10-Q: Quarterly report pursuant to Section 13 or 15(d)
Published on May 15, 2000
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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, 2000
Commission file number 1-12672
AVALONBAY COMMUNITIES, INC.
(Exact name of registrant as specified in its charter)
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Maryland 77-0404318
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2900 Eisenhower Avenue, Suite 300
Alexandria, Virginia 22314
(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)
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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 [X] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS
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Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date:
66,169,359 shares outstanding as of May 1, 2000
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AVALONBAY COMMUNITIES, INC.
FORM 10-Q
INDEX
1
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
AVALONBAY COMMUNITIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share data)
See accompanying notes to condensed consolidated financial statements.
2
AVALONBAY COMMUNITIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Dollars in thousands, except per share data)
See accompanying notes to condensed consolidated financial statements.
3
AVALONBAY COMMUNITIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands)
See accompanying notes to condensed consolidated financial statements.
4
Supplemental disclosures of non-cash investing and financing activities (dollars
in thousands):
During the three months ended March 31, 1999, 17,598 units of limited
partnership were presented for redemption to the DownREIT partnership that
issued such units and were acquired by the Company for an equal number of shares
of the Company's common stock. During the three months ended March 31, 2000,
7,048 units of limited partnership were presented for redemption to the DownREIT
partnership that issued such units and were acquired by the Company for an equal
number of shares of the Company's common stock.
Common and preferred dividends declared but not paid as of March 31, 2000 and
1999 totaled $46,887 and $42,688, respectively.
5
AVALONBAY COMMUNITIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
1. Organization and Significant Accounting Policies
Organization and Recent Developments
AvalonBay Communities, Inc. (the "Company," which term is often used to refer to
AvalonBay Communities, Inc. together with its subsidiaries) is a Maryland
corporation that has elected to be taxed as a real estate investment trust
("REIT") under the Internal Revenue Code of 1986, as amended. The Company
focuses on the ownership and operation of upscale apartment communities in high
barrier-to-entry markets of the United States. These markets include Northern
and Southern California and selected markets in the Mid-Atlantic, Northeast,
Midwest and Pacific Northwest regions of the country.
At March 31, 2000, the Company owned or held a direct or indirect ownership
interest in 124 operating apartment communities containing 36,348 apartment
homes in twelve states and the District of Columbia, of which six communities
containing 2,496 apartment homes were under reconstruction. The Company also
owned nine communities with 2,473 apartment homes under construction and rights
to develop an additional 34 communities that, if developed as expected, will
contain an estimated 9,140 apartment homes.
During the three months ended March 31, 2000, the Company completed the
development of three new communities, Avalon Corners, Avalon Fox Mill and Avalon
Court North for a total investment of $92,400. These communities, which are
located in Stamford, Connecticut, Herndon, Virginia and Melville, New York,
contain an aggregate of 700 apartment homes.
In 1998, the Company adopted a strategy of disposing of certain assets in
markets that did not meet its long-term strategic direction and redeploying the
proceeds from such sales to help fund the Company's development and
redevelopment activities. In connection with this strategy, the Company sold one
community containing 360 apartment homes for net proceeds of approximately
$29,325 during the three months ended March 31, 2000. The net proceeds from this
disposition will be redeployed to develop and redevelop communities currently
under construction or reconstruction. Pending such redeployment, the proceeds
from the sale of this community were used to reduce amounts outstanding under
the Company's variable rate unsecured credit facility.
The interim unaudited financial statements have been prepared in accordance with
generally accepted accounting principles ("GAAP") for interim financial
information and in conjunction with the rules and regulations of the Securities
and Exchange Commission. 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 Annual Report on Form 10-K for the year ended December 31,
1999. The results of operations for the three months ended March 31, 2000 are
not necessarily indicative of the operating results for the full year.
Management believes the disclosures are adequate to make the information
presented 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.
Presentation of Historical Financial Statements for the Three Months Ended
March 31, 1999
The financial presentation of the historical financial statements for the three
months ended March 31, 1999, has been changed from the presentation that
appeared in the Company's Form 10-Q for the three months ended March 31, 1999.
For a discussion of the change in the presentation and the reasons therefor, see
Footnote 2 to the consolidated financial statements presented in the Company's
Form 10-K for the fiscal year ended December 31, 1999.
Principles of Consolidation
The accompanying condensed consolidated financial statements include the
accounts of the Company and its wholly-owned partnerships and certain joint
venture partnerships in addition to subsidiary partnerships structured as
DownREITs. All significant intercompany balances and transactions have been
eliminated in consolidation.
6
In each of the partnerships structured as DownREITs, either the Company or one
of the Company's wholly-owned subsidiaries is the general partner, and there are
one or more limited partners whose interest in the partnership is represented by
units of limited partnership interest. For each DownREIT partnership, limited
partners are entitled to receive distributions before any distribution is made
to the general partner. Although the partnership agreements for each of the
DownREITs are different, generally the distributions per unit paid to the
holders of units of limited partnership interests approximate the Company's
current common stock dividend per share. Each DownREIT partnership has been
structured so that it is unlikely the limited partners will be entitled to a
distribution greater than the initial distribution provided for in the
partnership agreement. The holders of units of limited partnership interest have
the right to present each unit of limited partnership interest for redemption
for cash equal to the fair market value of a share of the Company's common stock
on the date of redemption. In lieu of cash redemption of a unit by a partner, we
may elect to acquire any unit presented for redemption for one share of common
stock.
Real Estate
Significant expenditures that improve or extend the life of an asset are
capitalized. The operating real estate assets are stated at cost and consist of
land, buildings and improvements, furniture, fixtures and equipment, and other
costs incurred during their development, redevelopment and acquisition.
Expenditures for maintenance and repairs are charged to operations as incurred.
The capitalization of costs during the development of assets (including interest
and related loan fees, property taxes and other direct and indirect costs)
begins when active development commences and ends when the asset is delivered
and a final certificate of occupancy is issued. Cost capitalization during
redevelopment of apartment homes (including interest and related loan fees,
property taxes and other direct and indirect costs) begins when an apartment
home is taken out-of-service for redevelopment and ends when the apartment home
redevelopment is completed and the apartment home is placed in-service. The
accompanying condensed consolidated financial statements include a charge to
expense for unrecoverable deferred development costs related to pre-development
communities that are unlikely to be developed.
Depreciation is calculated on buildings and improvements using the straight-line
method over their estimated useful lives, which range from seven to thirty
years. Furniture, fixtures and equipment are generally depreciated using the
straight-line method over their estimated useful lives, which range from three
years (computer related equipment) to seven years.
Lease terms for apartment homes are generally one year or less. Rental income
and operating costs incurred during the initial lease-up or post-redevelopment
lease-up period are fully recognized as they accrue.
Development Costs of Software for Internal Use
The Company has entered into a formal joint venture cost sharing agreement with
another public multifamily real estate company to develop a new on-site property
management system and a leasing automation system to enable the Company to
capture, review and analyze data to a greater degree than the Company found
currently possible with third-party software products. The software development
process is currently being managed by Company employees who oversee a project
team of employees and third-party consultants. Development costs associated with
the software project include computer hardware costs, direct labor costs and
third-party consultant costs related to programming and documenting the system.
The project began in January 1998 and is expected to be fully implemented in
early 2001, although no assurance can be provided in this regard. The Company
will continue to develop these systems through the joint venture agreement and
the total cost of development will be shared equally between the Company and the
joint venture partner. Once developed, the Company and the joint venture partner
intend to use the property management and leasing systems in place of their
respective systems currently in use for which fees are generally paid to third
party vendors.
Costs associated with the project are accounted for in accordance with the
American Institute of Certified Public Accountants' Statement of Position 98-1
("SOP 98-1") "Accounting for Costs of Computer Software Developed or
7
Obtained for Internal Use." Under SOP 98-1, costs of acquiring hardware and
costs of coding, documenting and testing the software are capitalized during the
application development stage. Following implementation, capitalized development
costs are amortized over the system's estimated useful life and other costs such
as training and application maintenance are expensed as incurred.
Earnings per Common Share
In accordance with the provisions of Statement of Financial Accounting Standards
("SFAS") No. 128, "Earnings per Share", basic earnings per share for the three
months ended March 31, 2000 and 1999 is computed by dividing earnings available
to common shares (net income less preferred stock dividends) by the weighted
average number of shares and units of limited partnership in the Company's
DownREIT partnerships that were outstanding during the period. Additionally,
other potentially dilutive common shares are considered when calculating
earnings per share on a diluted basis. The Company's basic and diluted weighted
average shares outstanding for the three months ended March 31, 2000 and 1999
are as follows:
Certain options to purchase shares of common stock in the amounts of 2,214,497
and 3,333,549 were outstanding during the three months ended March 31, 2000 and
1999, respectively, but were not included in the computation of diluted earnings
per share because the options' exercise prices were greater than the average
market price of the common shares.
Non-recurring Charges
In February 1999, the Company announced certain management changes including (i)
the departure of three senior officers who became entitled to severance benefits
in accordance with the terms of their employment agreements with the Company
dated as of March 9, 1998 and (ii) elimination of duplicate accounting functions
and related employee departures. The Company recorded a non-recurring charge of
approximately $16,100 in the first quarter of 1999 related to the expected costs
associated with this management realignment and certain related organizational
adjustments.
The expenses associated with the management realignment have been treated as a
non-recurring charge. The charge includes severance and benefits expenses, costs
to eliminate duplicate accounting functions and legal fees. Certain former
employees have elected to receive their severance benefits in an installment
basis for up to twelve months.
The non-recurring charge also includes Year 2000 remediation costs of $448 that
had been incurred for the three months ended March 31, 1999.
Selected information relating to the non-recurring charge is summarized below:
(1) Excludes Y2K costs of $448.
8
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.
Recently Issued Accounting Standards
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." This
pronouncement establishes accounting and reporting standards requiring that
every derivative instrument be recorded on the balance sheet as either an asset
or liability measured at its fair value. SFAS No. 133 requires that changes in
the derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. In June 1999, the Financial Accounting
Standards Board issued SFAS No. 137, "Accounting for Derivative Instruments and
Hedging Activities - Deferral of the Effective date of SFAS No. 133." SFAS No.
137 delays the effective date of SFAS No. 133 for one year, to fiscal years
beginning after June 15, 2000. The Company currently plans to adopt this
pronouncement effective January 1, 2001, and will determine both the method and
impact of adoption, which is not expected to be material to the financial
statements.
In December 1999, the Securities and Exchange Commission issued Staff Accounting
Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial Statements". SAB
101 provides guidance on applying generally accepted accounting principles to
revenue recognition issues in financial statements. The Company adopted SAB 101
effective with the March 31, 2000 reporting period, as required, and the
adoption did not have a material effect on the Company's condensed consolidated
financial statements.
2. Interest Capitalized
Capitalized interest associated with communities under development or
redevelopment totaled $3,494 and $7,283 for the three months ended March 31,
2000 and 1999, respectively.
3. Notes Payable, Unsecured Notes and Credit Facility
The Company's notes payable, unsecured notes and credit facility are summarized
as follows:
Mortgage notes payable are collateralized by certain apartment communities and
mature at various dates from May 2001 through December 2036. The weighted
average interest rate of the Company's variable rate notes and credit facility
was 6.7% at March 31, 2000. The weighted average interest rate of the Company's
fixed rate notes (conventional and tax-exempt) was 6.8% at March 31, 2000.
9
The maturity schedule for the Company's unsecured notes is as follows:
The Company's unsecured notes contain a number of financial and other covenants
with which the Company must comply, including, but not limited to, limits on the
aggregate amount of total and secured indebtedness the Company may have on a
consolidated basis and limits on the Company's required debt service payments.
The Company has a $600,000 variable rate unsecured credit facility (the
"Unsecured Facility") with Morgan Guaranty Trust Company of New York, Union Bank
of Switzerland and Fleet National Bank, serving as co-agents for a syndicate of
commercial banks. The Unsecured Facility bears interest at a spread over the
London Interbank Offered Rate ("LIBOR") based on rating levels achieved on the
Company's unsecured notes and on a maturity selected by the Company. The current
stated pricing is LIBOR plus 0.6% per annum (6.7% at March 31, 2000). In
addition, the Unsecured Facility includes a competitive bid option (which allows
banks that are part of the lender consortium to bid to make loans to the Company
at a rate that is lower than the stated rate provided by the Unsecured Facility)
for up to $400,000. The Company is subject to certain customary covenants under
the Unsecured Facility, including, but not limited to, maintaining certain
maximum leverage ratios, a minimum fixed charges coverage ratio, minimum
unencumbered assets and equity levels and restrictions on paying dividends in
amounts that exceed 95% of the Company's Funds from Operations, as defined
therein. The Unsecured Facility matures in July 2001 and has two, one-year
extension options.
4. Stockholders' Equity
The following summarizes the changes in stockholders' equity for the three
months ended March 31, 2000:
10
During the three months ended March 31, 2000, the Company issued 12,790 common
stock shares in connection with stock options exercised, 86,849 shares through
the Company's Dividend Reinvestment Plan, 7,048 shares to acquire operating
partnership units from a third party, 9,797 shares in connection with the
Company's Employee Stock Purchase Plan and 93,816 shares in connection with
restricted stock grants to employees.
5. Investments in Unconsolidated Joint Ventures
At March 31, 2000, the Company's investments in unconsolidated joint ventures
consisted of a 50% general partnership interest in Falkland Partners, a 49%
general partnership interest in Avalon Run and a 50% limited liability company
membership interest in Avalon Grove. Also during 1999, the Company entered into
a joint venture to develop an on-site property management system and a leasing
automation system; the Company's joint venture interest consists of a 60%
limited liability company membership interest. The following is a combined
summary of the financial position of these joint ventures as of the dates
presented.
The following is a combined summary of the operating results of these joint
ventures for the periods presented:
11
6. Communities Held for Sale
During 1998, the Company completed a strategic planning effort resulting in a
decision to pursue a disposition strategy for certain assets in markets that did
not meet the Company's long-term strategic direction. In connection with this
strategy, the Company solicits competing bids from unrelated parties for
individual assets, and considers the sales price and tax ramifications of each
proposal. In connection with this strategy, the Company sold one community
during the three months ended March 31, 1999. Similarly, one community, Avalon
Chase, a 360 apartment home community located in Marlton, New Jersey was sold in
connection with this strategy during the three months ended March 31, 2000. The
net proceeds of approximately $29,325 from the sale of Avalon Chase will be
redeployed to development and redevelopment communities. Pending such
redeployment, the proceeds from the sale of this community were primarily used
to reduce amounts outstanding under the Company's Unsecured Facility.
Management intends to market additional communities for sale during the
remainder of 2000. However, there can be no assurance that such assets will be
sold, or that such sales will prove to be beneficial to the Company. The assets
targeted for sale include land, buildings and improvements and furniture,
fixtures and equipment, and are recorded at the lower of cost or fair value less
estimated selling costs. The Company has not recognized a write-down in its real
estate to arrive at net realizable value, although there can be no assurance
that the Company can sell these assets for amounts that equal or exceed its
estimates of net realizable value. At March 31, 2000, total real estate, net of
accumulated depreciation, subject to sale totaled $95,009. Certain individual
assets are secured by mortgage indebtedness which may be assumed by the
purchaser or repaid by the Company from the net sales proceeds.
The Company's Condensed Consolidated Statements of Operations include net income
of the communities held for sale at March 31, 2000 of $1,821 and $820 for the
three months ended March 31, 2000 and 1999, respectively.
7. Segment Reporting
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information," 131 established standards for reporting financial and descriptive
information about operating segments in annual financial statements. Operating
segments are defined as components of an enterprise about which separate
financial information is available that is evaluated regularly by the chief
operating decision maker, or decision making group, in deciding how to allocate
resources and in assessing performance. The Company's chief operating decision
making group consists primarily of the Company's senior officers.
The Company's reportable operating segments include Stable Communities,
Developed Communities and Redeveloped Communities:
- Stable Communities are communities that 1) have attained
stabilized occupancy levels (at least 95% occupancy) and operating
costs since the beginning of the prior calendar year (these
communities are also known as Established Communities); or 2) were
acquired after the beginning of the previous calendar year but
were stabilized in terms of occupancy levels and operating costs
at the time of acquisition, and remained stabilized throughout the
end of the current calendar year. Stable Communities do not
include communities where planned redevelopment or development
activities have not yet commenced. The primary financial measure
for this business segment is Net Operating Income ("NOI"), which
represents total revenue less operating expenses and property
taxes. With respect to Established Communities, an additional
financial measure of performance is NOI for the current year as
compared against the prior year and against current year budgeted
NOI. With respect to other Stable Communities, performance is
primarily based on reviewing growth in NOI for the current period
as compared against prior periods within the calendar year and
against current year budgeted NOI.
12
- Developed Communities are communities which completed development
during the prior calendar year of presentation. The primary
financial measure for this business segment is Operating Yield
(defined as NOI divided by total capitalized costs). Lease-up
activities immediately following the completion of development
adversely impact operating yields, as stabilized occupancy and
operating costs are not yet reached. Performance of Developed
Communities is based on comparing Operating Yields against
projected yields as determined by Management prior to undertaking
the development activity.
- Redeveloped Communities are communities that completed
redevelopment during the prior calendar year of presentation.
The primary financial measure for this business segment is
Operating Yield. Lease-up activities immediately following the
completion of redevelopment adversely impact operating yields,
as stabilized occupancy and operating costs are not yet reached.
Performance for Redeveloped Communities is based on comparing
Operating Yields against projected yields as estimated by
Management prior to undertaking the redevelopment activity.
Other communities owned by the Company which are not included in the above
segments are communities that were under development or redevelopment at any
point in time during the applicable calendar year as well as communities held
for sale. The primary performance measure for these assets depends on the stage
of development or redevelopment of the community. While under development or
redevelopment, Management monitors actual construction costs against budgeted
costs as well as economic occupancy. The primary performance measure for
communities held for sale is NOI.
Net Operating Income for each community is generally equal to that community's
contribution to Funds from Operations ("FFO"), except that interest expense
related to indebtedness secured by an individual community and depreciation and
amortization on non-real estate assets are not included in the community's NOI
although such expenses decrease the Company's consolidated net income and FFO.
The segments are classified based on the individual community's status as of 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.
In addition to reporting segments based on the above property types, Management
currently reviews its operating segments by geographic regions, including
Northern and Southern California, Pacific Northwest, Northeast, Mid-Atlantic and
Midwest regions. Because the various locations within each individual region
have similar economic and other characteristics, Management finds it useful to
review the performance of the Company's communities in those locations on a
regional, aggregated basis.
The accounting policies applicable to the operating segments described above are
the same as those described in the summary of significant accounting policies.
13
Operating expenses as reflected on the Condensed Consolidated Statements of
Operations include $6,372 and $5,502 for the three months ended March 31, 2000
and 1999, respectively, of property management overhead costs that are not
allocated to individual communities. These costs are not reflected in NOI as
shown in the above tables. The amount reflected for "Communities held for sale"
on the Condensed Consolidated Balance Sheets is net of $6,646 of accumulated
depreciation as of March 31, 2000.
8. Subsequent Events
In March 2000, the Company and Gilbert M. Meyer, the Company's Executive
Chairman of the Board, announced that Mr. Meyer would retire from his management
position on May 10, 2000, the date of the Company's 2000 Annual Meeting of
Stockholders ("Annual Meeting"). Although his role as an executive officer of
the Company ceased on that date, Mr. Meyer was reelected as a director of the
Company at the Annual Meeting. In connection with his retirement, Mr. Meyer
entered into various agreements with the Company. Pursuant to a consulting
agreement,
14
Mr. Meyer will serve as a consultant to the Company for three years following
his retirement. The Company will pay to Mr. Meyer an annual fee of $1,395 in
accordance with the terms of the consulting agreement, and will also pay to Mr.
Meyer 5,880 shares of common stock during each of the first four calendar
quarters of the consulting period. During the period of the consultant
agreement, Mr. Meyer has agreed that he will not participate, as an officer,
employee, consultant or in any other manner, in the affairs of a publicly-traded
real estate investment trust or publicly-traded real estate company that is
significantly involved in the ownership, operation, management or rental of
multifamily apartment homes. Mr. Meyer also agreed, in a retirement agreement,
to more restrictive non-competition provisions that will apply for as long as he
is a director of the Company.
15
ITEM 2. MANAGMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Forward-Looking Statements
This Form 10-Q, including the footnotes to the Company's condensed consolidated
financial statements, contains "forward-looking statements" as that term is
defined under the Private Securities Litigation Reform Act of 1995. You can
identify forward-looking statements by our use of the words "believe," "expect,"
"anticipate," "intend," "estimate," "assume," and other similar expressions in
this Form 10-Q, that predict or indicate future events and trends or that do not
relate to historical matters. In addition, information concerning the following
are forward-looking statements:
- the timing and cost of completion of apartment communities under
construction, reconstruction, development or redevelopment;
- the timing of lease-up and occupancy of apartment communities;
- the pursuit of land on which we are considering future
development;
- cost, yield and earnings estimates;
- the development, implementation and use of management information
systems.
We cannot assure the future results or outcome of the matters described in these
statements; rather, these statements merely reflect our current expectations of
the approximate outcomes of the matters discussed. You should not rely on
forward-looking statements because they involve known and unknown risks,
uncertainties and other factors, some of which are beyond our control. These
risks, uncertainties and other factors may cause our actual results, performance
or achievements to differ materially from the anticipated future results,
performance or achievements expressed or implied by these forward-looking
statements. Some of the factors that could cause our actual results, performance
or achievements to differ materially from those expressed or implied by these
forward-looking statements include, but are not limited to, the following:
- we may be unsuccessful in managing our current growth in the
number of apartment communities and the related growth of our
business operations;
- our previous or possible future expansion into new geographic
market areas may not produce financial results that are consistent
with our historical performance;
- we may fail to secure development opportunities due to an
inability to reach agreements with third parties or to obtain
desired zoning and other local approvals;
- we may abandon development opportunities for a number of reasons,
including changes in local market conditions which make
development less desirable, increases in costs of development and
increases in the cost of capital;
- construction costs of a community may exceed our original
estimates;
- we may not complete construction and lease-up of communities under
development or redevelopment on schedule, resulting in increased
interest expense, construction costs and rental revenues that are
lower than originally expected;
- occupancy rates and market rents may be adversely affected by
local economic and market conditions which are beyond our control;
- financing may not be available on favorable terms or at all, and
our cash flow from operations and access to cost effective capital
may be insufficient for the development of our pipeline and could
limit our pursuit of opportunities;
- our cash flow may be insufficient to meet required payments of
principal and interest, and we may be unable to refinance existing
indebtedness or the terms of such refinancing may not be as
favorable as the terms of existing indebtedness; and
16
- the development, implementation and use of new management
information systems may cost more than anticipated or may be
delayed for a number of reasons, including unforeseen
technological or integration issues.
You should read our unaudited condensed consolidated financial statements and
notes included in this report and the audited financial statements for the year
ended December 31, 1999 and the notes included in our annual report on Form 10-K
in conjunction with the following discussion. These forward-looking statements
represent our estimates and assumptions only as of the date of this report. We
do not undertake to update these forward-looking statements, and you should not
rely upon them after the date of this report.
Business Description and Community Information
AvalonBay is a Maryland corporation that has elected to be treated as a real
estate investment trust, or REIT, for federal income tax purposes. We focus on
the ownership and operation of upscale apartment communities (which we consider
to be apartment communities that generally command among the highest rents in
their submarkets) in high barrier-to-entry markets of the United States. This is
because we believe that the limited new supply of upscale apartment homes in
these markets helps achieve more predictable cash flows. These barriers-to-entry
generally include a difficult and lengthy entitlement process with local
jurisdictions and dense in-fill locations where zoned and entitled land is in
limited supply. These markets are located in Northern and Southern California
and selected states in the Mid-Atlantic, Northeast, Midwest and Pacific
Northwest regions of the country.
We are a fully-integrated real estate organization with in-house expertise in
the following areas:
- acquisition;
- development and redevelopment;
- construction and reconstruction;
- financing;
- marketing;
- leasing and management; and
- information technologies.
With our expertise and in-house capabilities, we believe we are well-positioned
to continue to pursue opportunities to develop and acquire upscale apartment
homes in our target markets. Our ability to pursue attractive opportunities,
however, may be constrained by capital market conditions that limit the
availability of cost effective capital to finance these activities. Recently, we
have limited our acquisition activity as compared to prior years due to these
capital constraints, and we expect to direct most of our invested capital to new
developments and redevelopments, rather than acquisitions, for the foreseeable
future. See "Liquidity and Capital Resources" and "Future Financing and Capital
Needs."
We believe apartment communities present an attractive investment opportunity
compared to other real estate investments because a broad potential resident
base results in relatively stable demand during all phases of a real estate
cycle. We intend, subject to the availability of cost-effective capital, to
pursue appropriate new investments, including both new developments and
acquisitions of communities, in markets where constraints to new supply exist
and where new household formations have out-paced multifamily permit activity in
recent years.
Our real estate investments as of May 1, 2000 consist primarily of stabilized
operating apartment communities as well as communities in various stages of the
development and redevelopment cycle and land or land options held for
development. We classify these investments into the following categories:
17
(*) Represents an estimate
Current Communities are apartment communities that have been completed and have
reached occupancy of at least 95%, have been complete for one year, are in the
initial lease-up process or are under redevelopment. Current Communities consist
of the following:
Stabilized Communities. Represents all Current Communities that have
completed initial lease-up by attaining physical occupancy levels of at
least 95% or have been completed for one year, whichever occurs earlier.
Stabilized Communities are categorized as either Established Communities
or Other Stabilized Communities.
- Established Communities. Represents all Stabilized Communities
owned as of January 1, 1999, with stabilized operating costs as of
January 1, 1999 such that a comparison of 1999 operating results
to 2000 operating results is meaningful. Each of the Established
Communities falls into one of the following six geographic areas:
Northern California, Southern California, Mid-Atlantic, Northeast,
Midwest and Pacific Northwest regions.
- Other Stabilized Communities. Represents Stabilized Communities as
defined above, but which became stabilized or were acquired after
January 1, 1999.
Lease-Up Communities. Represents all communities where construction has
been complete for less than one year and where occupancy has not reached
at least 95%. As of May 1, 2000, there were no lease-up communities.
18
Redevelopment Communities. Represents all communities where
substantial redevelopment has begun. Redevelopment is considered
substantial when capital invested during the reconstruction effort
exceeds the lesser of $5 million or 10% of the community's
acquisition cost.
Development Communities are communities that are under construction and
for which a final certificate of occupancy has not been received. These
communities may be partially complete and operating.
Development Rights are development opportunities in the early phase of
the development process for which we have an option to acquire land or
where we own land to develop a new community. We capitalize all related
pre-development costs incurred in pursuit of these new developments.
Of the Current Communities as of May 1, 2000, we owned:
- a fee simple, or absolute, ownership interest in 109 operating
communities, one of which is on land subject to a 149 year land
lease;
- a general partnership interest in five partnerships that each own
a fee simple interest in an operating community;
- a general partnership interest in four partnerships structured as
"DownREITs," as described more fully below, that own an aggregate
of nine communities; and
- a 100% interest in a senior participating mortgage note secured by
one community, which allows us to share in part of the rental
income or resale proceeds of the community.
We also hold a fee simple ownership interest in eight of the Development
Communities and a membership interest in a limited liability company that holds
a fee simple interest in one Development Community.
In each of the four partnerships structured as DownREITs, either AvalonBay or
one of our wholly-owned subsidiaries is the general partner, and there are one
or more limited partners whose interest in the partnership is represented by
units of limited partnership interest. For each DownREIT partnership, limited
partners are entitled to receive distributions before any distribution is made
to the general partner. Although the partnership agreements for each of the
DownREITs are different, generally the distributions per unit paid to the
holders of units of limited partnership interests approximate thecurrent
AvalonBay common stock dividend rate per share. Each DownREIT partnership has
been structured so that it is unlikely the limited partners will be entitled to
a distribution greater than the initial distribution provided for in the
partnership agreement. The holders of units of limited partnership interest have
the right to present each unit of limited partnership interest for redemption
for cash equal to the fair market value of a share of AvalonBay common stock on
the date of redemption. In lieu of cash redemption of a unit, we may elect to
acquire any unit presented for redemption for one share of our common stock. As
of March 31, 2000, there were 966,822 units outstanding. The DownREIT
partnerships are consolidated for financial reporting purposes.
At March 31, 2000, we had positioned our portfolio of Stabilized Communities,
excluding communities owned by unconsolidated joint ventures, to an average
physical occupancy level of 97.5%. Our strategy is to maximize total rental
revenue through management of rental rates and occupancy levels. Our strategy of
maximizing total rental revenue could lead to lower occupancy levels. Given the
current high occupancy level of our portfolio, we believe that any rental
revenue and net income gains from our Established Communities would be achieved
primarily through higher rental rates and the lower average operating costs per
apartment home that result from economies of scale due to national and regional
growth of our portfolio.
We elected to be taxed as a REIT for federal income tax purposes for the year
ended December 31, 1994
19
and we have not revoked that election. We were incorporated under the laws of
the State of California in 1978, and we were reincorporated in the State of
Maryland in July 1995. Our principal executive offices are located at 2900
Eisenhower Avenue, Suite 300, Alexandria, Virginia, 22314, and our telephone
number at that location is (703) 329-6300. We also maintain regional offices and
administrative or specialty offices in or near the following cities:
- San Jose, California;
- Wilton, Connecticut;
- Boston, Massachusetts;
- Chicago, Illinois;
- Los Angeles, California;
- Minneapolis, Minnesota;
- Newport Beach, California;
- New York, New York;
- Princeton, New Jersey; and
- Seattle, Washington.
Recent Developments
Sales of Existing Communities. During 1998, we completed a strategic planning
effort that resulted in our decision to increase our geographical concentration
in selected high barrier-to-entry markets where we believe we can:
- apply sufficient market and management presence to enhance revenue
growth;
- reduce operating expenses; and
- leverage management talent.
To effect this increased concentration, we adopted an aggressive capital
redeployment strategy and are selling assets in certain markets where our
current presence is limited. We intend to redeploy the proceeds from sales to
develop and redevelop communities currently under construction or
reconstruction. Pending such redeployment, we will use the proceeds from the
sale of these communities to reduce amounts outstanding under our variable rate
unsecured credit facility. Accordingly, we sold one community containing 360
apartment homes in connection with our capital redeployment strategy during the
three months ended March 31, 2000. Net proceeds from this sale totaled
$29,325,000. We intend to dispose of additional assets as described more fully
under "Future Financing and Capital Needs."
Development, Redevelopment and Acquisition Activities. During the three months
ended March 31, 2000, we completed the development of three new communities,
Avalon Corners, Avalon Fox Mill and Avalon Court North, for a total investment
of $92,400,000. These communities, which are located in Stamford, Connecticut,
Herndon, Virginia and Melville, New York, contain an aggregate of 700 apartment
homes.
We also acquired one land parcel located in Darien, Connecticut during the first
quarter of 2000 on which construction has not yet begun. We expect to develop
one new community containing a total of 189 apartment homes on this parcel. The
total investment in this community, including land acquisition costs of
$5,474,000, is projected to be approximately $37,000,000.
During the first quarter of 2000, we began the redevelopment of two communities,
Avalon at Cortez Hill and Lakeside. These communities are located in San Diego,
California and Burbank, California, respectively. The total projected investment
in redevelopment for these communities (i.e., excluding acquisition costs),
which contain 1,041 apartment homes, is $29,400,000.
20
The development and redevelopment of communities involves risks that the
investment will fail to perform in accordance with expectations. See "Risks of
Development and Redevelopment" for our discussion of these and other risks
inherent in developing or redeveloping communities.
In March 2000, AvalonBay and Gilbert M. Meyer, AvalonBay's Executive
Chairman of the Board, announced that Mr. Meyer would retire from his management
position on May 10, 2000, the date of AvalonBay's 2000 Annual Meeting of
Stockholders. Although his role as an executive officer of AvalonBay ceased on
that date, Mr. Meyer was reelected as a director of AvalonBay at the May 2000
Annual Meeting of Stockholders. In connection with his retirement, Mr. Meyer
entered into various agreements with AvalonBay. Pursuant to a consulting
agreement, Mr. Meyer will serve as a consultant to AvalonBay for three years
following his retirement. AvalonBay will pay to Mr. Meyer an annual fee of
$1,395,000 in accordance with the terms of the consulting agreement, and will
also pay to Mr. Meyer 5,880 shares of common stock during each of the first four
calendar quarters of the consulting period. During the period of the consultant
agreement, Mr. Meyer has agreed that he will not participate, as an officer,
employee, consultant or in any other manner, in the affairs of a publicly-traded
real estate investment trust or publicly-traded real estate company that is
significantly involved in the ownership, operation, management or rental of
multifamily apartment homes. Mr. Meyer also agreed, in a retirement agreement,
to more restrictive non-competition provisions that will apply for as long as he
is a director of AvalonBay.
Results of Operations
Historically, the changes in our operating results from period-to-period have
been primarily the result of increases in the number of apartment homes owned.
Where appropriate, period-to-period comparisons of the number of occupied
apartment homes are made on a weighted average basis to adjust for changes in
the number of apartment homes during the period. For Stabilized Communities,
excluding communities owned by unconsolidated joint ventures, all occupied
apartment homes are included in the calculation of weighted average occupied
apartment homes for each reporting period. For communities in the initial
lease-up phase, only apartment homes of communities that are completed and
occupied are included in the weighted average number of occupied apartment homes
calculation for each reporting period.
The financial presentation of our historical financial statements for the three
months ended March 31, 1999, has been changed from the presentation that
appeared in AvalonBay's Form 10-Q for the three months ended March 31, 1999. For
a discussion of the change in the presentation and the reasons therefor, see
Footnote 2 to the consolidated financial statements presented in AvalonBay's
Form 10-K for the fiscal year ended December 31, 1999.
A comparison of our operating results for the three months ended March 31, 2000
and March 31, 1999 follows.
Net income available to common stockholders increased $32,272,000 to $37,227,000
for the three months ended March 31, 2000 compared to $4,955,000 for the
comparable period of the preceding year. Adjusting for non-recurring charges and
gain on sale of communities, net income available to common stockholders
increased by $7,838,000 for the three months ended March 31, 2000 compared to
the comparable period of the preceding year. The increase in net income, as
adjusted, for the three months ended March 31, 2000 is primarily attributable to
additional operating income from newly developed or redeveloped communities as
well as growth in operating income from Established Communities.
Rental income increased $16,212,000 (13.7%) to $134,785,000 for the three months
ended March 31, 2000 compared to $118,573,000 for the comparable period of the
preceding year. The increase is primarily due to the addition of newly
developed, redeveloped and acquired apartment homes, partially offset by the
sale of communities during the three months ended March 31, 2000 and 1999.
Overall Portfolio - The $16,212,000 increase in rental income is
primarily due to an increase in the weighted average monthly rental
income per occupied apartment home offset by a decrease in the weighted
average number of occupied apartment homes. The weighted average number
of occupied apartment homes decreased from 34,291 apartment homes for the
three months ended March 31, 1999 to 33,746 apartment homes for the three
months ended March 31, 2000 primarily
21
as a result of the sale of communities during 1999, offset by the
development, redevelopment and acquisition of new communities. For the
three months ended March 31, 2000, the weighted average monthly revenue
per occupied apartment home increased $184 (16.1%) to $1,328 compared to
$1,144 for the comparable period of the preceding year, which is
primarily attributable to the development of new apartment communities
with higher average rents and the sale of communities with lower average
rents. These newly developed apartment communities were funded in part
from the proceeds of communities sold in markets where rental rates are
lower.
Established Communities - Rental revenue increased $4,678,000 (6.6%) for
the three months ended March 31, 2000 compared to the comparable period
of the preceding year. The increase is due to market conditions that
allowed for higher average rents and higher economic occupancy levels.
For the three months ended March 31, 2000, weighted average monthly
revenue per occupied apartment home increased $64 (5.2%) to $1,314
compared to $1,250 for the comparable period of the preceding year. The
average economic occupancy increased from 96.1% for the three months
ended March 31, 1999 to 97.5% for the three months ended March 31, 2000.
Management fees decreased $91,000 (26.8%) to $248,000 for the three months ended
March 31, 2000 compared to $339,000 for the comparable period of the preceding
year. The decrease is primarily attributable to a decline in the number of third
party communities that we manage from five communities at March 31, 1999 to two
communities at March 31, 2000. We anticipate that management and development
fees will increase over the next several years due to the receipt of fees
pursuant to joint venture arrangements.
Operating expenses, excluding property taxes increased $637,000 (1.9%) to
$33,338,000 for the three months ended March 31, 2000 compared to $32,701,000
for the comparable period of the preceding year.
Overall Portfolio - The increase for the three months ended March 31,
2000 is primarily due to the addition of newly developed, redeveloped and
acquired apartment homes, partially offset by the sale of communities
during the three months ended March 31, 2000 and 1999. Maintenance,
insurance and other costs associated with Development and Redevelopment
Communities are expensed as communities move from the initial
construction and lease-up phase to the stabilized operating phase.
Established Communities - Operating expenses increased $422,000 (3.0%) to
$14,370,000 for the three months ended March 31, 2000 compared to
$13,948,000 for the comparable period of the preceding year. The net
change is the result of higher redecorating, maintenance, payroll,
insurance and administrative costs offset by lower utility and marketing
costs.
Property taxes increased $516,000 (4.8%) to $11,230,000 for the three months
ended March 31, 2000 compared to $10,714,000 for the comparable period of the
preceding year.
Overall Portfolio - The increase for the three months ended March 31,
2000 is primarily due to the addition of newly developed, redeveloped or
acquired apartment homes, partially offset by the sale of communities
during the three months ended March 31, 2000 and 1999. Property taxes on
Development and Redevelopment Communities are expensed as communities
move from the initial construction and lease-up phase to the stabilized
operating phase.
Established Communities - Property taxes decreased $310,000 (4.9%) to
$6,013,000 for the three months ended March 31, 2000 compared to
$6,323,000 for the comparable period of the preceding year. The decrease
is primarily a result of revised base year tax assessments for previously
renovated communities which resulted in supplemental taxes that were
lower than those originally projected.
22
Interest expense increased $3,599,000 (21.9%) to $20,067,000 for the three
months ended March 31, 2000 compared to $16,468,000 for the comparable period of
the preceding year. The increase is primarily attributable to a decrease in
capitalized interest and secondarily to the issuance of unsecured notes during
1999. This reflects our strategy to mitigate the risk of floating rate debt in a
rising interest rate environment by repaying floating rate debt under the
unsecured credit facility (with relatively lower current interest rates) with
longer dated fixed rate unsecured debt that has a higher current interest rate.
Depreciation increased $2,193,000 (8.1%) to $29,419,000 for the three months
ended March 31, 2000 compared to $27,226,000 for the comparable period of the
preceding year. The increase is primarily due to the addition of newly
developed, redeveloped and acquired apartment homes, partially offset by the
sale of communities during the three months ended March 31, 2000 and 1999.
General and administrative increased $579,000 (24.5%) to $2,947,000 for the
three months ended March 31, 2000 compared to $2,368,000 for the comparable
period of the preceding year. The increase is the result of additional overhead
from both the hiring of one officer and the recognition of expense in the
current period for an existing senior officer whose salary was previously
capitalized when he served the Company in a different capacity. Cost savings
attained from a management reorganization in the first quarter of 1999 partially
offset the increase in expense.
Equity in income of unconsolidated joint ventures decreased $32,000 (4.4%) to
$694,000 for the three months ended March 31, 2000 compared to $726,000 for the
comparable period of the preceding year. The decrease is primarily attributable
to costs incurred related to the formation of the joint venture to develop our
on-site property management system. Equity in income of unconsolidated joint
ventures represents our share of income from joint ventures.
Interest income decreased $642,000 (38.6%) to $1,020,000 for the three months
ended March 31, 2000 from $1,662,000 for the comparable period of the preceding
year. The decrease is primarily attributable to the sale of the Fairlane Woods
participating mortgage note that was sold in the fourth quarter of 1999.
Gain on sale of communities of $7,910,000 for the three months ended March 31,
2000 was attributable to the sale of one community in conjunction with the
disposition strategy we implemented in the third quarter of 1998.
Capitalization of Fixed Assets and Community Improvements
Our policy with respect to capital expenditures is generally to capitalize only
non-recurring expenditures. We capitalize improvements and upgrades only if the
item:
- exceeds $15,000;
- extends the useful life of the asset; and
- is not related to making an apartment home ready for the next
resident.
Under this policy, virtually all capitalized costs are non-recurring, as
recurring make-ready costs are expensed as incurred. Recurring make-ready costs
include the following:
- carpet and appliance replacements;
- floor coverings;
- interior painting; and
- other redecorating costs.
23
We capitalize purchases of personal property, such as computers and furniture,
only if the item is a new addition and the item exceeds $2,500. We generally
expense purchases of personal property made for replacement purposes. The
application of these policies for the three months ended March 31, 2000 resulted
in non-revenue generating capitalized expenditures for Stabilized Communities of
approximately $12 per apartment home. For the three months ended March 31, 2000,
we charged to maintenance expense, including carpet and appliance replacements,
a total of approximately $8,631,000 for Stabilized Communities or $272 per
apartment home. We anticipate that capitalized costs per apartment home will
gradually increase as the average age of our communities increases.
Liquidity and Capital Resources
Liquidity. The primary source of liquidity is our cash flows from operations.
Operating cash flows have historically been determined by:
- the number of apartment homes;
- rental rates;
- occupancy levels; and
- our expenses with respect to these apartment homes.
The timing, source and amount of cash flows provided by financing activities and
used in investing activities are sensitive to the capital markets environment,
particularly to changes in interest rates that are charged to us because changes
in interest rates affect our decision as to whether to issue debt securities,
borrow money and invest in real estate. Thus, changes in the capital markets
environment affect our plans for the undertaking of construction and development
as well as acquisition activity.
Cash and cash equivalents increased from $7,621,000 at March 31, 1999 to
$8,076,000 at March 31, 2000 due to the excess of cash provided by operating
activities over cash used in investing and financing activities.
Net cash provided by operating activities increased by $9,251,000 from
$51,056,000 for the three months ended March 31, 1999 to $60,307,000 for
the three months ended March 31, 2000. The increase is primarily from
additional operating cash flow from Established Communities as well as
the development and redevelopment of new communities, offset by the loss
of cash flow from communities sold during the three months ended March
31, 2000 and 1999.
Net cash used in investing activities decreased by $77,835,000 from
$122,631,000 for the three months ended March 31, 1999 to $44,796,000 for
the three months ended March 31, 2000. This decrease in expenditures
reflects a reduction in development, redevelopment and acquisition
activity offset by increased proceeds from the sale of communities. The
decrease in acquisitions is attributable to a shift in our investment
focus away from acquisitions and towards development opportunities that
offer higher projected yields, primarily in response to the lack of
available properties that meet our increased yield requirements combined
with a decrease in the availability of cost-effective capital.
Net cash provided by financing activities decreased by $96,331,000 from
$81,275,000 for the three months ended March 31, 1999 to $15,056,000 used
in financing activities for the three months ended March 31, 2000. The
decrease is primarily due to our development and redevelopment activities
increasingly being funded through the sale of existing communities as
opposed to incurring debt or selling equity, which reflects a reduction
in our use of debt financing as opposed to other sources of financing in
response to market conditions.
24
We regularly review our short and long-term liquidity needs and the adequacy of
Funds from Operations, as defined below, and other expected liquidity sources to
meet these needs. We believe our principal short-term liquidity needs are to
fund:
- normal recurring operating expenses;
- debt service payments;
- the distributions required with respect to our series of preferred
stock;
- the minimum dividend payments required to maintain our REIT
qualification under the Internal Revenue Code of 1986; and
- development and redevelopment activity in which we are currently
engaged.
We anticipate that we can fully satisfy these needs from a combination of cash
flows provided by operating activities and borrowing capacity under the
unsecured revolving credit facility. We anticipate that we can satisfy any
short-term liquidity needs not satisfied by current operating cash flows from
our unsecured revolving credit facility.
We believe our principal long-term liquidity needs are the reduction of medium
and long-term debt, as well as the procurement of long-term debt to refinance
construction and other development related short-term debt. We anticipate that
no significant portion of the principal of any indebtedness will be repaid prior
to maturity. If we do not have funds on hand sufficient to repay our
indebtedness, it will be necessary for us to refinance this debt. This
refinancing may be accomplished through additional debt financing, which may be
collateralized by mortgages on individual communities or groups of communities,
by uncollateralized private or public debt offerings or by additional equity
offerings. We also anticipate having significant retained cash flow in each year
so that when a debt obligation matures, some or all of each maturity can be
satisfied from this retained cash. Although we believe we will have the capacity
to meet our long-term liquidity needs, we cannot assure you that additional debt
financing or debt or equity offerings will be available or, if available, that
they will be on terms we consider satisfactory.
Capital Resources. We intend to match the long-term nature of our real estate
assets with long-term cost effective capital to the extent permitted by
prevailing market conditions. We follow a focused strategy to help facilitate
uninterrupted access to capital. This strategy includes:
- Hiring, training and retaining associates with a strong resident
service focus, which should lead to higher rents, lower turnover
and reduced operating costs;
- Managing, acquiring and developing upscale communities in dense
locations where the availability of zoned and entitled land is
limited to provide consistent, sustained earnings growth;
- Operating in markets with growing demand, as measured by household
formation and job growth, and high barriers-to-entry. We believe
these characteristics generally combine to provide a favorable
demand-supply balance, which we believe will create a favorable
environment for future rental rate growth while protecting
existing and new communities from new supply. We expect this
strategy to result in a high level of quality to the revenue
stream;
- Maintaining a conservative capital structure, largely comprised of
equity, and with modest, cost-effective leverage. We generally
avoid secured debt except in order to obtain low cost, tax-exempt
debt. We believe that such a structure should promote an
environment whereby current credit ratings levels can be
maintained;
- Following accounting practices that provide a high level of
quality to reported earnings; and
- Providing timely, accurate and detailed disclosures to the
investment community.
25
We believe these strategies provide a disciplined approach to capital access to
help position AvalonBay to fund portfolio growth.
Capital markets conditions have decreased our access to cost effective capital.
See "Future Financing and Capital Needs" for a discussion of our response to the
current capital markets environment.
The following is a discussion of specific capital transactions, arrangements and
agreements.
Unsecured Facility
Our unsecured revolving credit facility is furnished by a consortium of banks
and provides up to $600,000,000 in short-term credit. We pay these banks an
annual facility fee of $900,000 in equal quarterly installments. The unsecured
facility bears interest at varying levels tied to the London Interbank Offered
Rate (LIBOR) based on ratings levels achieved on our unsecured notes and on a
maturity selected by us. The current stated pricing is LIBOR plus 0.6% per
annum. The unsecured facility matures in July 2001, however we have two one-year
extension options. Therefore, subject to certain conditions, we may extend the
maturity to July 2003. A competitive bid option is available for borrowings of
up to $400,000,000. This option allows banks that are part of the lender
consortium to bid to provide us loans at a rate that is lower than the stated
pricing provided by the unsecured facility. The competitive bid option may
result in lower pricing if market conditions allow. Pricing under the
competitive bid option resulted in average pricing of LIBOR plus 0.5% for
amounts most recently borrowed under the competitive bid option. At May 1, 2000,
$246,500,000 was outstanding, $83,142,000 was used to provide letters of credit
and $270,358,000 was available for borrowing under the unsecured facility. We
intend to use borrowings under the unsecured facility for:
- capital expenditures;
- construction, development and redevelopment costs;
- acquisitions of developed or undeveloped communities;
- credit enhancement for tax-exempt bonds; and
- working capital purposes.
Interest Rate Protection Agreements
We are not a party to any long-term interest rate agreements, other than
interest rate protection and swap agreements on approximately $190 million of
our variable rate tax-exempt indebtedness. We intend, however, to evaluate the
need for long-term interest rate protection agreements as interest rate market
conditions dictate, and we have engaged a consultant to assist in managing our
interest rate risks and exposure.
Financing Commitments/Transactions Completed
During January 2000, we entered into a joint venture agreement with an entity
controlled by Multi-Employer Development Partners ("MEDP") to develop Avalon on
the Sound, a 412 apartment high rise community in New Rochelle, New York, with
total capitalized costs estimated to be $92,130,000. The terms of the limited
liability company operating agreement contemplate a long-term capital structure
comprised of 60% equity and 40% debt. Equity contributions will be funded 25% by
AvalonBay and 75% by MEDP. Construction financing that converts to long-term
financing following completion of construction will provide the debt capital.
Operating cash flow will be distributed 25% to AvalonBay and 75% to MEDP until
each receives a 9% return on invested capital for three consecutive months.
Thereafter, operating cash flow will be distributed equally to AvalonBay and
MEDP. Upon a sale to a third party, cash will be distributed first to each
partner until capital contributions are recovered. Thereafter, sales proceeds
26
will be distributed based upon achievement of certain internal rate of return
levels. Distributions that result in an internal rate of return to MEDP and the
Company of 12-15% are made 40% to AvalonBay and 60% to MEDP. Thereafter, sales
proceeds will be distributed equally to AvalonBay and MEDP. After three years
following completion of construction, buy-sell provisions are in effect.
AvalonBay will receive construction, development and management fees for
services rendered to the joint venture.
Future Financing and Capital Needs
As of March 31, 2000, we had 18 new communities under construction either by us
or by unaffiliated third parties with whom we have entered into forward purchase
commitments. As of March 31, 2000, a total estimated cost of $237,449,000
remained to be invested in these communities. In addition, we had six other
communities under reconstruction, for which an estimated $62,412,000 remained to
be invested as of March 31, 2000.
Substantially all of the capital expenditures necessary to complete the
communities currently under construction and reconstruction will be funded from:
- the remaining capacity under our $600,000,000 unsecured credit
facility;
- the net proceeds from sales of existing communities;
- retained operating cash; and/or
- the issuance of debt or equity securities.
We expect to continue to fund deferred development costs related to future
developments from retained operating cash and borrowings under the unsecured
facility. We believe these sources of capital will be adequate to take the
proposed communities to the point in the development cycle where construction
can begin.
We have observed and been impacted by a reduction in the availability of cost
effective capital since the third quarter of 1998. We cannot assure you that
cost effective capital will be available to meet future expenditures required to
begin planned reconstruction activity or the construction of the Development
Rights. Before planned reconstruction activity or the construction of a
Development Right begins, we intend to arrange adequate capital sources to
complete these undertakings, although we cannot assure you that we will be able
to obtain such financing. In the event that financing cannot be obtained, we may
have to abandon Development Rights, write-off associated pursuit costs and/or
forego reconstruction activity. In such instances, we will not realize the
increased revenues and earnings that we expected from such pursuits, and the
related write-off of costs will increase current period expenses and reduce
Funds from Operations.
To meet the balance of our liquidity needs, we will need to arrange additional
capacity under our existing unsecured facility, sell additional existing
communities and/or issue additional debt or equity securities. While we believe
we have the financial position to expand our short term credit capacity and
support our capital markets activity, we cannot assure you that we will be
successful in completing these arrangements, offerings or sales. The failure to
complete these transactions on a cost-effective basis could have a material
adverse impact on our operating results and financial condition, including the
abandonment of deferred development costs and a resultant charge to earnings.
During 1998, we determined that we would pursue a disposition strategy for
certain assets in markets that did not meet our long-term strategic direction.
Under this program, we solicit competing bids from unrelated parties for these
individual assets, and consider the sales price and tax ramifications of each
proposal. In connection with this disposition program, we have disposed of one
community since January 1, 2000. The net proceeds from the sale of this asset
were approximately $29,325,000. We intend to
27
actively seek buyers for the remaining communities held for sale. However, we
cannot assure you that these assets can be sold on terms that we consider
satisfactory.
The remaining assets that we have identified for disposition include land,
buildings and improvements and furniture, fixtures and equipment. Total real
estate, net of accumulated depreciation, of all communities identified for sale
at March 31, 2000 totaled $95,009,000. Certain individual assets are secured by
mortgage indebtedness which may be assumed by the purchaser or repaid from our
net sales proceeds. Our Condensed Consolidated Statements of Operations include
net income from the communities held for sale of $1,821,000 for the three months
ended March 31, 2000 and $820,000 for the three months ended March 31, 1999.
Because the proceeds from the sale of communities are used initially to reduce
borrowings under our unsecured facility, the immediate effect of a sale of a
community is to reduce Funds from Operations. This is because the yield on a
community that is sold exceeds the interest rate on the borrowings that are
repaid from such net proceeds. Therefore, changes in the number and timing of
dispositions, and the redeployment of the resulting net proceeds, may have a
material and adverse effect on our Funds from Operations.
Debt Maturities
The table on the following page details debt maturities for the next five years,
excluding the unsecured facility:
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(Dollars in thousands)
(1) Includes credit enhancement fees, facility fees, trustees, etc.
Inflation
Substantially all of the leases at the Current Communities are for a term of one
year or less. This may enable us to realize increased rents upon renewal of
existing leases or the beginning of new leases. Short-term leases generally
minimize our risk from the adverse effects of inflation, although these leases
generally permit residents to leave at the end of the lease term without
penalty. We believe that short-term leases combined with relatively consistent
demand allow rents, and therefore cash flow, from our portfolio of apartments to
provide an attractive inflation hedge.
Funds from Operations
We generally consider Funds from Operations, or FFO, to be an appropriate
measure of our operating performance because it helps investors understand our
ability to incur and service debt and to make capital expenditures. We believe
that to understand our operating results, FFO should be examined with net income
as presented in the Condensed Consolidated Statements of Operations included
elsewhere in this report. FFO is determined based on a definition adopted by the
Board of Governors of the National Association of Real Estate Investment
Trusts(R) (NAREIT), and is defined as:
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- net income or loss computed in accordance with generally accepted
accounting principles (GAAP), except that excluded from net income
or loss are gains or losses on sales of property and extraordinary
(as defined by GAAP) gains or losses on debt restructuring;
- plus depreciation of real estate assets; and
- after adjustments for unconsolidated partnerships and joint
ventures.
FFO does not represent cash generated from operating activities in accordance
with GAAP. Therefore it should not be considered an alternative to net income as
an indication of our performance. FFO should also not be considered an
alternative to net cash flows from operating activities as determined by GAAP as
a measure of liquidity. Additionally, it is not necessarily indicative of cash
available to fund cash needs. Further, FFO as calculated by other REITs may not
be comparable to our calculation of FFO.
For the three months ended March 31, 2000, FFO increased to $58,614,000 from
$48,896,000 for the comparable period of the preceding year. This increase is
primarily due to the completion of new development and redevelopment communities
as well as growth in earnings from Established Communities.
FFO previously reported for the three months ended March 31, 1999 excluded a
non-recurring restructuring charge of $16,524,000 in conformance with the NAREIT
definition of FFO calculations then in effect, or the original definition.
NAREIT issued a White Paper dated October 1999 that clarifies the definition of
FFO and the treatment of certain nonrecurring charges. The clarified definition
includes non-recurring charges in the calculation of FFO. Although we believe
the comparison of FFO using the original definition represents a better guide to
investors of comparable operations and growth between years, both FFO
calculations are presented below for the three months ended March 31, 2000 and
1999 (dollars in thousands):
(1) Represents Funds from Operations calculated in accordance with
NAREIT's October 1999 White Paper on FFO. Our calculation of FFO
in accordance with NAREIT's clarified definition of FFO includes
the effect on earnings of non-recurring charges for certain
management and other organizational changes and Year 2000
remediation costs.
(2) Consists of $16,076 related to management and other organizational
changes announced during 1998 and $706 for Year 2000 remediation
costs.
(3) Funds from Operations calculated based on NAREIT's definition of
FFO prior to the issuance of the October 1999 White Paper on FFO.
Previously, the effect on earnings of non-recurring charges for
certain management and other organizational changes and Year 2000
remediation costs were excluded from the calculation of FFO.
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Management Information Systems
We believe that an innovative management information systems infrastructure will
be an important element in managing our future growth. This is because timely
and accurate collection of financial and resident profile data will enable us to
maximize revenue through careful leasing decisions and financial management. We
currently employ a proprietary company-wide intranet using a digital network
with high-speed digital lines. This network connects all of our communities and
offices to central servers in Alexandria, Virginia, providing access to our
associates and to AvalonBay's corporate information throughout the country from
all locations.
We are currently engaged in the development of an innovative on-site property
management system and a leasing automation system to enable management to
capture, review and analyze data to a greater extent than is possible using
existing commercial software. We have entered into a formal joint venture
agreement, in the form of a limited liability company agreement, with United
Dominion Realty Trust, Inc., another public multifamily real estate company, to
continue development of these systems and system software, which are
collectively referred to in this discussion as the "system." The system
development process is currently managed by our employees, who have significant
related project management experience, and the employees of the joint venturer.
The actual programming and documentation of the system is being conducted by our
employees, the employees of our joint venturer and third party consultants under
the supervision of these experienced project managers. We currently expect that
the total development costs over a three-year period will be approximately $8.0
million including hardware costs and expenses, the costs of employees and
related overhead, and the costs of engaging third party consultants. These
development costs will generally be shared on an equal basis by our joint
venture partner and us, although we may fund 60% of some costs. Once developed,
we intend to use the property management system in place of current property
management information software for which we pay a license fee to third
parties, and we intend to use the leasing automation system to make the lease
application process easier for residents and more efficient for us to manage.
We currently project that the property management system will undergo an
on-site test (i.e., a "beta test") during the last half of 2000 and that the
system will be functional and implemented during early 2001.
We believe that when implemented the system will result in cost savings due to
increased data reliability and efficiencies in management time and overhead, and
that these savings will largely offset the expense associated with amortizing
the system development costs and maintaining the software. We also believe that
it is possible that other real estate companies may desire to use the system
concept and system software that we are developing and that therefore there may
be an opportunity to recover, in the future, a portion of our investment by
licensing the system to others and/or admitting one or more other real estate
companies to the joint venture. However, at the present time these potential
cost savings and ancillary revenue are speculative, and we cannot assure that
the system will provide sufficient benefits to offset the cost of development
and maintenance.
We have never before engaged in the development of systems or system software on
this scale and have never licensed a system concept or system software to
others. There are a variety of risks associated with the development of the
system, both for internal use and for potential sale or licensing to third
parties. Among the principal risks associated with this undertaking are the
following:
- we may not be able to maintain the schedule or budget that we have
projected for the development and implementation of the system;
- we may be unable to implement the system with the functionality
and efficiencies we desire on commercially reasonable terms;
- we may decide not to endeavor to license the system to other
enterprises, the system may not be attractive to other
enterprises, and we may not be able to effectively manage the
licensing of the system to other enterprises; and
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- the system may not provide AvalonBay with meaningful cost savings
or a meaningful source of ancillary revenues.
The occurrence of any of the events described above could prevent us from
achieving increased efficiencies, realizing revenue growth produced by ancillary
revenues or recovering our initial investment.
Natural Disasters
Many of our West Coast communities are located in the general vicinity of active
earthquake faults. In July 1998, we obtained a seismic risk analysis from an
engineering firm which estimated the probable maximum damage for each of the 60
West Coast communities that we owned at that time and for each of the five West
Coast communities under development at that time. The seismic risk analysis was
obtained for each individual community and for all of those communities
combined. To establish a probable maximum damage, the engineers first define a
severe earthquake event for the applicable geographic area, which is an
earthquake that has only a 10% likelihood of occurring over a 50-year period.
The probable maximum damage is determined as the structural and architectural
damage and business interruption loss that is estimated to have only a 10%
probability of being exceeded in the event of such an earthquake. Because a
significant number of our communities are located in the San Francisco Bay Area,
the engineers' analysis defined an earthquake on the Hayward Fault with a
Richter Scale magnitude of 7.1 as a severe earthquake with a 10% probability of
occurring within a 50-year period. The engineers then established an aggregate
probable maximum damage at that time of $113 million for the 60 West Coast
communities that we owned at that time and the five West Coast communities then
under development. The $113 million probable maximum damage for those
communities was a probable maximum level that the engineers expected to be
exceeded only 10% of the time in the event of such a severe earthquake. The
actual aggregate probable maximum damage could be higher or lower as a result of
variations in soil classifications and structural vulnerabilities. For each
community, the engineers' analysis calculated an individual probable maximum
damage as a percentage of the community's replacement cost and projected
revenues. We cannot assure you that:
- an earthquake would not cause damage or losses greater than the
probable maximum damage assessments indicate;
- future probable maximum damage levels will not be higher than the
current probable maximum damage levels described above for our
communities located on the West Coast; or
- acquisitions or developments after July 1998 will not have
probable maximum damage assessments indicating the possibility of
greater damage or losses than currently indicated.
In August 1999, we renewed our earthquake insurance, both for physical damage
and lost revenue, with respect to all communities we owned at that time and all
of the communities under development. For any single occurrence, we have in
place $75,000,000 of coverage with a five percent deductible. The five percent
deductible is subject to a minimum of $100,000 and a maximum of $25,000,000 per
occurrence. In addition, our general liability and property insurance program
provides coverage for public liability and fire damage. In the event an
uninsured disaster or a loss in excess of insured limits were to occur, we could
lose our capital invested in the affected community, as well as anticipated
future revenue from that community. We would also continue to be obligated to
repay any mortgage indebtedness or other obligations related to the community.
Any such loss could materially and adversely affect our business and our
financial condition and results of operations.
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Development Communities
As of March 31, 2000, we had nine Development Communities under construction. We
expect these Development Communities, when completed, to add a total of 2,473
apartment homes to our portfolio for a total capitalized cost, including land
acquisition costs, of approximately $410.9 million. Statements regarding the
future development or performance of the Development Communities are
forward-looking statements. We cannot assure you that:
- we will complete the Development Communities;
- our budgeted costs or estimates of occupancy rates will be
realized;
- our schedule of leasing start dates or construction completion
dates will be achieved; or
- future developments will realize returns comparable to our past
developments.
You should carefully review the discussion under "Risks of Development and
Redevelopment" below.
We hold a fee simple ownership interest in eight of the Development Communities
and a membership interest in a limited liability company that holds a fee simple
interest in one Development Community. The following table presents a summary of
the Development Communities:
(1) Total budgeted cost includes all capitalized costs projected to be
incurred to develop the respective Development Community, including land
acquisition costs, construction costs, real estate taxes, capitalized
interest and loan fees, permits, professional fees, allocated development
overhead and other regulatory fees determined in accordance with GAAP.
(2) Future initial occupancy dates are estimates.
(3) Stabilized operations is defined as the first full quarter of 95% or
greater occupancy after completion of construction.
(4) This community will be developed under a joint venture structure with
third party financing. AvalonBay's portion of the Budgeted Cost is
expected to be $13.3 million.
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Redevelopment Communities
As of March 31, 2000, we had six communities under redevelopment. We expect the
total budgeted cost to complete these Redevelopment Communities, including the
cost of acquisition and redevelopment, to be approximately $263.1 million, of
which approximately $68.1 million is the additional capital invested or expected
to be invested above the original purchase cost. Statements regarding the future
redevelopment or performance of the Redevelopment Communities are
forward-looking statements. We have found that the cost to redevelop an existing
apartment community is more difficult to budget than the cost to develop a new
community. Accordingly, we expect that actual costs may vary over a wider range
than for a new development community. We cannot assure you that we will meet our
schedules for redevelopment completion, or that we will meet our budgeted costs,
either individually or in the aggregate. See the discussion under "Risks of
Development and Redevelopment" below.
The following presents a summary of Redevelopment Communities:
(1) Total budgeted cost includes all capitalized costs projected to be
incurred to redevelop the respective Redevelopment Community, including
costs to acquire the community, reconstruction costs, real estate taxes,
capitalized interest and loan fees, permits, professional fees, allocated
redevelopment overhead and other regulatory fees determined in accordance
with GAAP.
(2) Reconstruction completion dates are estimates.
(3) Restabilized operations is defined as the first full quarter of 95% or
greater occupancy after completion of reconstruction.
(4) Formerly named Avalon Ridge.
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Development Rights
As of March 31, 2000, we are considering the development of 34 new apartment
communities. These Development Rights range from land owned or under contract
for which design and architectural planning has just begun to land under
contract or owned by us with completed site plans and drawings where
construction can begin almost immediately. We estimate that the successful
completion of all of these communities would ultimately add 9,140 upscale
apartment homes to our portfolio. At March 31, 2000, the cumulative capitalized
costs incurred in pursuit of the 34 Development Rights, including the cost of
land acquired in connection with seven of the Development Rights, was
approximately $74.0 million, of which $46.0 million was land. Substantially all
of these apartment homes will offer features like those offered by the
communities we currently own.
We generally hold Development Rights through options to acquire land, although
one Development Right located in New Canaan, Connecticut is controlled through a
joint venture partnership that owns the land. The properties comprising the
Development Rights are in different stages of the due diligence and regulatory
approval process. The decisions as to which of the Development Rights to pursue,
if any, or to continue to pursue once an investment in a Development Right is
made are business judgments that we make after we perform financial, demographic
and other analysis. Finally, we currently intend to limit the percentage of debt
used to finance new developments in order to maintain our general historical
practice with respect to the proportion of debt in our capital structure.
Therefore, other financing alternatives may be required to finance the
development of those Development Rights scheduled to start construction after
April 1, 2000. Although the development of any particular Development Right
cannot be assured, we believe that the Development Rights, in the aggregate,
present attractive potential opportunities for future development and growth of
our FFO.
Statements regarding the future development of the Development Rights are
forward-looking statements. We cannot assure you that:
- we will succeed in obtaining zoning and other necessary
governmental approvals or the financing required to develop these
communities, or that we will decide to develop any particular
community; or
- if we undertake construction of any particular community, that we
will complete construction at the total budgeted cost assumed in
the financial projections below.
The following presents a summary of the 34 Development Rights we are currently
pursuing:
35
(1) AvalonBay owns land, but construction has not yet begun.
(2) The land currently is owned by a limited partnership in which AvalonBay
is a majority partner. It is currently anticipated that the land seller
will retain a minority limited partner interest.
36
Risks of Development and Redevelopment
We intend to continue to pursue the development and redevelopment of apartment
home communities. Our development and redevelopment activities may be exposed to
the following industry risks:
- we may abandon opportunities we have already begun to explore
based on further review of, or changes in, financial, demographic,
environmental or other factors;
- we may encounter liquidity constraints, including the
unavailability of financing on favorable terms for the development
or redevelopment of a community;
- we may be unable to obtain, or we may experience delays in
obtaining, all necessary zoning, land-use, building, occupancy,
and other required governmental permits and authorizations;
- we may incur construction or reconstruction costs for a community
that exceed our original estimates due to increased materials,
labor or other expenses, which could make completion or
redevelopment of the community uneconomical;
- occupancy rates and rents at a newly completed or redevelopment
community may fluctuate depending on a number of factors,
including market and general economic conditions, and may not be
sufficient to make the community profitable; and
- we may be unable to complete construction and lease-up on
schedule, resulting in increased debt service expense and
construction costs.
The occurrence of any of the events described above could adversely affect our
ability to achieve our projected yields on communities under development or
redevelopment and could affect our payment of distributions to our stockholders.
Construction costs are projected by us based on market conditions prevailing in
the community's market at the time our budgets are prepared and reflect changes
to those market conditions that we anticipated at that time. Although we attempt
to anticipate changes in market conditions, we cannot predict with certainty
what those changes will be. Construction costs have been increasing and, for
some of our Development Communities, the total construction costs have been or
are expected to be higher than the original budget. Total budgeted cost includes
all capitalized costs projected to be incurred to develop the respective
Development or Redevelopment Community, including:
- land and/or property acquisition costs;
- construction costs;
- real estate taxes;
- capitalized interest;
- loan fees;
- permits;
- professional fees;
- allocated development overhead; and
- other regulatory fees determined in accordance with generally
accepted accounting principles.
Nonetheless, because of increases in prevailing market rents we believe that, in
the aggregate, we will still achieve our targeted projected yield (i.e., return
on invested capital) for those communities experiencing costs in excess of the
original budget. We believe that we could experience similar increases in
construction costs and market rents with respect to other development
communities resulting in total construction costs that exceed original budgets.
Likewise, costs to redevelop communities that have been acquired have, in some
cases, exceeded our original estimates and similar increases in costs may be
experienced in the future. We cannot assure that market rents in effect at the
time new development communities or repositioned communities complete lease-up
will be sufficient to fully offset the effects of any increased construction or
reconstruction costs.
37
Capitalized Interest
In accordance with generally accepted accounting principles, we capitalize
interest expense during construction or reconstruction until a building obtains
a certificate of occupancy. Thereafter, the interest allocated to that completed
building within the community is expensed. Capitalized interest totaled
$3,494,000 for the three months ended March 31, 2000 and $7,283,000 for the
three months ended March 31, 1999.
38
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Not Applicable
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
We are involved in certain ordinary routine litigation
incidental to the conduct of our business. In addition, as
reported in the Company's Form 10-K for the year ended
December 31, 1999, we are currently involved in litigation
with York Hunter Construction, Inc., and National Union Fire
Insurance Company. While the outcome of such litigation
cannot be predicted with certainty, we do not expect any
current litigation, including the litigation with York Hunter
and National Union, to have a material effect on our business
or financial condition.
Item 2. Changes in Securities
On February 28, 2000, the Company filed a Form 8-A/A (i) to
file an amendment to the Company's Shareholder Rights
Agreement that affects the rights of holders of the Company's
Preferred Stock Purchase Rights and (ii) to describe the
terms of such Shareholder Rights Agreement, as amended. The
description set forth in such Form 8-A/A is incorporated
herein by reference.
During the three months ended March 31, 2000, the Company
issued 7,048 shares of common stock in exchange for units of
limited partnership held by a limited partner of Avalon
DownREIT V, L.P., a DownREIT partnership subsidiary of the
Company. These shares were issued in reliance on an
exemption from registration under Section 4(2) of the
Securities Act of 1933. The Company is relying on the
exemption based upon factual representations received from the
limited partner who received these shares.
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) EXHIBITS
39
40
On March 10, 2000, the Company filed a report on Form 8-K with respect to Item
5 thereof (Other Event) to report the mailing of a letter to stockholders and to
file a copy of such letter.
41
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
AVALONBAY COMMUNITIES, INC.
Date: May 15, 2000 /s/: RICHARD L. MICHAUX
-----------------------------------------------
Richard L. Michaux
President, Chief Executive Officer and Director
Date: May 15, 2000 /s/: THOMAS J. SARGEANT
-----------------------------------------------
Thomas J. Sargeant
Chief Financial Officer and Treasurer
42