. In connection with each forward sale agreement, the Company will pay the relevant forward seller, in the form of a reduced initial forward sale price, a commission of up to 2.0% of the sales prices of all borrowed shares of common stock sold. During the three months ended March 31, 2017, the Company sold 306,177 shares at an average sales price of $186.44 per share, for net proceeds of $56,228,000. As of March 31, 2017, the Company had $942,915,000 of shares remaining authorized for issuance under this program.


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Table of Contents

5.  Investments in Real Estate Entities

Investment in Unconsolidated Real Estate Entities

As of March 31, 2017, the Company had investments in five unconsolidated real estate entities with ownership interest percentages ranging from 20.0% to 31.3%, excluding development joint ventures and joint ventures formed with Equity Residential as part of the Archstone acquisition. 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 three months ended March 31, 2017, AvalonBay Value Added Fund II, L.P. ("Fund II") sold Eaves Gaithersburg, located in Gaithersburg, MD, containing 684 apartment homes, for $117,000,000. The Company's share of the gain in accordance with GAAP for the disposition was $8,697,000, which is reported as a component of equity in income of unconsolidated real estate entities on the accompanying Condensed Consolidated Statements of Comprehensive Income. In conjunction with the disposition of this community during the three months ended March 31, 2017, Fund II repaid $63,200,000 of secured indebtedness at par in advance of its scheduled maturity date.

The Company has an equity interest of 31.3% in Fund II, and upon achievement of a threshold return, the Company has a right to incentive distributions for its promoted interest based on the current returns earned by Fund II, which represents 20.0% of further Fund II distributions, which is in addition to its proportionate share of the remaining 80.0% of distributions. During the three months ended March 31, 2017, the Company recognized income of $6,765,000 for its promoted interest, which is reported as a component of equity in income of unconsolidated real estate entities on the accompanying Condensed Consolidated Statements of Comprehensive Income.

The following is a combined summary of the financial position of the entities accounted for using the equity method discussed above as of the dates presented (dollars in thousands):
 
3/31/2017
 
12/31/2016
 
(unaudited)
 
(unaudited)
Assets:
 

 
 

Real estate, net
$
862,612

 
$
954,493

Other assets
76,208

 
49,519

Total assets
$
938,820

 
$
1,004,012

 
 
 
 
Liabilities and partners' capital:
 

 
 

Mortgage notes payable, net and credit facility
$
625,256

 
$
689,573

Other liabilities
15,861

 
16,537

Partners' capital
297,703

 
297,902

Total liabilities and partners' capital
$
938,820

 
$
1,004,012

 

The following is a combined summary of the operating results of the entities accounted for using the equity method discussed above for the periods presented (dollars in thousands):
 
For the three months ended
 
3/31/2017
 
3/31/2016
 
(unaudited)
Rental and other income
$
28,642

 
$
36,955

Operating and other expenses
(11,094
)
 
(14,170
)
Gain on sale of communities
29,447

 
103,321

Interest expense, net (1)
(6,948
)
 
(20,001
)
Depreciation expense
(7,327
)
 
(9,240
)
Net income
$
32,720

 
$
96,865

_____________________________________

(1)
Amount for the three months ended March 31, 2016 includes charges for prepayment penalties and write-offs of deferred financing costs of $10,864.

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In conjunction with the formation of Fund II and North Point II JV, LP ("AVA North Point"), and the acquisition of Archstone Multifamily Partners AC LP (the "U.S. Fund"), Multifamily Partners AC JV LP (the "AC JV") and Brandywine Apartments of Maryland, LLC ("Brandywine"), the Company incurred costs in excess of its equity in the underlying net assets of the respective investments. These costs represent $37,148,000 and $38,015,000 at March 31, 2017 and December 31, 2016, respectively, of the Company's respective investment balances. These amounts are being amortized over the lives of the underlying assets as a component of equity in income of unconsolidated entities on the accompanying Condensed Consolidated Statements of Comprehensive Income.

Investments in Consolidated Real Estate Entities

In conjunction with the development of Avalon Brooklyn Bay, the Company entered into a joint venture agreement to construct a mixed-use building that will contain rental apartments, for-sale residential condominium units and related common elements. The Company owns a 70.0% interest in the venture and will have all of the rights and obligations associated with the rental apartments, and the venture partner owns the remaining 30.0% interest and will have all of the rights and obligations associated with the for-sale residential condominium units. The Company is responsible for the development and construction of the structure, and is providing a loan to the venture partner for the venture partner's share of costs. As of March 31, 2017, the Company has a receivable from the venture partner in the form of a variable rate mortgage note, secured by the for-sale residential condominium units, in the amount of $32,036,000 for outstanding principal and interest, reported as a component of prepaid expenses and other assets on the accompanying Condensed Consolidated Balance Sheets. The Company recognizes interest income on the accrual basis. The loan will be repaid by the venture partner with the proceeds the partner receives from the sales of the residential condominium units which are expected to occur during 2017 and 2018. The venture is considered a VIE, and the Company consolidates its interest in the rental apartments and common areas.

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 expensed. 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 acquisition and disposition activity did not occur, in the amounts of $728,000 and $746,000 for the three months ended March 31, 2017 and 2016, respectively. These costs are included in expensed acquisition, development, and other pursuit costs, net of recoveries on the accompanying Condensed Consolidated Statements of Comprehensive Income. Abandoned pursuit 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 property or long-lived asset may not be recoverable, the Company assesses its recoverability by comparing the carrying amount of the property or 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 property or long-lived asset. Based on periodic tests of recoverability of long-lived assets for the three months ended March 31, 2017 and 2016, the Company did not recognize any impairment losses for wholly-owned operating real estate assets.

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. During the three months ended March 31, 2017, the Company recognized an impairment charge of $9,350,000 relating to a land parcel which the Company had acquired for development in 2004 and no longer intends to develop. During the three months ended March 31, 2016, the Company recognized an aggregate impairment charge of $6,500,000 relating to two undeveloped land parcels. These charges were determined as the excess of the Company's carrying basis over the expected sales price for each parcel, and these charges are included in casualty and impairment loss (gain), net on the accompanying Condensed Consolidated Statements of Comprehensive Income.


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The Company evaluates its unconsolidated investments for other than temporary impairment, considering both the extent and amount by which the carrying value of the investment exceeds the fair value, and the Company's intent and ability to hold the investment to recover its carrying value. The Company also evaluates its proportionate share of any impairment of assets held by unconsolidated investments. There were no other than temporary impairment losses recognized by any of the Company's investments in unconsolidated real estate entities during the three months ended March 31, 2017 and 2016.

Casualty Gains and Losses

During the three months ended March 31, 2017, the Company recorded a casualty loss of $19,481,000 composed of a charge of $16,361,000 to write-off the net book value of the fixed assets destroyed in the Maplewood casualty loss, and demolition and additional incident expenses of $3,120,000. The casualty loss was partially offset by $17,143,000 of expected property damage insurance proceeds, of which $4,545,000 was received during the three months ended March 31, 2017. The receivable for the remaining $12,598,000 of expected property damage insurance proceeds is included in prepaid expenses and other assets on the accompanying Condensed Consolidated Balance Sheets. The net casualty loss of $2,338,000 is included in casualty and impairment loss (gain), net on the accompanying Condensed Consolidated Statements of Comprehensive Income. See discussion in Note 1, "Organization, Basis of Presentation and Significant Accounting Policies, Legal and Other Contingencies," for further discussion of the Maplewood casualty loss.

During the three months ended March 31, 2016, the Company reached a final insurance settlement for the property damage and lost income for the Edgewater casualty loss. In 2015 and 2016, the Company received aggregate insurance proceeds for Edgewater of $73,150,000, after self-insurance and deductibles. During the three months ended March 31, 2016, the Company received the final $29,008,000 of insurance proceeds, of which $8,702,000 was recognized as casualty and impairment loss (gain), net on the accompanying Condensed Consolidated Statements of Comprehensive Income, and $20,306,000 as business interruption insurance proceeds, which is recorded as a component of rental and other income on the accompanying Condensed Consolidated Statements of Comprehensive Income. See discussion in Note 1, "Organization, Basis of Presentation and Significant Accounting Policies, Legal and Other Contingencies," and Part II, Item 1, "Legal Proceedings," for further discussion of the Edgewater casualty loss.

6.  Real Estate Disposition Activities

During the three months ended March 31, 2017, the Company sold the following real estate assets.

Avalon Pines, located in Coram, NY, containing 450 homes, and the adjacent golf course were sold for $140,000,000. The Company's gain in accordance with GAAP on the disposition was $87,949,000, reported in gain on sale of communities on the accompanying Condensed Consolidated Statements of Comprehensive Income. The sale of Avalon Pines is expected to be part of a tax deferred exchange under which the Company has restricted the cash proceeds in an escrow account, classified as cash in escrow on the accompanying Condensed Consolidated Balance Sheet.

Two undeveloped land parcels, located in Newcastle, WA, that are adjacent to one of the Company's Development Communities, and 421-a tax certificates, representing the right to qualify for certain property tax exemptions in New York City, were sold for an aggregate sales price of $22,286,000. The Company's gain in accordance with GAAP on the dispositions was $366,000, reported in gain on sale of other real estate on the accompanying Condensed Consolidated Statements of Comprehensive Income.

At March 31, 2017, the Company had no real estate assets that qualified as held for sale.


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Table of Contents

7.  Segment Reporting

The Company's reportable operating segments include Established Communities, Other Stabilized Communities, and Development/Redevelopment Communities.  Annually as of January 1, 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.

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 of recoveries, interest expense, net, loss (gain) on extinguishment of debt, net, general and administrative expense, equity in (loss) income of unconsolidated real estate entities, depreciation expense, corporate income tax expense, casualty and impairment loss (gain), net, gain on sale of real estate assets and net operating income from real estate assets sold or held for sale. 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 months ended March 31, 2017 and 2016 is as follows (dollars in thousands):
 
For the three months ended
 
3/31/2017
 
3/31/2016
Net income
$
235,781

 
$
237,877

Indirect operating expenses, net of corporate income
16,297

 
16,537

Investments and investment management expense
1,321

 
1,145

Expensed acquisition, development and other pursuit costs, net of recoveries
728

 
3,462

Interest expense, net
49,295

 
43,410

General and administrative expense
13,206

 
11,404

Equity in income of unconsolidated real estate entities
(16,672
)
 
(27,969
)
Depreciation expense
140,621

 
127,216

Income tax expense
20

 
37

Casualty and impairment loss (gain), net
11,688

 
(2,202
)
Gain on sale of real estate
(88,315
)
 
(51,430
)
Net operating income from real estate assets sold or held for sale
(1,387
)
 
(8,606
)
        Net operating income
$
362,583

 
$
350,881


The following is a summary of NOI from real estate assets sold or held for sale for the periods presented (dollars in thousands):
 
For the three months ended
 
3/31/2017
 
3/31/2016
Rental income from real estate assets sold or held for sale
$
2,650

 
$
13,916

Operating expenses from real estate assets sold or held for sale
(1,263
)
 
(5,310
)
Net operating income from real estate assets sold or held for sale
$
1,387

 
$
8,606


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.


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Table of Contents

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 the beginning of the given calendar year. 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 total revenue and NOI for the three months ended March 31, 2017 and 2016 has been adjusted to exclude the real estate assets that were sold from January 1, 2016 through March 31, 2017, or otherwise qualify as held for sale as of March 31, 2017, as described in Note 6, "Real Estate Disposition Activities." Segment information for gross real estate as of March 31, 2017 and 2016 has not been adjusted to exclude real estate assets that were sold or otherwise qualified as held for sale subsequent to the respective balance sheet dates.
 
For the three months ended
 
 
 
Total
revenue
 
NOI
 
% NOI  change from  prior year
 
Gross real estate (1)
For the three months ended March 31, 2017
 
 

 
 

Established
 

 
 

 
 

 
 

New England
$
58,607

 
$
37,816

 
3.3
%
 
$
1,875,024

Metro NY/NJ
87,544

 
60,060

 
3.8
%
 
2,903,317

Mid-Atlantic
55,755

 
39,147

 
3.7
%
 
2,062,311

Pacific Northwest
20,454

 
14,815

 
5.2
%
 
731,537

Northern California
83,323

 
63,717

 
2.0
%
 
2,815,589

Southern California
83,225

 
60,551

 
6.2
%
 
3,005,810

Total Established
388,908

 
276,106

 
3.9
%
 
13,393,588

 
 
 
 
 
 
 
 
Other Stabilized
74,021

 
51,571

 
N/A

 
3,032,689

Development / Redevelopment
55,547

 
34,906

 
N/A

 
4,276,266

Land Held for Development
N/A

 
N/A

 
N/A

 
103,954

Non-allocated (3)
1,200

 
N/A

 
N/A

 
112,987

 
 
 
 
 
 
 
 
Total
$
519,676

 
$
362,583

 
3.3
%
 
$
20,919,484

 
 
 
 
 
 
 
 
For the three months ended March 31, 2016
 
 

 
 

Established
 

 
 

 
 

 
 

New England
$
57,196

 
$
36,508

 
15.9
%
 
$
1,860,863

Metro NY/NJ
83,079

 
56,702

 
3.2
%
 
2,883,958

Mid-Atlantic
57,530

 
40,063

 
1.3
%
 
2,330,106

Pacific Northwest
19,289

 
14,078

 
5.8
%
 
795,228

Northern California
78,452

 
60,248

 
11.5
%
 
2,651,741

Southern California
71,257

 
51,041

 
9.8
%
 
2,633,553

Total Established
366,803

 
258,640

 
7.9
%
 
13,155,449

 
 
 
 
 
 
 
 
Other Stabilized (2)
73,004

 
56,914

 
N/A

 
2,196,700

Development / Redevelopment
53,251

 
35,327

 
N/A

 
3,802,952

Land Held for Development
N/A

 
N/A

 
N/A

 
477,072

Non-allocated (3)
1,524

 
N/A

 
N/A

 
89,056

 
 
 
 
 
 
 
 
Total
$
494,582

 
$
350,881

 
21.7
%
 
$
19,721,229

__________________________________

(1)
Does not include gross real estate assets held for sale of $20,341 as of March 31, 2016.
(2)
Total revenue and NOI for the three months ended March 31, 2016 includes $20,306 in business interruption insurance proceeds related to the Edgewater casualty loss.
(3)
Revenue represents third-party management, asset management and developer fees and miscellaneous income which are not allocated to a reportable segment.


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Table of Contents

8.  Stock-Based Compensation Plans

As part of its long term compensation plans, the Company has granted stock options, performance awards and restricted stock. Detail of the outstanding awards and activity is presented below.

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") is as follows:
 
 
2009 Plan
shares
 
Weighted average
exercise price
per share
 
1994 Plan
shares
 
Weighted average
exercise price
per share
Options Outstanding, December 31, 2016
 
177,333

 
$
124.25

 
22,541

 
$
77.91

Exercised
 
(3,085
)
 
120.74

 
(4,181
)
 
129.72

Forfeited
 

 

 

 

Options Outstanding, March 31, 2017 (1)
 
174,248

 
$
124.31

 
18,360

 
$
66.11

__________________________________

(1)
All options outstanding are exercisable as of March 31, 2017.

Information with respect to performance awards granted is as follows:
 
 
Performance awards
 
Weighted average grant date fair value per award
Outstanding at December 31, 2016
 
251,163

 
$
136.74

  Granted (1)
 
81,708

 
176.59

  Change in awards based on performance (2)
 
49,323

 
119.26

  Converted to restricted stock
 
(128,482
)
 
118.75

  Forfeited
 
(792
)
 
160.39

Outstanding at March 31, 2017
 
252,920

 
$
155.27

__________________________________

(1)
The amount of restricted stock that ultimately may be earned is based on the total shareholder return metrics related to the Company's common stock for 49,374 performance awards and financial metrics related to operating performance and leverage metrics of the Company for 32,334 performance awards.
(2)
Represents the change in the number of performance awards earned based on performance achievement.

The Company used a Monte Carlo model to assess the compensation cost associated with the portion of the performance awards determined by using total shareholder return measures. The assumptions used are as follows:
 
 
2017
Dividend yield
 
3.2%
Estimated volatility over the life of the plan (1)
 
15.3% - 19.7%
Risk free rate
 
0.69% - 1.61%
Estimated performance award value based on total shareholder return measure
 
$175.86
__________________________________

(1)
Estimated volatility over the life of the plan is using 50% historical volatility and 50% implied volatility.

For the portion of the performance awards granted in 2017, for which achievement will be determined by using financial metrics, the compensation cost was based on a weighted average grant date value of $179.07, and the Company's estimate of corporate achievement for the financial metrics.


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Information with respect to restricted stock granted is as follows:
 
 
Restricted stock shares
 
Restricted stock shares weighted average grant date fair value per share
 
Restricted stock shares converted from performance awards
Outstanding at December 31, 2016
 
136,705

 
$
158.51

 
176,698

  Granted - restricted stock shares
 
70,020

 
179.07

 
128,482

  Vested - restricted stock shares
 
(65,702
)
 
153.05

 
(69,149
)
  Forfeited
 
(236
)
 
173.73

 

Outstanding at March 31, 2017
 
140,787

 
$
171.25

 
236,031


Total employee stock-based compensation cost recognized in income was $3,986,000 and $3,742,000 for the three months ended March 31, 2017 and 2016, respectively, and total capitalized stock-based compensation cost was $2,078,000 and $3,048,000 for the three months ended March 31, 2017 and 2016, respectively. At March 31, 2017, there was a total unrecognized compensation cost of $45,637,000 for unvested restricted stock and performance awards, which does not include forfeitures, and is expected to be recognized over a weighted average period of 3.9 years.

9.  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 $1,200,000 and $1,524,000 during the three months ended March 31, 2017 and 2016, respectively. These fees are recognized on an accrual basis when earned in accordance with the accounting guidance applicable to revenue recognition, and 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 property and construction management role of $3,846,000 and $5,239,000 as of March 31, 2017 and December 31, 2016, respectively.

Director Compensation

The Company recorded non-employee director compensation expense relating to restricted stock grants and deferred stock awards in the amount of $371,000 and $341,000 in the three months ended March 31, 2017 and 2016, respectively, as a component of general and administrative expense. Deferred compensation relating to these restricted stock grants and deferred stock awards to non-employee directors was $212,000 and $531,000 on March 31, 2017 and December 31, 2016, respectively.

10.  Fair Value

Financial Instruments Carried at Fair Value

Derivative Financial Instruments

Currently, the Company uses interest rate swap and 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, such as interest rate, term to maturity and volatility, 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 March 31, 2017, 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 March 31, 2017, or any prior period, and the Company does not anticipate that it will have a material effect in the future.

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Table of Contents


The following table summarizes the consolidated derivative positions at March 31, 2017 (dollars in thousands):
 
Non-designated
Hedges
Interest Rate Caps
 
Cash Flow
Hedges
Interest Rate Caps
 
Cash Flow
Hedges
Interest Rate Swaps
 
 
 
 
 
 
Notional balance
$
696,591

 
$
35,685

 
$
900,000

Weighted average interest rate (1)
2.6
%
 
2.8
%
 
N/A

Weighted average swapped/capped interest rate
6.1
%
 
5.9
%
 
2.3
%
Earliest maturity date
Aug 2017

 
Apr 2019

 
Nov 2017

Latest maturity date
Nov 2021

 
Apr 2019

 
May 2018

____________________________________

(1)
For interest rate caps, represents the weighted average interest rate on the hedged debt.

During the three months ended March 31, 2017, the Company entered into $100,000,000 of forward interest rate swap agreements executed to reduce the impact of variability in interest rates on a portion of the Company's expected debt issuance activity in 2018. As of March 31, 2017, the Company has $900,000,000 in aggregate outstanding forward interest rate swap agreements. At maturity of the outstanding swap agreements, the Company expects to cash settle the contracts and either pay or receive cash for the then current fair value. Assuming that the Company issues the debt as expected, the hedging impact from these positions will then be recognized over the life of the issued debt as a yield adjustment.

Excluding derivatives executed to hedge secured debt on communities classified as held for sale, the Company had 13 derivatives designated as cash flow hedges and 14 derivatives not designated as hedges at March 31, 2017. Fair value changes for derivatives not in qualifying hedge relationships for the three months ended March 31, 2017 and 2016 were not material. During three months ended March 31, 2017, the Company deferred $145,000 of gains for cash flow hedges reported as a component of other comprehensive income (loss).

The following table summarizes the deferred losses reclassified from accumulated other comprehensive income as a component of interest expense, net (dollars in thousands):
 
For the three months ended
 
3/31/2017
 
3/31/2016
 
 
 
 
Cash flow hedge losses reclassified to earnings
$
1,752

 
$
1,374


The Company anticipates reclassifying approximately $6,975,000 of hedging losses from accumulated other comprehensive loss into earnings within the next 12 months to offset the variability of cash flows of the hedged item during this period. The Company did not have any derivatives designated as fair value hedges as of March 31, 2017 and 2016.

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.


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Table of Contents

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

Rents and other receivables and prepaids, accounts and construction payable and accrued expenses and other liabilities are carried at their face amounts, which reasonably approximate their fair values.

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. The process also considers credit valuation adjustments to appropriately reflect the Company's nonperformance risk. The Company has concluded that the value of its notes payable and amounts outstanding under its Credit Facility and Term Loan are Level 2 prices as the majority of the inputs used to value its positions fall within Level 2 of the fair value hierarchy.

Financial Instruments Measured/Disclosed at Fair Value on a Recurring Basis

The following tables summarize the classification between the three levels of the fair value hierarchy of the Company's financial instruments measured/disclosed at fair value on a recurring basis (dollars in thousands):
Description
 
Total Fair Value
 
Quoted Prices
in Active
Markets for Identical Asset
(Level 1)
 
Significant
Other
Observable Inputs
(Level 2)
 
Significant
Unobservable Inputs
(Level 3)
 
 
 
 
 
 
3/31/2017
Non-Designated Hedges
 
 
 
 
 
 
 
 
Interest Rate Caps
 
$
30

 
$

 
$
30

 
$

Cash Flow Hedges
 
 
 
 
 
 
 
 
Interest Rate Swaps - Assets
 
14,955

 

 
14,955

 

Interest Rate Swaps - Liabilities
 
(102
)
 

 
(102
)
 

Puts
 
(5,928
)
 

 

 
(5,928
)
DownREIT units
 
(1,377
)
 
(1,377
)
 

 

Indebtedness
 
 
 
 
 
 
 
 
Unsecured notes
 
(4,226,278
)
 
(4,226,278
)
 

 

Mortgage notes payable and unsecured term loan
 
(2,743,794
)
 

 
(2,743,794
)
 

Total
 
$
(6,962,494
)
 
$
(4,227,655
)
 
$
(2,728,911
)
 
$
(5,928
)

20

Table of Contents

Description
 
Total Fair Value
 
Quoted Prices
in Active
Markets for Identical Asset
(Level 1)
 
Significant
Other
Observable Inputs
(Level 2)
 
Significant
Unobservable Inputs
(Level 3)
 
 
 
 
 
 
12/31/2016
Non-Designated Hedges
 
 
 
 
 
 
 
 
Interest Rate Caps
 
$
79

 
$

 
$
79

 
$

Cash Flow Hedges
 
 
 
 
 
 
 
 
Interest Rate Caps
 
2

 

 
2

 

Interest Rate Swaps - Assets
 
14,775

 

 
14,775

 

Puts
 
(6,002
)
 

 

 
(6,002
)
DownREIT units
 
(1,329
)
 
(1,329
)
 

 

Indebtedness
 
 
 
 
 
 
 
 
Unsecured notes
 
(4,218,627
)
 
(4,218,627
)
 

 

Mortgage notes payable and unsecured term loan
 
(2,744,462
)
 

 
(2,744,462
)
 

Total
 
$
(6,955,564
)
 
$
(4,219,956
)
 
$
(2,729,606
)
 
$
(6,002
)

11.  Subsequent Events

The Company has evaluated subsequent events through the date on which this Form 10-Q was filed, the date on which these financial statements were issued, and identified the items below for discussion.

In April 2017, the Company borrowed the $250,000,000 available under the $250 million Term Loan discussed in Note 3, "Mortgage Notes Payable, Unsecured Notes and Credit Facility."

In May 2017, the Company repaid $498,357,000 of fixed rate mortgage notes with an effective interest rate of 3.36%, secured by eight communities at par in advance of their November 2017 maturity dates.

As of May 2, 2017, the Company has $395,000,000 outstanding under the Credit Facility.

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Table of Contents

ITEM 2.
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") is intended to help provide an understanding of our business, financial condition and results of operations. This MD&A should be read in conjunction with our Condensed Consolidated Financial Statements and the accompanying Notes to Condensed Consolidated Financial Statements included elsewhere in this report. This report, including the following MD&A, contains forward-looking statements regarding future events or trends that should be read in conjunction with the factors described under "Forward-Looking Statements" included in this report.  Actual results or developments could differ materially from those projected in such statements as a result of the factors described under "Forward-Looking Statements" as well as the risk factors described in Item 1A. "Risk Factors" of our Form 10-K for the year ended December 31, 2016 (the "Form 10-K").

Capitalized terms used without definition have the meanings provided elsewhere in this Form 10-Q.

Executive Overview

Business Description

We develop, redevelop, acquire, own and operate multifamily apartment communities primarily in New England, the New York/New Jersey metro area, the Mid-Atlantic, the Pacific Northwest, and Northern and Southern California. We focus on leading metropolitan areas that we believe are characterized by growing employment in high wage sectors of the economy, lower housing affordability and a diverse and vibrant quality of life. We believe these market characteristics offer the opportunity for superior risk-adjusted returns on apartment community investments relative to other markets that do not have these characteristics. We seek to create long-term shareholder value by accessing capital on cost effective terms; deploying that capital to develop, redevelop and acquire apartment communities in our selected markets; operating apartment communities; and selling communities when they no longer meet our long-term investment strategy or when pricing is attractive.

Our strategic vision is to be the leading apartment company in select US markets, providing a range of distinctive living experiences that customers value. We pursue this vision by targeting what we believe are among the best markets and submarkets, leveraging our strategic capabilities in market research and consumer insight and being disciplined in our capital allocation and balance sheet management. Our communities are predominately upscale and generally command among the highest rents in their markets. However, we also pursue the ownership and operation of apartment communities that target a variety of customer segments and price points, consistent with our goal of offering a broad range of products and services. We regularly evaluate the allocation of our investments by the amount of invested capital and by product type within our individual markets.

First Quarter 2017 Highlights

Net income attributable to common stockholders for the three months ended March 31, 2017 was $235,875,000, a decrease of $2,056,000, or 0.9%, as compared to the prior year period. The decrease is primarily due to a net casualty and impairment loss in the current year period as compared to a net gain in the prior year period, as well as increases in depreciation and interest expense. The decrease was partially offset by an increase in real estate sales and related gains and an increase in NOI from existing, acquired and newly developed operating communities.

Established Communities NOI for the three months ended March 31, 2017 was $276,106,000, an increase of $10,316,000, or 3.9%, over the prior year period. This increase was driven by an increase in rental revenue of 3.2%, partially offset by an increase in operating expenses of 1.5% compared to the prior year period.

During the three months ended March 31, 2017, we completed the construction of three communities, one of which is dual-branded, containing an aggregate of 1,548 apartment homes for an aggregate total capitalized cost of $648,800,000. At March 31, 2017, we owned or held a direct or indirect interest in 24 communities under construction expected to contain 7,581 apartment homes with a projected total capitalized cost of $3,399,600,000, including the total projected capitalized cost for one community being developed within an unconsolidated joint venture in which we own a 55.0% interest. In addition, as of March 31, 2017, we held a direct or indirect ownership interest in land or rights to land on which we expect to develop an additional 28 apartment communities that, if developed as expected, will contain 9,304 apartment homes, and will be developed for an aggregate total capitalized cost of $3,373,000,000, an increase of $345,000,000 from our position as of December 31, 2016.


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Table of Contents

During the three months ended March 31, 2017, we sold one wholly-owned operating community. Avalon Pines, located in Coram, NY, containing 450 homes, and the adjacent golf course were sold for $140,000,000. Our gain in accordance with GAAP on the disposition was $87,949,000.

We expect to be able to meet our reasonably foreseeable liquidity needs, as they arise, through a combination of one or more of the following sources: existing cash on hand; operating cash flows; borrowings under our Credit Facility and the $250 million Term Loan; secured debt; the issuance of corporate securities (which could include unsecured debt, preferred equity and/or common equity); the sale of apartment communities; or through the formation of joint ventures. See the discussion under "Liquidity and Capital Resources".

Maplewood Casualty Loss

In February 2017, a fire occurred at our Avalon Maplewood Development Community ("Maplewood"). See Note 1, "Organization, Basis and Presentation and Significant Accounting Policies - Legal and Other Contingencies," and Note 5, "Investments in Real Estate Entities - Casualty Gains and Losses," in the accompanying Condensed Consolidated Financial Statements for additional discussions related to the Maplewood casualty loss.

Communities Overview

Our real estate investments consist primarily of current operating apartment communities, communities in various stages of development ("Development Communities") and Development Rights (as defined below).  Our current operating communities are further distinguished as Established Communities, Other Stabilized Communities, Lease-Up Communities, Redevelopment Communities and Unconsolidated Communities. While we generally establish the classification of communities on an annual basis, we intend to update the classification of communities during the calendar year to the extent that our plans with regard to the disposition or redevelopment of a community change during the year. The following is a description of each category:

Current Communities are categorized as Established, Other Stabilized, Lease-Up, Redevelopment, or Unconsolidated according to the following attributes:

Established Communities (also known as Same Store Communities) are consolidated communities where a comparison of operating results from the prior year to the current year is meaningful, as these communities were owned and had stabilized occupancy as of the beginning of the respective prior year period.  For the three month periods ended March 31, 2017 and 2016, the Established Communities are communities that are consolidated for financial reporting purposes, had stabilized occupancy as of January 1, 2016, are not conducting or planning to conduct substantial redevelopment activities and are not held for sale or planned for disposition within the current year. A community is considered to have stabilized occupancy at the earlier of (i) attainment of 95% physical occupancy or (ii) the one-year anniversary of completion of development or redevelopment.

Other Stabilized Communities are all other completed consolidated communities that have stabilized occupancy, as defined above, as of the beginning of the current calendar year. Other Stabilized Communities do not include communities that are conducting or planning to conduct substantial redevelopment activities within the current year. 

Lease-Up Communities are consolidated communities where construction has been complete for less than one year and where physical occupancy has not reached 95%.

Redevelopment Communities are consolidated communities where substantial redevelopment is in progress or is planned to begin during the current year.  Redevelopment is considered substantial when capital invested during the reconstruction effort is expected to exceed the lesser of $5,000,000 or 10% of the community's pre-redevelopment basis and is expected to have a material impact on the operations of the community, including occupancy levels and future rental rates.

Unconsolidated Communities are communities that we have an indirect ownership interest in through our investment interest in an unconsolidated joint venture.

Development Communities are communities that are under construction and for which a certificate or certificates of occupancy for the entire community have not been received.  These communities may be partially complete and operating.


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Table of Contents

Development Rights are development opportunities in the early phase of the development process where we either have an option to acquire land or enter into a leasehold interest, where we are the buyer under a long-term conditional contract to purchase land, where we control the land through a ground lease or own land to develop a new community, or where we are the designated developer in a public-private partnership. We capitalize related pre-development costs incurred in pursuit of new developments for which we currently believe future development is probable.

We currently lease our corporate headquarters located in Arlington, Virginia, as well as our other regional and administrative offices under operating leases.

As of March 31, 2017, communities that we owned or held a direct or indirect interest in were classified as follows:
 
 
Number of
communities
 
Number of
apartment homes
 
 
 
 
 
Current Communities
 
 

 
 

 
 
 
 
 
Established Communities:
 
 

 
 

New England
 
38

 
8,631

Metro NY/NJ
 
35

 
10,388

Mid-Atlantic
 
26

 
9,123

Pacific Northwest
 
13

 
3,305

Northern California
 
35

 
10,321

Southern California
 
45

 
13,330

Total Established
 
192

 
55,098

 
 
 
 
 
Other Stabilized Communities:
 
 

 
 

New England
 
7

 
1,868

Metro NY/NJ
 
11

 
2,882

Mid-Atlantic
 
7

 
2,443

Pacific Northwest
 
3

 
656

Northern California
 
3

 
1,068

Southern California
 
8

 
1,310

Non Core
 
3

 
1,014

Total Other Stabilized
 
42

 
11,241

 
 
 
 
 
Lease-Up Communities
 
3

 
1,048

 
 
 
 
 
Redevelopment Communities
 
9

 
4,075

 
 
 
 
 
Unconsolidated Communities
 
14

 
3,490

 
 
 
 
 
Total Current Communities
 
260

 
74,952

 
 
 
 
 
Development Communities (1)
 
24

 
7,581

 
 
 
 
 
Total Communities
 
284

 
82,533

 
 
 
 
 
Development Rights
 
28

 
9,304

_________________________

(1)
Development Communities includes AVA North Point, expected to contain 265 apartment homes, which is being developed within an unconsolidated joint venture.


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Table of Contents

Results of Operations

Our year-over-year operating performance is primarily affected by both overall and individual geographic market conditions and apartment fundamentals and is reflected in changes in NOI of our Established Communities; NOI derived from acquisitions and development completions; the loss of NOI related to disposed communities; and capital market and financing activity.  A comparison of our operating results for the three months ended March 31, 2017 and 2016 follows (unaudited, dollars in thousands):
 
For the three months ended
 
3/31/2017
 
3/31/2016
 
$ Change
 
% Change
 
 
 
 
 
 
 
 
Revenue:
 

 
 

 
 

 
 

Rental and other income
$
521,126

 
$
506,974

 
$
14,152

 
2.8
 %
Management, development and other fees
1,200

 
1,524

 
(324
)
 
(21.3
)%
Total revenue
522,326

 
508,498

 
13,828

 
2.7
 %
 
 
 
 
 
 
 
 
Expenses:
 

 
 

 
 

 
 

Direct property operating expenses, excluding property taxes
104,233

 
97,387

 
6,846

 
7.0
 %
Property taxes
52,930

 
50,067

 
2,863

 
5.7
 %
Total community operating expenses
157,163

 
147,454

 
9,709

 
6.6
 %
 
 
 
 
 
 
 
 
Corporate-level property management and other indirect operating expenses
17,490

 
18,094

 
(604
)
 
(3.3
)%
Investments and investment management expense
1,321

 
1,145

 
176

 
15.4
 %
Expensed acquisition, development and other pursuit costs, net of recoveries
728

 
3,462

 
(2,734
)
 
(79.0
)%
Interest expense, net
49,295

 
43,410

 
5,885

 
13.6
 %
Depreciation expense
140,621

 
127,216

 
13,405

 
10.5
 %
General and administrative expense
13,206

 
11,404

 
1,802

 
15.8
 %
Casualty and impairment loss (gain), net
11,688

 
(2,202
)
 
13,890

 
N/A (1)

Total other expenses
234,349

 
202,529

 
31,820

 
15.7
 %
 
 
 
 
 
 
 
 
Equity in income of unconsolidated real estate entities
16,672

 
27,969

 
(11,297
)
 
(40.4
)%
Gain on sale of communities
87,949

 
51,430

 
36,519

 
71.0
 %
Gain on sale of other real estate
366

 

 
366

 
100.0
 %
Income before income taxes
235,801

 
237,914

 
(2,113
)
 
(0.9
)%
Income tax expense
20

 
37

 
(17
)
 
(45.9
)%
Net income
235,781

 
237,877

 
(2,096
)
 
(0.9
)%
 
 
 
 
 
 
 
 
Net loss attributable to noncontrolling interests
94

 
54

 
40

 
74.1
 %
 
 
 
 
 
 
 
 
Net income attributable to common stockholders
$
235,875

 
$
237,931

 
$
(2,056
)
 
(0.9
)%
_________________________

(1)
Percent change is not meaningful.

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Net income attributable to common stockholders decreased $2,056,000, or 0.9%, to $235,875,000 for the three months ended March 31, 2017 as compared to the prior year period. The decrease for the three months ended March 31, 2017 is primarily due to a casualty and impairment loss in the current year period as compared to a gain in the prior year period, as well as increases in depreciation and interest expense. The decrease was partially offset by an increase in real estate sales and related gains and an increase in NOI from existing, acquired and newly developed operating communities.

NOI is considered by management to be an important and appropriate supplemental performance measure to net income because it helps both investors and management to understand the core operations of a community or communities prior to the allocation of any corporate-level or financing-related costs.  NOI reflects the operating performance of a community and allows for an easier comparison of the operating performance of individual assets or groups of assets. In addition, because prospective buyers of real estate have different financing and overhead structures, with varying marginal impact to overhead as a result of acquiring real estate, NOI is considered by many in the real estate industry to be a useful measure for determining the value of a real estate asset or group of assets. We define NOI 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 of recoveries, interest expense, net, loss (gain) on extinguishment of debt, net, general and administrative expense, equity in (loss) income of unconsolidated real estate entities, depreciation expense, corporate income tax expense, casualty and impairment loss (gain), net, gain on sale of real estate assets and net operating income from real estate assets sold or held for sale.

NOI does not represent cash generated from operating activities in accordance with GAAP, and NOI should not be considered an alternative to net income as an indication of our performance. NOI should also not be considered an alternative to net cash flow from operating activities, as determined by GAAP, as a measure of liquidity, nor is NOI indicative of cash available to fund cash needs.  Reconciliations of NOI for the three months ended March 31, 2017 and 2016 to net income for each period are as follows (unaudited, dollars in thousands):
 
For the three months ended
 
3/31/2017
 
3/31/2016
 
 
 
 
Net income
$
235,781

 
$
237,877

Indirect operating expenses, net of corporate income
16,297

 
16,537

Investments and investment management expense
1,321

 
1,145

Expensed acquisition, development and other pursuit costs, net of recoveries
728

 
3,462

Interest expense, net
49,295

 
43,410

General and administrative expense
13,206

 
11,404

Equity in income of unconsolidated real estate entities
(16,672
)
 
(27,969
)
Depreciation expense
140,621

 
127,216

Income tax expense
20

 
37

Casualty and impairment loss (gain), net
11,688

 
(2,202
)
Gain on sale of real estate assets
(88,315
)
 
(51,430
)
Net operating income from real estate assets sold or held for sale
(1,387
)
 
(8,606
)
Net operating income
$
362,583

 
$
350,881



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The NOI changes for the three months ended March 31, 2017, compared to the prior year period, consist of changes in the following categories (unaudited, dollars in thousands):
 
For the three months ended
 
3/31/2017
 
 

Established Communities
$
10,316

Other Stabilized Communities (1)
(3,020
)
Development and Redevelopment Communities
4,406

Total
$
11,702

____________________________

(1)
NOI for the three months ended March 31, 2016 includes $20,306 in business interruption insurance proceeds related to the Edgewater casualty loss.

Rental and other income increased in the three months ended March 31, 2017 compared to the prior year period due to additional rental income generated from newly developed, acquired and existing operating communities and an increase in rental rates at our Established Communities, discussed below.

Consolidated Communities — The weighted average number of occupied apartment homes increased to 69,069 apartment homes for the three months ended March 31, 2017, compared to 67,156 homes for the prior year period. The weighted average monthly revenue per occupied apartment home increased to $2,512 for the three months ended March 31, 2017 compared to $2,412 in the prior year period.

Established Communities — Rental revenue increased $11,932,000, or 3.2%, for the three months ended March 31, 2017 compared to the prior year period due to an increase in average rental rates of 3.1% to $2,456 per apartment home and an increase in economic occupancy of 0.1% to 95.7%. Economic occupancy takes into account the fact that apartment homes of different sizes and locations within a community have different economic impacts on a community's gross revenue.  Economic occupancy is defined as gross potential revenue less vacancy loss, as a percentage of gross potential revenue. Gross potential revenue is determined by valuing occupied homes at leased rates and vacant homes at market rents.

The Metro New York/New Jersey region accounted for approximately 22.5% of Established Community rental revenue for the three months ended March 31, 2017, and experienced an increase in rental revenue of 3.0% compared to the prior year period. Average rental rates increased 2.8% to $2,938 per apartment home, and economic occupancy increased 0.2% to 95.6% for the three months ended March 31, 2017, compared to the prior year period. While New York City is absorbing a larger pipeline of new apartment deliveries, suburban markets surrounding the city are more insulated from this new competition, and we expect to see continued growth over the prior year in the Metro New York/New Jersey region in 2017.

The Northern California region accounted for approximately 21.4% of Established Community rental revenue for the three months ended March 31, 2017, and experienced an increase in rental revenue of 2.3% compared to the prior year period. Average rental rates increased 2.2% to $2,809 per apartment home, and economic occupancy increased 0.1% to 95.7% for the three months ended March 31, 2017, compared to the prior year period. We expect slower job growth and elevated levels of new apartment deliveries will temper growth in 2017 relative to prior years.

The Southern California region accounted for approximately 21.4% of Established Community rental revenue for the three months ended March 31, 2017, and experienced an increase in rental revenue of 4.0% compared to the prior year period. Average rental rates increased 4.5% to $2,170 per apartment home, and were partially offset by a 0.5% decrease in economic occupancy to 95.8% for the three months ended March 31, 2017, compared to the prior year period. Southern California has seen steady job growth and limited new apartment supply, which we expect will continue to support favorable operating results in 2017.

The New England region accounted for approximately 15.1% of Established Community rental revenue for the three months ended March 31, 2017, and experienced an increase in rental revenue of 3.0% compared to the prior year period. Average rental rates increased 2.5% to $2,363 per apartment home, and economic occupancy increased 0.5% to 95.8% for the three months ended March 31, 2017, compared to the prior year period. Stable job growth in the Boston metro area is expected to support apartment demand in 2017. The Fairfield market continues to experience moderate economic growth due to the area's greater exposure to the financial services sector, which has experienced slower job growth during this recovery than other industries.

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The Mid-Atlantic region accounted for approximately 14.3% of Established Community rental revenue for the three months ended March 31, 2017, and experienced an increase in rental revenue of 2.8% compared to the prior year period.  Average rental rates increased 2.3% to $2,127 per apartment home, and economic occupancy increased 0.5% to 95.7% for the three months ended March 31, 2017, compared to the prior year period. Although new apartment supply will remain elevated, accelerating job growth is expected to support modest growth in 2017.

The Pacific Northwest region accounted for approximately 5.3% of Established Community rental revenue for the three months ended March 31, 2017, and experienced an increase in rental revenue of 6.1% compared to the prior year period. Average rental rates increased 6.1% to $2,150 per apartment home, and economic occupancy remained consistent at 95.9% for the three months ended March 31, 2017, compared to the prior year period. We believe healthy job growth will continue to support favorable operating results in 2017.
 
Management, development and other fees decreased $324,000, or 21.3%, for the three months ended March 31, 2017 as compared to the prior year period. The decrease for the three months ended March 31, 2017 is primarily due to lower property and asset management fees earned as a result of dispositions from AvalonBay Value Added Fund II, L.P. ("Fund II") and the Archstone Multifamily Partners AC LP (the "U.S. Fund").

Direct property operating expenses, excluding property taxes increased $6,846,000, or 7.0%, for the three months ended March 31, 2017, compared to the prior year period. The increase for the three months ended March 31, 2017 is primarily due to the addition of newly developed and acquired apartment communities.

For Established Communities, direct property operating expenses, excluding property taxes, increased $1,430,000, or 2.0%, for the three months ended March 31, 2017 compared to the prior year period. The increase for the three months ended March 31, 2017 is primarily due to increased maintenance costs, compensation expense and bad debt expense, partially offset by a decrease in property insurance costs.

Property taxes increased $2,863,000, or 5.7%, for the three months ended March 31, 2017 compared to the prior year period. The increase for the three months ended March 31, 2017 is primarily due to the addition of newly developed and acquired apartment communities, coupled with increased assessments across our portfolio.

For Established Communities, property taxes increased $190,000, or 0.5%, for the three months ended March 31, 2017 compared to the prior year period. The increase for the three months ended March 31, 2017 is primarily due to increased assessments, partially offset by successful appeals in the current year period. For communities in California, property tax changes are determined by the change in the California Consumer Price Index, with increases limited by law (Proposition 13). Massachusetts also has laws in place to limit property tax increases. We evaluate property tax increases internally and also engage third-party consultants to assist in our evaluations. We appeal property tax increases when appropriate.

Corporate-level property management and other indirect operating expenses decreased $604,000, or 3.3%, for the three months ended March 31, 2017 compared to the prior year period, primarily due to decreased compensation related costs, including severance costs in the prior year period not present in three months ended March 31, 2017.

Expensed acquisition, development and other pursuit costs, net of recoveries primarily reflect abandoned pursuit costs as well as acquisition costs related to business acquisitions that occurred prior to the adoption of ASU 2017-01 as of October 1, 2016. Subsequent to the adoption of ASU 2017-01, we expect that acquisitions of individual operating communities will generally be viewed as asset acquisitions, and result in acquisition costs being capitalized instead of expensed. Abandoned pursuit costs include costs incurred for development pursuits not yet considered probable for development, as well as the abandonment of Development Rights and disposition pursuits, and also includes costs related to acquisition pursuits. These costs can be volatile, particularly in periods of increased acquisition activity, periods of economic downturn or when there is limited access to capital, and the costs may vary significantly from period to period. These costs decreased $2,734,000, or 79.0%, for the three months ended March 31, 2017 compared to the prior year period. The decrease for the three months ended March 31, 2017 is primarily due to the non-cash write-off of asset management fee intangibles associated with the disposition of communities in the U.S. Fund in the prior year period, as well as acquisition costs related to two communities acquired during the three months ended March 31, 2016.


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Interest expense, net increased