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 June 30, 2005

Commission file number 1-12672

AVALONBAY COMMUNITIES, INC.

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)

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 þ           Noo

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).

Yes þ           Noo

APPLICABLE ONLY TO CORPORATE ISSUERS

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date:

73,488,179 shares of common stock, par value $0.01 per share, were outstanding as of July 29, 2005

 

 

AVALONBAY COMMUNITIES, INC.

FORM 10-Q
INDEX

PART I — FINANCIAL INFORMATION

		Page
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets as of June 30, 2005 (unaudited) and December 31, 2004		1
Condensed Consolidated Statements of Operations and Other Comprehensive Income (unaudited) for the three and six months ended June 30, 2005 and 2004		2
Condensed Consolidated Statements of Cash Flows (unaudited) for the six months ended June 30, 2005 and 2004		3-4
Notes to Condensed Consolidated Financial Statements (unaudited)		5-20
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		21-48
Item 3. Quantitative and Qualitative Disclosures About Market Risk		49
Item 4. Controls and Procedures		49
PART II — OTHER INFORMATION
Item 1. Legal Proceedings		49
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		50
Item 3. Defaults Upon Senior Securities		50
Item 4. Submission of Matters to a Vote of Security Holders		50
Item 5. Other Information		51
Item 6. Exhibits		51-52
Signatures		53

AVALONBAY COMMUNITIES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)

		6-30-05				12-31-04
		(unaudited)
ASSETS
Real estate:
Land		$	877,785			$	885,118
Buildings and improvements			4,379,731				4,259,000
Furniture, fixtures and equipment			134,694				131,943
			5,392,210				5,276,061
Less accumulated depreciation			(895,435	)			(803,850	)
Net operating real estate			4,496,775				4,472,211
Construction in progress, including land			196,833				173,291
Land held for development			211,119				166,751
Operating real estate assets held for sale, net			10,428				65,572
Total real estate, net			4,915,155				4,877,825
Cash and cash equivalents			2,877				1,526
Cash in escrow			14,545				13,075
Resident security deposits			27,493				23,478
Investments in unconsolidated real estate entities			41,672				41,379
Deferred financing costs, net			20,024				21,859
Deferred development costs			38,777				37,007
Prepaid expenses and other assets			54,163				52,132
Total assets		$	5,114,706			$	5,068,281
LIABILITIES AND STOCKHOLDERS’ EQUITY
Unsecured notes		$	1,809,150			$	1,859,448
Variable rate unsecured credit facility			156,000				102,000
Mortgage notes payable			474,099				480,843
Dividends payable			54,204				52,982
Payables for construction			20,311				23,005
Accrued expenses and other liabilities			76,366				70,410
Accrued interest payable			34,266				37,254
Resident security deposits			37,362				34,516
Liabilities related to real estate assets held for sale			284				1,007
Total liabilities			2,662,042				2,661,465
Minority interest of unitholders in consolidated partnerships			20,221				21,525
Commitments and contingencies
Stockholders’ equity:
Preferred stock, $0.01 par value; $25 liquidation preference; 50,000,000 shares authorized at both June 30, 2005 and December 31, 2004; 4,000,000 shares issued and outstanding at both June 30, 2005 and December 31, 2004			40				40
Common stock, $0.01 par value; 140,000,000 shares authorized at both June 30, 2005 and December 31, 2004; 73,280,345 and 72,582,076 shares issued and outstanding at June 30, 2005 and December 31, 2004, respectively			733				726
Additional paid-in capital			2,426,232				2,389,511
Deferred compensation			(17,219	)			(8,659	)
Dividends less than accumulated earnings			28,807				10,769
Accumulated other comprehensive loss			(6,150	)			(7,096	)
Total stockholders’ equity			2,432,443				2,385,291
Total liabilities and stockholders’ equity		$	5,114,706			$	5,068,281

See accompanying notes to Condensed Consolidated Financial Statements.

AVALONBAY COMMUNITIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND OTHER COMPREHENSIVE INCOME
(Unaudited)
(Dollars in thousands, except per share data)

		For the three months ended								For the six months ended
		6-30-05				6-30-04				6-30-05				6-30-04
Revenue:
Rental and other income		$	170,514			$	157,257			$	337,520			$	309,318
Management, development and other fees			1,363				157				1,796				305
Total revenue			171,877				157,414				339,316				309,623
Expenses:
Operating expenses, excluding property taxes			47,519				46,458				93,753				90,732
Property taxes			16,772				14,762				33,461				29,991
Interest expense			32,379				32,416				64,533				64,610
Depreciation expense			40,202				38,949				81,168				77,295
General and administrative expense			6,262				4,486				13,421				9,200
Total expenses			143,134				137,071				286,336				271,828
Equity in income of unconsolidated entities			178				276				6,761				463
Interest income			270				36				301				56
Venture partner interest in profit-sharing			—				(352	)			—				(677	)
Minority interest in consolidated partnerships			(337	)			(408	)			(851	)			(250	)
Income from continuing operations before cumulative effect of change in accounting principle			28,854				19,895				59,191				37,387
Discontinued operations:
Income from discontinued operations			793				2,764				2,452				6,002
Gain on sale of real estate assets			27,264				12,375				64,878				12,375
Total discontinued operations			28,057				15,139				67,330				18,377
Income before cumulative effect of change in accounting principle			56,911				35,034				126,521				55,764
Cumulative effect of change in accounting principle			—				—				—				4,547
Net income			56,911				35,034				126,521				60,311
Dividends attributable to preferred stock			(2,175	)			(2,175	)			(4,350	)			(4,350	)
Net income available to common stockholders		$	54,736			$	32,859			$	122,171			$	55,961
Other comprehensive income (loss):
Unrealized gain (loss) on cash flow hedges			(354	)			1,307				946				935
Comprehensive income		$	54,382			$	34,166			$	123,117			$	56,896
Dividends declared per common share		$	0.71			$	0.70			$	1.42			$	1.40
Earnings per common share — basic:
Income from continuing operations (net of dividends attributable to preferred stock)		$	0.36			$	0.25			$	0.75			$	0.53
Discontinued operations			0.39				0.21				0.93				0.26
Net income available to common stockholders		$	0.75			$	0.46			$	1.68			$	0.79
Earnings per common share — diluted:
Income from continuing operations (net of dividends attributable to preferred stock)		$	0.36			$	0.25			$	0.75			$	0.53
Discontinued operations			0.38				0.21				0.90				0.26
Net income available to common stockholders		$	0.74			$	0.46			$	1.65			$	0.79

See accompanying notes to Condensed Consolidated Financial Statements.

AVALONBAY COMMUNITIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands)

		For the six months ended
		6-30-05				6-30-04
Cash flows from operating activities:
Net income		$	126,521			$	60,311
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation expense			81,168				77,295
Depreciation expense from discontinued operations			140				2,575
Amortization of deferred financing costs and debt premium/discount			1,944				2,094
Amortization of deferred compensation			4,503				2,324
Income allocated to minority interest in consolidated partnerships including discontinued operations			851				275
Income allocated to venture partner interest in profit-sharing			—				677
Gain on sale of real estate assets			(64,878	)			(12,375	)
Gain on sale of technology investment			(6,252	)			—
Cumulative effect of change in accounting principle			—				(4,547	)
Increase in cash in operating escrows			(2,033	)			(1,338	)
Decrease (increase) in resident security deposits, prepaid expenses and other assets			(1,845	)			6,666
Increase in accrued expenses, other liabilities and accrued interest payable			4,650				1,952
Net cash provided by operating activities			144,769				135,909
Cash flows from investing activities:
Development/redevelopment of real estate assets including land acquisitions and deferred development costs			(187,465	)			(173,918	)
Acquisition of real estate assets, including partner equity interest			(57,415	)			(24,065	)
Capital expenditures — existing real estate assets			(7,960	)			(6,127	)
Capital expenditures — non-real estate assets			(946	)			(366	)
Proceeds from sale of communities and technology investment, including reimbursement for fund communities, net of selling costs			232,291				40,909
Decrease in payables for construction			(2,694	)			(365	)
Decrease in cash in construction escrows			563				895
Decrease (increase) in investments in unconsolidated real estate entities			(13,074	)			613
Net cash used in investing activities			(36,700	)			(162,424	)
Cash flows from financing activities:
Issuance of common stock			21,251				28,598
Dividends paid			(106,854	)			(104,033	)
Net borrowings under unsecured credit facility			54,000				77,800
Issuance of mortgage notes payable and draws on construction loans			16,596				42,800
Repayments of mortgage notes payable			(39,679	)			(37,000	)
Issuance (repayment) of unsecured notes			(50,000	)			25,000
Payment of deferred financing costs			(1,304	)			(8,752	)
Redemption of units for cash by minority partners			(50	)			(163	)
Distributions to DownREIT partnership unitholders			(611	)			(741	)
Distributions to joint venture and profit-sharing partners			(67	)			(1,658	)
Net cash provided by (used in) financing activities			(106,718	)			21,851
Net increase (decrease) in cash and cash equivalents			1,351				(4,664	)
Cash and cash equivalents, beginning of period			1,526				7,165
Cash and cash equivalents, end of period		$	2,877			$	2,501
Cash paid during period for interest, net of amount capitalized		$	63,317			$	62,579

See accompanying notes to Condensed Consolidated Financial Statements.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

Supplemental disclosures of non-cash investing and financing activities (dollars in thousands):

During the six months ended June 30, 2005:

	•		As described in Note 4, “Stockholders’ Equity,” 163,792 shares of common stock were issued in connection with stock grants, 738 shares were issued through the Company’s dividend reinvestment plan, 45,243 shares were withheld to satisfy employees’ tax withholding and other liabilities and 3,925 shares were forfeited, for a net value of $9,076. In addition, the Company granted 720,059 options for common stock at a value of $4,600.
	•		33,102 units of limited partnership, valued at $1,445, were presented for redemption to the DownREIT partnerships that issued such units and were acquired by the Company in exchange for an equal number of shares of the Company’s common stock.
	•		The Company deconsolidated mortgage notes payable in the aggregate amount of $24,869 upon admittance of outside investors into a previously consolidated discretionary investment fund. See Note 6, “Investments in Unconsolidated Entities.”
	•		The Company assumed fixed rate debt of $4,566 in connection with the acquisition of an improved land parcel.
	•		The Company recorded a decrease to other liabilities and a corresponding gain to other comprehensive income of $946 to adjust the Company’s Hedged Derivatives (as defined in Note 5, “Derivative Instruments and Hedging Activities”) to their fair value.
	•		Common and preferred dividends declared but not paid totaled $54,204.

During the six months ended June 30, 2004:

	•		147,517 shares of common stock were issued in connection with stock grants, 35,215 shares were issued in connection with non-cash stock option exercises, 49,583 shares were withheld to satisfy employees’ tax withholding and other liabilities and 72 shares were forfeited, for a net value of $6,170.
	•		49,391 units of limited partnership, valued at $1,852, were presented for redemption to the DownREIT partnerships that issued such units and were acquired by the Company in exchange for an equal number of shares of the Company’s common stock.
	•		The Company sold one community with a mortgage note payable of $18,755 that was assumed by the buyer as part of the total sales price.
	•		The Company assumed fixed rate debt of $13,322 in connection with the acquisition of two improved land parcels.
	•		The Company recorded a decrease to other liabilities and a corresponding gain to other comprehensive income of $935 to adjust the Company’s Hedged Derivatives to their fair value.
	•		Common and preferred dividends declared but not paid totaled $52,491.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except per share data)

1. Organization and Significant Accounting Policies

Organization

AvalonBay Communities, Inc. (the “Company,” which term, unless the context otherwise requires, refers to AvalonBay Communities, Inc. together with its subsidiaries) is a Maryland corporation that has elected to be 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 apartment communities in high barrier-to-entry markets of the United States. These markets are located in the Northeast, Mid-Atlantic, Midwest, Pacific Northwest, and Northern and Southern California regions of the country.

At June 30, 2005, the Company owned or held a direct or indirect ownership interest in 139 operating apartment communities containing 40,478 apartment homes in ten states and the District of Columbia, of which four communities containing 1,491 apartment homes were under reconstruction. In addition, the Company owned or held a direct or indirect ownership interest in 11 communities under construction that are expected to contain an aggregate of 2,593 apartment homes when completed. The Company also owned or held a direct or indirect ownership interest in rights to develop an additional 46 communities that, if developed in the manner expected, will contain an estimated 12,216 apartment homes.

During the three months ended June 30, 2005:

	•		The Company sold one community, Avalon Lake, located in the Fairfield-New Haven, Connecticut area. This community, which contained 135 apartment homes, was sold for a sales price of $37,700. The sale of this community resulted in a gain calculated in accordance with generally accepted accounting principles (“GAAP”) of $22,647.
	•		The Company completed the development of two communities, Avalon Run East II, located in Central New Jersey and Avalon Orange, located in the Fairfield-New Haven, Connecticut area. These garden-style communities contain an aggregate of 480 apartment homes and were completed for a total capitalized cost of $74,300.
	•		The Company completed the redevelopment of one community, Avalon Towers, located in the Long Island, New York area. This high-rise community contains 109 apartment homes and was completed for a total capitalized cost of $21,200, of which $17,300 was incurred prior to redevelopment.
	•		The Company commenced construction of two communities. Avalon Pines II, located in the Long Island, New York area, is expected to contain 152 apartment homes when completed, for a total capitalized cost of $26,600. Avalon Chestnut Hill, located in the greater Boston, Massachusetts area, is expected to contain 204 apartment homes when completed, for a total capitalized cost of $60,600.
	•		The Company acquired five parcels of land to hold for future development, for an aggregate purchase price of $45,534. These parcels of land, if developed as expected, will contain 1,154 apartment homes for a total capitalized cost of $297,000.
	•		The Company sold two land parcels, one located in Seattle, Washington and one located in the Oakland-East Bay area, for an aggregate sales price of $23,000 which resulted in a gain calculated in accordance with GAAP of $4,617.

The interim unaudited financial statements have been prepared in accordance with GAAP for interim financial information and in conjunction with the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements required by GAAP have been condensed or omitted pursuant to such rules and regulations. These unaudited financial statements should be read in conjunction with the financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 and the Company’s quarterly reports on Form 10-Q for subsequent quarters. The results of operations for the six months ended June 30, 2005 are not necessarily indicative of the operating results for the full year. Management believes the disclosures are adequate to ensure the information presented is not misleading. In the opinion of management, all adjustments and eliminations, consisting only of normal, recurring adjustments necessary for a fair presentation of the financial statements for the interim periods, have been included.

Principles of Consolidation

The Company assesses consolidation of variable interest entities under the guidance of FASB Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51,” as revised in December 2003. The Company accounts for joint venture partnerships and subsidiary partnerships structured as DownREITs that are not variable interest entities in accordance with Statement of Position (“SOP”) 78-9, “Accounting for Investments in Real Estate Ventures.” Under SOP 78-9, the Company consolidates joint venture and DownREIT partnerships when the Company controls the major operating and financial policies of the partnership through majority ownership or in its capacity as general partner. The accompanying Condensed Consolidated Financial Statements include the accounts of the Company and its wholly-owned partnerships, certain joint venture partnerships, subsidiary partnerships structured as DownREITs and any variable interest entities consolidated under FIN 46. All significant intercompany balances and transactions have been eliminated in consolidation.

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 an initial distribution 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 have approximated 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 all or some of their units for redemption for a cash amount as determined by the applicable partnership agreement and based on the fair value of the Company’s common stock. In lieu of a cash redemption, the Company may elect to acquire such units for an equal number of shares of the Company’s common stock.

The Company accounts for investments in unconsolidated entities that are not variable interest entities in accordance with SOP 78-9 and Accounting Principles Board (“APB”) Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock.” The Company uses the equity method to account for investments in which it owns greater than 20% of the equity value or has significant and disproportionate influence over that entity. Investments in which the Company owns 20% or less of the equity value and does not have significant and disproportionate influence are accounted for using the cost method. If there is an event or change in circumstance that indicates a loss in the value of an investment, the Company’s policy is to record the loss and reduce the value of the investment to its fair value. A loss in value would be indicated if the Company could not recover the carrying value of the investment or if the investee could not sustain an earnings capacity that would justify the carrying amount of the investment.

Revenue Recognition

Rental income related to leases is recognized on an accrual basis when due from residents in accordance with SEC Staff Accounting Bulletin No. 104, “Revenue Recognition” and Statement of Financial Accounting Standards (“SFAS”) No. 13, “Accounting for Leases.” In accordance with the Company’s standard lease terms, rental payments are generally due on a monthly basis. Any cash concessions given at the inception of the lease are amortized over the approximate life of the lease, which is generally one year.

Real Estate

Significant expenditures which 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 Company’s policy with respect to capital expenditures is generally to capitalize only non-recurring expenditures. Improvements and upgrades are capitalized only if the item exceeds $15, extends the useful life of the asset and is not related to making an apartment home ready for the next resident. Purchases of personal property, such as computers and furniture, are capitalized only if the item is a new addition and exceeds $2.5. The Company generally expenses purchases of personal property made for replacement purposes.

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, or a portion of an asset, is delivered and is ready for its intended use, which is generally indicated by the issuance of a certificate of occupancy. 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 available for a new resident. Rental income and operating costs incurred during the initial lease-up or post-redevelopment lease-up period are fully recognized as they accrue.

In accordance with SFAS No. 67, “Accounting for Costs and Initial Rental Operations of Real Estate Projects,” the Company capitalizes pre-development costs incurred in pursuit of new development opportunities for which the Company currently believes future development is probable (“Development Rights”). Future development of these Development Rights is dependent upon various factors, including zoning and regulatory approval, rental market conditions, construction costs and availability of capital. Pre-development costs incurred in the pursuit of Development Rights for which future development is not yet considered probable are expensed as incurred. In addition, if the status of a Development Right changes, deeming future development no longer probable, any capitalized pre-development costs are written-off with a charge to expense. The Company expensed costs related to abandoned pursuits, which includes the abandonment or impairment of Development Rights, acquisition pursuits and technology investments, in the amounts of $146 and $936 for the three months ended June 30, 2005 and 2004, respectively, and $366 and $1,177 for the six months ended June 30, 2005 and 2004, respectively.

The Company owns land improved with office buildings and industrial space occupied by unrelated third-parties in connection with five Development Rights. The Company intends to manage the current improvements until such time as all tenant obligations have been satisfied or eliminated through negotiation, and construction of new apartment communities is ready to begin. As provided under the guidance of SFAS No. 67, the revenue from incidental operations received from the current improvements in excess of any incremental costs are being recorded as a reduction of total capitalized costs of the Development Right and not as part of net income.

In connection with the acquisition of an operating community, the Company performs a valuation and allocation to each asset and liability acquired in such transaction, based on their estimated fair values at the date of acquisition in accordance with SFAS No. 141, “Business Combinations.” The purchase price allocations to tangible assets, such as land, buildings and improvements, and furniture, fixtures and equipment, are reflected in real estate assets and depreciated over their estimated useful lives. Any purchase price allocation to intangible assets, such as in-place leases, is included in prepaid expenses and other assets and amortized over the average remaining lease term of the acquired leases. The fair value of acquired in-place leases is determined based on the estimated cost to replace such leases, including foregone rents during an assumed re-lease period, as well as the impact on projected cash flow of acquired leases with leased rents above or below current market rents.

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 (primarily computer-related equipment) to seven years.

If there is an event or change in circumstance that indicates an impairment in the value of an operating community, the Company’s policy is to assess any impairment in value by making a comparison of the current and projected operating cash flow of the community over its remaining useful life, on an undiscounted basis, to the carrying amount of the community. If the carrying amount is in excess of the estimated projected operating cash flow of the community, the Company would recognize an impairment loss equivalent to an amount required to adjust the carrying amount to its estimated fair market value.

Deferred Financing Costs

Deferred financing costs include fees and costs incurred to obtain debt financing and are amortized on a straight-line basis, which approximates the effective interest method, over the shorter of the term of the loan or the related credit enhancement facility, if applicable. Unamortized financing costs are written-off when debt is retired before the maturity date. Accumulated amortization of deferred financing costs was $14,012 at June 30, 2005 and $12,966 at December 31, 2004.

Cash, Cash Equivalents and Cash in Escrow

Cash and cash equivalents include all cash and liquid investments with an original maturity of three months or less from the date acquired. The majority of the Company’s cash, cash equivalents and cash in escrows is held at major commercial banks.

Interest Rate Contracts

The Company utilizes derivative financial instruments to manage interest rate risk and has designated these financial instruments as hedges under the guidance of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” and SFAS No. 138, “Accounting for Certain Instruments and Certain Hedging Activities, an Amendment of Statement No. 133.” For fair value hedge transactions, changes in the fair value of the derivative instrument and changes in the fair value of the hedged item due to the risk being hedged are recognized in current period earnings. For cash flow hedge transactions, changes in the fair value of the derivative instrument are reported in other comprehensive income. For cash flow hedges where the changes in the fair value of the derivative exceed the change in fair value of the hedged item, the ineffective portion is recognized in current period earnings. Derivatives which are not part of a hedge relationship are recorded at fair value through earnings. As of June 30, 2005 and December 31, 2004, the Company had approximately $234,000 and $236,000, respectively, in variable rate debt subject to cash flow hedges. See Note 5, “Derivative Instruments and Hedging Activities.”

Comprehensive Income

Comprehensive income, as reflected on the Condensed Consolidated Statements of Operations and Other Comprehensive Income, is defined as all changes in equity during each period except for those resulting from investments by or distributions to shareholders. Accumulated other comprehensive loss as reflected in Note 4, “Stockholders’ Equity,” reflects the changes in the fair value of effective cash flow hedges.

Earnings per Common Share

In accordance with the provisions of SFAS No. 128, “Earnings per Share,” basic earnings per share is computed by dividing earnings available to common stockholders by the weighted average number of shares outstanding during the period. Other potentially dilutive common shares, and the related impact to earnings, are considered when calculating earnings per share on a diluted basis. The Company’s earnings per common share are determined as follows:

		For the three months ended								For the six months ended
		6-30-05				6-30-04				6-30-05				6-30-04
Basic and diluted shares outstanding
Weighted average common shares — basic			72,786,719				71,409,668				72,640,134				71,164,908
Weighted average DownREIT units outstanding			477,970				581,941				487,913				594,850
Effect of dilutive securities			1,324,547				1,045,875				1,289,458				1,031,712
Weighted average common shares — diluted			74,589,236				73,037,484				74,417,505				72,791,470
Calculation of Earnings per Share — basic
Net income available to common stockholders		$	54,736			$	32,859			$	122,171			$	55,961
Weighted average common shares — basic			72,786,719				71,409,668				72,640,134				71,164,908
Earnings per common share — basic		$	0.75			$	0.46			$	1.68			$	0.79
Calculation of Earnings per Share — diluted
Net income available to common stockholders		$	54,736			$	32,859			$	122,171			$	55,961
Add: Minority interest of DownREIT unitholders in consolidated partnerships, including discontinued operations			303				912				780				1,239
Adjusted net income available to common stockholders		$	55,039			$	33,771			$	122,951			$	57,200
Weighted average common shares — diluted			74,589,236				73,037,484				74,417,505				72,791,470
Earnings per common share — diluted		$	0.74			$	0.46			$	1.65			$	0.79

Certain employee options to purchase shares of common stock of 0 and 16,267 were outstanding during the three and six months ended June 30, 2005, respectively, and 3,000 were outstanding during both the three and six months ended June 30, 2004, 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 for the period and therefore, are anti-dilutive.

Stock-Based Compensation

Effective January 1, 2003, the Company adopted the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation – Transition and Disclosure – an amendment of FASB Statement No. 123,” prospectively to all employee awards granted, modified, or settled on or after January 1, 2003. Awards under the Company’s stock option plans vest over periods ranging from one to three years. Therefore, the cost related to stock-based employee compensation for employee stock options included in the determination of net income for the three and six months ended June 30, 2005 and 2004, is less than that which would have been recognized if the fair value based method had been applied to all awards since the original effective date of SFAS No. 123. The Company will adopt the provisions of SFAS 123(R), “Share Based Payment,” on January 1, 2006. The Company is currently assessing the expected impact of the adoption of SFAS 123(R) on its financial position and results of operations.

The following table illustrates the effect on net income available to common stockholders and earnings per share if the fair value based method had been applied to all outstanding and unvested awards in each period based on the fair market value as determined on the date of grant:

		For the three months ended								For the six months ended
		6-30-05				6-30-04				6-30-05				6-30-04
Net income available to common stockholders, as reported		$	54,736			$	32,859			$	122,171			$	55,961
Add: Actual compensation expense recorded under fair value based method, net of related tax effects			564				222				1,038				389
Deduct: Total compensation expense determined under fair value based method, net of related tax effects			(568	)			(433	)			(1,142	)			(736	)
Pro forma net income available to common stockholders		$	54,732			$	32,648			$	122,067			$	55,614
Earnings per share:
Basic — as reported		$	0.75			$	0.46			$	1.68			$	0.79
Basic — pro forma		$	0.75			$	0.46			$	1.68			$	0.78
Diluted — as reported		$	0.74			$	0.46			$	1.65			$	0.79
Diluted — pro forma		$	0.74			$	0.46			$	1.65			$	0.78

Legal Contingencies

The Company is subject to various legal proceedings and claims that arise in the ordinary course of business. These matters are frequently covered by insurance. If it has been determined that a loss is probable to occur, the estimated amount of the loss is expensed in the financial statements. While the resolution of these matters cannot be predicted with certainty, management believes the final outcome of such matters will not have a material adverse effect on the financial position or results of operations of the Company.

The Company is currently involved in construction litigation with a general contractor and a surety bond provider related to a community that has since completed development. A non-jury trial ended in April 2004, and in May 2004, the court issued a ruling, finding that these parties were liable to the Company for consequential damages due to breach of contract and other failures to perform. The court issued a ruling in October 2004, awarding the Company approximately $1,250 plus interest. However, the Company has determined that it will file an appeal to seek an increase in the damage award. There is no guarantee that a higher, or any, damage award, will be received by the Company after all appeals are filed and a final ruling is provided.

The Company is currently involved in a lawsuit regarding the handling of security deposits in California. The lawsuit in essence alleges that the amounts withheld by the Company from security deposits at the end of tenancies exceeded the Company’s actual damages. The plaintiff in the lawsuit is seeking class action certification, but that has not yet been obtained.

During the three months ended June 30, 2005, the Company accrued $1,500 related to these and other various litigation matters.

Variable Interest Entities under FIN 46

The Company adopted the final provisions of FIN 46 as of January 1, 2004, which resulted in the consolidation of one entity during 2004 from which the Company held a participating mortgage note. As a result, the Company recognized a cumulative effect of change in accounting principle in January 2004 in the amount of $4,547, which increased earnings per common share – diluted by $0.06. The Company did not hold an equity interest in this entity, and therefore 100% of the entity’s net income or loss was recognized by the Company as minority interest in consolidated partnerships on the Condensed Consolidated Statements of Operations and Other Comprehensive Income. In October 2004, the Company received payment in full of the outstanding mortgage note. Upon note repayment, the Company did not continue to hold a variable interest in this entity and therefore the Company discontinued consolidating the entity under the provisions of FIN 46.

Venture Partner Interest in Profit-Sharing

Prior to its expiration in December 2004, the Company had a repurchase option on its third-party partner’s 75% equity interest in a joint venture owning the Avalon on the Sound community. Due to the repurchase option, the Company accounted for its investment in this joint venture as a profit-sharing arrangement as required by SFAS No. 66, “Accounting for Sales of Real Estate.” As a result, the revenues and expenses, and assets and liabilities of Avalon on the Sound were included in the Company’s Condensed Consolidated Financial Statements for periods prior to December 31, 2004. The income allocated to the controlling partner is shown as venture partner interest in profit-sharing on the Company’s Condensed Consolidated Statements of Operations and Other Comprehensive Income for the three and six months ended June 30, 2004.

Discontinued Operations

On January 1, 2002, the Company adopted SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” which requires that the assets and liabilities and the results of operations of any communities which have been sold since January 1, 2002, or otherwise qualify as held for sale, be presented as discontinued operations in the Company’s Condensed Consolidated Financial Statements in both current and prior periods presented. The community specific components of net income that are presented as discontinued operations include net operating income, depreciation expense, minority interest expense and interest expense. In addition, the net gain or loss (including any impairment loss) on the eventual disposal of communities held for sale will be presented as discontinued operations when recognized. A change in presentation for discontinued operations will not have any impact on the Company’s financial condition or results of operations. Real estate assets held for sale are measured at the lower of the carrying amount or the fair value less the cost to sell, and are presented separately in the accompanying Condensed Consolidated Balance Sheets. Subsequent to classification of a community as held for sale, no further depreciation is recorded.

Recently Issued Accounting Standards

In June 2005, the Financial Accounting Standards Board (“FASB”) ratified the consensus in EITF Issue No. 04-5, “Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights,” which provides guidance in determining whether a general partner controls a limited partnership. EITF Issue No. 04-5 states that the general partner in a limited partnership is presumed to control that limited partnership. That presumption may be overcome if the limited partners have either (i) the substantive ability, either by a single limited partner or through a simple majority vote, to dissolve the limited partnership or otherwise remove the general partner without cause or (ii) substantive participating rights. The Company adopted EITF Issue No. 04-5 on June 29, 2005 for all new limited partnerships formed or existing limited partnerships that are modified after June 29, 2005 and will adopt EITF Issue No. 04-5 on January 1, 2006 for other existing limited partnerships. Although the Company is still assessing the impact of the adoption on January 1, 2006, the Company does not expect the final adoption of EITF Issue No. 04-5 to have a material effect on its financial position or results of operations.

Use of Estimates

The preparation of financial statements in conformity with GAAP in the United States requires management to make certain estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Actual results could differ from those estimates.

Reclassifications

Certain reclassifications have been made to amounts in prior period’s financial statements to conform with current period presentations.

2. Interest Capitalized

Capitalized interest associated with communities under development or redevelopment totaled $6,036 and $5,010 for the three months ended June 30, 2005 and 2004, respectively, and $11,698 and $10,078 for the six months ended June 30, 2005 and 2004, respectively.

3. Notes Payable, Unsecured Notes and Credit Facility

The Company’s mortgage notes payable, unsecured notes and variable rate unsecured credit facility as of June 30, 2005 and December 31, 2004 are summarized as follows:

		6-30-05				12-31-04
Fixed rate unsecured notes (1)		$	1,809,150			$	1,859,448
Fixed rate mortgage notes payable — conventional and tax-exempt			241,213				263,669
Variable rate mortgage notes payable — conventional and tax-exempt			210,012				210,896
Total notes payable and unsecured notes			2,260,375				2,334,013
Variable rate secured short-term debt			22,874				6,278
Variable rate unsecured credit facility			156,000				102,000
Total mortgage notes payable, unsecured notes and unsecured credit facility		$	2,439,249			$	2,442,291

The following debt activity occurred during the six months ended June 30, 2005:

	•		The Company repaid $150,000 in previously issued unsecured notes in January 2005, along with any unpaid interest, pursuant to their scheduled maturity. No prepayment penalty was incurred;
	•		The Company issued $100,000 in unsecured notes in March 2005 under its existing shelf registration statement at an annual effective interest rate of 4.999%. Interest on these notes is payable semi-annually on March 15 and September 15, and they mature in March 2013;
	•		In connection with the admittance of outside investors into the Fund (as defined in Note 6, “Investments in Unconsolidated Entities”), the Company deconsolidated the assets and liabilities of four communities owned by the Fund including $24,869 in fixed rate mortgage debt secured by two of the communities;
	•		The Company made a payment in the amount of $36,142 to the third-party lender of a joint venture entity that was unconsolidated at December 31, 2004 but was consolidated in March 2005 upon acquisition of the 75% equity interest of the third-party partner (see Note 6, “Investments in Unconsolidated Entities”); and
	•		The Company assumed $4,566 in fixed rate debt in connection with the acquisition of a parcel of improved land.

In the aggregate, secured notes payable mature at various dates from September 2007 through April 2043 and are secured by certain apartment communities (with a net carrying value of $684,076 as of June 30, 2005). As of June 30, 2005, the Company has guaranteed approximately $129,000 of mortgage notes payable held by wholly-owned subsidiaries; all such mortgage notes payable are consolidated for financial reporting purposes. The weighted average interest rate of the Company’s fixed rate mortgage notes payable (conventional and tax-exempt) was 6.8% at June 30, 2005 and 6.7% at December 31, 2004. The weighted average interest rate of the Company’s variable rate mortgage notes payable and its unsecured credit facility (as discussed on the following page), including the effect of certain financing related fees, was 4.4% at June 30, 2005 and 3.9% at December 31, 2004.

Scheduled payments and maturities of mortgage notes payable and unsecured notes outstanding at June 30, 2005 are as follows:

																Stated
												Unsecured				interest rate
				Secured notes				Secured notes				notes				of unsecured
	Year			payments				maturities				maturities				notes
	2005			$	4,514			$	—			$	—				—
	2006				8,074				—				150,000				6.800	%
	2007				8,600				22,874				110,000 150,000				6.875 5.000	% %
	2008				9,149				4,356				50,000 150,000				6.625 8.250	% %
	2009				8,279				73,784				150,000				7.500	%
	2010				6,563				28,989				200,000				7.500	%
	2011				6,554				7,204				300,000 50,000				6.625 6.625	% %
	2012				6,207				12,096				250,000				6.125	%
	2013				6,339				—				100,000				4.950	%
	2014				6,784				—				150,000				5.375	%
	Thereafter				149,627				104,106				—				—
				$	220,690			$	253,409			$	1,810,000

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 $500,000 revolving variable rate unsecured credit facility with JPMorgan Chase Bank and Wachovia Bank, N.A. serving as banks and syndication agents for a syndicate of commercial banks. The Company had $156,000 outstanding under the facility and $28,468 in letters of credit on June 30, 2005 and $102,000 outstanding under the facility and $26,580 in letters of credit on December 31, 2004. Under the terms of the credit facility, if the Company elects to increase the facility by up to an additional $150,000, and one or more banks (from the syndicate or otherwise) voluntarily agree to provide the additional commitment, then the Company will be able to increase the facility up to $650,000, and no member of the syndicate of banks can prohibit such increase; such an increase in the facility will only be effective to the extent banks (from the syndicate or otherwise) choose to commit to lend additional funds. The Company pays participating banks, in the aggregate, an annual facility fee of approximately $750 in quarterly installments. The unsecured credit facility bears interest at varying levels based on the London Interbank Offered Rate (“LIBOR”), rating levels achieved on the Company’s unsecured notes and on a maturity schedule selected by the Company. The current stated pricing is LIBOR plus 0.55% per annum (3.89% on June 30, 2005). The spread over LIBOR can vary from LIBOR plus 0.50% to LIBOR plus 1.15% based upon the rating of the Company’s long-term unsecured debt. In addition, the unsecured credit 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 credit facility for up to $250,000. The competitive bid option may result in lower pricing if market conditions allow. The Company has $85,000 outstanding under this competitive bid option as of June 30, 2005 priced at LIBOR plus 0.29%, or 3.41%. The Company is subject to (i) certain customary covenants under the unsecured credit facility, including, but not limited to, maintaining certain maximum leverage ratios, a minimum fixed charges coverage ratio and minimum unencumbered assets and equity levels and (ii) prohibitions on paying dividends in amounts that exceed 95% of the Company’s Funds from Operations, as defined therein, except as may be required to maintain the Company’s REIT status. The credit facility matures in May 2008, assuming exercise of a one-year renewal option by the Company.

4. Stockholders’ Equity

The following summarizes the changes in stockholders’ equity for the six months ended June 30, 2005:

																		Dividends				Accumulated
										Additional								less than				other
		Preferred				Common				paid-in				Deferred				accumulated				comprehensive				Stockholders’
		stock				stock				capital				compensation				earnings				loss				equity
Balance at December 31, 2004		$	40			$	726			$	2,389,511			$	(8,659	)		$	10,769			$	(7,096	)		$	2,385,291
Net income			—				—				—				—				126,521				—				126,521
Unrealized gain on cash flow hedges			—				—				—				—				—				946				946
Dividends declared to common and preferred stockholders			—				—				—				—				(108,127	)			—				(108,127	)
Issuance of common stock, net of withholdings			—				7				32,121				(8,463	)			(356	)			—				23,309
Issuance of stock options			—				—				4,600				(4,600	)			—				—				—
Amortization of deferred compensation			—				—				—				4,503				—				—				4,503
Balance at June 30, 2005		$	40			$	733			$	2,426,232			$	(17,219	)		$	28,807			$	(6,150	)		$	2,432,443

During the six months ended June 30, 2005, the Company (i) issued 549,817 shares of common stock in connection with stock options exercised, (ii) issued 33,102 shares of common stock to acquire an equal number of DownREIT limited partnership units, (iii) issued 738 shares through the Company’s dividend reinvestment plan, (iv) issued 163,792 common shares in connection with stock grants to employees of which 80% are restricted, (v) had forfeitures of 3,925 shares of restricted stock grants to employees and (vi) withheld 45,243 shares to satisfy employees’ tax withholding and other liabilities.

Dividends per common share for the six months ended June 30, 2005 and 2004 were $1.42 and $1.40 per share, respectively. In both the six months ended June 30, 2005 and 2004, average dividends for preferred shares were $1.09 per share.

5. Derivative Instruments and Hedging Activities

The Company has historically used interest rate swap and cap agreements (collectively, the “Hedged Derivatives”) to reduce the impact of interest rate fluctuations on its variable rate, tax-exempt bonds and its variable rate conventional secured debt. The Company has not entered into any interest rate hedge agreements or treasury locks for its conventional unsecured debt and does not hold interest rate hedge agreements for trading or other speculative purposes. As of June 30, 2005, the Hedged Derivatives fix $68,000 of the Company’s tax-exempt debt at a weighted average interest rate of 6.3% through interest rate swaps. In addition, as of June 30, 2005, the Company has Hedged Derivatives on $166,000 of its variable rate debt, which floats at a weighted average coupon interest rate of 3.8% and has been capped at a weighted average interest rate of 8.0% through interest rate caps. These Hedged Derivatives have maturity dates ranging from 2007 to 2010. The Hedged Derivatives are accounted for in accordance with SFAS No. 133. SFAS No. 133 requires that every derivative instrument be recorded on the balance sheet as either an asset or liability measured at its fair value, with changes in fair value recognized currently in earnings unless specific hedge accounting criteria are met.

The Company has determined that its Hedged Derivatives qualify as effective cash-flow hedges under SFAS No. 133, resulting in the Company recording all changes in the fair value of the Hedged Derivatives in other comprehensive income. Amounts recorded in other comprehensive income will be reclassified into earnings in the period in which earnings are affected by the hedged cash flow. To adjust the Hedged Derivatives to their fair value, the Company recorded unrealized gains to other comprehensive income of $946 and $935 during the six months ended June 30, 2005 and 2004, respectively. The estimated amount, included in accumulated other comprehensive income as of June 30, 2005, expected to be reclassified into earnings within the next twelve months to offset the variability of cash flow during this period is not material.

The Company assesses, both at inception and on an on-going basis, the effectiveness of all hedges in offsetting cash flow of hedged items. Hedge ineffectiveness did not have a material impact on earnings and the Company does not anticipate that it will have a material effect in the future. The fair values of the obligations under the Hedged Derivatives are included in accrued expenses and other liabilities on the accompanying Condensed Consolidated Balance Sheets.

By using derivative financial instruments to hedge exposures to changes in interest rates, the Company exposes itself to credit risk and market risk. The credit risk is the risk of a counterparty not performing under the terms of the Hedged Derivatives. The counterparties to these Hedged Derivatives are major financial institutions which have an A+ or better credit rating by the Standard & Poor’s Ratings Group. The Company monitors the credit ratings of counterparties and the amount of the Company’s debt subject to Hedged Derivatives with any one party. Therefore, the Company believes the likelihood of realizing material losses from counterparty non-performance is remote. Market risk is the adverse effect of the value of financial instruments that results from a change in interest rates. The market risk associated with interest-rate contracts is managed by the establishment and monitoring of parameters that limit the types and degree of market risk that may be undertaken. These risks are managed by the Company’s Chief Financial Officer and Senior Vice President — Finance.

6. Investments in Unconsolidated Entities

Investments in Unconsolidated Real Estate Entities

The Company accounts for investments in unconsolidated real estate entities that are not considered variable interest entities under FIN 46 in accordance with SOP 78-9 and APB Opinion No. 18. The Company applies the equity method of accounting to an investment in an entity if it owns greater than 20% of the equity value or has significant and disproportionate influence over that entity. At June 30, 2005, the Company’s investments in unconsolidated real estate entities accounted for under the equity method of accounting consisted of:

	•		a general partnership interest in a partnership that owns the Avalon Run community, in which after the partnership makes certain distributions to the third-party partner, the Company will generally be entitled to receive 40% of all operating cash flow distributions and 49% of all residual cash flow following a sale;
	•		a limited liability company membership interest in a limited liability company that owns the Avalon Grove community, in which after the limited liability company makes certain distributions to the third-party partner, the Company will generally be entitled to receive 50% of all distributions;
	•		a 25% limited liability company membership interest (with a right to 50% of distributions after achievement of a threshold return) in a limited liability company that owns the Avalon Bedford community;
	•		a 20% limited liability company membership interest (with a right to 50% of distributions after achievement of a threshold return) in the limited liability company that is developing and will own the Avalon Chrystie Place I community;
	•		a 25% limited liability company membership interest (with a right to 45% of distributions after achievement of a threshold return) in the limited liability company that is developing and will own the Mission Bay North II community; and
	•		a 15.2% combined general partner and indirect limited partner equity interest in AvalonBay Value Added Fund, L.P. (the “Fund”), which owns the Redondo Beach, Avalon Lakeside, Hobbits Grove and Ravenswood communities.

The following is a combined summary of the financial position of the entities accounted for using the equity method, as of the dates presented:

		(Unaudited)
		6-30-05				12-31-04
Assets:
Real estate, net		$	375,789			$	221,236
Other assets			77,145				86,821
Total assets		$	452,934			$	308,057
Liabilities and partners’ equity:
Mortgage notes payable and credit facility		$	241,678			$	139,500
Other liabilities			31,175				32,579
Partners’ equity			180,081				135,978
Total liabilities and partners’ equity		$	452,934			$	308,057

The following is a combined summary of the operating results of the entities accounted for using the equity method, for the periods presented:

		For the three months ended								For the six months ended
		(unaudited)								(unaudited)
		6-30-05				6-30-04				6-30-05				6-30-04
Rental income		$	8,061			$	5,343			$	13,815			$	10,450
Operating and other expenses			(4,825	)			(2,030	)			(8,194	)			(4,102	)
Interest expense, net			(1,387	)			(443	)			(1,942	)			(893	)
Depreciation expense			(1,804	)			(999	)			(2,917	)			(2,002	)
Net income		$	45			$	1,871			$	762			$	3,453

The Company has also entered into two agreements whereby upon completion of construction of two communities currently under construction, the communities will each be owned through a joint venture arrangement. The Company will retain a 30% equity interest in one of the joint ventures, but will not retain an equity interest (only a residual profits interest) in the second joint venture.

7. Discontinued Operations – Real Estate Assets Sold or Held for Sale

During the six months ended June 30, 2005, the Company sold three communities, one located in San Diego, California, one located in the San Jose, California area and one located in the Fairfield-New Haven, Connecticut area. These three communities, which contained a total of 531 apartment homes, were sold for an aggregate sales price of $116,950, resulting in net proceeds, net of selling costs, of $114,942 and a gain calculated in accordance with GAAP of $60,261.

In addition, as of June 30, 2005, the Company had one community that qualified as held for sale under the provisions of SFAS No. 144. As required under SFAS No. 144, the operations for any communities sold from January 1, 2004 through June 30, 2005 and communities held for sale as of June 30, 2005 have been presented as discontinued operations in the accompanying Condensed Consolidated Financial Statements. Accordingly, certain reclassifications have been made in prior periods to reflect discontinued operations consistent with current period presentation. The following is a summary of income from discontinued operations for the periods presented:

		For the three months ended								For the six months ended
		6-30-05				6-30-04				6-30-05				6-30-04
Rental income		$	1,052			$	6,320			$	3,615			$	13,575
Operating and other expenses			(259	)			(2,202	)			(1,023	)			(4,602	)
Interest expense, net			—				(118	)			—				(371	)
Minority interest expense			—				(12	)			—				(25	)
Depreciation expense			—				(1,224	)			(140	)			(2,575	)
Income from discontinued operations		$	793			$	2,764			$	2,452			$	6,002

The Company’s Condensed Consolidated Balance Sheets include other assets (excluding net real estate) of $95 and $482, and other liabilities of $284 and $1,007 as of June 30, 2005 and December 31, 2004, respectively, relating to real estate assets sold or held for sale. The estimated proceeds less anticipated costs to sell the real estate asset held for sale as of June 30, 2005 are greater than the carrying value as of June 30, 2005, and therefore no provision for possible loss was recorded.

During the six months ended June 30, 2005, the Company sold two parcels of land, one located in Seattle, Washington and one located in the Oakland-East Bay area, for an aggregate sales price of $23,000. The Company recorded an impairment loss in the amount of $3,000 in 2002 related to one of these land parcels to reflect the land at fair value based on its entitlement status at the time it was determined planned for disposition. The sale of these two land parcels resulted in an aggregate GAAP gain of $4,617.

8. Segment Reporting

The Company’s reportable operating segments include Established Communities, Other Stabilized Communities, and Development/Redevelopment Communities. Annually as of January 1^st, the Company determines which of its communities fall into each of these categories and maintains that classification, unless disposition plans regarding a community change, throughout the year for the purpose of reporting segment operations.

	•		Established Communities (also known as Same Store Communities) are communities where a comparison of operating results from the prior year to the current year is meaningful, as these communities were owned and had stabilized occupancy and operating expenses as of the beginning of the prior year. For the year 2005, the Established Communities are communities that had stabilized occupancy and operating expenses as of January 1, 2004, are not conducting or planning to conduct substantial redevelopment activities and are not held for sale or planned for disposition within the current year. A community is considered to have stabilized occupancy at the earlier of (i) attainment of 95% physical occupancy or (ii) the one-year anniversary of completion of development or redevelopment. The number of Established Communities was adjusted during the three months ended June 30, 2005 to reflect changes in the Company’s disposition program. All amounts for Established Communities have been adjusted from amounts previously reported to reflect this new classification.
	•		Other Stabilized Communities includes all other completed communities that have stabilized occupancy, as defined above. Other Stabilized Communities do not include communities that are conducting or planning to conduct substantial redevelopment activities within the current year.
	•		Development/Redevelopment Communities consists of communities that are under construction and have not received a final certificate of occupancy, communities where substantial redevelopment is in progress or is planned to begin during the current year and communities under lease-up, that had not reached stabilized occupancy, as defined above, as of January 1, 2004.

In addition, the Company owns land held for future development and has other corporate assets that are not allocated to an operating segment.

SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” requires that segment disclosures present the measure(s) used by the chief operating decision maker for purposes of assessing such segments’ performance. The Company’s chief operating decision maker is comprised of several members of its executive management team who use Net Operating Income (“NOI”) as the primary financial measure for

Established and Other Stabilized Communities. NOI is defined by the Company as total property revenue less direct property operating expenses, including property taxes, and excludes corporate-level income (including management, development and other fees), corporate-level property management and other indirect operating expenses, investments and investment management, interest income and expense, general and administrative expense, equity in income of unconsolidated entities, minority interest in consolidated partnerships, venture partner interest in profit-sharing, depreciation expense, cumulative effect of change in accounting principle, gain on sale of real estate assets and income from discontinued operations. Although the Company considers NOI a useful measure of a community’s or communities’ operating performance, NOI should not be considered an alternative to net income or net cash flow from operating activities, as determined in accordance with GAAP.

A reconciliation of NOI to net income for the three and six months ended June 30, 2005 and 2004 is as follows:

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

The following table provides details of the Company’s segment information as of the dates specified. 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. The accounting policies applicable to the operating segments described above are the same as those described in Note 1, “Organization and Significant Accounting Policies.” Segment information for the three and six months ending June 30, 2005 and 2004 has been adjusted for the communities that were designated as held for sale as of June 30, 2005 or sold from January 1, 2004 through June 30, 2005 as described in Note 7, “Discontinued Operations – Real Estate Assets Sold or Held for Sale.”

		For the three months ended																For the six months ended
		Total								% NOI change				Gross				Total								% NOI change				Gross
		revenue				NOI				from prior year				real estate (1)				revenue				NOI				from prior year				real estate (1)
For the periods ended June 30, 2005
Established
Northeast		$	41,597			$	27,742				(0.6	%)		$	1,056,726			$	82,574			$	55,110				2.5	%		$	1,056,726
Mid-Atlantic			16,985				11,974				3.1	%			386,622				33,483				23,702				1.6	%			386,622
Midwest			2,798				1,798				16.2	%			91,180				5,515				3,475				11.4	%			91,180
Pacific Northwest			7,393				4,812				8.6	%			314,873				14,700				9,608				7.4	%			314,873
Northern California			37,622				25,964				2.6	%			1,520,691				74,874				51,644				2.1	%			1,520,691
Southern California			12,037				8,673				5.7	%			330,297				23,922				17,318				5.5	%			330,297
Total Established			118,432				80,963				2.5	%			3,700,389				235,068				160,857				3.0	%			3,700,389
Other Stabilized			24,181				16,042				n/a				818,608				47,295				30,808				n/a				818,608
Development / Redevelopment			27,823				17,905				n/a				1,048,027				54,899				35,269				n/a				1,048,027
Land Held for Future Development			n/a				n/a				n/a				211,119				n/a				n/a				n/a				211,119
Non-allocated (2)			1,441				n/a				n/a				22,019				2,054				n/a				n/a				22,019
Total		$	171,877			$	114,910				9.6	%		$	5,800,162			$	339,316			$	226,934				11.0	%		$	5,800,162
For the periods ended June 30, 2004
Established
Northeast		$	37,167			$	25,363				(0.8	%)		$	914,298			$	73,394			$	48,840				(3.0	%)		$	914,298
Mid-Atlantic			12,936				9,108				4.2	%			272,915				25,649				18,051				3.7	%			272,915
Midwest			2,682				1,547				1.7	%			90,665				5,341				3,120				6.0	%			90,665
Pacific Northwest			7,915				4,924				2.9	%			346,730				15,776				9,901				0.7	%			346,730
Northern California			33,382				23,291				(6.3	%)			1,339,815				66,793				46,683				(8.1	%)			1,339,815
Southern California			13,849				9,799				2.4	%			400,816				27,721				19,650				0.9	%			400,816
Total Established			107,931				74,032				(1.3	%)			3,365,239				214,674				146,245				(3.0	%)			3,365,239
Other Stabilized			27,421				17,672				n/a				1,015,933				54,133				34,840				n/a				1,015,933
Development / Redevelopment			21,856				13,116				n/a				953,213				40,369				23,313				n/a				953,213
Land Held for Future Development			n/a				n/a				n/a				102,418				n/a				n/a				n/a				102,418
Non-allocated (2)			206				n/a				n/a				20,784				447				n/a				n/a				20,784
Total		$	157,414			$	104,820				8.6	%		$	5,457,587			$	309,623			$	204,398				6.2	%		$	5,457,587

9. Related Party Arrangements

Unconsolidated Entities

The Company manages several unconsolidated real estate entities for which it receives management fee, asset management fee and development fee revenue. From these entities the Company received management fee revenue of $1,323 and $1,746 in the three and six months ended June 30, 2005, respectively, and $181 and $351 in the three and six months ended June 30, 2004, respectively.

In addition, in connection with the general contractor services that the Company provides to CVP I, LLC, the entity that owns and is developing Avalon Chrystie Place I, the Company has funded certain construction costs on behalf of CVP I, LLC and expects to be reimbursed through draws on the related construction loan. As of June 30, 2005 and December 31, 2004, the Company has recorded a receivable from CVP I, LLC in the amounts of $8,018 and $19,983, respectively. The Company provides similar services to Mission Bay Venture Partners, LLC, the entity that owns and is developing Avalon at Mission Bay North II. The Company has funded $8,798 in construction costs on behalf of Mission Bay Venture Partners, LLC as of June 30, 2005 and has recorded a corresponding receivable from Mission Bay Venture Partners, LLC. The Company expects to be reimbursed through draws on a construction loan. These receivables are included in prepaid expenses and other assets on the accompanying Condensed Consolidated Balance Sheets.

Director Compensation

The Company’s 1994 Plan provides that directors of the Company who are also employees receive no additional compensation for their services as a director. In accordance with the Company’s 1994 Plan, as then in effect, on the fifth business day following the Company’s May 2003 Annual Meeting of Stockholders, each of the Company’s non-employee directors automatically received options to purchase 7,000 shares of common stock at the last reported sale price of the common stock on the NYSE on such date, and a restricted stock grant (or, in lieu thereof, a deferred stock award) of 2,500 shares of common stock. On May 14, 2003, the Company’s Board of Directors approved an amendment to the 1994 Plan pursuant to which, in lieu of the stock and option awards described above, each non-employee director would receive, following the 2004 Annual Meeting of Stockholders and each annual meeting thereafter, (i) a number of shares of restricted stock (or deferred stock awards) having a value of $100 based on the last reported sale price of the common stock on the NYSE on the fifth business day following the prior year’s annual meeting and (ii) $30 cash, payable in quarterly installments of $7.5. A non-employee director may elect to receive all or a portion of such cash payment in the form of a deferred stock award. In addition, the Lead Independent Director receives an annual fee of $30 payable in equal monthly installments of $2.5. The Company recorded non-employee director compensation expense relating to the restricted stock grants, deferred stock awards and stock options in the amount of $234 and $452 in the three and six months ended June 30, 2005, respectively, and $226 and $456 in the three and six months ended June 30, 2004, respectively. Deferred compensation relating to these restricted stock grants, deferred stock awards and stock options was $1,043 and $748 on June 30, 2005 and December 31, 2004, respectively.

10. Subsequent Events

On July 1, 2005, the Company sold Avalon Crossing, a 132 apartment home community located in the Washington, DC area for a gross sales price of $44,500, resulting in a GAAP gain of approximately $33,400. The net proceeds of approximately $44,000 were used to reduce borrowings under the Company’s unsecured credit facility. This community was classified as held for sale under the provisions of SFAS No. 144 as of June 30, 2005 (see Note 7, “Discontinued Operations – Real Estate Assets Sold or Held for Sale”).

Avalon at Poplar Creek, a 196 apartment home community located in the Chicago, Illinois area, was acquired by the Fund on July 1, 2005 for a purchase price of $24,950. The Company’s pro rata share of the required capital investment for this acquisition is $3,780.

As of July 29, 2005, seven communities previously held for operating purposes were classified as held for sale under SFAS No. 144. These communities have a net real estate carrying value of $202,137 as of June 30, 2005. The Company is actively pursuing the disposition of these communities and expects to close on six of these dispositions during the second half of 2005.

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

We focus on the investment in and ownership and operation of apartment communities in high barrier-to-entry markets of the United States. As of July 29, 2005, we owned 139 current operating communities, which are the primary contributors to our overall operating performance. The net operating income of these communities, which is one of the financial measures that we use to evaluate community performance, is affected by the demand and supply dynamics within our markets, our rental rates and occupancy levels, and our ability to control operating costs. Our overall financial performance is also impacted by the general availability and cost of capital and the performance of our newly developed and acquired apartment communities. We seek to create long-term shareholder value by accessing capital on cost effective terms; deploying that capital to develop, redevelop and acquire apartment communities in high barrier-to-entry markets; operating apartment communities; and selling communities when they no longer meet our long-term investment strategy and when pricing is attractive.

This Form 10-Q, including the following discussion and analysis of our financial condition and results of operations, contains forward-looking statements that predict or indicate future events or trends and that do not report historical matters. Actual results or developments could differ materially from those projected in such statements as a result of the risk factors set forth on page 47 of this report. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our Condensed Consolidated Financial Statements and notes included elsewhere in this report, as well as our Annual Report filed on Form 10-K for the year ended December 31, 2004 and our quarterly reports on Form 10-Q for subsequent quarters.

Business Description and Community Information Overview

We believe that apartment communities present an attractive long-term investment opportunity compared to other real estate investments because a broad potential resident base should help reduce demand volatility over a real estate cycle. We intend to continue to pursue real estate investments in markets where constraints to new supply exist, and where new rental household formations are expected to out-pace multi-family permit activity over the course of the real estate cycle. Barriers-to-entry in our markets generally include a difficult and lengthy entitlement process with local jurisdictions and dense urban or suburban areas where zoned and entitled land is in limited supply.

We regularly evaluate the allocation of our investments by the amount of invested capital and by product type within our individual markets, which are located in the Northeast, Mid-Atlantic, Midwest, Pacific Northwest, and Northern and Southern California regions of the United States. Our strategy is to more deeply penetrate these markets with a broad range of products and services and an intense focus on our customer. A substantial majority of our communities are upscale, which generally command among the highest rents in their markets. However, we also pursue the ownership and operation of apartment communities that target a variety of customer segments and price points, consistent with our goal of offering a broad range of products and services.

We believe that, over an entire real estate cycle, lower housing affordability and the limited new supply of apartment homes in our markets will result in a higher propensity to rent and larger increases in cash flow relative to other markets. However, throughout the real estate cycle, apartment market fundamentals, and therefore operating cash flows, are affected by overall economic conditions. A number of our markets experienced economic contraction due to job losses in 2002 and 2003, particularly in the technology, telecom and financial services sectors. This resulted in a prolonged period of weak apartment market fundamentals as reflected in declining rental rates and demand. However, 2004 was a year of transition, where the economy showed signs of an early phase recovery, as evidenced by modest job growth and declining unemployment claims. The improvement in the economic environment has resulted in more stabilized apartment market fundamentals, and 2005 is proving to be a year of continued growth.

This is supported by the following operating results achieved within our Established Community portfolio during the three months ending June 30, 2005:

	•		we achieved both sequential and year-over-year revenue growth, the largest year-over-year increase in over three years and the largest sequential increase in over four years;
	•		we reached a transition point in drivers of rental rate growth, shifting from occupancy gains to increases in rental rates as the primary driver;
	•		we achieved the highest year-over-year increase in average rental rates in three years; and
	•		economic occupancy remained at approximately 95% in each of our markets, despite increases in rental rates.

For the remainder of 2005, we expect continued job growth in our markets and additional apartments taken off the rental market through condominium conversion. Accordingly, apartment market fundamentals (the demand/supply balance) will continue to improve such that apartment rental demand will outpace new supply. The improvement may not be experienced evenly throughout our markets, as seen during the first six months of 2005, but we nevertheless expect continued overall revenue growth for our Established Community portfolio in 2005.

In anticipation of continued improvement in apartment fundamentals and stronger apartment demand, we have been increasing our development volume. We continue to secure new Development Rights, as discussed below, including the acquisition of land for future development, and we anticipate having close to $950,000,000 under construction by the end of 2005 (measured by total capitalized cost of the communities, including the portions owned by joint venture partners, at completion).

We continue to look for acquisition opportunities through our investment in and management of a discretionary investment fund (the “Fund”), which during its investment period, will be our exclusive vehicle for acquiring apartment communities, subject to certain exceptions. The acquisition environment is currently very competitive, particularly as a result of the condominium market, and therefore we will continue to be selective and focus on only those acquisition opportunities where we believe we can create value, generally through redevelopment or repositioning opportunities.

The competitive acquisition environment and the strength of the condominium market results in an attractive selling environment. There continues to be strong institutional demand for high-quality apartment communities, particularly from condominium converters. We continue to be an opportunistic seller, disposing of three apartment communities in the first six months of 2005. We anticipate continuing disposition activity and have increased our expectation for disposition volume to approximately $500,000,000 for the full year 2005 in response to the strong demand for product in our markets. While the active condominium market has created demand for multi-family apartment communities, it has also created a challenging environment for us in other ways, such as:

	•		increased competition for land and subcontractors;
	•		increased competition for experienced multi-family development and construction professionals, particularly in our markets;
	•		increased competition for our customers, resulting in increased move-outs due to home ownership; and
	•		increased risk of potential liability from disposing of communities to condominium converters.

Our real estate investments consist primarily of current operating apartment communities, communities in various stages of development (“Development Communities”) and Development Rights as defined below. Our current operating communities are further distinguished as Established Communities, Other Stabilized Communities, Lease-Up Communities and Redevelopment Communities. The following is a description of each category:

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

•

Established Communities (also known as Same Store Communities) are communities where a comparison of operating results from the prior year to the current year is meaningful, as these communities were owned and had

			stabilized occupancy and operating expenses as of the beginning of the prior year. We determine which of our communities fall into the Established Communities category as of January 1st of each year and maintain that classification throughout the year, unless disposition plans regarding a community change. For the year 2005, the Established Communities were communities that had stabilized occupancy and operating expenses as of January 1, 2004 and were not conducting or planning to conduct substantial redevelopment activities, as described below, and were not held for sale or planned for disposition in 2005. We consider a community to have stabilized occupancy at the earlier of (i) attainment of 95% physical occupancy or (ii) the one-year anniversary of completion of development or redevelopment. The number of Established Communities was adjusted during the three months ended June 30, 2005 to reflect changes in the Company’s disposition program. All amounts for Established Communities have been adjusted from amounts previously reported to reflect this new classification.
	•		Other Stabilized Communities includes all other completed communities that have stabilized occupancy, as defined above. Other Stabilized Communities do not include communities that are conducting or planning to conduct substantial redevelopment activities within the current year.
	•		Lease-Up Communities are communities where construction has been complete for less than one year and where physical occupancy has not reached 95%.
	•		Redevelopment Communities are communities where substantial redevelopment is in progress or is planned to begin during the current year. Redevelopment is considered substantial when capital invested during the reconstruction effort exceeds the lesser of $5,000,000 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 either have an option to acquire land or to enter into a leasehold interest, for which we are the buyer under a long-term conditional contract to purchase land or where we own land to develop a new community. We capitalize related pre-development costs incurred in pursuit of new developments for which we currently believe future development is probable.

In addition, we own our corporate office building and a regional office building, in Alexandria, Virginia and New Canaan, Connecticut, respectively, with an aggregate of approximately 77,000 square feet of office space. All other regional and administrative offices are leased under operating leases.

As of June 30, 2005, our communities were classified as follows:

		Number of				Number of
		communities				apartment homes
Current Communities
Established Communities:
Northeast			30				7,657
Mid-Atlantic			13				4,247
Midwest			3				887
Pacific Northwest			10				2,500
Northern California			31				9,069
Southern California			10				3,207
Total Established			97				27,567
Other Stabilized Communities:
Northeast			19				5,641
Mid-Atlantic			7				2,238
Midwest			1				409
Pacific Northwest			2				638
Northern California			1				135
Southern California			4				1,391
Total Other Stabilized			34				10,452
Lease-Up Communities			4				968
Redevelopment Communities			4				1,491
Total Current Communities			139				40,478
Development Communities			11				2,593
Development Rights			46				12,216