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, 2007

Commission file number 1-12672

AVALONBAY COMMUNITIES, INC.

(Exact name of registrant as specified in its charter)

Maryland (State or other jurisdiction of incorporation or organization)		77-0404318 (I.R.S. Employer 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           No o

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

Large accelerated filer þ           Accelerated filer o           Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).

Yes o           No þ

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:

79,646,291 shares of common stock, par value $0.01 per share, were outstanding as of April 30, 2007

 

 

AVALONBAY COMMUNITIES, INC.
FORM 10-Q
INDEX

		Page
PART I — FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets as of March 31, 2007 (unaudited) and December 31, 2006			2
Condensed Consolidated Statements of Operations and Other Comprehensive Income (unaudited) for the three months ended March 31, 2007 and 2006 (restated)			3
Condensed Consolidated Statements of Cash Flows (unaudited) for the three months ended March 31, 2007 and 2006 (restated)			4-5
Notes to Condensed Consolidated Financial Statements (unaudited)			6-26
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			27-50
Item 3. Quantitative and Qualitative Disclosures About Market Risk			51
Item 4. Controls and Procedures			51
PART II — OTHER INFORMATION
Item 1. Legal Proceedings			51
Item 1a. Risk Factors			51
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			51-52
Item 3. Defaults Upon Senior Securities			52
Item 4. Submission of Matters to a Vote of Security Holders			52
Item 5. Other Information			52
Item 6. Exhibits			52-54
SIGNATURES			54

EXPLANATORY NOTE

We have filed Amendment No. 1 on Form 10-K/A to our Annual Report on Form 10-K for the fiscal year ended December 31, 2006 filed on March 1, 2007 (the “Form 10-K”) (1) to restate our financial statements as of December 31, 2006, 2005 and 2004 and for the years then ended and to amend other Items contained in the Form 10-K to reflect such restatement, and (2) to correct a typographical error in the description of the Second Amended and Restated Revolving Loan Agreement of the Company referenced as Exhibit 10.32 to the Form 10-K. In addition we have restated our financial statements for the three months ended March 31, 2006. This restatement is reported in this Quarterly Report on Form 10-Q for the quarter ended March 31, 2007. We have not amended and do not anticipate amending our Annual Reports on Form 10-K for any years prior to fiscal year 2006, nor will we be amending any of our previously filed Quarterly Reports on Form 10-Q. The financial statements and other information that have been previously filed or otherwise reported for these periods should no longer be relied upon; all such prior information is superseded by the information in our Form 10-K/A and this Quarterly Report on Form 10-Q for the quarter ended March 31, 2007.

As discussed in Amendment No. 1 on our Form 10-K/A filed on May 10, 2007, this restatement revises our accounting for long-term land leases. We revised the accounting for leases with fixed, or minimum, escalations, recognizing as rental expense on a straight-line basis, the aggregate undiscounted payments required over the non-cancelable portion of the lease term, as opposed to our expected holding period of our interest in the related asset. This change primarily impacts the land lease accounting related to one consolidated asset with a 90-year lease that became effective in 1999, in which the land lessor is also our partner in the venture holding the asset. In addition, we recognized as a component of minority interest, the value associated with a provision allowing our partner in that same venture to put their interest in the venture to us based on the fair market value of the underlying real estate as a component of minority interest, with the offset to stockholders’ equity.

AVALONBAY COMMUNITIES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except per share data)

		3-31-07				12-31-06
		(unaudited)
ASSETS
Real estate:
Land		$	993,964			$	958,254
Buildings and improvements			4,697,012				4,597,435
Furniture, fixtures and equipment			147,047				143,480
			5,838,023				5,699,169
Less accumulated depreciation			(1,148,518	)			(1,104,507	)
Net operating real estate			4,689,505				4,594,662
Construction in progress, including land			685,665				641,781
Land held for development			315,241				209,568
Operating real estate assets held for sale, net			64,680				64,351
Total real estate, net			5,755,091				5,510,362
Cash and cash equivalents			356,435				8,567
Cash in escrow			132,123				136,989
Resident security deposits			28,938				26,574
Investments in unconsolidated real estate entities			40,243				42,724
Deferred financing costs, net			25,656				26,343
Deferred development costs			38,932				39,365
Prepaid expenses and other assets			46,631				54,567
Total assets		$	6,424,049			$	5,845,491
LIABILITIES AND STOCKHOLDERS’ EQUITY
Unsecured notes, net		$	2,153,184			$	2,153,078
Variable rate unsecured credit facility			—				—
Mortgage notes payable			654,723				672,508
Dividends payable			69,871				60,417
Payables for construction			58,844				59,232
Accrued expenses and other liabilities			192,430				189,767
Accrued interest payable			29,229				37,236
Resident security deposits			39,819				38,803
Liabilities related to real estate assets held for sale			42,792				42,985
Total liabilities			3,240,892				3,254,026
Minority interest of unitholders in consolidated partnerships			21,950				18,311
Commitments and contingencies			—				—
Stockholders’ equity:
Preferred stock, $0.01 par value; $25 liquidation preference; 50,000,000 shares authorized at both March 31, 2007 and December 31, 2006; 4,000,000 shares issued and outstanding at both March 31, 2007 and December 31, 2006			40				40
Common stock, $0.01 par value; 140,000,000 shares authorized at both March 31, 2007 and December 31, 2006; 79,639,601 and 74,668,372 shares issued and outstanding at March 31, 2007 and December 31, 2006, respectively			796				747
Additional paid-in capital			3,099,813				2,482,516
Accumulated earnings less dividends			63,965				93,430
Accumulated other comprehensive loss			(3,407	)			(3,579	)
Total stockholders’ equity			3,161,207				2,573,154
Total liabilities and stockholders’ equity		$	6,424,049			$	5,845,491

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
		3-31-07				3-31-06
						(restated)
Revenue:
Rental and other income		$	195,262			$	173,952
Management, development and other fees			1,444				1,207
Total revenue			196,706				175,159
Expenses:
Operating expenses, excluding property taxes			57,718				51,724
Property taxes			17,726				16,904
Interest expense, net			23,878				28,664
Depreciation expense			44,094				40,225
General and administrative expense			6,780				6,283
Total expenses			150,196				143,800
Equity in income of unconsolidated entities			(86	)			227
Minority interest in consolidated partnerships			(449	)			(132	)
Gain on sale of land			545				13,166
Income from continuing operations			46,520				44,620
Discontinued operations:
Income from discontinued operations			—				1,075
Gain on sale of communities			—				65,419
Total discontinued operations			—				66,494
Net income			46,520				111,114
Dividends attributable to preferred stock			(2,175	)			(2,175	)
Net income available to common stockholders		$	44,345			$	108,939
Other comprehensive income:
Unrealized gain on cash flow hedges			172				541
Comprehensive income		$	44,517			$	109,480
Dividends declared per common share		$	0.85			$	0.78
Earnings per common share — basic:
Income from continuing operations (net of dividends attributable to preferred stock)		$	0.57			$	0.58
Discontinued operations			—				0.90
Net income available to common stockholders		$	0.57			$	1.48
Earnings per common share — diluted:
Income from continuing operations (net of dividends attributable to preferred stock)		$	0.56			$	0.57
Discontinued operations			—				0.88
Net income available to common stockholders		$	0.56			$	1.45

See accompanying notes to Condensed Consolidated Financial Statements.

AVALONBAY COMMUNITIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(Dollars in thousands)

		For the three months ended
		3-31-07				3-31-06
						(restated)
Cash flows from operating activities:
Net income		$	46,520			$	111,114
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation expense			44,094				40,225
Amortization of deferred financing costs and debt premium/discount			1,199				1,037
Amortization of deferred compensation			5,539				5,156
Income allocated to minority interest in consolidated partnerships			449				132
Equity in income of unconsolidated entities, net of eliminations			326				(17	)
Return on investment of unconsolidated entities			99				46
Gain on sale of real estate assets			(545	)			(78,585	)
Decrease (increase) in cash in operating escrows			4,866				(1,040	)
Decrease in resident security deposits, prepaid expenses and other assets			6,603				4,708
Decrease in accrued expenses, other liabilities and accrued interest payable			(9,962	)			(8,864	)
Net cash provided by operating activities			99,188				73,912
Cash flows provided by investing activities:
Development/redevelopment of real estate assets including land acquisitions and deferred development costs			(291,082	)			(116,853	)
Capital expenditures — existing real estate assets			(355	)			(1,909	)
Capital expenditures — non-real estate assets			(568	)			(188	)
Proceeds from sale of real estate assets, net of selling costs			5,129				179,022
Increase (decrease) in payables for construction			(388	)			4,832
Decrease in cash in construction escrows			—				19,572
Decrease in investments in unconsolidated real estate entities			1,998				657
Net cash (used in) provided by investing activities			(285,266	)			85,133
Cash flows from financing activities:
Issuance of common stock			612,744				12,500
Dividends paid			(60,342	)			(54,454	)
Net borrowings under unsecured credit facility			—				(66,800	)
Issuance of mortgage notes payable							5,150
Repayments of mortgage notes payable			(17,785	)			(1,546	)
Repayment of unsecured notes			—				(4,000	)
Payment of deferred financing costs			(406	)			—
Distributions to DownREIT partnership unitholders			(88	)			(99	)
Distributions to joint venture and profit sharing partners			(177	)			(33	)
Net cash provided by (used in) financing activities			533,946				(109,282	)
Net increase in cash and cash equivalents			347,868				49,763
Cash and cash equivalents, beginning of period			8,567				6,138
Cash and cash equivalents, end of period		$	356,435			$	55,901
Cash paid during year for interest, net of amount capitalized		$	36,052			$	33,957

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 three months ended March 31, 2007:

	•		As described in Note 4, “Stockholders’ Equity,” 69,576 shares of common stock valued at $10,279 were issued in connection with stock grants, 534 shares valued at $73 were issued through the Company’s dividend reinvestment plan, 38,692 shares valued at $4,329 were withheld to satisfy employees’ tax withholding and other liabilities and 1,904 shares valued at $70 were forfeited, for a net value of $5,953. In addition, the Company granted 335,856 options for common stock, net of forfeitures, at a value of $7,417.
	•		15,173 units of limited partnership, valued at $737, 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 recorded a decrease to other liabilities of $194 and a gain to other comprehensive income of $172 to adjust the Company’s Hedging Derivatives (as defined in Note 5, “Derivative Instruments and Hedging Activities”) to their fair value.
	•		Common and preferred dividends declared but not paid totaled $69,871.

During the three months ended March 31, 2006:

	•		118,191 shares of common stock valued at $11,960 were issued in connection with stock grants, 233 shares valued at $22 were issued through the Company’s dividend reinvestment plan, and 40,577 shares valued at $3,216 were withheld to satisfy employees’ tax withholding and other liabilities, for a net value of $8,766. In addition, the Company granted 859,613 options for common stock, net of forfeitures, at a value of $9,816.
	•		301,298 units of limited partnership, valued at $13,953, 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 recorded a decrease to other liabilities and a corresponding gain to other comprehensive income of $541 to adjust the Company’s Hedging Derivatives to their fair value.
	•		Common and preferred dividends declared but not paid totaled $60,161.

AVALONBAY COMMUNITIES, INC.

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 (“the Code”), 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. The Company is the surviving corporation from the merger (the “Merger”) of Bay Apartment Communities, Inc., and Avalon Properties, Inc. on June 4, 1998.
		At March 31, 2007, the Company owned or held a direct or indirect ownership interest in 155 operating apartment communities containing 44,353 apartment homes in ten states and the District of Columbia, of which six communities containing 2,054 apartment homes were under reconstruction. In addition, the Company owned or held a direct or indirect ownership interest in 16 communities under construction that are expected to contain an aggregate of 5,049 apartment homes when completed. The Company also owned or held a direct or indirect ownership interest in rights to develop an additional 56 communities that, if developed in the manner expected, will contain an estimated 14,809 apartment homes.
		During the three months ended March 31, 2007:

	•		The Company completed the development of two communities, Avalon at Chestnut Hill and Avalon at Decoverly II. Avalon at Chestnut Hill, located in Chestnut Hill, Massachusetts, is a mid-rise community containing 204 homes and was completed for a total capitalized cost of $61,200. Avalon at Decoverly II, the second phase of a two-phase community located in Rockville, Maryland, is a garden-style community containing 196 homes and was completed for a total capitalized cost of $30,800.
	•		The Company commenced construction of Avalon Morningside Park, located in New York, New York. Avalon Morningside Park is expected to have 296 apartment homes when completed for a total projected capitalized cost of $125,500.
	•		The Company completed the redevelopment of Avalon Arlington Heights, located in Arlington Heights, Illinois. Avalon Arlington Heights is a high-rise community with 409 apartment homes and redevelopment was completed for a total capitalized cost of $6,700, excluding costs incurred prior to redevelopment.
	•		The Company purchased a parcel of land located in Brooklyn, New York for approximately $70,000. The Company expects to begin construction of a 628 apartment home high-rise community in the second half of 2007.
	•		In conjunction with the inclusion of its common stock in the S&P 500 Index, the Company issued 4,600,000 shares of its common stock at $129.30 per share. Net proceeds of approximately $594,000 will be used for general corporate purposes.
	•		The Company sold a parcel of land in Kensington, Maryland through a taxable REIT subsidiary for a sales price of $5,800, resulting in a gain in accordance with generally accepted accounting principles (“GAAP”) of $545.
	•		AvalonBay Value Added Fund, L.P. (the “Fund”), the private, discretionary investment vehicle in which the Company holds an equity interest of approximately 15%, acquired three communities. The Fund also commenced redevelopment of Fuller Martel, located in Los Angeles, California. Fuller Martel is a garden-style community containing 82 homes and the projected total capitalized cost for redevelopment is $3,400, excluding costs incurred prior to redevelopment. See Note 6, “Investments in Unconsolidated Entities.”

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/A for the year ended December 31, 2006. The results of operations for the three months ended March 31, 2007 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 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 FASB Interpretation No. 46 (“FIN 46(R)”), “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51,” as revised in December 2003. All significant intercompany balances and transactions have been eliminated in consolidation.

The Company assesses consolidation of variable interest entities under the guidance of FIN 46(R). The Company accounts for joint venture entities and subsidiary partnerships, including those structured as DownREITs, that are not variable interest entities, in accordance with 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”, Statement of Position (“SOP”) 78-9, “Accounting for Investments in Real Estate Ventures”, Accounting Principles Board (“APB”) Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock” and EITF Topic D-46, “Accounting for Limited Partnership Investments.” The Company uses EITF Issue No. 04-5 to evaluate the partnership of each joint venture entity and determine whether control over the partnership, as defined by the EITF, lies with the general partner, or the limited partners, when the limited partners have certain rights. The general partner in a limited partnership is presumed to control that limited partnership, unless that presumption is overcome by the limited partners having 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. If the Company is the general partner and has control over the partnership, or if the Company’s limited partnership ownership includes the ability to dissolve the partnership, or has substantive participating rights, as discussed above, the Company consolidates the investments. If the Company is not the general partner, or the Company’s partnership interest does not contain either of the above terms which overcome the presumption of control in a limited partnership residing with the general partner, the Company then looks to the guidance in SOP 78-9, APB 18 and EITF D-46 to determine the accounting framework to apply. The Company generally uses the equity method to account for these investments unless its ownership interest is so minor that it has virtually no influence over the partnership operating and financial policies. Investments in which the Company has little or no influence are accounted for using the cost method.

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. 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 cash redemption, the Company may elect to exchange such units for an equal number of shares of the Company’s common stock.

In conjunction with the acquisition and development of investments in unconsolidated entities, the Company may incur costs in excess of its equity in the underlying assets. These costs are capitalized and depreciated over the life of the underlying assets to the extent that the Company expects to recover the costs.

Revenue and Gain 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.

The Company accounts for sales of real estate assets and the related gain recognition in accordance with SFAS No. 66, “Accounting for Sales of Real Estate.”

Real Estate

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. Significant expenditures which improve or extend the life of an asset are capitalized. 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 the Company has determined that development of the future asset is probable and ends when the asset, or a portion of an asset, is delivered and is ready for its intended use. 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 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, making future development by the Company no longer probable, any capitalized pre-development costs are written-off with a charge to expense. The Company expensed costs related to abandoned pursuits, which includes the abandonment or impairment of Development Rights, acquisition pursuits and disposition pursuits, in the amounts of $787 and $322 for the three months ended March 31, 2007 and 2006, respectively. These costs are included in operating expenses, excluding property taxes on the accompanying Condensed Consolidated Statements of Operations and Other Comprehensive Income. Abandoned pursuit costs can vary greatly, and the costs incurred in any given period may be significantly different in future years.

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 on the accompanying Condensed Consolidated Balance Sheets 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.

It is the Company’s policy to perform a quarterly qualitative analysis to determine if there are changes in circumstances that suggest the carrying value of a long-lived asset may not be recoverable. If there is an event or change in circumstance that indicates an impairment in the value of an operating community, the Company compares 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. The Company did not recognize an impairment loss on any of its operating communities during the three months ended March 31, 2007 or 2006.

Deferred Financing Costs

Deferred financing costs include fees and other expenditures necessary 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 $17,284 at March 31, 2007 and was $16,179 at December 31, 2006.

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. Cash in escrow consists primary of construction financing proceeds that is restricted for use in the construction of a specific community. The majority of the Company’s cash, cash equivalents and cash in escrows are 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 cash flow 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.” This statement 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. For cash flow hedge relationships, changes in the fair value of the derivative instrument that are deemed effective at offsetting the risk being hedged are reported in other comprehensive income. For cash flow hedges where the cumulative changes in the fair value of the derivative exceed the cumulative changes in fair value of the hedged item, the ineffective portion is recognized in current period earnings. As of March 31, 2007 and December 31, 2006, the Company had approximately $234,000 and $277,000, respectively, in variable rate debt subject to cash flow hedges. As of March 31, 2007, the Company had an additional $33,100 in variable rate debt which is subject to an interest rate cap for which hedge accounting was not applied. See Note 5, “Derivative Instruments and Hedging Activities,” for further discussion of derivative financial instruments.

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 effective portion of the cumulative changes in the fair value of derivatives in qualifying cash flow hedge relationships.

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
		3-31-07				3-31-06
						(restated)
Basic and diluted shares outstanding
Weighted average common shares — basic			78,431,936				73,808,643
Weighted average DownREIT units outstanding			144,586				237,575
Effect of dilutive securities			1,354,226				1,243,906
Weighted average common shares — diluted			79,930,748				75,290,124
Calculation of Earnings per Share — basic
Net income available to common stockholders		$	44,345			$	108,939
Weighted average common shares — basic			78,431,936				73,808,643
Earnings per common share — basic		$	0.57			$	1.48
Calculation of Earnings per Share — diluted
Net income available to common stockholders		$	44,345			$	108,939
Add: Minority interest of DownREIT unitholders in consolidated partnerships, including discontinued operations			88				99
Adjusted net income available to common stockholders		$	44,433			$	109,038
Weighted average common shares — diluted			79,930,748				75,290,124
Earnings per common share — diluted		$	0.56			$	1.45

Certain options to purchase shares of common stock in the amounts of 335,856 and 3,000 were outstanding during the three months ended March 31, 2007 and 2006, respectively but were not included in the computation of diluted earnings per share because in applying the treasury stock method under the provisions of SFAS No. 123(R), such options are anti-dilutive.

Stock-Based Compensation

The Company adopted the provisions of SFAS No. 123(R), “Share Based Payment,” using the modified prospective transition method on January 1, 2006. The adoption of SFAS No. 123(R) did not have a material impact on the Company’s financial position or results of operations. However, the adoption of SFAS No. 123(R) changed the service period for, and timing of, the recognition of compensation cost related to retirement eligibility, which will generally result in accelerated expense recognition by the Company for its stock-based compensation programs. Under the provisions of SFAS No. 123(R), the Company is required to estimate the forfeiture of stock options and recognize compensation cost net of the estimated forfeitures. The estimated forfeitures included in compensation cost are adjusted to reflect actual forfeitures at the end of the vesting period. Prior to the adoption of SFAS No. 123(R), option forfeitures were recognized as they occurred. The forfeiture rate at March 31, 2007 was 2.5%. The application of estimated forfeitures did not materially impact compensation expense for the three months ended March 31, 2007 and 2006.

Legal and Other Contingencies

The Company is currently involved in litigation alleging that 100 communities owned by the Company, at the time of the suit, violate the accessibility requirements of the Fair Housing Act and the Americans with Disabilities Act. The lawsuit, Equal Rights Center v. AvalonBay Communities, Inc, was filed on September 23, 2005 in the federal district court in Maryland. The plaintiff seeks compensatory and punitive damages in unspecified amounts as well as injunctive relief (such as modification of existing assets), an award of attorneys’ fees, expenses and costs of suit. The Company has

filed a motion to dismiss all or parts of the suit, which has not been ruled on yet by the court. We cannot predict or determine the outcome of this lawsuit, nor is it reasonably possible to estimate the amount of loss, if any, that would be associated with an adverse decision.

During 2006, the Company determined that contaminated soil from imported fill was delivered to its Avalon Lyndhurst development site by third parties. The contaminants exceeded allowable levels for residential use under New Jersey state and local regulations. The remediation effort is substantially complete. The Company has estimated that the net cost associated with this remediation effort after considering insurance proceeds received to date, including costs associated with construction delays, necessary to complete construction and commence operations, is expected to be approximately $6,000. The Company is pursuing the recovery of these additional net costs through its insurance as well as from the third parties involved, but no assurance can be given as to the amount or timing of additional reimbursements to the Company. The Company is recording these incremental costs as they are incurred, and potential recoveries as they become certain or are received. Although the estimated costs to complete construction of this community exceed the original construction budget, the Company does not expect that, upon completion, there will be an impairment in value of this asset which would require a write down in the carrying value. The Company will continue to review this assessment based on changes in circumstances or market conditions.

In addition, 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 currently 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. However, if these matters are resolved unfavorably, they may have a material adverse effect on the Company’s financial position and results of operations.

Assets Held for Sale & Discontinued Operations

The Company follows SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”) which requires that the assets and liabilities of any communities which have been sold, or otherwise qualify as held for sale, be presented separately in the Condensed Consolidated Balance Sheets. In addition, the results of operations for those assets that meet the definition of discontinued operations are presented as such in the Company’s Condensed Consolidated Statements of Operations and Other Comprehensive Income. Held for sale and discontinued operations classifications are provided in both the current and prior periods presented. Real estate assets held for sale are measured at the lower of the carrying amount or the fair value less the cost to sell. Both the real estate assets and corresponding liabilities 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. For those assets qualifying for classification as discontinued operations, the community specific components of net income presented as discontinued operations include net operating income, minority interest expense, depreciation expense and interest expense, net. For periods prior to the asset qualifying for discontinued operations under SFAS 144, the Company reclassified the results of operations to discontinued operations in accordance with SFAS 144. Subsequent to the reclassification to discontinued operations, the impact of assets classified as discontinued operations on the statements of operations and other comprehensive income will include depreciation. 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 held for sale or discontinued operations will not have any impact on the Company’s financial condition or results of operations. The Company combines the operating, investing and financing portions of cash flows attributable to discontinued operations with the respective cash flows from continuing operations on the accompanying Condensed Consolidated Statements of Cash Flows.

Recently Issued Accounting Standards

The Company adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an Interpretation of FASB Statement No. 109,” “FIN 48”, on January 1, 2007. The Company did not have any unrecognized tax benefits and there was no material effect on either the financial condition or results of operations of the Company as a result of implementing FIN 48. We do not believe that there will be any material changes in our unrecognized tax positions over the next 12 months. The Company is subject to examination by the respective taxing authorities for the tax years 2003 through 2005.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make certain estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses

during the reporting periods. Actual results could differ from those estimates.

Reclassifications

Certain reclassifications have been made to amounts in prior periods’ financial statements to conform to current year presentations.

2. Interest Capitalized

The Company capitalized interest during the development and redevelopment of real estate assets in accordance with SFAS No. 34, “Capitalization of Interest Cost.” Capitalized interest associated with communities under development or redevelopment totaled $15,433 for the three months ended March 31, 2007 and $8,364 for the three months ended March 31, 2006.

3. Notes Payable, Unsecured Notes and Credit Facility

The Company’s mortgage notes payable, unsecured notes and variable rate unsecured credit facility as of March 31, 2007 and December 31, 2006 are summarized below. The following amounts and discussion do not include the construction loan payable related to a community classified as held for sale as of March 31, 2007 (see Note 7, “Real Estate Disposition Activities”).

		3-31-07				12-31-06
Fixed rate unsecured notes (1)		$	2,153,184			$	2,153,078
Fixed rate mortgage notes payable — conventional and tax-exempt			217,160				234,272
Variable rate mortgage notes payable — conventional and tax-exempt			437,563				438,236
Total notes payable and unsecured notes			2,807,907				2,825,586
Variable rate unsecured credit facility			—				—
Total mortgage notes payable, unsecured notes and unsecured credit facility		$	2,807,907			$	2,825,586

During the three months ended March 31, 2007, the Company repaid an outstanding mortgage note in the amount of $15,980, secured by the operating assets of a community.

In the aggregate, secured notes payable mature at various dates from October 2008 through April 2043 and are secured by certain apartment communities and improved land parcels (with a net carrying value of $964,730 as of March 31, 2007). As of March 31, 2007, the Company has guaranteed approximately $67,316 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 March 31, 2007 and December 31, 2006. 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 5.1% at March 31, 2007 and 5.8% at December 31, 2006.

Scheduled payments and maturities of mortgage notes payable and unsecured notes outstanding at March 31, 2007 are as follows:

														Stated
										Unsecured				interest rate
		Secured notes				Secured notes				notes				of unsecured
Year		payments				maturities				maturities				notes
2007		$	6,202			$	—			$	110,000				6.875	%
											150,000				5.000	%
2008			8,163				4,368				50,000				6.625	%
											146,000				8.250	%
2009			7,236				73,793				150,000				7.500	%
2010			5,719				28,989				200,000				7.500	%
2011			4,623				35,910				300,000				6.625	%
											50,000				6.625	%
2012			3,873				12,166				250,000				6.125	%
											250,000				5.500	%
2013			3,950				—				100,000				4.950	%
2014			2,915				34,450				150,000				5.375	%
2015			4,606				—				—				—
2016			4,968				—				250,000				5.750	%
Thereafter			135,553				277,239				—				—
		$	187,808			$	466,915			$	2,156,000

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 $650,000 revolving variable rate unsecured credit facility with a syndicate of commercial banks. There were no amounts outstanding under the current facility and $37,443 outstanding in letters of credit on March 31, 2007. The Company did not have any amounts outstanding under the current credit facility and $38,713 outstanding in letters of credit on December 31, 2006. Under the terms of the credit facility, the Company may elect to increase the facility up to $1,000,000, provided that one or more banks (from the syndicate or otherwise) voluntarily agree to provide the additional commitment. 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 $813, which is subject to increase in the event that the amount available on the facility is increased. 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 0.40% per annum. The stated spread over LIBOR can vary from LIBOR plus 0.325% to LIBOR plus 1.00% based on the Company’s credit rating. 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 $422,500. The competitive bid option may result in lower pricing than the stated rate if market conditions allow. The Company had no amounts outstanding under this competitive bid option as of March 31, 2007. The Company is subject to 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. The credit facility matures in November 2011, assuming exercise of a one-year renewal option by the Company.

4. Stockholders’ Equity

The following summarizes the changes in stockholders’ equity for the three months ended March 31, 2007:

														Accumulated				Accumulated
										Additional				earnings				other
		Preferred				Common				paid-in				less				comprehensive				Stockholders'
		stock				stock				capital				dividends				loss				equity
Balance at December 31, 2006 (restated)		$	40			$	747			$	2,482,516			$	93,430			$	(3,579	)		$	2,573,154
Net income			—				—				—				46,520				—				46,520
Unrealized gain on cash flow hedges			—				—				—				—				172				172
Change in redemption value of minority interest			—				—				—				(4,376	)			—				(4,376	)
Dividends declared to common and preferred stockholders			—				—				—				(69,869	)			—				(69,869	)
Issuance of common stock, net of withholdings			—				49				610,846				(1,740	)			—				609,155
Amortization of deferred compensation			—				—				6,451				—				—				6,451
Balance at March 31, 2007		$	40			$	796			$	3,099,813			$	63,965			$	(3,407	)		$	3,161,207

During the three months ended March 31, 2007, the Company:

	(i)		Issued 4,600,000 shares of common stock in connection with an equity offering;
	(ii)		issued 326,542 shares of common stock in connection with stock options exercised;
	(iii)		issued 15,173 shares of common stock to acquire an equal number of DownREIT limited partnership units;
	(iv)		issued 534 shares through the Company’s dividend reinvestment plan;
	(v)		issued 69,576 common shares in connection with stock grants;
	(vi)		had 1,904 shares of restricted stock forfeited; and
	(vii)		withheld 38,692 shares to satisfy employees’ tax withholding and other liabilities.

In addition, the Company granted 339,429 options for common stock to employees. As required under SFAS No. 123(R), any deferred compensation related to the Company’s stock option and restricted stock grants during the three months ended March 31, 2007 is not reflected on the Company’s Condensed Consolidated Balance Sheet as of March 31, 2007 or above, and will not be reflected until earned as compensation cost.

Dividends per common share were $0.85 for the three months ended March 31, 2007 and $0.78 for the three months ended March 31, 2006. The average dividend for all non-redeemed preferred shares for the three months ended March 31, 2007 and 2006 was $0.54 per share.

In 2004, the Company resumed its Dividend Reinvestment and Stock Purchase Plan (the “DRIP”). The DRIP allows for holders of the Company’s common stock or preferred stock to purchase shares of common stock through either reinvested dividends or optional cash payments. The purchase price per share for newly issued shares of common stock under the DRIP will be equal to the last reported sale price for a share of the Company’s common stock as reported by the New York Stock Exchange (“NYSE”) on the applicable investment date.

5. Derivative Instruments and Hedging Activities

The Company enters into interest rate swap and interest rate cap agreements (collectively, the “Hedging Derivatives”) to reduce the impact of interest rate fluctuations on its variable rate, tax-exempt bonds and its variable rate conventional secured debt (collectively, the “Hedged Debt”). The Company has not entered into any interest rate hedge agreements for its conventional unsecured debt and does not enter into derivative transactions for trading or other speculative purposes. The following table summarizes the consolidated Hedging Derivatives at March 31, 2007 (dollars in thousands):

		Interest				Interest
		Rate Caps				Rate Swaps
Notional balance		$	201,787			$	65,343
Weighted average interest rate (1)			5.5	%			6.3	%
Weighted average capped interest rate			7.8	%			n/a
Earliest maturity date		Sep-07				Aug-07
Latest maturity date		Mar-14				Jun-10
Estimated derivative fair value		$	96			$	(2,838	)

At March 31, 2007, the Company had 11 derivatives designated as cash flow hedges and one derivative not designated as a hedge. For the derivative positions that the Company has determined qualify as effective cash flow hedges under SFAS No. 133, the Company has recorded the effective portion of cumulative changes in the fair value of the Hedging Derivatives in other comprehensive income. Amounts recorded in other comprehensive income will be reclassified into earnings in the periods in which earnings are affected by the hedged cash flow. To adjust the Hedging Derivatives to their fair value, the Company recorded unrealized gains in other comprehensive income of $172 and $541 during the three months ended March 31, 2007 and 2006, respectively. These amounts will be reclassified into earnings in conjunction with the periodic adjustment of the floating rates on the Hedged Debt, in interest expense, net. The amount reclassified into earnings for the three months ended March 31, 2007, as well as the estimated amount included in accumulated other comprehensive income as of March 31, 2007, expected to be reclassified into earnings within the next twelve months to offset the variability of cash flows of the hedged items during this period are not material.

The Company assesses both at inception and on an on-going basis, the effectiveness of qualifying cash flow hedges. Hedge ineffectiveness, reported as a component of general and administrative expenses, did not have a material impact on earnings of the Company for any prior period, and the Company does not anticipate that it will have a material effect in the future. The fair values of the Hedging Derivatives are included in accrued expenses and other liabilities on the accompanying Condensed Consolidated Balance Sheets.

Derivative financial instruments expose the Company to credit risk in the event of nonperformance by the counterparties under the terms of the Hedging Derivatives. The Company minimizes its credit risk on these transactions by dealing with major, creditworthy financial institutions which have an A+ or better credit rating by the Standard & Poor’s Ratings Group. As part of its on-going control procedures, the Company monitors the credit ratings of counterparties and the exposure of the Company to any single entity, thus minimizing credit risk concentration. The Company believes the likelihood of realizing losses from counterparty non-performance is remote.

6. Investments in Unconsolidated Entities

Investments in Unconsolidated Real Estate Entities

The Company accounts for its investments in unconsolidated real estate entities that are not considered variable interest entities under FIN 46(R) in accordance with EITF Issue No. 04-5. As of March 31, 2007, the Company’s investments in unconsolidated real estate entities accounted for under the equity method of accounting consisted of:

	•		a 50% 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 20% limited liability company membership interest in the limited liability company that owns the Avalon Chrystie Place I community, in which after the limited liability company makes certain distributions equaling a certain threshold return, to both the Company and its 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 45% of distributions after achievement of a threshold return) in the limited liability company that developed and owns the Avalon at Mission Bay North II community;
•		a 15.2% combined general partner and indirect limited partner equity interest in the Fund, which owns the following communities: Avalon at Redondo Beach, Avalon Lakeside, Avalon Columbia, Avalon Redmond, Avalon at Poplar Creek, Fuller Martel, Civic Center Place, Paseo Park, Aurora at Yerba Buena, Avalon at Aberdeen Station, The Springs, Cedar Valley and The Covington. During the three months ended March 31, 2007, the Fund acquired the following three communities.

	•		Centerpoint, located within a single downtown city block of Baltimore, Maryland, contains a total of 392 apartment homes and approximately 33,000 square feet of retail space, and was acquired for a purchase price of $78,500.
	•		Crystal Hill Apartments, a garden-style community consisting of 168 apartment homes located in Pomona, New York, was acquired for a purchase price of $37,800, and
	•		Middlesex Crossing Apartments, located in Billerica, Massachusetts, was acquired for a purchase price of $37,100. Middlesex Crossing Apartments is a garden-style community consisting of 252 apartment homes.

In addition, as part of the formation of the Fund, the Company provided a guarantee to one of the limited partners. The guarantee provides that, if, upon final liquidation of the Fund, the total amount of all distributions to that partner during the life of the Fund (whether from operating cash flow or property sales) does not equal the total capital contributions made by that partner, then the Company will pay the partner an amount equal to the shortfall, but in no event more than 10% of the total capital contributions made by the partner (maximum of approximately $3,400 as of March 31, 2007). As of March 31, 2007, the fair value of the real estate assets owned by the Fund is considered adequate to cover such potential payment under a liquidation scenario. The estimated fair value of and the Company’s obligation under this guarantee, both at inception and as of March 31, 2007 was not significant and therefore the Company has not recorded any obligation for this guarantee as of March 31, 2007.

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

		3-31-07				12-31-06
		(unaudited)
Assets:
Real estate, net		$	876,208			$	707,227
Other assets			33,212				55,716
Total assets		$	909,420			$	762,943
Liabilities and partners’ equity:
Mortgage notes payable and credit facility		$	660,017			$	510,784
Other liabilities			40,153				33,505
Partners’ equity			209,250				218,654
Total liabilities and partners’ equity		$	909,420			$	762,943

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
		(unaudited)
		3-31-07				3-31-06
Rental income		$	19,214			$	14,505
Operating and other expenses			(8,775	)			(6,747	)
Interest expense, net			(8,526	)			(4,908	)
Depreciation expense			(5,877	)			(3,758	)
Net income		$	(3,964	)		$	(908	)

In addition, the Company is subject to the following arrangements related to entities that are not accounted for under the equity method of accounting:

	•		The Company holds a 30% limited liability company membership interest in a limited liability company that owns the Avalon Del Rey community. In conjunction with the construction management services that the Company provided to Avalon Del Rey, the Company provided a construction completion guarantee to the construction loan lender in order to fulfill their standard financing requirements related to construction financing. The obligation of the Company under this guarantee will terminate following satisfaction of the lender’s standard completion requirements, which the Company expects to occur in 2007.
			The Company provided an operating guarantee to the third-party investor in the limited liability company that owns Avalon Del Rey. This guarantee, which extends until December 2007, provides that if the one-year return for the initial year of the joint venture partner’s investment is less than a threshold return of 7% on its initial equity investment, then the Company will pay the joint venture partner an amount equal to the shortfall, up to the 7% threshold return required. As of March 31, 2007, the cash flows and return on investment for Avalon Del Rey are expected to meet and exceed the initial year threshold return required by our joint venture partner. As a result, the Company’s obligation under this guarantee is insignificant, and the Company has therefore not recorded any liability associated with this guarantee as of March 31, 2007.
			The sale of the 70% ownership interest in 2006 is being accounted for under the deposit method of accounting pursuant to SFAS 66, with the recognition of the sale deferred until the Company is relieved of its obligation under the operating guarantee. Accordingly, the Company continues to consolidate this community for financial reporting purposes, reporting the joint venture partner’s interest in the net assets of the limited liability company as a component of accrued expenses and other liabilities, and recognizing the

			joint venture partner’s interest in the operating results of the limited liability company as a component of minority interest in consolidated partnerships.
	•		The Company holds an option to make a capital contribution to an entity in connection with the pursuit of a Development Right in Pleasant Hill, California. The Company currently does not have any equity or economic interest in this entity. However, due to the nature of the Company’s option to make a capital contribution, this entity is considered a variable interest entity under FIN 46(R), where the Company is the primary beneficiary. This entity does not have any operations and has minimal assets and equity, and is therefore not considered a significant variable interest entity.

7. Real Estate Disposition Activities

During the three months ended March 31, 2007, the Company did not sell any communities. During the three months ended March 31, 2006, the Company sold two communities, Avalon Estates, located in the Boston, Massachusetts area, and Avalon Cupertino, located in San Jose, California. These two communities, which contained a total of 473 apartment homes, were sold for an aggregate sales price of $122,550. The sale of these two communities resulted in a gain as reported in accordance with GAAP of approximately $65,419.

As of March 31, 2007, the Company had one community, Avalon Del Rey, which qualified as held for sale under the provisions of SFAS No. 144. In 2006, the Company admitted a third-party partner into the joint venture entity that owns Avalon Del Rey (see Note 6, “Investments in Unconsolidated Entities”). However, due to the operating guarantee provided to the joint venture partner, the Company will account for its investment under the deposit method as required by SFAS No. 66, “Accounting for Sales of Real Estate.” As a result, the Company has classified the real estate assets (which are net of an impairment charge taken on the land in 2002, as well as accumulated depreciation recorded through December 31, 2006) and the related liabilities for Avalon Del Rey as held for sale, as separate captions in the accompanying Condensed Consolidated Balance Sheets. However, due to the continuing involvement of the Company through its 30% ownership interest and its role as the managing member in the venture, Avalon Del Rey has been and will continue to be reported as a component of continuing operations on the accompanying Condensed Consolidated Financial Statements.

Also, in accordance with the requirements of SFAS No. 144, the operations for any communities sold from January 1, 2006 through March 31, 2007 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
		3-31-07				3-31-06
Rental income		$	—			$	1,630
Operating and other expenses			—				(555	)
Interest expense, net			—				—
Depreciation expense			—				—
Income from discontinued operations		$	—			$	1,075

The Company’s Condensed Consolidated Balance Sheets include other assets (excluding net real estate) of $1,941 and $1,558 as of March 31, 2007 and December 31, 2006, respectively and other liabilities of $42,792 as of March 31, 2007 and $42,985 as of December 31, 2006, relating to real estate assets sold or held for sale.

During the three months ended March 31, 2007, the Company sold one parcel of land through a taxable REIT subsidiary, located in the Mid Atlantic, for a sales price of $5,800, resulting in a GAAP gain of $545.

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 2007, the Established Communities are communities that are consolidated for financial reporting purposes, had stabilized occupancy and operating expenses as of January 1, 2006, are not conducting or planning to conduct substantial redevelopment activities and are not held for sale or planned for disposition within the current year. A community is considered to have stabilized occupancy at the earlier of (i) attainment of 95% physical occupancy or (ii) the one-year anniversary of completion of development or redevelopment.
	•		Other Stabilized Communities 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, 2007.

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 Communities and Other Stabilized Communities. NOI is defined by the Company as total revenue less direct property operating expenses. Although the Company considers NOI a useful measure of a community’s or communities’ operating performance, NOI should not be considered an alternative to net income or net cash flow from operating activities, as determined in accordance with GAAP. NOI excludes a number of income and expense categories as detailed in the reconciliation of NOI to net income.

A reconciliation of NOI to net income for the three months ended March 31, 2007 and 2006 is as follows:

		For the three months ended
		3-31-07				3-31-06
						(restated)
Net income		$	46,520			$	111,114
Indirect operating expenses, net of corporate income			6,996				7,435
Investments and investment management			2,024				1,471
Interest expense, net			23,878				28,664
General and administrative expense			6,780				6,283
Equity in income of unconsolidated entities			86				(227	)
Minority interest in consolidated partnerships			449				132
Depreciation expense			44,094				40,225
Gain on sale of land			(545	)			(13,166	)
Gain on sale of communities			—				(65,419	)
Income from discontinued operations			—				(1,075	)
Net operating income		$	130,282			$	115,437

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 table below 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 months ended March 31, 2007 and 2006 has been adjusted for the communities that were sold from January 1, 2006 through March 31, 2007 as described in Note 7, “Real Estate Disposition Activities.”

		For the three months ended
		Total								% NOI change				Gross
		revenue				NOI				from prior year				real estate(1)
For the period ended March 31, 2007
Established
Northeast		$	67,908			$	45,403				5.8	%		$	1,817,580
Mid-Atlantic			27,965				17,632				7.4	%			688,405
Midwest			2,994				1,768				6.1	%			92,408
Pacific Northwest			8,094				5,480				17.1	%			289,682
Northern California			38,880				28,292				12.7	%			1,386,297
Southern California			13,824				10,068				8.1	%			349,115
Total Established			159,665				108,643				8.5	%			4,623,487
Other Stabilized			15,128				9,715				n/a				425,980
Development / Redevelopment			20,469				11,924				n/a				1,430,977
Land Held for Future Development			n/a				n/a				n/a				315,241
Non-allocated (2)			1,444				n/a				n/a				43,244
Total		$	196,706			$	130,282				12.9	%		$	6,838,929
For the period ended March 31, 2006 (restated)
Established
Northeast		$	49,696			$	33,073				3.8	%		$	1,262,747
Mid-Atlantic			25,598				15,949				14.5	%			620,877
Midwest			2,736				1,666				(0.7	%)			91,784
Pacific Northwest			7,873				5,167				7.7	%			315,386
Northern California			36,911				25,988				9.4	%			1,434,050
Southern California			14,025				10,085				9.8	%			371,767
Total Established			136,839				91,928				7.9	%			4,096,611
Other Stabilized			22,184				14,287				n/a				760,127
Development / Redevelopment			14,838				9,222				n/a				746,389
Land Held for Future Development			n/a				n/a				n/a				185,204
Non-allocated (2)			1,298				n/a				n/a				30,021
Total		$	175,159			$	115,437				9.6	%		$	5,818,352

9. Stock-Based Compensation Plans

The Company has a stock incentive plan (the “1994 Plan”), which was amended and restated on December 8, 2004, and amended on February 9, 2006 and December 6, 2006. Individuals who are eligible to participate in the 1994 Plan include officers, other associates, outside directors and other key persons of the Company and its subsidiaries who are responsible for or contribute to the management, growth or profitability of the Company and its subsidiaries. The 1994 Plan authorizes (i) the grant of stock options that qualify as incentive stock options (“ISOs”) under Section 422 of the Internal Revenue Code, (ii) the grant of stock options that do not so qualify, (iii) grants of shares of restricted and unrestricted common stock, (iv) grants of deferred stock awards, (v) performance share awards entitling the recipient to acquire shares of common stock and (vi) dividend equivalent rights.

Shares of common stock of 2,143,629 and 1,791,861 were available for future option or restricted stock grant awards under the 1994 Plan as of March 31, 2007 and December 31, 2006, respectively. Annually on January 1^st, the maximum number available for issuance under the 1994 Plan is increased by between 0.48% and 1.00% of the total number of shares of common stock and DownREIT units actually outstanding on such date. Notwithstanding the foregoing, the maximum number of shares of stock for which ISOs may be issued under the 1994 Plan shall not exceed 2,500,000 and no awards shall be granted under the 1994 Plan after May 11, 2011. Options and restricted stock granted under the 1994 Plan vest and expire over varying periods, as determined by the Compensation Committee of the Board of Directors.

Before the Merger, Avalon had adopted its 1995 Equity Incentive Plan (the “Avalon 1995 Incentive Plan”). Under the Avalon 1995 Incentive Plan, a maximum number of 3,315,054 shares (or 2,546,956 shares as adjusted for the Merger) of common stock were issuable, plus any shares of common stock represented by awards under Avalon’s 1993 Stock Option and Incentive Plan (the “Avalon 1993 Plan”) that were forfeited, canceled, reacquired by Avalon, satisfied without the issuance of common stock or otherwise terminated (other than by exercise). Options granted to officers, non-employee directors and associates under the Avalon 1995 Incentive Plan generally vested over a three-year term, expire ten years from the date of grant and are exercisable at the market price on the date of grant.

In connection with the Merger, the exercise prices and the number of options under the Avalon 1995 Incentive Plan and the Avalon 1993 Plan were adjusted to reflect the equivalent Bay shares and exercise prices based on the 0.7683 share conversion ratio used in the Merger. Officers, non-employee directors and associates with Avalon 1995 Incentive Plan or Avalon 1993 Plan options may exercise their adjusted number of options for the Company’s common stock at the adjusted exercise price. As of June 4, 1998, the date of the Merger, options and other awards ceased to be granted under the Avalon 1993 Plan or the Avalon 1995 Incentive Plan. Accordingly, there were no options to purchase shares of common stock available for grant under the Avalon 1995 Incentive Plan or the Avalon 1993 Plan at March 31, 2007 or 2006.

Information with respect to stock options granted under the 1994 Plan, the Avalon 1995 Incentive Plan and the Avalon 1993 Plan is as follows:

										Avalon 1995
						Weighted				Incentive Plan				Weighted
						average				and Avalon				average
		1994 Plan				exercise price				1993 Plan				exercise price
		shares				per share				shares				per share
Options Outstanding, December 31, 2006			2,487,239			$	69.65				4,240			$	36.81
Exercised			(326,542	)			58.78				—				—
Granted			339,429				147.75				—				—
Forfeited			(11,974	)			106.09				—				—
Options Outstanding, March 31, 2007			2,488,152			$	81.55				4,240			$	36.81
Options Exercisable:
March 31, 2007			1,369,274			$	59.71				4,240			$	36.81

For options outstanding at March 31, 2007 under the 1994 Plan, 298,243 options had exercise prices ranging between $31.50 and $39.99 and a weighted average remaining contractual life of 3.06 years, 222,274 options had exercise prices ranging between $40.00 and $49.99 and a weighted average remaining contractual life of 4.69 years, 254,895 options had exercise prices between $50.00 and $59.99 and a weighted average remaining contractual life of 6.88 years, 571,680 options had exercise prices ranging between $69.93 and $79.99 and a weighted average remaining contractual life of 7.88 years, 794,704 options had exercise prices ranging between $81.42 and $99.99 and a weighted average remaining contractual life of 8.87 years, 10,500 options had exercise prices between $103.00 and $123.03 and a weighted average remaining contractual life of 9.25 years, and 335,856 options had exercise prices of $147.75 and a weighted average remaining contractual life of 9.87 years. Options outstanding and exercisable at March 31, 2007 for the Avalon 1993 and Avalon 1995 Plans had exercise prices ranging from $35.31 to $37.66 and a weighted average contractual life of less than one year and an intrinsic value of $395. Options outstanding under the 1994 Plan at March 31, 2007, had an intrinsic value of $150,160. Options exercisable at March 31, 2007 under the 1994 plan had a weighted average contractual life of 6.29 years and an intrinsic value of $96,249. The intrinsic value of options exercised during the three months ended March 31, 2007 and 2006 was $23,256 and $17,954, respectively.

The weighted average fair value of the options granted during the three months ended March 31, 2007 is estimated at $21.85 per share on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions: dividend yield of 4.0% over the expected life of the option, volatility of 17.30%, risk-free interest rates of 4.73% and an expected life of approximately seven years.

The Company issued restricted stock as part of its stock-based compensation plan during the three months ended March 31, 2007. Compensation cost is recognized over the requisite service period, which varies, but does not exceed five years. The fair value of restricted stock is the closing stock price on the date of the grant. Provisions of SFAS 123(R) require the Company to recognize compensation cost taking into consideration retirement eligibility. The cost related to stock-based compensation for restricted stock included in the determination of net income is based on actual forfeitures for the given year. Restricted stock awards typically vest over a five-year period with the exception of accelerated vesting provisions . Restricted stock vesting during the three months ended March 31, 2007 had fair values ranging from $36.33 to $147.75 per share. The total fair value of shares vested was $8,091 for the period ended March 31, 2007.

Total compensation cost recognized in income relating to deferred compensation for the three months ended March 31, 2007 was $5,539 and total capitalized compensation cost relating to deferred compensation for the three months ended March 31, 2007 was $912. At March 31, 2007, there was a total of $14,097 and $17,003 in unrecognized compensation cost for unvested stock options and unvested restricted stock, respectively. The unrecognized compensation cost for stock options does not take into account estimated forfeitures. The unrecognized compensation cost for unvested stock options and restricted stock is expected to be recognized over a weighted average period of 2.25 years and 2.87 years, respectively.

10. Related Party Arrangements

Unconsolidated Entities

The Company manages unconsolidated real estate entities for which it receives asset management, property management, development and redevelopment fee revenue. From these entities, the Company received fees of $1,444 and $1,207 in the three months ended March 31, 2007 and 2006, respectively. These fees are included in management, development and other fees on the accompanying Condensed Consolidated Statements of Operations and Other Comprehensive Income.

In addition, in connection with the construction management services that the Company provided to MVP I, LLC, the entity that owns and developed Avalon at Mission Bay North II, the Company funds certain construction costs that are expected to be reimbursed through construction financing within 30 to 60 days. Construction was completed in 2006, and depending on the timing of such funding, the accompanying Condensed Consolidated Balance Sheets may reflect a corresponding receivable in prepaid expenses and other assets or a corresponding liability in accrued expenses and other liabilities. The Company has recorded receivables in the amounts of $5,368 as of March 31, 2007 and $5,654 as of December 31, 2006, from MVP I, LLC.

Director Compensation

The 1994 Plan provides that directors of the Company who are also employees receive no additional compensation for their services as a director. On May 14, 2003, the Company’s Board of Directors approved an amendment to the 1994 Plan and certain cash compensation arrangements pursuant to which 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 New York Stock Exchange (“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. In February 2006, the Company’s Board of Directors approved another amendment to the 1994 Plan and modified the cash compensation arrangements under which (i) following the 2006 Annual Meeting of Stockholders the cash payment was adjusted to $40, payable in quarterly installments of $10 and (ii) following the 2007 Annual Meeting of Stockholders, the number of shares of restricted stock (or deferred stock awards) will be calculated based on the closing price on the day of the award (rather than the closing price on the award date of the prior year). The Company recorded non-employee director compensation expense relating to the restricted stock grants, deferred stock awards and stock options in the amount of $90 in the three months ended March 31, 2007 as a component of general and administrative expense. Deferred compensation relating to these restricted stock grants, deferred stock awards and stock options was $688 and $778 on March 31, 2007 and December 31, 2006, respectively.

11. Subsequent Events

In April 2007, in connection with a parcel of land owned by the Company in Brooklyn, New York, the Company purchased additional development rights for $10,500.

In April 2007, a fire at Avalon Danvers, a development community located in Danvers, Massachusetts, damaged 147 of the planned 433 apartment homes. The impacted apartment homes were under construction and unoccupied. The fire did not damage the structures housing the current leasing operations or occupied apartment homes. The Company expects that insurance proceeds will substantially cover the cost to reconstruct all damaged assets as well as provide for a reimbursement of lost net operating income due to schedule delays, resulting in no material net economic loss to the Company.

12. Restatement of Previously Issued Financial Statements

The Company has restated its Condensed Consolidated Balance Sheet as of December 31, 2006 in its Form 10-K/A as filed with the SEC. In addition, the Company has restated its unaudited Condensed Consolidated Statements of Operations and Other Comprehensive Income for the three months ended March 31, 2006, as presented in the table below. The restatement adjustments reflected in the following tables relate to the Company’s accounting for long-term land leases, changing the straight-line recognition of lease payments with fixed, or minimum, escalations over the period equal to the non-cancelable portion of the lease term as opposed to the Company’s expected holding period of its interest in the asset. This change primarily impacts the land lease accounting related to one consolidated asset with a 90 year lease in which the land lessor is also the partner in the venture holding the asset. The change resulted in an additional non-cash increase to operating expenses of approximately $2,625, per quarter in excess of the current quarterly cash payments, as well as additional depreciation expense. The effects of the restatement did not impact the total operating, investing or financing cash flows. The cumulative effect of the restatement on the Condensed Consolidated Statements of Operations for the periods affected is as follows:

		For the three months ended March 31, 2006
		As Previously
		Reported				Adjustments				As Restated
Revenue:
Rental and other income		$	173,952			$	—			$	173,952
Management, development and other fees			1,207				—				1,207
Total revenue			175,159				—				175,159
Expenses:
Operating expenses, excluding property taxes			49,069				2,655				51,724
Property taxes			16,904				—				16,904
Interest expense, net			28,664				—				28,664
Depreciation expense			39,917				308				40,225
General and administrative expense			6,283				—				6,283
Total expenses			140,837				2,963				143,800
Joint venture income and minority interest expense			227				—				227
Minority interest in consolidated partnerships			(132	)			—				(132	)
Gain on sale of land			13,166				—				13,166
Income from continuing operations			47,583				(2,963	)			44,620
Discontinued operations:
Income from discontinued operations			1,075				—				1,075
Gain on sale of communities			65,419				—				65,419
Total discontinued operations			66,494				—				66,494
Net income			114,077				—				111,114
Dividends attributable to preferred stock			(2,175	)			—				(2,175	)
Net income available to common stockholders		$	111,902			$	—			$	108,939
Other comprehensive income:
Unrealized gain on cash flow hedges			541								541
Comprehensive income		$	112,443			$	—			$	109,480
Net income per common share basic		$	1.52			$	(0.04	)		$	1.48
Net income per common share - diluted		$	1.49			$	(0.04	)		$	1.45

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

Management’s Discussion and Analysis of Financial Condition and Results of Operations as set forth in this Item 2 contains financial information as of December 31, 2006 and for the three months ended March 31, 2006, that has been revised to reflect the restatement of the Consolidated Financial Statements contained in our Annual Report on Form 10-K for the period ended December 31, 2006, and in our Quarterly Report on Form 10-Q for the period ended March 31, 2006. See Note 12,“Restatement of Previously Issued Financial Statements” to the Condensed Consolidated Financial Statements included in Item 1 of this report.

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help provide an understanding of our business and results of operations. This MD&A should be read in conjunction with our Condensed Consolidated Financial Statements and the accompanying Notes to Condensed Consolidated Financial Statements included elsewhere in this report. This report, including the following MD&A, contains forward-looking statements regarding future events or trends as described more fully under “Forward-Looking Statements” on page 51 of this report. Actual results or developments could differ materially from those projected in such statements as a result of the risk factors described in Item 1a, “Risk Factors,” of our Form 10-K/A for the year ended December 31, 2006.

Executive Overview

Business Description

We are primarily engaged in developing, acquiring, owning and operating apartment communities in high barrier-to-entry markets of the United States. 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. However, throughout the real estate cycle, apartment market fundamentals, and therefore operating cash flows, are affected by overall economic conditions. 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 or when pricing is attractive. 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.

Our individual markets 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.

First Quarter 2007 Highlights

	•		Strong apartment fundamentals continued in the first quarter of 2007, though at a moderating pace from the strong performance experienced in 2006. This is supported by the performance of our Established Community Portfolio (as defined later in this report). Net operating income (“NOI”) for Established Communities increased 8.5%, driven by an increase in rental revenue of 6.6% partially offset by moderate growth in operating expenses of 2.7%. The revenue growth over the comparable period in 2006 is comprised of an increase in rental rates of 7.0% and a decrease in occupancy of 0.4%.
	•		We continued to focus on creating value through our development activities and pipeline. In the first quarter of 2007, we completed the development of two communities containing 400 apartment homes and the redevelopment of one community containing 409 apartment homes. In addition we began the construction of a wholly-owned apartment community that, upon completion is expected to contain 296 apartment homes for a total capitalized cost of $125,500,000.

	•		We strengthened our balance sheet through a common stock offering. In conjunction with the inclusion of our common stock in the S&P 500 Index, we issued 4,600,000 shares of our common stock at $129.30 per share. At March 31, 2007 we have approximately $356,400,000 in unrestricted cash available.
	•		We obtained an investment interest in three additional communities containing an aggregate of 813 apartment homes and 33,000 of retail space through acquisitions by the Fund (as defined later in this report).

Financial Outlook

We expect continued revenue and net operating income growth from Established Communities for the remainder of 2007, but at a more moderate rate than recent levels. The combination of low home affordability and continued but moderating job growth is expected to support continued favorable apartment fundamentals. The single-family housing market continues to moderate, such that the increase in home prices is flat or down, and for-sale inventory has increased. In addition, the weak for-sale market and concerns about price declines have served to increase the attractiveness of renting versus owning. As a result, the current gap between the cost to rent and the cost to own continues to make rental apartments an economically attractive housing alternative in our markets. These recent trends increase the likelihood that potential homebuyers will extend the period they rent a home. We expect that job growth will continue in our markets, but at a more modest rate in 2007. After two years of low levels of net new apartment supply, the supply of new apartment homes is expected to return to historical levels. Overall, we expect apartment market fundamentals to remain healthy in our markets such that apartment rental demand will outpace new supply. Given these key fundaments, our current financial outlook provides for rental revenue growth of 5.0% to 6.5% in our Established Community portfolio in 2007, and projected NOI growth of 5.5% to 7.5%.

We expect that our development activity will continue to create value. In positioning for future growth, we have increased our development activity and our investments in Development Rights. We currently have approximately $1,400,000,000 under construction (measured by total projected capitalized cost of the communities at completion, including the portions in which joint venture partners hold an equity or economic interest). We anticipate our construction activity will remain at or be slightly higher than this level throughout 2007. For new development, the slowing for-sale market has resulted in increased investment opportunities. We are being selective in pursuing these opportunities, given continued high land prices and construction costs. We continue to secure new Development Rights, including the acquisition of land for future development. In the first quarter of 2007, we added Development Rights for construction of new apartment communities that, based on total projected capitalized cost, increased Development Rights by $400,000,000 to $4,000,000,000 at March 31, 2007.

Through our investment in and management of AvalonBay Value Added Fund, L.P., a discretionary investment fund (the “Fund”) in which we hold an interest of approximately 15%, we expect to continue to gain investment interests in existing communities. During its investment period (which will end on or before March 16, 2008), the Fund will be our principal vehicle for acquiring apartment communities, subject to certain exceptions. As of March 31, 2007, the total amount invested by the Fund is $609,250,000. We expect the Fund to continue to focus on acquisition opportunities where value can be created, generally through redevelopment, repositioning and market cycle timing opportunities.

Real estate capital flows remain strong, with income investors seeking to acquire existing apartment communities. As a result, opportunities to realize value upon disposition have continued to be available. We expect asset sales of approximately $150,000,000 to $200,000,000 in 2007.

Community Information Overview

Our real estate investments consist primarily of current operating apartment communities, communities in various stages of development (“Development Communities”) and Development Rights as defined below. Our current operating communities and our Development Communities include communities in which we hold a direct and indirect ownership interest.

Our current operating communities are further distinguished as follows:

	•		Established Communities (also known as Same Store Communities) are consolidated communities that have stabilized occupancy and operating expenses as of January 1, 2006, and are not Redevelopment Communities, as defined below. A community has stabilized occupancy at the earlier of (i) attainment of 95% physical occupancy or (ii) the one-year anniversary of completion of development or redevelopment.
	•		Other Stabilized Communities are all other completed communities with stabilized occupancy, as defined above, other than Redevelopment Communities as defined below.
	•		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. For wholly owned communities, redevelopment is considered substantial when capital invested during the reconstruction effort is expected to exceed the lesser of $5,000,000 or 10% of the community’s acquisition cost. The definition of substantial redevelopment may differ for communities that are not wholly owned.

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 either acquire land or 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 generally evaluate overall operating, industry and market trends based on the operating results of Established Communities, for which a detailed discussion can be found in “Results of Operations” as part of our discussion of overall operating results. We focus on the net operating income of our current operating communities, as defined later in this report, as one of the financial measures to evaluate community performance. We evaluate our current and future cash needs and future operating potential based on acquisition, disposition, development, redevelopment and financing activities within Other Stabilized, Redevelopment and Development Communities, and discussions related to these segments of our business can be found in “Liquidity and Capital Resources.”

As of March 31, 2007, the composition of our current direct and indirect ownership interests in apartment communities and Development Rights is as follows:

		Number of				Number of
		communities				apartment homes
Current Communities
Established Communities:
Northeast			42				11,348
Mid-Atlantic			18				5,933
Midwest			3				887
Pacific Northwest			9				2,278
Northern California			26				7,855
Southern California			9				2,424
Total Established			107				30,725
Other Stabilized Communities:
Northeast			14				3,834
Mid-Atlantic			5				1,269
Midwest			3				869
Pacific Northwest			2				433
Northern California			6				1,198
Southern California			8				3,052
Total Other Stabilized			38				10,655
Lease-Up Communities			4				919
Redevelopment Communities			6				2,054
Total Current Communities			155				44,353
Development Communities			16				5,049
Development Rights			56				14,809

Results of Operation

Our year-over-year operating performance is primarily affected by changes in net operating income of our current operating apartment communities due to market conditions; net operating income derived from acquisitions and development completions; the loss of net operating income related to disposed communities; and capital market, disposition and financing activity. A comparison of our operating results for the three months ended March 31, 2007 and 2006 follows (dollars in thousands):

		For the three months ended
						3-31-06
		3-31-07				(restated)				$ Change				% Change
Revenue:
Rental and other income		$	195,262			$	173,952			$	21,310				12.3	%
Management, development and other fees			1,444				1,207				237				19.6	%
Total revenue			196,706				175,159				21,547				12.3	%
Expenses:
Direct property operating expenses, excluding property taxes			47,255				41,622				5,633				13.5	%
Property taxes			17,726				16,904				822				4.9	%
Total community operating expenses			64,981				58,526				6,455				11.0	%
Corporate-level property management and other indirect operating expenses			8,439				8,631				(192	)			(2.2	%)
Investments and investment management			2,024				1,471				553				37.6	%
Interest expense, net			23,878				28,664				(4,786	)			(16.7	%)
Depreciation expense			44,094				40,225				3,869				9.6	%
General and administrative expense			6,780				6,283				497				7.9	%
Total other expenses			85,215				85,274				(59	)			(0.1	%)
Gain on sale of land			545				13,166				(12,621	)			(95.9	%)
Equity in income of unconsolidated entities			(86	)			227				(313	)			(137.9	%)
Minority interest in consolidated partnerships			(449	)			(132	)			(317	)			240.2	%
Income from continuing operations			46,520				44,620				1,900				4.3	%
Discontinued operations:
Income from discontinued operations			—				1,075				(1,075	)			(100.0	%)
Gain on sale of communities			—				65,419				(65,419	)			(100.0	%)
Total discontinued operations			—				66,494				(66,494	)			(100.0	%)
Net Income			46,520				111,114				(64,594	)			(58.1	%)
Dividends attributable to preferred stock			(2,175	)			(2,175	)			—				0.0	%
Net income available to common stockholders		$	44,345			$	108,939			$	(64,594	)			(59.3	%)

Net income available to common stockholders decreased $64,594,000 or 59.3%, to $44,345,000 for the three months ended March 31, 2007. This decrease is primarily attributable to asset sales and related gains occurring in the first quarter of 2006, partially offset by growth in net operating income from Established Communities and contributions to net operating income from newly developed communities in 2007.

Net operating income (“NOI”) is considered by management to be an important and appropriate supplemental performance measure to net income because it helps both investors and management to understand the core operations of a community or communities prior to the allocation of any corporate-level or financing-related costs. NOI reflects the operating performance of a community and allows for an easy comparison of the operating performance of individual assets or groups of assets. In addition, because prospective buyers of real estate have different financing and overhead structures, with varying marginal impacts to overhead by acquiring real estate, NOI is considered by many in the real estate industry to be a useful measure for determining the value of a real estate asset or group of assets. We define NOI as total property revenue less direct property operating expenses, including property taxes.

NOI does not represent cash generated from operating activities in accordance with GAAP. Therefore, NOI should not be considered an alternative to net income as an indication of our performance. NOI should also not be considered an alternative to net cash flow from operating activities, as determined by GAAP, as a measure of liquidity, nor is NOI necessarily indicative of cash available to fund cash needs. A calculation of NOI for the three months ended March 31, 2007 and 2006, along with reconciliation to net income for each year, is as follows (dollars in thousands):

		For the three months ended
						3-31-06
		3-31-07				(restated)
Net income		$	46,520			$	111,114
Indirect operating expenses, net of corporate income			6,996				7,435
Investments and investment management			2,024				1,471
Interest expense, net			23,878				28,664
General and administrative expense			6,780				6,283
Equity in income of unconsolidated entities			86				(227	)
Minority interest in consolidated partnerships			449				132
Depreciation expense			44,094				40,225
Gain on sale of real estate assets			(545	)			(78,585	)
Income from discontinued operations			—				(1,075	)
Net operating income		$	130,282			$	115,437