November 2, 2018 - 10-Q: Quarterly report pursuant to Section 13 or 15(d)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2018

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, every Interactive Data File required to be submitted 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 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 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:

138,222,567 shares of common stock, par value $0.01 per share, were outstanding as of October 31, 2018.

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AVALONBAY COMMUNITIES, INC.

FORM 10-Q

INDEX



		PAGE
PART I - FINANCIAL INFORMATION

ITEM 1.	CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

	CONDENSED CONSOLIDATED BALANCE SHEETS AS OF SEPTEMBER 30, 2018 (UNAUDITED) AND DECEMBER 31, 2017	1

	CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED) FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2018 AND 2017	2

	CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2018 AND 2017	3

	NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)	5

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS		25

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK		48

ITEM 4. CONTROLS AND PROCEDURES		48

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS		48

ITEM 1A. RISK FACTORS		49

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS		50

ITEM 3. DEFAULTS UPON SENIOR SECURITIES		50

ITEM 4. MINE SAFETY DISCLOSURES		50

ITEM 5. OTHER INFORMATION		50

ITEM 6. EXHIBITS		51

SIGNATURES		53

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AVALONBAY COMMUNITIES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except per share data)



	9/30/2018			12/31/2017
	(unaudited)
ASSETS
Real estate:
Land and improvements	$	4,186,360		$	4,237,318
Buildings and improvements	15,808,498			15,708,666
Furniture, fixtures and equipment	673,013			615,288
	20,667,871			20,561,272
Less accumulated depreciation	(4,585,609		)	(4,218,379		)
Net operating real estate	16,082,262			16,342,893
Construction in progress, including land	1,651,406			1,306,300
Land held for development	116,582			68,364
Real estate assets held for sale, net	79,963			—
Total real estate, net	17,930,213			17,717,557

Cash and cash equivalents	55,887			67,088
Cash in escrow	225,704			134,818
Resident security deposits	34,132			32,686
Investments in unconsolidated real estate entities	173,563			163,475
Deferred development costs	45,869			45,819
Prepaid expenses and other assets	196,751			253,378
Total assets	$	18,662,119		$	18,414,821

LIABILITIES AND EQUITY
Unsecured notes, net	$	6,153,945		$	5,852,764
Variable rate unsecured credit facility	56,000			—
Mortgage notes payable, net	1,323,283			1,476,706
Dividends payable	203,624			196,094
Payables for construction	92,323			85,377
Accrued expenses and other liabilities	300,827			308,189
Accrued interest payable	66,546			43,116
Resident security deposits	61,059			58,473
Liabilities related to real estate assets held for sale	1,037			—
Total liabilities	8,258,644			8,020,719

Commitments and contingencies

Redeemable noncontrolling interests	6,077			6,056

Equity:
Preferred stock, $0.01 par value; $25 liquidation preference; 50,000,000 shares authorized at September 30, 2018 and December 31, 2017; zero shares issued and outstanding at September 30, 2018 and December 31, 2017	—			—
Common stock, $0.01 par value; 280,000,000 shares authorized at September 30, 2018 and December 31, 2017; 138,222,168 and 138,094,154 shares issued and outstanding at September 30, 2018 and December 31, 2017, respectively	1,382			1,381
Additional paid-in capital	10,249,311			10,235,475
Accumulated earnings less dividends	167,946			188,609
Accumulated other comprehensive loss	(21,241		)	(37,419		)
Total equity	10,397,398			10,388,046
Total liabilities and equity	$	18,662,119		$	18,414,821

See accompanying notes to Condensed Consolidated Financial Statements.

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AVALONBAY COMMUNITIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(unaudited)

(Dollars in thousands, except per share data)



	For the three months ended						For the nine months ended
	9/30/2018			9/30/2017			9/30/2018			9/30/2017
Revenue:
Rental and other income	$	575,070		$	549,507		$	1,703,263		$	1,600,047
Management, development and other fees	912			993			2,752			3,290
Total revenue	575,982			550,500			1,706,015			1,603,337

Expenses:
Operating expenses, excluding property taxes	132,918			129,590			396,703			379,319
Property taxes	61,230			57,698			181,120			164,195
Interest expense, net	54,097			47,741			165,795			147,138
Loss on extinguishment of debt, net	1,678			—			2,717			24,162
Depreciation expense	156,538			144,990			472,282			427,050
General and administrative expense	13,905			11,655			42,013			38,808
Expensed transaction, development and other pursuit costs, net of recoveries	1,020			789			2,709			2,087
Casualty and impairment (gain) loss, net	(554		)	—			(612		)	11,688
Total expenses	420,832			392,463			1,262,727			1,194,447

Income before equity in income of unconsolidated real estate entities, gain (loss) on sale of communities and other real estate, and income taxes	155,150			158,037			443,288			408,890

Equity in income of unconsolidated real estate entities	10,031			52,568			12,560			70,386
Gain on sale of communities	27,243			27,738			132,444			159,754
Gain (loss) on other real estate transactions, net	12			(120		)	335			246

Income before income taxes	192,436			238,223			588,627			639,276
Income tax expense	29			24			87			102

Net income	192,407			238,199			588,540			639,174
Net loss attributable to noncontrolling interests	79			49			251			174

Net income attributable to common stockholders	$	192,486		$	238,248		$	588,791		$	639,348

Other comprehensive income (loss):
Gain (loss) on cash flow hedges	—			359			11,499			(15,654		)
Cash flow hedge losses reclassified to earnings	1,466			1,767			4,679			5,301
Comprehensive income	$	193,952		$	240,374		$	604,969		$	628,995

Earnings per common share - basic:
Net income attributable to common stockholders	$	1.39		$	1.73		$	4.26		$	4.64

Earnings per common share - diluted:
Net income attributable to common stockholders	$	1.39		$	1.72		$	4.26		$	4.63

Dividends per common share	$	1.47		$	1.42		$	4.41		$	4.26

See accompanying notes to Condensed Consolidated Financial Statements.

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AVALONBAY COMMUNITIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(Dollars in thousands)



	For the nine months ended
	9/30/2018			9/30/2017
Cash flows from operating activities:
Net income	$	588,540		$	639,174
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation expense	472,282			427,050
Amortization of deferred financing costs	6,066			5,729
Amortization of debt discount (premium)	1,259			(6,254		)
Loss on extinguishment of debt, net	2,717			24,162
Amortization of stock-based compensation	15,617			13,979
Equity in loss (income) of, and return on, unconsolidated real estate entities and noncontrolling interests, net of eliminations	4,514			(21,627		)
Casualty and impairment (gain) loss, net	(58		)	8,568
Abandonment of development pursuits	725			388
Cash flow hedge losses reclassified to earnings	4,679			5,301
Gain on sale of real estate assets	(141,415		)	(200,110		)
Decrease (increase) in resident security deposits, prepaid expenses and other assets	16,691			(27,384		)
Increase in accrued expenses, other liabilities and accrued interest payable	9,742			64,802
Net cash provided by operating activities	981,359			933,778

Cash flows from investing activities:
Development/redevelopment of real estate assets including land acquisitions and deferred development costs	(864,550		)	(743,275		)
Acquisition of real estate assets, including partnership interest	(84,088		)	(228,011		)
Capital expenditures - existing real estate assets	(59,950		)	(41,809		)
Capital expenditures - non-real estate assets	(2,142		)	(5,308		)
Proceeds from sale of real estate, net of selling costs	466,187			336,542
Insurance proceeds for property damage claims	58			13,268
Mortgage note receivable lending	(2,880		)	(14,244		)
Mortgage note receivable payments	50,929			—
Increase (decrease) in payables for construction	6,946			(16,660		)
Distributions from unconsolidated real estate entities	2,013			89,305
Investments in unconsolidated real estate entities	(7,979		)	(14,560		)
Net cash used in investing activities	(495,456		)	(624,752		)

Cash flows from financing activities:
Issuance of common stock, net	1,224			110,117
Dividends paid	(602,152		)	(576,685		)
Net borrowings under unsecured credit facility	56,000			242,000
Issuance of mortgage notes payable	—			185,100
Repayments of mortgage notes payable, including prepayment penalties	(157,164		)	(1,289,234		)
Issuance of unsecured notes	299,442			948,616
Payment of deferred financing costs	(3,347		)	(11,743		)
Payment of capital lease obligation	(802		)	(18,683		)
Receipts for termination of forward interest rate swaps	12,598			391
Payments related to tax withholding for share-based compensation	(10,543		)	(10,460		)
Distributions to DownREIT partnership unitholders	(33		)	(32		)
Contributions from joint venture and profit-sharing partners	—			1,038
Distributions to joint venture and profit-sharing partners	(321		)	(317		)
Preferred interest obligation redemption and dividends	(1,120		)	(2,000		)
Net cash used in financing activities	(406,218		)	(421,892		)

Net increase (decrease) in cash and cash equivalents	79,685			(112,866		)

Cash and cash equivalents and restricted cash, beginning of period	201,906			329,977
Cash and cash equivalents and restricted cash, end of period	$	281,591		$	217,111

Cash paid during the period for interest, net of amount capitalized	$	130,361		$	124,585

See accompanying notes to Condensed Consolidated Financial Statements.

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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

The following table provides a reconciliation of cash, cash equivalents and restricted cash reported in the Condensed Consolidated Statements of Cash Flows (dollars in thousands):



	For the nine months ended
	9/30/2018		9/30/2017
Cash and cash equivalents	$	55,887	$	36,042
Cash in escrow	225,704		181,069
Cash, cash equivalents and restricted cash reported in the Condensed Consolidated Statements of Cash Flows	$	281,591	$	217,111

Supplemental disclosures of non-cash investing and financing activities:

During the nine months ended September 30, 2018:

•

As described in Note 4, "Equity," 187,010 shares of common stock were issued as part of the Company's stock-based compensation plans, of which 88,297 shares related to the conversion of performance awards to restricted shares, and the remaining 98,713 shares valued at $15,950,000 were issued in connection with new stock grants; 1,713 shares valued at $290,000 were issued through the Company's dividend reinvestment plan; 67,963 shares valued at $10,543,000 were withheld to satisfy employees' tax withholding and other liabilities; and 4,622 restricted shares with an aggregate value of $679,000 previously issued in connection with employee compensation were canceled upon forfeiture.


•	Common stock dividends declared but not paid totaled $203,624,000.


•	The Company recorded an increase of $626,000 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 reclassified $4,679,000 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.

During the nine months ended September 30, 2017:

•

The Company issued 201,314 shares of common stock 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 72,832 shares valued at $13,079,000 were issued in connection with new stock grants; 2,466 shares valued at $452,000 were issued through the Company's dividend reinvestment plan; 60,165 shares valued at $10,514,000 were withheld to satisfy employees' tax withholding and other liabilities; and 3,045 restricted shares with an aggregate value of $528,000 previously issued in connection with employee compensation were canceled upon forfeiture.


•	Common stock dividends declared but not paid totaled $196,079,000.


•	The Company recorded an increase of $458,000 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 an increase in prepaid expenses and other assets of $1,422,000 and an increase in accrued expenses and other liabilities of $1,998,000, and a corresponding adjustment to other comprehensive income, and reclassified $5,301,000 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 non-cash 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 Avalon Maplewood community ("Maplewood").

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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 September 30, 2018, the Company owned or held a direct or indirect ownership interest in 271 operating apartment communities containing 78,383 apartment homes in 12 states and the District of Columbia, of which 15 communities containing 6,242 apartment homes were under redevelopment. In addition, the Company owned or held a direct or indirect ownership interest in 19 communities under development that are expected to contain an aggregate of 6,107 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 25 communities that, if developed as expected, will contain an estimated 8,600 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 2017 Annual Report on Form 10-K. The results of operations for the three and nine months ended September 30, 2018 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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	For the three months ended						For the nine months ended
	9/30/2018			9/30/2017			9/30/2018			9/30/2017
Basic and diluted shares outstanding
Weighted average common shares - basic	137,848,788			137,715,192			137,818,076			137,457,293
Weighted average DownREIT units outstanding	7,500			7,500			7,500			7,500
Effect of dilutive securities	466,776			584,354			405,148			541,399
Weighted average common shares - diluted	138,323,064			138,307,046			138,230,724			138,006,192

Calculation of Earnings per Share - basic
Net income attributable to common stockholders	$	192,486		$	238,248		$	588,791		$	639,348
Net income allocated to unvested restricted shares	(555		)	(672		)	(1,722		)	(1,794		)
Net income attributable to common stockholders, adjusted	$	191,931		$	237,576		$	587,069		$	637,554

Weighted average common shares - basic	137,848,788			137,715,192			137,818,076			137,457,293

Earnings per common share - basic	$	1.39		$	1.73		$	4.26		$	4.64

Calculation of Earnings per Share - diluted
Net income attributable to common stockholders	$	192,486		$	238,248		$	588,791		$	639,348
Add: noncontrolling interests of DownREIT unitholders in consolidated partnerships	11			11			33			32
Adjusted net income attributable to common stockholders	$	192,497		$	238,259		$	588,824		$	639,380

Weighted average common shares - diluted	138,323,064			138,307,046			138,230,724			138,006,192

Earnings per common share - diluted	$	1.39		$	1.72		$	4.26		$	4.63

All options to purchase shares of common stock outstanding as of September 30, 2018 and 2017 are included in the computation of diluted earnings per share.

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 interest expense, net. 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 cumulative changes in the fair value of Hedging Derivatives in other comprehensive loss. Amounts recorded in accumulated other comprehensive 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.

Legal and Other Contingencies

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 and the Company is completing its reconstruction. The second building, containing 168 apartment homes, suffered minimal damage and has been repaired.

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In conjunction with legal matters associated with the Edgewater casualty loss, 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.

With regard to the building that was destroyed, three class action lawsuits have been filed against the Company 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 settlement which provides 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 July 2017 the District Court granted final approval of the settlement and all claims have been submitted to the independent claims adjuster. A total of 66 units (consisting of residents who did not previously settle their claims and who did not opt out of the class settlement) are included in the class action settlement and bound by its terms. However, only 44 units submitted claims. The independent claims adjuster is currently reviewing the claims submitted; the submitted claims total approximately $6,900,000 but, based on the Company's review of the initial determinations made by the adjuster on a number of claims, the Company believes that the total amount actually awarded will be significantly less. To date, the claims adjuster has completed his evaluation of 35 of these claims and it is expected that the evaluation of the remaining claims should be completed within the next two months. In addition to the class action lawsuits described above, the Company has resolved litigated claims with approximately 60 units. There is currently one remaining resident lawsuit with respect to the destroyed building filed in the Superior Court of New Jersey, Bergen County - Law Division; the Company believes it has meritorious defenses to the extent of damages claimed in that suit. A number of subrogation lawsuits had been filed against the Company by insurers of Edgewater residents who obtained renters insurance; these lawsuits have been or are expected to be resolved in 2018. A fourth class action, being heard in the same federal court, was filed against the Company on behalf of a purported class of residents of the second Edgewater building that suffered minimal damage.

Having settled many third party claims as described above, 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) 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 Part II, Item 1, "Legal Proceedings," for further discussion of and updates about the casualty gains and losses and lawsuits associated with the Edgewater casualty loss through the date this Form 10-Q is filed.

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.

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 first requires that the Company determine if the real estate investment is the acquisition of an asset or a business combination. Under either model, the Company must identify and determine the fair value of any assets acquired, liabilities assumed and any noncontrolling interest in the acquiree. Typical assets acquired and liabilities assumed 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 a business combination, the Company records the assets acquired and liabilities assumed based on the fair value of each respective item. For an asset acquisition, the allocation of the purchase price is based on the relative fair value of the net assets. The Company expenses all applicable acquisition costs for a business combination and capitalizes all applicable acquisition costs for an asset acquisition. 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.

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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, disposition activity and segment classification.

Revenue and Gain Recognition

As of January 1, 2018, the Company adopted ASU 2014-09, Revenue from Contracts with Customers, using the modified retrospective approach, which applies the new standard to contracts that are not completed as of the date of adoption. Under the new standard, revenue is recognized in accordance with the transfer of goods and services to customers at an amount that reflects the consideration the Company expects to be entitled for those goods and services. The majority of the Company’s revenue is derived from residential and retail rental income and other lease income, which are scoped out from this standard and included in the current lease accounting framework, and will be accounted for under ASU 2016-02, Leases, discussed under Recently Issued Accounting Standards below. Revenue streams that are scoped into ASU 2014-09 include:

•

Management fees - The Company has investment interests in real estate joint ventures, for which the Company may manage (i) the venture, (ii) the associated operating communities owned by the ventures and/or (iii) the development or redevelopment of those operating communities. For these activities, the Company receives asset management, property management, development and/or redevelopment fee revenue. The performance obligation is the management of the venture, community or other defined task such as the development or redevelopment of the community. While the individual activities that comprise the performance obligation of the management fees can vary day to day, the nature of the overall performance obligation to provide management service is the same and considered by the Company to be a series of services that have the same pattern of transfer to the customer and the same method to measure progress toward satisfaction of the performance obligation. The Company recognizes revenue for fees as earned on a monthly basis and has concluded this is appropriate under the new standard.


•	Rental and non-rental related income - The Company recognizes revenue for new rental related income not included as components of a lease, such as reservation and application fees, as well as for non-rental related income, as earned, and has concluded this is appropriate under the new standard.

•

Gains or losses on sales of real estate - The Company accounts for the sale of real estate assets and any related gain recognition in accordance with the accounting guidance applicable to sales of real estate, which establishes standards for recognition of profit on all real estate sales transactions, other than retail land sales. The Company recognizes the sale, and associated gain or loss from the disposition, provided that the earnings process is complete and the Company does not have significant continuing involvement. Subsequent to the adoption of the new standard, a gain or loss is recognized when the criteria for an asset to be derecognized are met, which include when (i) a contract exists and (ii) the buyer obtained control of the nonfinancial asset that was sold. As a result, the Company may recognize a gain on a real estate disposition transaction that previously did not qualify as a sale or for full profit recognition due to the timing of the transfer of control or certain forms of continuing involvement. In addition, subsequent to the adoption of the new standard, a gain or loss recognized on the sale of a nonfinancial asset to an unconsolidated entity will be recognized at 100%, and not the Company’s proportionate ownership percentage.

The Company concluded that the adoption of the new standard did not require an adjustment to the opening balance of retained earnings.

The following table provides details of the Company’s revenue streams disaggregated by the Company’s reportable operating segments, further discussed in Note 7, “Segment Reporting,” for the three and nine months ended September 30, 2018 and 2017. Segment information for total revenue has been adjusted to exclude the real estate assets that were sold from January 1, 2017 through September 30, 2018, or otherwise qualify as held for sale as of September 30, 2018, as described in Note 6, "Real Estate Disposition Activities," (dollars in thousands):

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	For the three months ended
	Established Communities		Other Stabilized Communities		Development/ Redevelopment Communities		Non- allocated (1)		Total
For the period ended September 30, 2018
Management, development and other fees	$	—	$	—	$	—	$	912	$	912
Rental and non-rental related income (2)	2,695		1,751		512		—		4,958
Total non-lease revenue (3)	2,695		1,751		512		912		5,870

Lease income (4)	424,328		64,791		76,987		—		566,106

Total revenue	$	427,023	$	66,542	$	77,499	$	912	$	571,976

For the period ended September 30, 2017
Management, development and other fees	$	—	$	—	$	—	$	993	$	993
Rental and non-rental related income (2)	2,667		1,734		450		—		4,851
Total non-lease revenue (3)	2,667		1,734		450		993		5,844

Lease income (4)	414,663		51,151		59,067		—		524,881
Business interruption insurance proceeds (5)	—		—		3,495		—		3,495

Total revenue	$	417,330	$	52,885	$	63,012	$	993	$	534,220



	For the nine months ended
	Established Communities		Other Stabilized Communities		Development/ Redevelopment Communities		Non- allocated (1)		Total
For the period ended September 30, 2018
Management, development and other fees	$	—	$	—	$	—	$	2,752	$	2,752
Rental and non-rental related income (2)	7,823		4,940		1,439		—		14,202
Total non-lease revenue (3)	7,823		4,940		1,439		2,752		16,954

Lease income (4)	1,258,243		190,094		215,977		—		1,664,314

Total revenue	$	1,266,066	$	195,034	$	217,416	$	2,752	$	1,681,268

For the period ended September 30, 2017
Management, development and other fees	$	—	$	—	$	—	$	3,290	$	3,290
Rental and non-rental related income (2)	7,798		4,778		1,095		—		13,671
Total non-lease revenue (3)	7,798		4,778		1,095		3,290		16,961

Lease income (4)	1,228,410		132,961		166,707		—		1,528,078
Business interruption insurance proceeds (5)	—		—		3,495		—		3,495

Total revenue	$	1,236,208	$	137,739	$	171,297	$	3,290	$	1,548,534

__________________________________


(1)	Revenue represents third-party management, asset management and developer fees and miscellaneous income which are not allocated to a reportable segment.


(2)	Amounts include revenue streams related to leasing activities that are not considered components of a lease, including but not limited to, apartment hold fees and application fees, as well as revenue streams not related to leasing activities, including but not limited to, vendor revenue sharing, building advertising, vending and dry cleaning revenue.


(3)	Represents all revenue accounted for under ASC 2014-09.


(4)	Amounts include all revenue streams derived from residential and retail rental income and other lease income, which are scoped out from ASC 2014-09 and accounted for under the lease accounting framework.


(5)	Amounts for the three and nine months ended September 30, 2017 are composed of business interruption insurance proceeds resulting from the final insurance settlement of the Maplewood casualty loss.

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Due to the nature and timing of the Company’s identified revenue streams, there are no material amounts of outstanding or unsatisfied performance obligations as of September 30, 2018.

Recently Issued Accounting Standards

In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. This ASU expands hedge accounting for both nonfinancial and financial risk components and aligns the recognition and presentation of the effects of the hedging instrument and the hedged item in the financial statements. This update also simplifies the application of hedge accounting guidance and eases the administrative burden of hedge documentation requirements and assessing hedge effectiveness. The Company adopted the guidance as of January 1, 2018 and it did not have a material effect on the Company’s financial position or results of operations.

In February 2017, the FASB issued 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 (i) clarifies the scope of the nonfinancial asset guidance and the derecognition of certain businesses and nonprofit activities, (ii) eliminates the exception in the financial asset guidance for transfers of investments (including equity method investments) in real estate entities and supersedes the guidance in the Exchanges of a Nonfinancial Asset for a Noncontrolling Ownership Interest and (iii) provides 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 Company adopted the new standard as of January 1, 2018 using the modified retrospective approach, applying the provisions to open contracts as of the date of adoption. See "Revenue and Gain Recognition" above for additional discussion of the impact of adopting the guidance.

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 the date of initial application, with an option to use certain transition relief. ASU 2016-02 provides for transition relief, which includes electing to not (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. Subsequently, the FASB issued ASU 2018-01 and ASU 2018-11 which provides further transition relief by providing (i) an option to not evaluate land easements that exist or have expired prior to the date of adoption under ASC 842, (ii) prospective adoption as a transition method and (iii) a practical expedient for lessors to not separate lease and non-lease components by class of underlying asset when certain conditions are met.

The Company plans to adopt ASC 842 on January 1, 2019 using the prospective adoption method, and plans to apply certain practical expedients allowed under the standard including:


•	not reassessing (i) whether any expired or existing contracts are or contain leases, (ii) the lease classification for any expired or existing leases, and (iii) the accounting for initial direct costs for any existing leases;


•	not evaluating short term leases;


•	not assessing whether existing land easements are, or contain leases; and


•	making an accounting policy election by class of underlying asset, to not separate non-lease components from lease components and instead to account for each separate lease and non- lease component as a single lease component.

The Company anticipates adoption of the standard to have a material impact on its financial position 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 until adoption in 2019.

Change in Accounting Principle

As of October 1, 2017, the Company adopted ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash. The guidance requires statements of cash flows to explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents, and was adopted retrospectively. The prior period amounts that have been impacted by the new guidance and retrospectively adjusted include (i) an increase in cash in operating escrows (cash provided by operating activities), (ii) an increase in cash in deposit escrows (cash used in investing activities) and (iii) repayments of mortgage notes payable, including prepayment penalties (cash used in financing activities), located on the Condensed Consolidated Statements of Cash Flows.

The following tables present the impact of the change in accounting principle to the Condensed Consolidated Statement of Cash Flows for the nine months ended September 30, 2017 (dollars in thousands):

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	9/30/2017 (as previously reported)			Impact of ASU 2016-18			9/30/2017 (as adjusted and currently reported)
	9/30/2017 (as previously reported)			Impact of ASU 2016-18			9/30/2017 (as adjusted and currently reported)
Net cash provided by operating activities	$	917,573		$	16,205		$	933,778
Net cash used in investing activities	(676,231		)	51,479			(624,752		)
Net cash used in financing activities	(420,294		)	(1,598		)	(421,892		)

Net (decrease) increase in cash, cash equivalents	(178,952		)	178,952			—
Net increase in cash, cash equivalents and restricted cash	—			(112,866		)	(112,866		)

Cash, cash equivalents, beginning of period	214,994			(214,994		)	—
Cash, cash equivalents and restricted cash, beginning of period	—			329,977			329,977
Cash, cash equivalents, end of period	$	36,042		—			—
Cash, cash equivalents and restricted cash, end of period				$	181,069		$	217,111

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 $16,277,000 and $16,223,000 for the three months ended September 30, 2018 and 2017, respectively, and $44,008,000 and $51,323,000 for the nine months ended September 30, 2018 and 2017, 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 September 30, 2018 and December 31, 2017 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 September 30, 2018 and December 31, 2017, as shown in the accompanying Condensed Consolidated Balance Sheets (dollars in thousands) (see Note 6, "Real Estate Disposition Activities").



	9/30/2018		12/31/2017

Fixed rate unsecured notes (1)	$	5,650,000	$	5,350,000
Variable rate unsecured notes (1)	300,000		300,000
Term Loans (1)	250,000		250,000
Fixed rate mortgage notes payable - conventional and tax-exempt (2)	534,629		593,987
Variable rate mortgage notes payable - conventional and tax-exempt (2)	813,163		910,326
Total mortgage notes payable, unsecured notes and Term Loans	7,547,792		7,404,313
Credit Facility	56,000		—
Total mortgage notes payable, unsecured notes, Term Loans and Credit Facility	$	7,603,792	$	7,404,313

_____________________________________


(1)	Balances at September 30, 2018 and December 31, 2017 exclude $10,293 and $10,850, respectively, of debt discount, and $35,762 and $36,386, respectively, of deferred financing costs, as reflected in unsecured notes, net on the accompanying Condensed Consolidated Balance Sheets.


(2)	Balances at September 30, 2018 and December 31, 2017 exclude $14,618 and $16,351, respectively, of debt discount, and $9,891 and $11,256, 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 nine months ended September 30, 2018:


•	In February 2018, the Company repaid $15,174,000 principal amount of 6.60% fixed rate debt secured by Avalon Oaks West in advance of its scheduled maturity date, incurring a charge of $426,000, consisting of a prepayment penalty of $152,000 and the non-cash write-off of unamortized deferred financing costs of $274,000.

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•	In February 2018, the Company repaid $11,038,000 principal amount of 4.61% fixed rate debt secured by AVA Pasadena at par in advance of its scheduled maturity date.

•

In March 2018, the Company issued $300,000,000 principal amount of unsecured notes in a public offering under its existing shelf registration statement for net proceeds of approximately $296,210,000. The notes mature in April 2048 and were issued at a 4.35% interest rate. The effective interest rate of the notes for the first 10 years is 3.97%, including the impact of an interest rate hedge and offering costs, and for the remainder of the term the effective interest rate is 4.39%.


•	In April 2018, the Company repaid $13,380,000 principal amount of 3.06% fixed rate debt secured by Avalon Andover at par at its scheduled maturity date.


•	In June 2018, the Company repaid $15,295,000 principal amount of 6.90% fixed rate debt secured by Avalon Orchards in advance of its scheduled maturity date, incurring a charge of $635,000, consisting of a prepayment penalty of $282,000 and the non-cash write-off of unamortized deferred financing costs of $353,000.


•	In August 2018, the Company repaid $95,859,000 aggregate principal amount of variable rate debt secured by Avalon Calabasas, of which $51,449,000 was repaid at par at its scheduled maturity date, and $44,410,000 was repaid at par in advance of its April 2028 maturity date. The Company recognized a non-cash charge of $1,678,000 for the write-off of unamortized debt discount.

At September 30, 2018, 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 (3.08% at September 30, 2018), 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 $56,000,000 outstanding under the Credit Facility as of September 30, 2018 and no borrowings outstanding under the Credit Facility as of December 31, 2017. The Company had $39,760,000 and $47,315,000 outstanding in letters of credit that reduced the borrowing capacity as of September 30, 2018 and December 31, 2017, respectively.

In the aggregate, secured notes payable mature at various dates from April 2019 through July 2066, and are secured by certain apartment communities (with a net carrying value of $2,073,747,000, excluding communities classified as held for sale, as of September 30, 2018).

As of September 30, 2018, the Company has guaranteed a wholly-owned subsidiary's $100,000,000 secured note payable that is consolidated for financial reporting purposes. The weighted average interest rate of the Company's fixed rate secured notes payable (conventional and tax-exempt) was 3.8% and 4.0% at September 30, 2018 and December 31, 2017, respectively. The weighted average interest rate of the Company's variable rate secured notes payable (conventional and tax-exempt) including the effect of certain financing related fees, was 3.4% and 3.2% at September 30, 2018 and December 31, 2017, respectively.

Scheduled payments and maturities of secured notes payable and unsecured notes outstanding at September 30, 2018 are as follows (dollars in thousands):

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Year	Secured notes payments		Secured notes maturities		Unsecured notes maturities		Stated interest rate of unsecured notes
2018	1,638		—		—		N/A
2019	3,824		114,722		—		N/A
2020	2,682		140,430		250,000		6.100	%
					400,000		3.625	%
2021	2,549		27,844		250,000		3.950	%
					300,000		LIBOR + 0.43%
2022	2,723		—		450,000		2.950	%
					100,000		LIBOR + .90%
2023	2,899		—		350,000		4.200	%
					250,000		2.850	%
2024	3,077		—		300,000		3.500	%
					150,000		LIBOR + 1.50%
2025	3,268		84,835		525,000		3.450	%
					300,000		3.500	%
2026	3,485		—		475,000		2.950	%
					300,000		2.900	%
2027	2,974		185,100		400,000		3.350	%
Thereafter	127,593		638,149		350,000		3.900	%
					300,000		4.150	%
					450,000		3.200	%
					300,000		4.350	%
	$	156,712	$	1,191,080	$	6,200,000

The Company was in compliance at September 30, 2018 with customary financial and other covenants under the Credit Facility, the Term Loans and the Company's fixed rate unsecured notes.

4. Equity

The following summarizes the changes in equity for the nine months ended September 30, 2018 (dollars in thousands):



	Common stock		Additional paid-in capital			Accumulated earnings less dividends			Accumulated other comprehensive loss			Total equity

Balance at December 31, 2017	$	1,381	$	10,235,475		$	188,609		$	(37,419	)	$	10,388,046
Net income attributable to common stockholders	—		—			588,791			—			588,791
Gain on cash flow hedges, net	—		—			—			11,499			11,499
Cash flow hedge losses reclassified to earnings	—		—			—			4,679			4,679
Change in redemption value of redeemable noncontrolling interest	—		—			(626		)	—			(626		)
Dividends declared to common stockholders	—		—			(609,972		)	—			(609,972		)
Issuance of common stock, net of withholdings	1		(11,217		)	1,144			—			(10,072		)
Amortization of deferred compensation	—		25,053			—			—			25,053
Balance at September 30, 2018	$	1,382	$	10,249,311		$	167,946		$	(21,241	)	$	10,397,398

As of September 30, 2018 and December 31, 2017, the Company's charter had authorized for issuance a total of 280,000,000 shares of common stock and 50,000,000 shares of preferred stock.

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During the nine months ended September 30, 2018, the Company:


i.	issued 5,263 shares of common stock in connection with stock options exercised;


ii.	issued 1,713 common shares through the Company's dividend reinvestment plan;


iii.	issued 187,010 common shares in connection with restricted stock grants and the conversion of performance awards to restricted shares;


iv.	withheld 67,963 common shares to satisfy employees' tax withholding and other liabilities;


v.	issued 6,613 common shares through the Employee Stock Purchase Plan; and


vi.	canceled 4,622 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 nine months ended September 30, 2018 is not reflected on the accompanying Condensed Consolidated Balance Sheets as of September 30, 2018, 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 (and/or enter into forward sale agreements for the sale of) 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. The Company expects that, if entered into, 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. As of September 30, 2018, there are no outstanding forward sales agreements. During the three and nine months ended September 30, 2018, the Company had no sales under the program. As of September 30, 2018, the Company had $892,915,000 of shares remaining authorized for issuance under this program.

5. Investments in Real Estate Entities

Investments in Unconsolidated Real Estate Entities

As of September 30, 2018, the Company had investments in six unconsolidated real estate entities with ownership interest percentages ranging from 20.0% to 55.0%, excluding 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.

The Company has an equity interest of 31.3% in AvalonBay Value Added Fund II, L.P. ("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 currently represents 40.0% of further Fund II distributions, which is in addition to its proportionate share of the remaining 60.0% of distributions. During 2017, Fund II sold its final apartment communities. During the nine months ended September 30, 2018, the Company recognized income of $925,000 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.

During the three and nine months ended September 30, 2018, Archstone Multifamily Partners AC LP (the "U.S. Fund") sold Avalon Kirkland at Carillon, located in Kirkland, WA, containing 131 apartment homes, for $85,500,000. The Company's share of the gain was $8,636,000. In conjunction with the disposition of this community, during the three and nine months ended September 30, 2018, the U.S. Fund repaid $27,928,000 of secured indebtedness in advance of its scheduled maturity date. This resulted in a charge for a prepayment penalty and the write-off of deferred financing costs, of which the Company's portion was $89,000, which is reported as a reduction of equity in income (loss) of unconsolidated real estate entities on the accompanying Condensed Consolidated Statements of Comprehensive Income.

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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):



	9/30/2018		12/31/2017
	(unaudited)		(unaudited)
Assets:
Real estate, net	$	731,006	$	695,077
Other assets	90,712		39,976
Total assets	$	821,718	$	735,053

Liabilities and partners' capital:
Mortgage notes payable, net and credit facility	$	492,965	$	523,815
Other liabilities	16,583		10,540
Partners' capital	312,170		200,698
Total liabilities and partners' capital	$	821,718	$	735,053

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						For the nine months ended
	9/30/2018			9/30/2017			9/30/2018			9/30/2017
	(unaudited)						(unaudited)
Rental and other income	$	24,535		$	24,568		$	68,324		$	79,999
Operating and other expenses	(8,749		)	(9,378		)	(26,066		)	(30,386		)
Gain on sale of communities	30,597			107,067			30,597			136,514
Interest expense, net	(5,938		)	(7,867		)	(17,130		)	(21,415		)
Depreciation expense	(6,288		)	(5,938		)	(18,704		)	(20,059		)
Net income	$	34,157		$	108,452		$	37,021		$	144,653

In conjunction with the acquisition of 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 $34,225,000 and $35,402,000 at September 30, 2018 and December 31, 2017, 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 real estate entities on the accompanying Condensed Consolidated Statements of Comprehensive Income.

Investments in Consolidated Real Estate Entities

In September 2018, the Company acquired Avalon Arundel Crossing, a consolidated community, located in Linthicum Heights, MD. Avalon Arundel Crossing contains 310 apartment homes and was acquired for a purchase price of $83,000,000.

The Company accounted for this as an asset acquisition and recorded the acquired assets and assumed liabilities, including identifiable intangibles, at their relative fair values based on the purchase price and acquisition costs incurred. The Company used third party pricing or internal models for the values of the land, a valuation model for the values of the buildings, and an internal model to determine the fair values of the remaining real estate assets and in-place leases. Given the heterogeneous nature of multifamily real estate, the fair values for the land, debt, real estate assets and in-place leases incorporated significant unobservable inputs and therefore are considered to be Level 3 prices within the fair value hierarchy.

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In conjunction with the development of Avalon Brooklyn Bay, the Company entered into a joint venture agreement to construct a mixed-use building that contains rental apartments, for-sale residential condominium units and related common elements. The Company owns a 70.0% interest in the venture, which represents a 100% interest in the rental apartments, and the venture partner owns the remaining 30.0% interest, which represents a 100% interest in the for-sale residential condominium units. The Company was responsible for the development and construction of the structure, and provided a loan to the venture partner for the venture partner's share of costs. The development of Avalon Brooklyn Bay was completed during the nine months ended September 30, 2018. The Company has a receivable from the venture partner in the form of a variable rate mortgage note, secured by the remaining for-sale residential condominium units. Beginning in 2018, the mortgage note is being repaid by the venture partner with the proceeds the venture partner receives from the sales of the residential condominium units. The balance as of September 30, 2018 was $14,001,000, representing outstanding principal and interest, net of repayments, and as of December 31, 2017, was $44,831,000, representing outstanding principal and interest. These amounts are 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 venture is considered a VIE, and the Company consolidates its interest in the rental apartments and common areas.

Expensed Transaction, Development and Other Pursuit Costs and Casualty 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 and costs for pursuits where development is not yet considered probable, as well as costs incurred in pursuing the acquisition or disposition of assets for which such acquisition and disposition activity did not occur, in the amounts of $1,020,000 and $789,000 for the three months ended September 30, 2018 and 2017, respectively, and $2,709,000 and $2,087,000 for the nine months ended September 30, 2018 and 2017, respectively. These costs are included in expensed transaction, 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 and nine months ended September 30, 2018 and 2017, the Company did not recognize any impairment losses for wholly-owned operating real estate assets, and did not record any impairment losses other than those related to the impairment on land held for investment and casualty gains and losses from property damage, as discussed below.

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 nine months ended September 30, 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 sold during 2017. This charge was determined as the excess of the Company's carrying basis over the expected sale price for the parcel, and is included in casualty and impairment (gain) loss, net on the accompanying Condensed Consolidated Statements of Comprehensive Income. There were no impairment losses recognized on the Company's investment in land during the three and nine months ended September 30, 2018.

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 and nine months ended September 30, 2018 and 2017.

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Casualty Gains and Losses

During the three months ended September 30, 2018, the Company recognized a gain of $554,000 for legal settlement proceeds relating to construction defects at a community acquired as part of the Archstone acquisition, which is included in casualty and impairment (gain) loss, net on the accompanying Condensed Consolidated Statements of Comprehensive Income.

During the nine months ended September 30, 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 an accrual for demolition and additional incident expenses of $3,120,000. The casualty loss was partially offset by $17,143,000 of property damage insurance proceeds. The net casualty loss of $2,338,000 for the nine months ended September 30, 2017 is included in casualty and impairment (gain) loss, net on the accompanying Condensed Consolidated Statements of Comprehensive Income.

During the three months ended September 30, 2017, the Company reached a final insurance settlement for the property damage and lost income for the Maplewood casualty loss of $19,696,000, after self-insurance and deductibles. Of this amount, the Company received $7,076,000 and $13,268,000 during the three and nine months ended September 30, 2017, respectively. As part of the settlement, the Company recognized $3,495,000 as business interruption insurance proceeds for the three and nine months ended September 30, 2017, which is recorded as a component of rental and other income on the accompanying Condensed Consolidated Statements of Comprehensive Income.

6. Real Estate Disposition Activities

The following real estate sales occurred during the nine months ended September 30, 2018:


•	In May 2018, the Company sold Avalon Blue Hills and Avalon Canton at Blue Hills, located in Randolph, MA, and Canton, MA, respectively, containing an aggregate of 472 apartment homes for $131,250,000. The Company's gain on disposition was $57,666,000, reported in gain on sale of communities on the accompanying Condensed Consolidated Statements of Comprehensive Income.


•	In May 2018, the Company sold Eaves North Quincy, located in Quincy, MA, containing 224 apartment homes for $64,250,000. The Company's gain on disposition was $18,055,000, reported in gain on sale of communities on the accompanying Condensed Consolidated Statements of Comprehensive Income.


•	In June 2018, the Company sold Avalon Anaheim Stadium, located in Anaheim, CA, containing 251 apartment homes for $111,600,000. The Company's gain on disposition was $29,490,000, reported in gain on sale of communities on the accompanying Condensed Consolidated Statements of Comprehensive Income.

•

In August 2018, the Company sold Avalon Ballston Place, located in Arlington, VA, containing 383 apartment homes for $169,000,000. The Company's gain on disposition was $27,215,000, reported in gain on sale of communities on the accompanying Condensed Consolidated Statements of Comprehensive Income. The sale of Avalon Ballston Place was part of a tax deferred exchange, under which the Company had restricted $85,828,000 of the cash proceeds in an escrow account, classified as cash in escrow on the accompanying Condensed Consolidated Balance Sheets.

At September 30, 2018, the Company had three communities and one land parcel that qualified as held for sale.

During 2016, the Company completed the construction of and sold an affordable restricted apartment building, containing 77 apartment homes. The Company received consideration for the sale in the form of a mortgage note secured by the underlying real estate. During the three months ended September 30, 2018, the Company received a payment of $16,627,000, of which $15,900,000 represents a repayment of substantially all of the outstanding principal, with the balance representing interest income on the note.

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.

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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 transaction, development and other pursuit costs, net of recoveries, interest expense, net, loss on extinguishment of debt, net, general and administrative expense, equity in income of unconsolidated real estate entities, depreciation expense, corporate income tax expense, casualty and impairment (gain) loss, net, gain on sale of communities, gain on other real estate transactions, net 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 and nine months ended September 30, 2018 and 2017 is as follows (dollars in thousands):



	For the three months ended						For the nine months ended
	9/30/2018			9/30/2017			9/30/2018			9/30/2017
Net income	$	192,407		$	238,199		$	588,540		$	639,174
Indirect operating expenses, net of corporate income	18,855			15,752			55,850			48,472
Investments and investment management expense	1,726			1,501			4,898			4,277
Expensed transaction, development and other pursuit costs, net of recoveries	1,020			789			2,709			2,087
Interest expense, net	54,097			47,741			165,795			147,138
Loss on extinguishment of debt, net	1,678			—			2,717			24,162
General and administrative expense	13,905			11,655			42,013			38,808
Equity in income of unconsolidated real estate entities	(10,031		)	(52,568		)	(12,560		)	(70,386		)
Depreciation expense	156,538			144,990			472,282			427,050
Income tax expense	29			24			87			102
Casualty and impairment (gain) loss, net	(554		)	—			(612		)	11,688
Gain on sale of communities	(27,243		)	(27,738		)	(132,444		)	(159,754		)
(Gain) loss on other real estate transactions, net	(12		)	120			(335		)	(246		)
Net operating income from real estate assets sold or held for sale	(2,545		)	(10,340		)	(15,913		)	(35,162		)
Net operating income	$	399,870		$	370,125		$	1,173,027		$	1,077,410

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						For the nine months ended
	9/30/2018			9/30/2017			9/30/2018			9/30/2017
Rental income from real estate assets sold or held for sale	$	4,006		$	16,280		$	24,747		$	54,803
Operating expenses from real estate assets sold or held for sale	(1,461		)	(5,940		)	(8,834		)	(19,641		)
Net operating income from real estate assets sold or held for sale	$	2,545		$	10,340		$	15,913		$	35,162

The primary performance measure for communities under development or redevelopment depends on the stage of completion. While under development, management monitors actual construction costs against budgeted costs as well as lease-up pace and rent levels compared to budget.

The following table provides details of the Company's segment information as of the dates specified (dollars in thousands). The segments are classified based on the individual community's status at January 1, 2018. Segment information for the three and nine months ended September 30, 2018 and 2017 has been adjusted to exclude the real estate assets that were sold from January 1, 2017 through September 30, 2018, or otherwise qualify as held for sale as of September 30, 2018, as described in Note 6, "Real Estate Disposition Activities."

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	For the three months ended				For the nine months ended
	Total revenue		NOI		Total revenue		NOI		Gross real estate (1)
For the period ended September 30, 2018
Established
New England	$	60,690	$	40,005	$	178,841	$	117,008	$	2,006,671
Metro NY/NJ	106,341		74,562		315,683		219,396		3,729,612
Mid-Atlantic	59,752		41,432		177,342		123,056		2,223,386
Pacific Northwest	22,014		15,681		64,609		45,753		726,752
Northern California	92,292		70,465		274,206		209,866		2,983,019
Southern California	85,934		60,931		255,385		182,875		2,916,530
Total Established	427,023		303,076		1,266,066		897,954		14,585,970

Other Stabilized	66,542		45,196		195,034		132,498		2,740,944
Development / Redevelopment	77,499		51,598		217,416		142,575		4,895,487
Land Held for Development	N/A		N/A		N/A		N/A		116,582
Non-allocated (2)	912		N/A		2,752		N/A		96,876

Total	$	571,976	$	399,870	$	1,681,268	$	1,173,027	$	22,435,859

For the period ended September 30, 2017
Established
New England	$	58,872	$	38,635	$	174,018	$	113,423	$	1,988,987
Metro NY/NJ	105,225		71,864		311,301		215,187		3,617,773
Mid-Atlantic	58,561		40,020		174,653		120,186		2,213,522
Pacific Northwest	21,531		15,692		62,833		45,632		723,674
Northern California	89,798		68,731		267,316		205,168		2,966,133
Southern California	83,343		59,013		246,087		177,326		2,901,525
Total Established	417,330		293,955		1,236,208		876,922		14,411,614

Other Stabilized	52,885		34,746		137,739		88,946		2,477,846
Development / Redevelopment (3)	63,012		41,424		171,297		111,542		3,847,578
Land Held for Development	N/A		N/A		N/A		N/A		85,863
Non-allocated (2)	993		N/A		3,290		N/A		93,778
Real estate disposed or held for sale (4)									629,970

Total	$	534,220	$	370,125	$	1,548,534	$	1,077,410	$	21,546,649

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(1)	Does not include gross real estate assets held for sale of $109,900 and $53,723 as of September 30, 2018 and 2017, respectively.


(2)	Revenue represents third-party management, asset management and developer fees and miscellaneous income which are not allocated to a reportable segment.


(3)	Total revenue and NOI for the three and nine months ended September 30, 2017 includes $3,495 in business interruption insurance proceeds related to the Maplewood casualty loss.


(4)	Represents real estate sold or held for sale during the period of September 30, 2017 to September 30, 2018, which is not allocated to a reportable segment.

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8. Stock-Based Compensation Plans

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

Information with respect to stock options granted under the Company's 1994 Stock Option and Incentive Plan (the "1994 Plan") and its Second Amended and Restated 2009 Equity Incentive Plan (the "2009 Plan") for the nine months ended September 30, 2018, 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, 2017	149,973		$	126.77	7,778		$	48.60
Exercised	(3,000	)	130.23		(2,263	)	48.60
Granted (1)	6,995		161.10		—		—
Forfeited	—		—		—		—
Options Outstanding, September 30, 2018	153,968		$	128.26	5,515		$	48.60
Options Exercisable, September 30, 2018	146,973		$	126.70	5,515		$	48.60

__________________________________


(1)	Options granted during the nine months ended September 30, 2018 are a result of recipient elections to receive a portion of earned performance awards and time-vesting restricted stock in the form of stock options.

Information with respect to performance awards granted is as follows:



	Performance awards	Weighted average grant date fair value per award
Outstanding at December 31, 2017	251,770

Form: 10-Q

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