10-Q: Quarterly report pursuant to Section 13 or 15(d)
Published on May 9, 2008
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
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
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2008
Commission file number 1-12672
AVALONBAY COMMUNITIES, INC.
(Exact name of registrant as specified in its charter)
Maryland | 77-0404318 | |
(State or other jurisdiction of | (I.R.S. Employer | |
incorporation or organization) | Identification No.) |
2900 Eisenhower Avenue, Suite 300
Alexandria, Virginia 22314
(Address of principal executive offices, including zip code)
Alexandria, Virginia 22314
(Address of principal executive offices, including zip code)
(703) 329-6300
(Registrants telephone number, including area code)
(Registrants 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, a non-accelerated filer or a smaller reporting company. See the definitions of large
accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2 of the
Exchange Act. (Check one):
Large accelerated filer þ | Accelerated filero | Non-accelerated filer o | Smaller reporting company o | |||
(Do not check if a smaller reporting company) |
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 issuers classes of common stock as of the
latest practicable date:
76,975,524 shares of common stock, par value $0.01 per share, were outstanding as of April 30, 2008
AVALONBAY COMMUNITIES, INC.
FORM 10-Q
INDEX
FORM 10-Q
INDEX
Page | ||||||
PART I - FINANCIAL INFORMATION |
||||||
Item 1.
|
Condensed Consolidated Financial Statements | |||||
Condensed Consolidated Balance Sheets as of March 31, 2008 (unaudited) and December 31, 2007 | 1 | |||||
Condensed Consolidated Statements of Operations and Other Comprehensive Income (unaudited) for the three months ended March 31, 2008 and 2007 | 2 | |||||
Condensed Consolidated Statements of Cash Flows (unaudited) for the three months ended March 31, 2008 and 2007 | 3-4 | |||||
Notes to Condensed Consolidated Financial Statements (unaudited) | 5-22 | |||||
Item 2.
|
Managements Discussion and Analysis of Financial Condition and Results of Operations | 23-48 | ||||
Item 3.
|
Quantitative and Qualitative Disclosures About Market Risk | 49 | ||||
Item 4.
|
Controls and Procedures | 49 | ||||
PART II - OTHER INFORMATION |
||||||
Item 1.
|
Legal Proceedings | 49 | ||||
Item 1a.
|
Risk Factors | 50 | ||||
Item 2.
|
Unregistered Sales of Equity Securities and Use of Proceeds | 50 | ||||
Item 3.
|
Defaults Upon Senior Securities | 51 | ||||
Item 4.
|
Submission of Matters to a Vote of Security Holders | 51 | ||||
Item 5.
|
Other Information | 51 | ||||
Item 6.
|
Exhibits | 51 | ||||
SIGNATURES | 54 |
AVALONBAY COMMUNITIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)
3-31-08 | 12-31-07 | |||||||
(unaudited) | ||||||||
ASSETS |
||||||||
Real estate: |
||||||||
Land |
$ | 1,014,121 | $ | 1,002,944 | ||||
Buildings and improvements |
5,183,407 | 5,017,057 | ||||||
Furniture, fixtures and equipment |
161,804 | 156,789 | ||||||
6,359,332 | 6,176,790 | |||||||
Less accumulated depreciation |
(1,267,010 | ) | (1,219,410 | ) | ||||
Net operating real estate |
5,092,322 | 4,957,380 | ||||||
Construction in progress, including land |
962,038 | 952,670 | ||||||
Land held for development |
305,669 | 288,423 | ||||||
Operating real estate assets held for sale, net |
97,642 | 98,709 | ||||||
Total real estate, net |
6,457,671 | 6,297,182 | ||||||
Cash and cash equivalents |
270,320 | 21,166 | ||||||
Cash in escrow |
128,190 | 189,171 | ||||||
Resident security deposits |
30,662 | 29,542 | ||||||
Investments in unconsolidated real estate entities |
60,474 | 57,990 | ||||||
Deferred financing costs, net |
28,209 | 27,682 | ||||||
Deferred development costs |
62,529 | 60,996 | ||||||
Prepaid expenses and other assets |
82,048 | 52,755 | ||||||
Total assets |
$ | 7,120,103 | $ | 6,736,484 | ||||
LIABILITIES AND STOCKHOLDERS EQUITY |
||||||||
Unsecured notes, net |
$ | 1,843,605 | $ | 1,893,499 | ||||
Variable rate unsecured credit facility |
798,500 | 514,500 | ||||||
Mortgage notes payable |
1,036,461 | 773,803 | ||||||
Dividends payable |
70,891 | 67,909 | ||||||
Payables for construction |
88,414 | 91,580 | ||||||
Accrued expenses and other liabilities |
190,132 | 234,873 | ||||||
Accrued interest payable |
27,217 | 38,536 | ||||||
Resident security deposits |
43,037 | 41,638 | ||||||
Liabilities related to real estate assets held for sale |
30,503 | 30,340 | ||||||
Total liabilities |
4,128,760 | 3,686,678 | ||||||
Minority interest of unitholders in consolidated partnerships |
19,652 | 23,152 | ||||||
Commitments and contingencies |
| | ||||||
Stockholders equity: |
||||||||
Preferred stock, $0.01 par value; $25 liquidation preference; 50,000,000 shares
authorized at both March 31, 2008 and December 31, 2007; 4,000,000 shares
issued and outstanding at both March 31, 2008 and December 31, 2007 |
40 | 40 | ||||||
Common stock, $0.01 par value; 140,000,000 shares authorized at both March
31, 2008
and December 31, 2007; 76,971,919 and 77,318,611 shares issued and
outstanding at
March 31, 2008 and December 31, 2007, respectively |
770 | 773 | ||||||
Additional paid-in capital |
3,015,160 | 3,026,708 | ||||||
Accumulated earnings less dividends |
(40,677 | ) | 2,499 | |||||
Accumulated other comprehensive loss |
(3,602 | ) | (3,366 | ) | ||||
Total stockholders equity |
2,971,691 | 3,026,654 | ||||||
Total liabilities and stockholders equity |
$ | 7,120,103 | $ | 6,736,484 | ||||
See accompanying notes to Condensed Consolidated Financial Statements.
1
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 | ||||||||
3-31-08 | 3-31-07 | |||||||
Revenue: |
||||||||
Rental and other income |
$ | 210,200 | $ | 187,171 | ||||
Management, development and other fees |
1,638 | 1,444 | ||||||
Total revenue |
211,838 | 188,615 | ||||||
Expenses: |
||||||||
Operating expenses, excluding property taxes |
61,380 | 55,446 | ||||||
Property taxes |
19,850 | 16,994 | ||||||
Interest expense, net |
28,005 | 23,186 | ||||||
Depreciation expense |
47,682 | 42,014 | ||||||
General and administrative expense |
8,119 | 6,780 | ||||||
Total expenses |
165,036 | 144,420 | ||||||
Equity in income (loss) of unconsolidated entities |
34 | (86 | ) | |||||
Minority interest in consolidated partnerships |
(106 | ) | (449 | ) | ||||
Gain on sale of land |
| 545 | ||||||
Income from continuing operations |
46,730 | 44,205 | ||||||
Discontinued operations: |
||||||||
Income from discontinued operations |
1,720 | 2,315 | ||||||
Total discontinued operations |
1,720 | 2,315 | ||||||
Net income |
48,450 | 46,520 | ||||||
Dividends attributable to preferred stock |
(2,175 | ) | (2,175 | ) | ||||
Net income available to common stockholders |
$ | 46,275 | $ | 44,345 | ||||
Other comprehensive income: |
||||||||
Unrealized gain (loss) on cash flow hedges |
(236 | ) | 172 | |||||
Comprehensive income |
$ | 46,039 | $ | 44,517 | ||||
Earnings per common share basic: |
||||||||
Income from continuing operations (net of dividends attributable to preferred stock) |
$ | 0.58 | $ | 0.54 | ||||
Discontinued operations |
0.02 | 0.03 | ||||||
Net income available to common stockholders |
$ | 0.60 | $ | 0.57 | ||||
Earnings per common share diluted: |
||||||||
Income from continuing operations (net of dividends attributable to preferred stock) |
$ | 0.58 | $ | 0.53 | ||||
Discontinued operations |
0.02 | 0.03 | ||||||
Net income available to common stockholders |
$ | 0.60 | $ | 0.56 | ||||
See accompanying notes to Condensed Consolidated Financial Statements.
2
AVALONBAY COMMUNITIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands)
For the three months ended | ||||||||
3-31-08 | 3-31-07 | |||||||
Cash flows from operating activities: |
||||||||
Net income |
$ | 48,450 | $ | 46,520 | ||||
Adjustments to reconcile net income to cash provided
by operating activities: |
||||||||
Depreciation expense |
47,682 | 42,014 | ||||||
Depreciation expense from discontinued operations |
1,110 | 2,080 | ||||||
Amortization of deferred financing costs and debt premium/discount |
1,147 | 1,199 | ||||||
Amortization of stock-based compensation |
4,617 | 5,539 | ||||||
Income allocated to minority interest in consolidated partnerships |
106 | 449 | ||||||
Equity in income of unconsolidated entities, net of eliminations |
257 | 326 | ||||||
Return on investment of unconsolidated entities |
| 99 | ||||||
Gain on sale of real estate assets |
| (545 | ) | |||||
Decrease in cash in operating escrows |
1,795 | 4,866 | ||||||
Decrease (increase) in resident security deposits,
prepaid expenses and other assets |
(28,711 | ) | 6,603 | |||||
Decrease in accrued expenses, other liabilities
and accrued interest payable |
(56,876 | ) | (9,962 | ) | ||||
Net cash provided by operating activities |
19,577 | 99,188 | ||||||
Cash flows from investing activities: |
||||||||
Development/redevelopment of real estate assets including
land acquisitions and deferred development costs |
(208,132 | ) | (291,082 | ) | ||||
Capital expenditures existing real estate assets |
(204 | ) | (355 | ) | ||||
Capital expenditures non-real estate assets |
(1,837 | ) | (568 | ) | ||||
Proceeds from sale of real estate, including reimbursement for Fund
communities, net of selling costs |
| 5,129 | ||||||
Decrease in payables for construction |
(3,166 | ) | (388 | ) | ||||
Decrease in cash in construction escrows |
59,186 | | ||||||
Decrease (increase) in investments in unconsolidated real estate entities |
(2,792 | ) | 1,998 | |||||
Net cash used in investing activities |
(156,945 | ) | (285,266 | ) | ||||
Cash flows from financing activities: |
||||||||
Issuance of common stock |
1,457 | 612,744 | ||||||
Repurchase of common stock |
(42,159 | ) | | |||||
Dividends paid |
(67,760 | ) | (60,342 | ) | ||||
Net borrowings under unsecured credit facility |
284,000 | | ||||||
Issuance of mortgage notes payable and draws on construction loans |
264,697 | | ||||||
Repayments of mortgage notes payable |
(2,039 | ) | (17,785 | ) | ||||
Repayment of unsecured notes |
(50,000 | ) | | |||||
Payment of deferred financing costs |
(1,568 | ) | (406 | ) | ||||
Distributions to DownREIT partnership unitholders |
(57 | ) | (88 | ) | ||||
Distributions to joint venture and profit-sharing partners |
(49 | ) | (177 | ) | ||||
Net cash provided by financing activities |
386,522 | 533,946 | ||||||
Net increase in cash and cash equivalents |
249,154 | 347,868 | ||||||
Cash and cash equivalents, beginning of period |
21,166 | 8,567 | ||||||
Cash and cash equivalents, end of period |
$ | 270,320 | $ | 356,435 | ||||
Cash paid during the period for interest, net of amount capitalized |
$ | 36,849 | $ | 36,052 | ||||
See accompanying notes to Condensed Consolidated Financial Statements.
3
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, 2008:
| As described in Note 4, Stockholders Equity, 127,077 shares of common stock valued at $11,317 were issued in connection with stock grants, 1,562 shares valued at $131 were issued through the Companys dividend reinvestment plan, 7,908 shares valued at $346 were issued to a member of the Board of Directors in fulfillment of a deferred stock award and 36,835 shares valued at $3,375 were withheld to satisfy employees tax withholding and other liabilities, for a net value of $8,419. In addition, the Company granted 401,212 options for common stock, net of forfeitures, at a value of $3,976. | ||
| The Company recorded a decrease to other comprehensive income of $236 to record the impact of the Companys hedge accounting activity. | ||
| Common and preferred dividends declared but not paid totaled $70,891. | ||
| The Company recorded a decrease of $3,500 to minority interest with a corresponding increase to accumulated earnings less dividends to adjust the redemption value associated with the put option held by a joint venture partner. This put option allows our partner to require the Company to purchase their interest in the investment at the future fair market value, payable in cash or, at the Companys option, shares of the Companys common stock. For further discussion of the nature and valuation of the put option, see Note 11, Fair Value Measurements. |
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 Companys 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 Companys common stock. | ||
| The Company recorded a decrease to other liabilities of $194 and a gain to other comprehensive income of $172 to adjust the Companys 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. | ||
| The Company recorded an increase of $4,376 to minority interest with a corresponding decrease to accumulated earnings less dividends to adjust the redemption value associated with the put option held by a joint venture partner. This put option allows our partner to require the Company to purchase their interest in the investment at the future fair market value, payable in cash or, at the Companys option, shares of the Companys common stock. |
4
AVALONBAY COMMUNITIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except per share data)
1. Organization and Significant Accounting Policies
Organization
AvalonBay Communities, Inc. (the Company, which term, unless the context otherwise requires,
refers to AvalonBay Communities, Inc. together with its subsidiaries), is a Maryland corporation
that has elected to be taxed as a real estate investment trust (REIT) under the Internal Revenue
Code of 1986 (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 New England, Metro New York/New Jersey, Mid-Atlantic, Midwest, Pacific Northwest,
and Northern and Southern California regions of the country.
At March 31, 2008, the Company owned or held a direct or indirect ownership interest in 161
operating apartment communities containing 45,151 apartment homes in ten states and the District of
Columbia, of which eight communities containing 2,120 apartment homes were under reconstruction.
In addition, the Company owned or held a direct or indirect ownership interest in 22 communities
under construction that are expected to contain an aggregate of 7,016 apartment homes when
completed. The Company also owned or held a direct or indirect ownership interest in rights to
develop an additional 46 communities that, if developed as expected, will contain an estimated
13,266 apartment homes.
During the three months ended March 31, 2008:
| The Company commenced construction of one community, Avalon Charles Pond, located in Coram, New York. Avalon Charles Pond will contain 200 apartment homes and, if completed as planned, will be completed for a projected total capitalized cost of approximately $46,500. | ||
| The Company purchased two land parcels for an aggregate purchase price of $26,925. These land parcels are located in Seattle, Washington and Los Angeles, California. | ||
| The Board of Directors of the Company authorized an increase of $200,000 in the Companys stock repurchase program, expanding the amount that the Company can acquire in open market or negotiated transactions to $500,000. During the first quarter of 2008, the Company purchased 482,100 shares of common stock in open market transactions under its program at an average price of $87.42 per share, bringing total purchases under the program to approximately $300,000. | ||
| The Company executed two separate five-year, interest only mortgage loans for an aggregate borrowing of approximately $264,697 at a weighted average effective interest rate of approximately 4.78%. One mortgage loan for approximately $170,125 is secured by Avalon at Arlington Square, located in Arlington, Virginia. The second mortgage loan, for approximately $94,572 is secured by Avalon at Cameron Court, located in Alexandria, Virginia. | ||
| AvalonBay Value Added Fund, L.P. (the Fund) is the private, discretionary investment vehicle in which the Company holds an equity interest of approximately 15%. The Company completed the redevelopment of Avalon at Poplar Creek, located in Schumburg, Illinois, on behalf of the Fund. Avalon at Poplar Creek is a garden-style community and was completed for a total capitalized cost of $3,100 excluding costs incurred prior to the start of redevelopment. During the first quarter of 2008, the Company also commenced the redevelopment of one community, South Hills Apartments, on behalf of the Fund. South Hills Apartments is a garden-style community located in West Covina, California that contains 85 apartment homes. The projected total capitalized cost for the redevelopment is $4,400, excluding costs incurred prior to redevelopment. |
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 Companys 2007 Annual Report on Form 10-K. The results of
operations for the three months ended March 31, 2008 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.
5
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. If the Company is the general partner and has
control over the partnership, or if the Companys limited partnership ownership includes the
ability to dissolve the partnership, or has substantive participating rights, the Company
consolidates the investments. If the Company is not the general partner, or the Companys
partnership interest does not overcome the presumption of control in a limited partnership residing
with the general partner as discussed in the EITF, the Company then looks to the guidance in SOP
78-9, APB No. 18 and EITF Topic 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 partnerships 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 Companys
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 of current
cash flow 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 Companys current
common stock dividend per share. The holders of units of limited partnership interests 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 Companys common stock. In
lieu of cash redemption, the Company may elect to exchange such units for an equal number of shares
of the Companys 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.
If there is an event or change in circumstance that indicates a loss in the value of an investment,
the Companys policy is to record the loss and reduce the value of the investment to its fair
value. A loss in value would be indicated if the Company could not recover the carrying value of
the investment or if the investee could not sustain an earnings capacity that would justify the
carrying amount of the investment. The Company did not recognize an impairment loss on any of its
investments in unconsolidated entities during the three months ended March 31, 2008 or 2007.
6
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
Companys 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 expense as incurred.
The Companys 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.
Project costs related to the acquisition, development, construction and redevelopment of real
estate projects (including interest and related loan fees, property taxes and other direct costs)
are capitalized as a cost of the project. Indirect project costs that relate to several projects
are capitalized and allocated to the projects to which they relate. Indirect costs not clearly
related to development, construction and redevelopment activity are expensed as incurred. For
development, capitalization 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. For redevelopment efforts, we capitalize costs either (i) in advance of taking
homes out of service when significant renovation of the common area has begun until the
redevelopment is completed, or (ii) when an apartment home is taken out-of-service for
redevelopment until the 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 the
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 $500 and
$787 for the three months ended March 31, 2008 and 2007, 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, industrial space and other commercial
ventures occupied by unrelated third parties in connection with 13 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.
7
In connection with the acquisition of an operating community, the Company performs a valuation,
allocating to each asset and liability acquired in such transaction, 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 Companys 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, 2008 or 2007.
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 $20,017 at March 31, 2008 and was $19,368
at December 31, 2007.
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 primarily of construction
financing proceeds that are restricted for use in the construction of a specific community. The
majority of the Companys 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 generally
designates these financial instruments as cash flow hedges under the guidance of SFAS No. 133,
Accounting for Derivative Instruments and Hedging Activities, as amended. As of March 31, 2008
and December 31, 2007, the Company had approximately $153,962 and $213,108, respectively, in
variable rate debt subject to cash flow hedges. Excluding debt on communities classified as held
for sale, the Company did not apply hedge accounting for an additional $94,820 in variable rate
debt which is subject to interest rate caps as of March 31, 2008. 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.
8
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
Companys earnings per common share are determined as follows:
For the three months ended | ||||||||
3-31-08 | 3-31-07 | |||||||
Basic and diluted shares outstanding |
||||||||
Weighted average common shares basic |
76,600,201 | 78,431,936 | ||||||
Weighted average DownREIT units outstanding |
64,019 | 144,586 | ||||||
Effect of dilutive securities |
776,672 | 1,354,226 | ||||||
Weighted average common shares diluted |
77,440,892 | 79,930,748 | ||||||
Calculation of Earnings per Share basic |
||||||||
Net income available to common stockholders |
$ | 46,275 | $ | 44,345 | ||||
Weighted average common shares basic |
76,600,201 | 78,431,936 | ||||||
Earnings per common share basic |
$ | 0.60 | $ | 0.57 | ||||
Calculation of Earnings per Share diluted |
||||||||
Net income available to common stockholders |
$ | 46,275 | $ | 44,345 | ||||
Add: Minority interest of DownREIT unitholders
in consolidated partnerships, including discontinued operations |
57 | 88 | ||||||
Adjusted net income available to common stockholders |
$ | 46,332 | $ | 44,433 | ||||
Weighted average common shares diluted |
77,440,892 | 79,930,748 | ||||||
Earnings per common share diluted |
$ | 0.60 | $ | 0.56 | ||||
Certain options to purchase shares of common stock in the amounts of 1,508,451 and 335,856 were
outstanding during the three months ended March 31, 2008 and 2007, 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), Share Based Payments as discussed below, such
options are anti-dilutive.
Legal and Other Contingencies
The Company is currently involved in litigation alleging that 100 communities currently or formerly
owned by the Company violated 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 communities), 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. The Company 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.
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.
9
Assets Held for Sale & Discontinued Operations
The Company follows SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets
(SFAS No. 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 Companys 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 No. 144, the Company reclassified the results of operations to discontinued
operations in accordance with SFAS No. 144. 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 Companys 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.
Income Taxes
As of March 31, 2008, the Company did not have any unrecognized tax benefits as defined in FASB
Interpretation No. 48, Accounting for Uncertainty in Income Taxes an Interpretation of FASB
Statement No. 109, (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 2004 through 2006.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make certain
estimates and assumptions. These estimates and assumptions affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at the dates of the financial
statements and the reported amounts of revenue and expenses during the reporting periods. Actual
results could differ from those estimates.
Reclassifications
Certain reclassifications have been made to amounts in prior periods financial statements to
conform to current year presentations.
Recently Issued Accounting Standards
On January 1, 2008, the Company adopted FASB Statement No. 157, Fair Value Measurements (SFAS No.
157). This standard defines fair value, establishes a methodology for measuring fair value and
expands the required disclosure for fair value measurements. SFAS No. 157 emphasizes that fair
value is a market-based, not an entity-specific, measurement that should be determined based on the
assumptions that market participants would use in pricing an asset or liability. This statement
applies under other accounting pronouncements that require or permit fair value measurements and
does not require any new fair value measurements. The standard applies prospectively to new fair
value measurements performed after the required effective dates, which are as follows: (i) on
January 1, 2008, the standard applied to the measurements of fair values for financial instruments
and recurring fair value measurements of non-financial assets and liabilities; and (ii) on January
1, 2009, the standard will apply to all remaining fair value measurements, including non-recurring
measurements of non-financial assets and liabilities such as the Companys long-lived assets. It
also will apply to fair value measurements of non-financial assets acquired and liabilities assumed
in business combinations. On January 18, 2008, the FASB issued proposed FASB Staff Position (FSP)
FAS 157-c, Measuring Liabilities under Statement 157, which will modify the definition of fair
value by requiring estimation of the proceeds that would be received if the entity were to issue
the liability at the measurement date. The adoption of the provisions
in SFAS No. 157 did not have a material impact on our consolidated financial statements.
10
The provisions in the consensus of Emerging Issues Task Force on Issue 07-6 Accounting for the
Sale of Real Estate Subject to the Requirements of FASB Statement No. 66 (SFAS No. 66) When the
Agreement Includes a Buy-Sell Clause (EITF 07-6) became effective for the Company for any new
arrangements entered into beginning January 1, 2008. EITF 07-6 addresses the impact of a buy-sell
clause contained within a joint venture agreement on a sellers continuing involvement in the
entity and corresponding ability to recognize profit on a sale of real estate to the joint venture,
in which they retain a partial ownership interest. In EITF 07-6, the Task Force reached a
consensus that a buy-sell clause, in and of itself, does not constitute a prohibited form of
continuing involvement that would preclude partial sales treatment under SFAS No. 66. However, a
buy-sell clause may constitute a prohibited form of continuing involvement that precludes partial
sales treatment if the buyer cannot act independently from the seller or if the seller is
economically compelled to reacquire the other partners interest in the jointly owned entity. The
Company does not believe the provisions of EITF 07-6 will have a material impact on its financial
position or results of operations.
2. Interest Capitalized
The Company capitalizes 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 $19,663 for the three months ended
March 31, 2008 and $15,433 for the three months ended March 31, 2007.
3. Notes Payable, Unsecured Notes and Credit Facility
The Companys mortgage notes payable, unsecured notes and variable rate unsecured credit facility
as of March 31, 2008 and December 31, 2007 are summarized below. The following amounts and
discussion do not include the mortgage notes related to two of the communities classified as held
for sale as of March 31, 2008 as shown in the Condensed Consolidated Balance Sheets (see Note 7,
Real Estate Disposition Activities).
3-31-08 | 12-31-07 | |||||||
Fixed rate unsecured notes (1)
|
$ | 1,843,605 | $ | 1,893,499 | ||||
Fixed rate mortgage notes payable conventional and tax-exempt |
493,627 | 230,050 | ||||||
Variable rate mortgage notes payable conventional and tax-exempt |
542,834 | 543,753 | ||||||
Total notes payable and unsecured notes |
2,880,066 | 2,667,302 | ||||||
Variable rate unsecured credit facility |
798,500 | 514,500 | ||||||
Total mortgage notes payable, unsecured notes and unsecured credit facility |
$ | 3,678,566 | $ | 3,181,802 | ||||
(1) | Balances at March 31, 2008 and December 31, 2007 include $2,395 and $2,501 of debt discount, respectively. |
The following debt activity occurred during the three months ended March 31, 2008:
| the Company repaid $50,000 in previously issued unsecured notes in January 2008, along with any unpaid interest, pursuant to their scheduled maturity; | ||
| the Company borrowed $284,000 under its unsecured credit facility; and | ||
| the Company executed two separate five-year, interest only mortgage loans for aggregate borrowings of approximately $264,697 at a weighted average effective interest rate of approximately 4.78%. One mortgage loan for approximately $170,125 is secured by Avalon at Arlington Square, located in Arlington, Virginia. The second mortgage loan, for approximately $94,572 is secured by Avalon at Cameron Court, located in Alexandria, Virginia. As discussed in Note 12, Subsequent Events, the Company used the net proceeds from these financings to reduce the outstanding amount on the Companys unsecured credit facility. |
11
In the aggregate, secured notes payable mature at various dates from October 2008 through October
2047 and are secured by certain apartment communities and improved land parcels (with a net
carrying value of $1,233,318 as of March 31, 2008). As of March 31, 2008, the Company has
guaranteed approximately $108,414 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 Companys fixed rate mortgage notes payable (conventional and
tax-exempt) was 5.6% and 6.5% at March 31, 2008 and December 31, 2007, respectively. The weighted
average interest rate of the Companys variable rate mortgage notes payable and its unsecured
credit facility, including the effect of certain financing related fees, was 4.0% at March 31, 2008
and 5.4% at December 31, 2007.
Scheduled payments and maturities of mortgage notes payable and unsecured notes outstanding at
March 31, 2008 are as follows:
Stated | ||||||||||||||||
Unsecured | interest rate | |||||||||||||||
Secured notes | Secured notes | notes | of unsecured | |||||||||||||
Year | payments | maturities | maturities | notes | ||||||||||||
2008 |
6,813 | 4,410 | 146,000 | 8.250 | % | |||||||||||
2009 (1)
|
6,128 | 76,030 | 150,000 | 7.500 | % | |||||||||||
2010 |
6,226 | 29,388 | 200,000 | 7.500 | % | |||||||||||
2011 |
5,324 | 36,579 | 300,000 | 6.625 | % | |||||||||||
50,000 | 6.625 | % | ||||||||||||||
2012 |
4,265 | 27,143 | 250,000 | 6.125 | % | |||||||||||
250,000 | 5.500 | % | ||||||||||||||
2013 |
4,610 | 264,697 | 100,000 | 4.950 | % | |||||||||||
2014 |
4,988 | 33,100 | 150,000 | 5.375 | % | |||||||||||
2015 |
5,396 | | | | ||||||||||||
2016 |
5,838 | | 250,000 | 5.750 | % | |||||||||||
2017 |
6,328 | 18,300 | | | ||||||||||||
Thereafter |
253,727 | 237,171 | | | ||||||||||||
$ | 309,643 | $ | 726,818 | $ | 1,846,000 | |||||||||||
(1) | As discussed in Note 12, Subsequent Events, in April 2008 the Company redeemed $10,000 of its $150,000, 7.5% medium term notes which mature in 2009. |
The Companys 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 Companys
required debt service payments.
The Company has a variable rate unsecured credit facility in the amount of $1,000,000 with a
syndicate of commercial banks, to whom the Company pays, in the aggregate, an annual facility fee
of approximately $1,250. The Company had $798,500 outstanding under the current credit facility
and $58,512 outstanding in letters of credit on March 31, 2008. At December 31, 2007, there was
$514,500 outstanding under the current credit facility and $61,689 outstanding in letters of
credit. The unsecured credit facility bears interest at varying levels based on the London
Interbank Offered Rate (LIBOR), rating levels achieved on the Companys unsecured notes and on a
maturity schedule selected by the Company. The current stated pricing is LIBOR plus 0.40% per
annum (3.10% at March 31, 2008). The stated spread over LIBOR can vary from LIBOR plus 0.325% to
LIBOR plus 1.00% based on the Companys 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 did not have any amounts outstanding under
this competitive bid option as of March 31, 2008. The Company is in compliance with 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.
12
4. Stockholders Equity
The following summarizes the changes in stockholders equity for the three months ended March 31,
2008:
Accumulated | Accumulated | |||||||||||||||||||||||
Additional | earnings | other | Total | |||||||||||||||||||||
Preferred | Common | paid-in | less | comprehensive | stockholders | |||||||||||||||||||
stock | stock | capital | dividends | loss | equity | |||||||||||||||||||
Balance at December 31, 2007 |
$ | 40 | $ | 773 | $ | 3,026,708 | $ | 2,499 | $ | (3,366 | ) | $ | 3,026,654 | |||||||||||
Net income |
| | | 48,450 | | 48,450 | ||||||||||||||||||
Unrealized loss on cash flow hedges |
| | | | (236 | ) | (236 | ) | ||||||||||||||||
Change in redemption value of minority interest |
| | | 3,500 | | 3,500 | ||||||||||||||||||
Dividends declared to common
and preferred stockholders |
| | | (70,873 | ) | | (70,873 | ) | ||||||||||||||||
Issuance of common stock, net of withholdings |
| 2 | (1,477 | ) | (185 | ) | | (1,660 | ) | |||||||||||||||
Purchase of common stock |
| (5 | ) | (18,086 | ) | (24,068 | ) | | (42,159 | ) | ||||||||||||||
Amortization of deferred compensation |
| | 8,015 | | | 8,015 | ||||||||||||||||||
Balance at March 31, 2008 |
$ | 40 | $ | 770 | $ | 3,015,160 | $ | (40,677 | ) | $ | (3,602 | ) | $ | 2,971,691 | ||||||||||
During the three months ended March 31, 2008, the Company:
(i) | issued 35,696 shares of common stock in connection with stock options exercised; | ||
(ii) | issued 7,908 shares to a member of the Board of Directors in fulfillment of a deferred stock award; | ||
(iii) | issued 1,562 shares through the Companys dividend reinvestment plan; | ||
(iv) | issued 127,077 common shares in connection with stock grants; | ||
(v) | withheld 36,835 shares to satisfy employees tax withholding and other liabilities; and |
||
(vi) | purchased 482,100 shares through the Companys stock repurchase program. |
In addition, the Company granted 401,212 options for common stock to employees. As required under
SFAS No. 123(R), any deferred compensation related to the Companys stock option and restricted
stock grants during the three months ended March 31, 2008 is not reflected on the Companys
Condensed Consolidated Balance Sheet as of March 31, 2008 or above, and will not be reflected until
earned as compensation cost.
Dividends per common share were $0.8925 for the three months ended March 31, 2008 and $0.85 for the
three months ended March 31, 2007. The average dividend for all non-redeemed preferred shares
during the three months ended March 31, 2008 and 2007 was $0.54 per share.
The Company offers a Dividend Reinvestment and Stock Purchase Plan (the DRIP), which allows for
holders of the Companys 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 Companys common stock as reported by the New York Stock Exchange (NYSE) on the
applicable investment date.
In February 2008, the Company announced that its Board of Directors increased the Companys common
stock repurchase program for purchases of shares of its common stock in open market or negotiated
transactions to $500,000. During the three months ended March 31, 2008, the Company repurchased
482,100 shares at an average price of $87.42 per share through this program, bringing the total
amount of common stock purchased under the program to approximately $300,000.
13
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, 2008 (dollars in
thousands):
Interest | Interest | |||||||
Rate Caps | Rate Swaps | |||||||
Notional balance |
$ | 235,637 | $ | 45,996 | ||||
Weighted average interest rate (1)
|
4.2 | % | 6.5 | % | ||||
Weighted average capped interest rate |
7.5 | % | n/a | |||||
Earliest maturity date |
May-09 | Jun-10 | ||||||
Latest maturity date |
Mar-14 | Jun-10 | ||||||
Estimated fair value, asset/(liability) |
$ | 133 | $ | (2,945 | ) |
(1) | For interest rate caps, this represents the weighted average interest rate on the debt. |
Excluding derivatives executed to hedge debt on communities classified as held for sale, the
Company had six derivatives designated as cash flow hedges and five derivatives not designated as
hedges at March 31, 2008. 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 and recognize the impact of hedge accounting, the Company recorded a reduction in other
comprehensive income of $236 during the three months ended March 31, 2008 and an increase of $172
during the three months ended March 31, 2007. Amounts in other comprehensive income 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, 2008, as well as the estimated amount included in accumulated other comprehensive
income as of March 31, 2008, 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 & Poors 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. Consistent with the
provisions of SFAS No. 157, the Company incorporates credit valuation adjustments to appropriately
reflect both its own nonperformance risk and the respective counterpartys nonperformance risk in
the fair value measurements of its derivative financial instruments. Refer to Note 11, Fair Value
Measurements for further discussion of fair value measurements under SFAS No. 157.
14
6. Investments in Real Estate 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, SOP
78-9, APB No. 18, and EITF Topic D-46 as applicable. As of March 31, 2008, the Companys
investments in unconsolidated real estate entities accounted for under the equity method of
accounting consisted of:
| a 20% limited liability company membership interest (with a right to 50% of distributions after achievement of a threshold return) in the limited liability company that owns the Avalon Chrystie Place I community; | ||
| a 25% limited liability company membership interest (with a right to 45% of distributions after achievement of a threshold return) in the limited liability company that developed and owns the Avalon at Mission Bay North II community; | ||
| a 30% limited liability company membership interest (with a right to 45% or the residual distribution after the joint venture partners receive both a return of their initial investment and an achievement of a threshold return on that investment) in the limited liability company that developed and owns the Avalon Del Rey community; | ||
| a 50% limited liability company membership interest (with a right to 95% of distributions until the Company receives a return of our investment capital and a threshold return thereon) in the limited liability company that will develop 64 for-sale town homes adjacent to the Companys Avalon Danvers community; and | ||
| a 15.2% combined general partner and indirect limited partner equity interest in the Fund (with the opportunity to receive as much as 20% of the Funds distributions in excess of return of capital, as an additional promoted distribution, based on the achievement of certain threshold returns), which owns the following 20 communities: Avalon at Redondo Beach, Avalon Lakeside, Avalon Columbia, Avalon Redmond, Avalon Sunset, Avalon at Poplar Creek, Avalon at Civic Center, Avalon Paseo Place, Avalon Yerba Buena, Avalon at Aberdeen Station, The Springs, The Covington, Avalon Cedar Place, Avalon Crystal Hill, Middlesex Crossing, Avalon Centerpoint, Skyway Terrace, Avalon Rutherford Station, South Hills Apartments and Colonial Towers/South Shore Manor. |
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 $7,192 as of
March 31, 2008). As of March 31, 2008, 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 Companys obligation under this guarantee, both at inception and as of March
31, 2008 was not significant and therefore the Company has not recorded any obligation for this
guarantee as of March 31, 2008.
15
The following is a combined summary of the financial position of the entities accounted for using
the equity method, as of the dates presented:
3-31-08 | 12-31-07 | |||||||
(unaudited) | (unaudited) | |||||||
Assets: |
||||||||
Real estate, net |
$ | 1,060,851 | $ | 997,319 | ||||
Other assets |
39,135 | 31,774 | ||||||
Total assets |
$ | 1,099,986 | $ | 1,029,093 | ||||
Liabilities and partners capital: |
||||||||
Mortgage notes payable and credit facility |
$ | 735,883 | $ | 719,310 | ||||
Other liabilities |
22,428 | 20,496 | ||||||
Partners capital |
341,675 | 289,287 | ||||||
Total liabilities and partners capital |
$ | 1,099,986 | $ | 1,029,093 | ||||
The following is a combined summary of the operating results of the entities accounted for using
the equity method, for the years presented:
For the three months ended | ||||||||
3-31-08 | 3-31-07 | |||||||
(unaudited) | (unaudited) | |||||||
Rental and
other income |
$ | 26,867 | $ | 19,214 | ||||
Operating and other expenses |
(11,354 | ) | (8,775 | ) | ||||
Interest expense, net |
(10,117 | ) | (8,526 | ) | ||||
Depreciation expense |
(8,031 | ) | (5,877 | ) | ||||
Net loss |
$ | (2,635 | ) | $ | (3,964 | ) | ||
In conjunction with the acquisition and development of the investments in unconsolidated entities,
the Company incurred costs in excess of its equity in the underlying net assets of the respective
investments. These costs represent $5,326 at March 31, 2008 and $5,375 at December 31, 2007 of the
respective investment balances.
Investments in Consolidated Real Estate Entities
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 Companys 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 has no 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, 2008, the Company did not sell any communities. As of
March 31, 2008, the Company had five communities that qualified as discontinued operations and held
for sale under the provisions of SFAS No. 144.
In accordance with the requirements of SFAS No. 144, the operations for any communities sold from
January 1, 2007 through March 31, 2008 and the communities that qualified as discontinued
operations and held for sale as of March 31, 2008 have been presented as such 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.
16
The following is a summary of income from discontinued operations for the periods presented:
For the three months ended | ||||||||
3-31-08 | 3-31-07 | |||||||
Rental income |
$ | 4,350 | $ | 8,091 | ||||
Operating and other expenses |
(1,334 | ) | (3,004 | ) | ||||
Interest expense, net |
(186 | ) | (692 | ) | ||||
Depreciation expense |
(1,110 | ) | (2,080 | ) | ||||
Income from discontinued operations |
$ | 1,720 | $ | 2,315 | ||||
The Companys Condensed Consolidated Balance Sheets include other assets (excluding net real
estate) of $1,074 and $891 as of March 31, 2008 and December 31, 2007, respectively, $26,400 of
mortgage notes as of March 31, 2008 and December 31, 2007, and other liabilities of $4,103 as of
March 31, 2008 and $3,940 as of December 31, 2007, relating to real estate assets sold or
classified as held for sale.
During the three months ended March 31, 2008, the Company did not sell any parcels of land. The
Company had gains on the sales of land parcels of $545 in the three months ended March 31, 2007.
8. Segment Reporting
The Companys reportable operating segments include Established Communities, Other Stabilized
Communities, and Development/Redevelopment Communities. Annually as of January 1st, 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 three months ended March 31, 2008, the Established Communities are communities that are consolidated for financial reporting purposes, had stabilized occupancy and operating expenses as of January 1, 2007, 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 Companys 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 communitys 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.
17
A reconciliation of NOI to net income for the three months ended March 31, 2008 and 2007 is as
follows:
For the three months ended | ||||||||
3-31-08 | 3-31-07 | |||||||
Net income |
$ | 48,450 | $ | 46,520 | ||||
Indirect operating expenses, net of corporate income |
8,458 | 6,996 | ||||||
Investments and investment management |
1,719 | 2,024 | ||||||
Interest expense, net |
28,005 | 23,186 | ||||||
General and administrative expense |
8,119 | 6,780 | ||||||
Equity in income of unconsolidated entities |
(34 | ) | 86 | |||||
Minority interest in consolidated partnerships |
106 | 449 | ||||||
Depreciation expense |
47,682 | 42,014 | ||||||
Gain on sale of real estate assets |
| (545 | ) | |||||
Income from discontinued operations |
(1,720 | ) | (2,315 | ) | ||||
Net operating income |
$ | 140,785 | $ | 125,195 | ||||
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 Companys segment information as of the dates specified.
The segments are classified based on the individual communitys 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, 2008 and 2007 has been adjusted for the communities that were sold
from January 1, 2007 through March 31, 2008, or otherwise qualify as discontinued operations as of
March 31, 2008, as described in Note 7, Real Estate Disposition Activities.
18
Total | % NOI change | Gross | ||||||||||||||
revenue | NOI | from prior year | real estate (1) | |||||||||||||
For the three months ended March 31, 2008 |
||||||||||||||||
Established |
||||||||||||||||
New England |
$ | 31,435 | $ | 19,897 | 1.3 | % | $ | 821,456 | ||||||||
Metro NY/NJ |
37,628 | 25,568 | 1.7 | % | 963,395 | |||||||||||
Mid-Atlantic/Midwest |
31,676 | 20,277 | 3.6 | % | 771,024 | |||||||||||
Pacific Northwest |
5,324 | 3,824 | 11.2 | % | 174,490 | |||||||||||
Northern California |
34,156 | 25,626 | 10.7 | % | 1,144,113 | |||||||||||
Southern California |
15,390 | 11,106 | 1.9 | % | 375,446 | |||||||||||
Total Established |
155,609 | 106,298 | 4.4 | % | 4,249,924 | |||||||||||
Other Stabilized |
29,153 | 18,889 | n/a | 1,089,627 | ||||||||||||
Development / Redevelopment |
25,438 | 15,598 | n/a | 1,934,647 | ||||||||||||
Land Held for Future Development |
n/a | n/a | n/a | 305,669 | ||||||||||||
Non-allocated (2) |
1,638 | n/a | n/a | 47,172 | ||||||||||||
Total |
$ | 211,838 | $ | 140,785 | 12.5 | % | $ | 7,627,039 | ||||||||
For the three months ended March 31, 2007 |
||||||||||||||||
Established |
||||||||||||||||
New England |
$ | 31,151 | $ | 20,937 | 4.0 | % | $ | 847,764 | ||||||||
Metro NY/NJ |
34,722 | 24,119 | 8.5 | % | 901,544 | |||||||||||
Mid-Atlantic/Midwest |
29,905 | 18,910 | 7.6 | % | 749,541 | |||||||||||
Pacific Northwest |
8,094 | 5,480 | 17.1 | % | 289,682 | |||||||||||
Northern California |
36,390 | 26,498 | 12.5 | % | 1,293,487 | |||||||||||
Southern California |
13,824 | 10,068 | 8.1 | % | 349,115 | |||||||||||
Total Established |
154,086 | 106,012 | 8.7 | % | 4,431,133 | |||||||||||
Other Stabilized |
12,616 | 7,259 | n/a | 360,763 | ||||||||||||
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 | 42,844 | ||||||||||||
Total |
$ | 188,615 | $ | 125,195 | 13.2 | % | $ | 6,580,958 | ||||||||
(1) | Does not include gross real estate assets held for sale of $138,901 and $323,376 as of March 31, 2008 and 2007, respectively. | |
(2) | Revenue represents third-party management, accounting and developer fees and miscellaneous income which are not allocated to a reportable segment. |
19
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, December 6, 2006 and September 19, 2007.
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 2,365,816 and 2,160,738 were available for future option or restricted
stock grant awards under the 1994 Plan as of March 31, 2008 and December 31, 2007, respectively.
Annually on January 1st, the maximum number available for issuance under the 1994 Plan
is increased by up to 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.
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, 2007 |
2,321,715 | $ | 83.15 | 768 | $ | 36.61 | ||||||||||
Exercised |
(35,696 | ) | 41.52 | | | |||||||||||
Granted |
401,212 | 89.06 | | | ||||||||||||
Forfeited |
(7,490 | ) | 117.04 | | | |||||||||||
Options Outstanding, March 31, 2008 |
2,679,741 | $ | 84.50 | 768 | $ | 36.61 | ||||||||||
Options Exercisable: |
||||||||||||||||
March 31, 2008 |
1,783,596 | $ | 73.46 | 768 | $ | 36.61 | ||||||||||
The weighted average fair value of the options granted during the three months ended March 31, 2008
is estimated at $9.91 per share on the date of grant using the Black-Scholes option pricing model
with the following weighted average assumptions: dividend yield of 5.5% over the expected life of
the option, volatility of 22.17%, risk-free interest rate of 3.09% and an expected life of
approximately seven years.
The Company issued 127,077 shares of restricted stock valued at $11,317, as part of its stock-based
compensation plan during the three months ended March 31, 2008. 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 No.
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, 2008 had fair values ranging from
$51.20 to $147.75 per share. The total fair value of shares vested was $9,614 for the three months
ended March 31, 2008.
Total stock-based compensation cost recognized in income was $4,617 and $5,539 for the three months
ended March 31, 2008 and 2007, respectively, and total capitalized stock-based compensation cost
was $1,377 and $912 for the three months ended March 31, 2008 and 2007, respectively. At March 31,
2008, there was a total of $10,146 and $16,234 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 1.93 years and 2.83 years, respectively.
20
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 $1,638 and $1,444 in the three months ended March 31, 2008 and 2007, respectively.
These fees are included in management, development and other fees on the accompanying Condensed
Consolidated Statements of Operations and Other Comprehensive Income.
Director Compensation
Directors of the Company who are also employees receive no additional compensation for their
services as a director. Following each annual meeting of stockholders starting with the 2006
annual meeting, non-employee directors receive (i) a number of shares of restricted stock (or
deferred stock awards) having a value of $100 and (ii) a cash payment of $40, payable in quarterly
installments of $10. After September 20, 2007, the cash payment increased to $50, payable in
quarterly installments of $12.5. The value of the restricted stock or deferred stock award will
increase to $125 following the 2008 annual meeting. Until the 2007 annual meeting, the number of
shares of restricted stock (or deferred stock awards) was calculated based on the last reported
sale price of the common stock on the NYSE on the fifth business day following the prior years
annual meeting. Following the 2007 annual meeting, the number of shares of restricted stock (or
deferred stock awards) is calculated based on the closing price on the day of the award.
Non-employee directors may elect to receive all or a portion of cash payments in the form of a
deferred stock award. In addition, the Lead Independent Director receives an annual fee of $30
payable in equal monthly installments of $2.5.
The Company recorded non-employee director compensation expense relating to the restricted stock
grants and deferred stock awards in the amount of $218 for the three months ended March 31, 2008 as
a component of general and administrative expense. Deferred compensation relating to these
restricted stock grants and deferred stock awards was $667 and $766 on March 31, 2008 and December
31, 2007, respectively.
11. Fair Value Measurements
As a basis for applying a market-based approach in fair value measurements, SFAS No. 157
establishes a fair value hierarchy that distinguishes between market participant assumptions based
on market data obtained from sources independent of the reporting entity (observable inputs that
are classified within Levels 1 and 2 of the hierarchy) and the reporting entitys own assumptions
about market participant assumptions (unobservable inputs classified within Level 3 of the
hierarchy).
Level 1 inputs utilize unadjusted quoted prices in active markets for identical assets or
liabilities. Level 2 inputs are observable inputs other than Level 1 prices. Level 2 inputs may
include quoted prices for similar assets and liabilities in active markets, as well as inputs other
than quoted prices that are observable, such as interest rates and yield curves at commonly quoted
intervals. Level 3 inputs are unobservable inputs which are typically based on the Companys
assumptions, as there is little, if any, related market activity. If inputs to the fair value
measurement come from different levels of the fair value hierarchy, the entire fair value
measurement is classified according to the lowest level input that is significant to the fair value
measurement. The Companys assessment of the significance of a particular input to the fair value
measurement in its entirety requires judgment, and considers factors specific to the asset or
liability.
Derivative
Financial Instruments
Currently, the Company uses interest rate swap and interest rate cap agreements to manage its
interest rate risk. The valuation of these instruments is determined using widely accepted
valuation techniques including discounted cash flow analysis on the expected cash flows of each
derivative. This analysis reflects the contractual terms of the derivatives, including the period
to maturity, and uses observable market-based inputs, including interest rate curves and implied
volatilities.
21
To comply with the provisions of SFAS No. 157, the Company incorporates credit valuation
adjustments to appropriately reflect both its own nonperformance risk and the respective
counterpartys nonperformance risk in the fair value measurements. In adjusting the fair value of
its derivative contracts for the effect of nonperformance risk, the Company has considered the
impact of its net position with a given counterparty, as well as any applicable credit
enhancements, such as collateral postings, thresholds, mutual puts, and guarantees.
Although the Company has determined that the majority of the inputs used to value its derivatives
fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with
its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the
likelihood of default by itself and its counterparties. However, as of March 31, 2008, the Company
has assessed the significance of the impact of the credit valuation adjustments on the overall
valuation of its derivative positions and has determined it is not significant. As a result, the
Company has determined that its derivative valuations are classified in Level 2 of the fair value
hierarchy. See Note 5, Derivative Instruments and Hedging Activities, for derivative values at
March 31, 2008.
Other Financial Instruments
In conjunction with a joint venture agreement, the Company provided our joint venture partner with
a redemption option (the Put). This Put allows our partner to require the Company to purchase
their interest in the investment at the future fair market value, payable in cash or, at the
Companys option, common equity shares of the Company. Consistent with the guidance in EITF Topic
D-98, Classification and Measurement of Redeemable Securities, we classify our obligation under
this Put as a component of minority interest at fair value, with a corresponding offset of changes
in the fair value of the Put recorded in accumulated earnings less dividends. The fair value of
the Put is based on the fair market value of the net assets of the joint venture. The Company
calculates the fair value of the Put based on unobservable inputs considering the assumptions that
market participants would make in pricing this obligation. Accordingly, the valuation of the Put
is classified in Level 3 of the fair value hierarchy. At March 31, 2008, the fair value of the Put
was $15,666, which represents an unrealized decrease in the fair value of this obligation of $3,500
for the three month period ended March 31, 2008.
12. Subsequent Events
In April 2008, the Company redeemed $10,000 aggregate principal amount of its $150,000, 7.5%
medium-term notes due August 2009. The Company recognized a 2.875% premium upon redemption,
purchasing the medium-term notes for approximately $10,288. The Company will record this premium
as a charge to earnings in the second quarter of 2008.
In April 2008, the Company obtained a seven year, interest only mortgage loan at an effective
interest rate of 5.48% for $110,600 secured by Avalon Crescent, located in McLean, Virginia. The
net carrying value of Avalon Crescent was $41,225 as of March 31, 2008. The Company used the net
proceeds from this financing as well as the two secured financings discussed in Note 3, Notes
Payable, Unsecured Notes and Credit Facility, to reduce the outstanding amount on the Companys
unsecured credit facility.
22
ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
Managements 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 included in 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
for the year ended December 31, 2007.
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 are 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.
We regularly evaluate the allocation of our investments by the amount of invested capital and by
product type within our individual markets, which are located in the New England, New York/New
Jersey metro, 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. Our communities are
predominately 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 2008 Highlights
| We continued to experience earnings growth in the first quarter of 2008 despite slowing economic conditions. | ||
| Net income available to common stockholders for the quarter ended March 31, 2008 was $46,275,000, as compared to $44,345,000 for the quarter ended March 31, 2007, an increase of 4.4%. This increase is primarily attributable to growth in income from newly developed and existing communities in the first quarter of 2008. | ||
| Our Established Community portfolio (as defined later in this report) experienced a 4.4% increase in net operating income (NOI) over the comparable period of 2007, driven by a 4.4% increase in rental revenue partially offset by growth in operating expenses of 4.2%. The rental revenue growth over the comparable period in 2007 is comprised of an increase in rental rates of 4.1% and an increase in occupancy of 0.3%. | ||
| In addition to our Established Community year-over-year growth in NOI, our operating results were supported by the growing contribution from communities that are both currently under development as well as those that have recently completed development. We continue to focus on creating value through our development activities and pipeline. We began the construction of one wholly-owned apartment community that, upon completion, is expected to contain 200 apartment homes for a total capitalized cost of $46,500,000 and have 22 communities under construction with a projected total capital cost upon completion of approximately $2,209,700,000 at March 31, 2008. | ||
| We executed two separate five-year, interest only secured financings for borrowings of approximately $265,000,000, at a weighted average effective interest rate of 4.78%. | ||
| We repurchased 482,100 shares of our common stock through open market transactions under our common stock repurchase program. The shares were repurchased at an average price of $87.42. |
23
Financial Outlook
We expect revenue and NOI growth at our Established Communities to remain positive but to continue
to moderate for the remainder of 2008 from the levels achieved over the last few quarters for the
remainder of 2008. Our expectation of continued growth in 2008 of NOI for our Established
Communities is supported by the apartment demand-supply fundamentals, but tempered by job losses.
New demand for rental apartments is supported by an increasing propensity to rent, as reflected in
the declining home ownership rate, as well as an increase in the demographic segments of our
population with traditionally higher propensities to rent. New rental supply remains modest and
the potential amount of new supply from unsold condominiums is less in our markets than in other
regions of the country. Our focus on high-barrier to entry markets with constrained supply and
favorable demographics has mitigated the impact of the current volatility in the credit and housing
markets. These supply constraints limit construction and lessen the impact of an economic slowdown
in our markets relative to other areas of the country. The strength of the markets in which we
operate has yielded above average employment growth during the first quarter for all but two of our
regions, and we expect will allow our markets to continue to achieve greater separation in market
performance for the balance of 2008.
We expect our development activity will continue to create long-term value. We currently have
approximately $2,210,000,000 under construction (measured by total projected capitalized cost of
the communities at completion). As of March 31, 2008,
approximately $1,411,041,000 of this
development had been funded, with $798,659,000 remaining to be disbursed. For the remainder of
2008, we anticipate our construction activity will remain at or slightly below this level. Given
current economic and capital market conditions, we continue to selectively secure new Development
Rights, including the acquisition of land for future development. We currently have Development
Rights for construction of new apartment communities that would, if developed as expected, total
approximately $3,914,000,000 based on total projected capitalized costs at March 31, 2008. During
the first quarter of 2008 we commenced the redevelopment of one community on behalf of the Fund (as
defined below). We expect to continue to increase our redevelopment activities in 2008, for both
wholly owned and Fund-owned assets. While current market conditions with respect to liquidity may
impact the types of funding sources used, we believe that our current level of indebtedness, our
current ability to service interest and other fixed charges and our large base of unencumbered
assets will provide us with the financial flexibility to access the capital necessary to fund our
development and redevelopment activities currently underway. We expect to meet these needs from
both secured and unsecured debt, as well as asset sales and retained cash.
AvalonBay Value Added Fund, L.P. (the Fund) is a discretionary investment fund in which we hold a
15% interest. The Fund has been our principal vehicle for acquiring apartment communities, subject
to certain exceptions, since its formation in March 2005. As of April 30, 2008, the total amount
invested by the Fund is $784,369,000. Management of the Fund expects
to invest approximately $34,000,000 of
additional funds to redevelop the assets acquired. The investment period for the Fund concluded in
March 2008. Accordingly, no new acquisitions for the Fund will be considered. We are exploring
various potential sources and vehicles for funding future acquisitions.
24
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 are further distinguished as Established
Communities, Other Stabilized Communities, Lease-Up Communities and Redevelopment Communities. The
following is a description of each category:
Current Communities are categorized as Established, Other Stabilized,
Lease-Up, or Redevelopment according to the following attributes:
| Established Communities (also known as Same Store Communities) are consolidated communities where a comparison of operating results from the prior year to the current year is meaningful, as these communities were owned and had stabilized occupancy and operating expenses as of the beginning of the prior year. For the period ended March 31, 2008, the Established Communities are communities that are consolidated for financial reporting purposes, had stabilized occupancy and operating expenses as of January 1, 2007, are not conducting or planning to conduct substantial redevelopment activities and are not held for sale or planned for disposition within the current year. A community is considered to have stabilized occupancy at the earlier of (i) attainment of 95% physical occupancy or (ii) the one-year anniversary of completion of development or redevelopment. | ||
| Other Stabilized Communities are all other completed communities that we own or have a direct or indirect ownership interest in, and that have stabilized occupancy, as defined above. Other Stabilized Communities do not include communities that are conducting or planning to conduct substantial redevelopment activities within the current year. | ||
| Lease-Up Communities are communities where construction has been complete for less than one year and where physical occupancy has not reached 95%. | ||
| Redevelopment Communities are communities where substantial redevelopment is in progress or is planned to begin during the current year. For communities that we wholly own, 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 communitys acquisition cost. The definition of substantial redevelopment may differ for communities owned through a joint venture arrangement. |
Development Communities are communities that are under construction and
for which a certificate of occupancy has not been received. These communities
may be partially complete and operating.
Development Rights are development opportunities in the early phase of the
development process for which we either have an option to acquire land or enter into
a leasehold interest, for which we are the buyer under a long-term conditional
contract to purchase land or where we own land to develop a new community. We
capitalize related pre-development costs incurred in pursuit of new developments for
which we currently believe future development is probable.
In addition, we own approximately 60,000 square feet of office space in Alexandria, Virginia, for
our corporate office, with all other regional and administrative offices leased under operating
leases.
25
As of March 31, 2008, communities that we owned or held a direct or indirect interest in were
classified as follows:
Number of | Number of | |||||||
communities | apartment homes | |||||||
Current Communities |
||||||||
Established Communities: |
||||||||
New England |
23 | 5,351 | ||||||
Metro NY/NJ |
18 | 5,621 | ||||||
Mid-Atlantic/Midwest |
19 | 6,422 | ||||||
Pacific Northwest |
6 | 1,320 | ||||||
Northern California |
22 | 6,207 | ||||||
Southern California |
11 | 3,430 | ||||||
Total Established |
99 | 28,351 | ||||||
Other Stabilized Communities: |
||||||||
New England |
10 | 3,181 | ||||||
Metro NY/NJ |
10 | 2,326 | ||||||
Mid-Atlantic/Midwest |
11 | 2,773 | ||||||
Pacific Northwest |
5 | 1,569 | ||||||
Northern California |
10 | 3,051 | ||||||
Southern California |
8 | 1,780 | ||||||
Total Other Stabilized |
54 | 14,680 | ||||||
Redevelopment Communities |
8 | 2,120 | ||||||
Total Current Communities |
161 | 45,151 | ||||||
Development Communities |
22 | 7,016 | ||||||
Development Rights |
46 | 13,266 | ||||||
26
Results of Operations
Our year-over-year operating performance is primarily affected by individual geographic market
conditions and apartment fundamentals as measured by changes in net operating income of our
Established Communities; NOI derived from acquisitions and development completions; the loss of NOI
related to disposed communities; and capital market and financing activity. A comparison of our
operating results for the three months ended March 31, 2008 and 2007 follows (dollars in
thousands):
For the three months ended | ||||||||||||||||
3-31-08 | 3-31-07 | $ Change | % Change | |||||||||||||
Revenue: |
||||||||||||||||
Rental and other income |
$ | 210,200 | $ | 187,171 | $ | 23,029 | 12.3 | % | ||||||||
Management, development and other fees |
1,638 | 1,444 | 194 | 13.4 | % | |||||||||||
Total revenue |
211,838 | 188,615 | 23,223 | 12.3 | % | |||||||||||
Expenses: |
||||||||||||||||
Direct property operating expenses,
excluding property taxes |
49,564 | 44,983 | 4,581 | 10.2 | % | |||||||||||
Property taxes |
19,850 | 16,994 | 2,856 | 16.8 | % | |||||||||||
Total community operating expenses |
69,414 | 61,977 | 7,437 | 12.0 | % | |||||||||||
Corporate-level property management
and other indirect operating expenses |
10,097 | 8,439 | 1,658 | 19.6 | % | |||||||||||
Investments and investment management |
1,719 | 2,024 | (305 | ) | (15.1 | %) | ||||||||||
Interest expense, net |
28,005 | 23,186 | 4,819 | 20.8 | % | |||||||||||
Depreciation expense |
47,682 | 42,014 | 5,668 | 13.5 | % | |||||||||||
General and administrative expense |
8,119 | 6,780 | 1,339 | 19.7 | % | |||||||||||
Total other expenses |
95,622 | 82,443 | 13,179 | 16.0 | % | |||||||||||
Equity in income of unconsolidated entities |
34 | (86 | ) | 120 | 139.5 | % | ||||||||||
Minority interest in consolidated partnerships |
(106 | ) | (449 | ) | 343 | (76.4 | %) | |||||||||
Gain on sale of land |
| 545 | (545 | ) | (100.0 | %) | ||||||||||
Income from continuing operations |
46,730 | 44,205 | 2,525 | 5.7 | % | |||||||||||
Discontinued operations: |
||||||||||||||||
Income from discontinued operations |
1,720 | 2,315 | (595 | ) | (25.7 | %) | ||||||||||
Gain on sale of communities |
| | | N/A | ||||||||||||
Total discontinued operations |
1,720 | 2,315 | (595 | ) | (25.7 | %) | ||||||||||
Net income |
48,450 | 46,520 | 1,930 | 4.1 | % | |||||||||||
Dividends attributable to preferred stock |
(2,175 | ) | (2,175 | ) | | | ||||||||||
Net income available to common stockholders |
$ | 46,275 | $ | 44,345 | $ | 1,930 | 4.4 | % | ||||||||
Net income available to common stockholders increased $1,930,000 or 4.4%, to $46,275,000 for the
three months ended March 31, 2008 due primarily to contributions to NOI from newly developed
communities and growth in net operating income from Established Communities.
NOI is considered by management to be an important and appropriate supplemental performance measure
to net income because it helps both investors and management to understand the core operations of a
community or communities prior to the allocation of any corporate-level or financing-related costs.
NOI reflects the operating performance of a community and allows for an 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.
27
NOI does not represent cash generated from operating activities in accordance with U.S. generally
accepted accounting principles (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.
Reconciliations of NOI for the
three months ended March 31, 2008 and 2007 to net income for each year, are as follows (dollars in
thousands):
For the three months ended | ||||||||
3-31-08 | 3-31-07 | |||||||
Net income |
$ | 48,450 | $ | 46,520 | ||||
Indirect operating expenses, net of corporate income |
8,458 | 6,996 | ||||||
Investments and investment management |
1,719 | 2,024 | ||||||
Interest expense, net |
28,005 | 23,186 | ||||||
General and administrative expense |
8,119 | 6,780 | ||||||
Equity in income of unconsolidated entities |
(34 | ) | 86 | |||||
Minority interest in consolidated partnerships |
106 | 449 | ||||||
Depreciation expense |
47,682 | 42,014 | ||||||
Gain on sale of real estate assets |
| (545 | ) | |||||
Income from discontinued operations |
(1,720 | ) | (2,315 | ) | ||||
Net operating income |
$ | 140,785 | $ | 125,195 | ||||
The NOI increases for the three months ended March 31, 2008, as compared to the prior year period,
consist of changes in the following categories (dollars in thousands):
For the three months ended | ||||
3-31-08 | ||||
Established Communities |
$ | 4,474 | ||
Other Stabilized Communities |
6,452 | |||
Development and Redevelopment Communities |
4,664 | |||
Total |
$ | 15,590 | ||
The NOI increases in Established Communities in 2008 were largely due to continued favorable but
moderating apartment market fundamentals. During the three months ended March 31, 2008, we
continued to focus on rental rate growth, while maintaining occupancy of at least 95% in all
regions. We anticipate that year over year increases in rental rates and overall rental revenue
growth will moderate during the remainder of 2008 as compared to the 4.4% growth achieved in the
first quarter of 2008, as we expect reduced job growth (demand) as well as a decline in new rental
completions in our markets (supply). Expense growth also impacts growth in NOI and we will
continue to monitor and manage operating expenses to constrain expense growth.
Rental and other income increased in the three months ended March 31, 2008 as compared to the prior
year due to increased rental rates for our Established Communities, coupled with additional rental
income generated from newly developed communities.
Overall Portfolio The weighted average number of occupied apartment homes increased to
38,350 apartment homes for the three months ended March 31, 2008 as compared to 38,047 homes
for the prior year period. This change is primarily the result of increased homes available
from newly developed and acquired communities, partially offset by communities sold in 2007. The weighted average
monthly revenue per occupied apartment home increased to $1,826 for the three months ended
March 31, 2008 as compared to $1,709 in the prior year period.
Established Communities Rental revenue increased $6,551,000, or 4.4%, for the three months
ended March 31, 2008 over the prior year period. These increases are due to increased
average rental rates and increased economic occupancy. For the three months ended March 31,
2008, the weighted average monthly revenue per occupied apartment home increased 4.1% to
$1,897 compared to $1,822 in the prior year period, primarily due to increased market rents.
The average economic occupancy increased 0.3% to 96.4% for the three months ended March 31,
2008. Economic occupancy takes into account the fact that apartment homes of different
sizes and locations within a community have different economic impacts on a communitys
gross revenue. Economic occupancy is defined as gross potential revenue less vacancy loss,
as a percentage of gross potential revenue. Gross potential revenue is determined by
valuing occupied homes at leased rates and vacant homes at market rents.
28
We experienced increases in Established Communities rental revenue in all six of our regions
for the three months ended March 31, 2008 as compared to the prior year period. The largest
increases in rental revenue were in the Pacific Northwest, Northern California and New England,
with increases of 7.9%, 7.7% and 3.5%, respectively, between years. The Metro New York/New
Jersey and Northern California regions are the two largest regions and comprise almost half of
our Established Community revenue, and therefore are discussed in more detail below.
Northern California, which represented approximately 21.9% of Established Community rental
revenue during the three months ended March 31, 2008, experienced an increase in rental
revenue of 7.7% as compared to the prior year period. Average rental rates increased by
7.6% to $1,888, and economic occupancy increased 0.1% to 97.1% for the three months ended
March 31, 2008. Apartment fundamentals remain strong in Northern California. We expect
Northern California to see continued but moderating revenue growth during the remainder of
2008, with growth levels in excess of those expected in other markets in the United States.
The Metro New York/New Jersey region, which accounted for approximately 24.2% of Established
Community rental revenue for the three months ended March 31, 2008, experienced an increase
in rental revenue of 3.3% for the three months ended March 31, 2008 as compared to the prior
year period. Average rental rates increased 3.6% to $2,321, and economic occupancy
decreased 0.3% to 96.1% for the three months ended March 31, 2008. Through the first
quarter of 2008, job growth remained positive in New York and rental market conditions
remained healthy in both New York City and surrounding suburban markets. Despite layoff
announcements by major banks and other financial institutions, reported securities industry
job losses have been nominal. However, we are watchful for changing in market conditions and
the potential that actual job losses may accelerate during the second half of 2008. We will
monitor these and other variables that may impact rental revenue during the second half of
2008 and first half of 2009, and will respond with pricing adjustments to optimize revenues.
In accordance with GAAP, cash concessions are amortized as an offset to rental revenue over the
approximate lease term, which is generally one year. As a supplemental measure, we also present
rental revenue with concessions stated on a cash basis to help investors evaluate the impact of
both current and historical concessions on GAAP based rental revenue and to more readily enable
comparisons to revenue as reported by other companies. Rental revenue with concessions stated on a
cash basis also allows investors to understand historical trends in cash concessions, as well as
current rental market conditions.
The following table reconciles total rental revenue in conformity with GAAP to total rental revenue
adjusted to state concessions on a cash basis for our Established Communities for the three months
ended March 31, 2008 and 2007 (dollars in thousands).
For the three months ended | ||||||||
3-31-08 | 3-31-07 | |||||||
Rental revenue (GAAP basis) |
$ | 155,561 | $ | 149,010 | ||||
Concessions amortized |
1,357 | 1,328 | ||||||
Concessions granted |
(1,144 | ) | (1,313 | ) | ||||
Rental revenue adjusted to state
concessions on a cash basis |
$ | 155,774 | $ | 149,025 | ||||
Year-over-year % change GAAP revenue |
4.4 | % | n/a | |||||
Year-over-year % change cash
concession based revenue |
4.5 | % | n/a |
29
Management, development and other fees increased $194,000, or 13.4% for the three months ended
March 31, 2008. The increase was due primarily to increased property management fees from the
Fund, as additional communities were acquired.
Direct property operating expenses, excluding property taxes increased $4,581,000 or 10.2% for the
three months ended March 31, 2008 as compared to the prior year period, primarily due to the
addition of recently developed and acquired apartment homes coupled with expense growth in our
Established Communities.
For Established Communities, direct property operating expenses, excluding property taxes,
increased $156,000, or 0.5% to $33,991,000 for the three months ended March 31, 2008, due primarily
to higher maintenance, office and administrative and redecorating costs offset by decreases in
insurance and utility expenses.
Property taxes increased $2,856,000 or 16.8% for the three months ended March 31, 2008, due to
overall higher assessments and the addition of newly developed and redeveloped apartment homes.
Property taxes are impacted by the size and timing of successful tax appeals in both years.
For Established Communities, property taxes increased by $1,810,000, or 13.4% for the three months
ended March 31, 2008 due to both higher assessments throughout all regions and reductions in
property taxes realized in 2007 that have not occurred in 2008. Year over year changes are
impacted by the size and timing of successful tax appeals. Overall, we expect property taxes in
2008 to continue to increase from 2007 levels due to increased valuations but at a more moderate
rate of growth than that experienced in the first quarter of 2008. However, property tax increases
are limited by law (Proposition 13) for communities in California. We evaluate property tax
increases internally, as well as engage third-party consultants, and appeal increases when
appropriate.
Corporate-level property management and other indirect operating expenses increased by $1,658,000,
or 19.6% for the three months ended March 31, 2008 over the prior year period due primarily to
increased costs relating to corporate initiatives focused on increasing efficiency and enhancing
controls at our operating communities, coupled with increased compensation and relocation costs.
The 2008 expense includes the set up and ongoing costs related to our Customer Care Center in
Virginia Beach, Virginia that we opened in the third quarter of 2007. This office is being used to
centralize certain community-related accounting, administrative and customer service functions.
The transition is expected to continue through the end of 2008.
Investments and investment management reflects the costs incurred for investment acquisitions,
investment management and abandoned pursuit costs, which include costs incurred for development
pursuits not yet considered probable for development, as well as the abandonment or impairment of
development pursuits, acquisition pursuits and disposition pursuits. Investments and investment
management costs decreased during the three months ended March 31, 2008 compared to the prior year period due primarily to decreased abandoned pursuit
costs. Abandoned pursuit costs can be volatile, and the costs incurred in any given period may
vary significantly in future periods.
Interest expense, net increased $4,819,000 or 20.8% for the three months ended March 31, 2008 due
primarily to a decrease in interest income in the three months ended March 31, 2008 as compared to
the prior year period. The higher level of interest income in the three months ended March 31,
2007 is due to higher invested cash balances from our January 2007 equity offering during that
period as well as higher yields on invested cash during the first quarter of 2007.
Depreciation expense increased $5,668,000 or 13.5% for the three months ended March 31, 2008
primarily due to the completion of development and redevelopment activities.
General and administrative expense (G&A) increased $1,339,000 or 19.7% for the three months ended
March 31, 2008 primarily due to increased compensation and office and administrative costs.
Gain on sale of land for the three months ended March 31, 2008 decreased from the prior year period
due to the absence of land sales in the first quarter of 2008.
30
Equity in income of unconsolidated entities for the three months ended March 31, 2008 increased
from the prior year period due primarily to income from joint ventures where the underlying
communities have achieved stabilized operations, gains from our investment in a joint venture
formed to develop for sale homes, offset by the sale of a partnership interest in a joint venture
in the fourth quarter of 2007.
Minority interest in consolidated partnerships decreased for the three months ended March 31, 2008
as compared to the prior year period due to the conversion and redemption of limited partnership
units in 2007, thereby reducing outside ownership interests and the allocation of net income to
outside ownership interests.
Income from discontinued operations represents the net income generated by communities sold or
qualifying as discontinued operations during the period from January 1, 2007 through March 31,
2008. This income decreased for the three months ended March 31, 2008 due to fewer communities
sold or classified as discontinued operations. See Note 7, Real Estate Disposition Activities,
of our Condensed Consolidated Financial Statements.
Funds from Operations Attributable to Common Stockholders (FFO)
FFO is considered by management to be an appropriate supplemental measure of our operating and
financial performance. In calculating FFO, we exclude gains or losses related to dispositions of
previously depreciated property and exclude real estate depreciation, which can vary among owners
of identical assets in similar condition based on historical cost accounting and useful life
estimates. FFO can help one compare the operating performance of a real estate company between
periods or as compared to different companies. We believe that in order to understand our
operating results, FFO should be examined with net income as presented in our Condensed
Consolidated Financial Statements included elsewhere this report.
Consistent with the definition adopted by the Board of Governors of the National Association of
Real Estate Investment Trustsâ (NAREIT), we calculate FFO as net income or loss
computed in accordance with GAAP, adjusted for:
| gains or losses on sales of previously depreciated operating communities; | ||
| extraordinary gains or losses (as defined by GAAP); | ||
| depreciation of real estate assets; and | ||
| adjustments for unconsolidated partnerships and joint ventures. |
FFO does not represent net income in accordance with GAAP, and therefore it should not be
considered an alternative to net income, which remains the primary measure as an indication of our
performance. In addition, FFO as calculated by other REITs may not be comparable to our
calculation of FFO.
The following is a reconciliation of net income to FFO (dollars in thousands, except per share
data):
For the three months ended | ||||||||
3-31-08 | 3-31-07 | |||||||
Net income |
$ | 48,450 | $ | 46,520 | ||||
Dividends attributable to preferred stock |
(2,175 | ) | (2,175 | ) | ||||
Depreciation real estate assets, including discontinued
operations and joint venture adjustments |
49,785 | 44,685 | ||||||
Minority interest expense, including discontinued operations |
57 | 88 | ||||||
Gain on sale of operating communities |
| | ||||||
Funds from operations attributable to common stockholders |
$ | 96,117 | $ | 89,118 | ||||
Weighted average common shares outstanding diluted |
77,440,892 | 79,930,748 | ||||||
EPS per common share diluted |
$ | 0.60 | $ | 0.56 | ||||
FFO per common share diluted |
$ | 1.24 | $ | 1.11 | ||||
31
FFO also does not represent cash generated from operating activities in accordance with GAAP, and
therefore should not be considered an alternative to net cash flows from operating activities, as
determined by GAAP, as a measure of liquidity. Additionally, it is not necessarily indicative of
cash available to fund cash needs.
A presentation of GAAP based cash flow metrics is as follows (dollars in thousands) and a
discussion of Liquidity and Capital Resources can be found below.
For the three months ended | ||||||||
3-31-08 | 3-31-07 | |||||||
Net cash provided by operating activities |
$ | 19,577 | $ | 99,188 | ||||
Net cash used in investing activities |
$ | (156,945 | ) | $ | (285,266 | ) | ||
Net cash provided by financing activities |
$ | 386,522 | $ | 533,946 | ||||
Liquidity and Capital Resources
Factors affecting our liquidity and capital resources are our cash flows from operations, financing
activities and investing activities, as well as general economic and market conditions. Operating
cash flow has historically been determined by: (i) the number of apartment homes currently owned,
(ii) rental rates, (iii) occupancy levels and (iv) operating expenses with respect to apartment
homes. The timing, source and amount of cash flows provided by financing activities and used in
investing activities are sensitive to the capital markets environment, particularly to changes in
interest rates. The timing and type of capital markets activity in which we engage, as well as our
plans for development, redevelopment, acquisition and disposition activity, are affected by changes
in the capital markets environment, such as changes in interest rates or the availability of
cost-effective capital.
We regularly review our liquidity needs, the adequacy of cash flows from operations, and other
expected liquidity sources to meet these needs. We believe our principal short-term liquidity
needs are to fund:
| normal recurring operating expenses; | ||
| debt service and maturity payments; | ||
| preferred stock dividends and DownREIT partnership unit distributions; | ||
| the minimum dividend payments on our common stock required to maintain our REIT qualification under the Internal Revenue Code of 1986; | ||
| development and redevelopment activity in which we are currently engaged; and | ||
| capital calls for the Fund, as required. |
We have traditionally accessed the unsecured debt markets to meet a significant portion of our
liquidity needs. Because market terms and rates for unsecured debt are not as attractive as those
available in the secured debt markets, we have recently chosen to take advantage of secured debt in
meeting our liquidity needs. During the first quarter of 2008 the Company executed two separate
five-year, interest only mortgage loans for an aggregate borrowing of approximately $264,697,000 at
a weighted average effective interest rate of 4.78%. One mortgage loan for approximately
$170,125,000 is secured by Avalon at Arlington Square, located in Arlington, Virginia. The second
mortgage loan, for approximately $94,572,000 is secured by Avalon at Cameron Court, located in
Alexandria, Virginia. In addition, in April 2008, we executed a seven-year, interest only mortgage
loan, borrowing approximately $110,600,000 at an effective interest rate of 5.48% secured by Avalon
Crescent, located in McLean, Virginia. Although general market liquidity is constrained, we
anticipate that we can satisfy our expected liquidity needs from a combination of cash flow
provided by operating activities, proceeds from asset dispositions and borrowing capacity under our
variable rate unsecured credit facility, as well as secured financings and other public or private
sources of liquidity.
Cash and cash equivalents totaled $270,320,000 at March 31, 2008, an increase of $249,154,000 from
$21,166,000 at December 31, 2007. The following discussion relates to changes in cash due to
operating, investing and financing activities, which are presented in our Consolidated Statements
of Cash Flows included elsewhere in this report.
32
Operating Activities Net cash provided by operating activities decreased to $19,577,000 for
the three months ended March 31, 2008 from $99,188,000 for the three months ended March 31,
2007. The decrease was driven primarily by an increase in prepaid rent associated with certain
development communities, payment of interest amounts and general corporate payables, partially
offset by the additional NOI from our Established Communities operations, as well as NOI from
recently developed communities.
Investing Activities Net cash used in investing activities of $156,945,000 for the three
months ended March 31, 2008 related to investments in assets through the development and
redevelopment of apartment communities. During the three months ended March 31, 2008, we
invested $210,173,000 in the purchase and development of the following real estate and capital
expenditures:
| We acquired two parcels of land in connection with Development Rights, for an aggregate purchase price of approximately $26,925,000. | ||
| We had capital expenditures of $2,041,000 for real estate and non-real estate assets. | ||
| We invested approximately $166,486,000 in the development of communities, including the commencement of the development of one community which is expected to contain a total of 200 apartment homes for an expected aggregate total capital cost of $46,500,000. |
Financing Activities Net cash provided by financing activities totaled $386,522,000 for the
three months ended March 31, 2008. The net cash inflow is due primarily to borrowings of
$284,000,000 under our unsecured credit facility and the issuance of two secured mortgage notes
for approximately $264,697,000, offset by the repurchase of 482,100 shares of our common stock
at an average price of $87.42 per share, the repayment of unsecured notes at maturity of
approximately $50,000,000 and dividend payments of $67,760,000.
Variable Rate Unsecured Credit Facility
We currently have a $1,000,000,000 revolving variable rate unsecured credit facility with a
syndicate of commercial banks, to whom we pay, in the aggregate, an annual facility fee of
approximately $1,250,000. The unsecured credit facility bears interest at varying levels based on
the London Interbank Offered Rate (LIBOR), our credit rating and on a maturity schedule selected
by us. The current stated pricing is LIBOR plus 0.40% per annum (3.20% on April 30, 2008). The
spread over LIBOR can vary from LIBOR plus 0.325% to LIBOR plus 1.00% based on our credit rating.
In addition, a competitive bid option is available for borrowings of up to $422,500,000. This
option allows banks that are part of the lender consortium to bid to provide us loans at a rate
that is lower than the stated pricing provided by the unsecured credit facility. The competitive
bid option may result in lower pricing if market conditions allow. We had no outstanding balance
under this competitive bid option at April 30, 2008. We are subject to and currently in compliance
with 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 our
exercise of a one-year renewal option. During April 2008, we used the net proceeds from the three
secured financings done in March and April 2008 to reduce the outstanding amount on the Companys
unsecured credit facility. At April 30, 2008, $520,500,000 was outstanding on the credit facility,
$65,659,000 was used to provide letters of credit and $413,841,000 was available for borrowing
under the unsecured credit facility.
33
Future Financing and Capital Needs Debt Maturities
One of our principal long-term liquidity needs is the repayment of long-term debt at the time that
such debt matures. For unsecured notes, we anticipate that no significant portion of the principal
of these notes will be repaid prior to maturity. If we do not have funds on hand sufficient to
repay our indebtedness as it becomes due, it will be necessary for us to refinance the debt. This
refinancing may be accomplished by uncollateralized private or public debt offerings, additional
debt financing that is collateralized by mortgages on individual communities or groups of
communities, draws on our unsecured credit facility or by equity offerings. Although we believe we
will have the capacity to meet our currently anticipated liquidity needs, we cannot assure you that
additional debt financing or debt or equity offerings will be available or, if available, that they
will be on terms we consider satisfactory.
The following financing activity occurred during the three months ended March 31, 2008:
| we repaid $50,000,000 in 6.625% of previously issued medium-term notes, along with any unpaid interest, pursuant to their scheduled maturity; | ||
| we borrowed $170,125,000 under an interest-only mortgage note secured by Avalon at Arlington Square, located in Arlington, Virginia at an effective rate of 4.69% for five years; | ||
| we borrowed $94,572,000 under an interest-only mortgage note secured by Avalon at Cameron Court, located in Alexandria, Virginia at an effective rate of 4.95% for five years; | ||
| we borrowed $284,000,000 under our unsecured credit facility; and | ||
| we repurchased 482,100 shares of our common stock at an average price of $87.42 per share, for a total approximate purchase price of $42,144,000. |
In February 2008, the Board of Directors authorized an increase of $200,000,000 in our common stock
repurchase program, increasing the total amount the Company can acquire to $500,000,000, of which
approximately $300,000,000 has been used to repurchase our common stock as of March 31, 2008. The
decision to use the additional share repurchase authorization will depend on current capital market
conditions and liquidity, our share price relative to the net asset value per share and other uses
of capital, including development.
34
The table below details debt maturities for the next five years, excluding our unsecured credit
facility and amounts outstanding related to communities classified as held for sale, for debt
outstanding at March 31, 2008 (dollars in thousands, except footnotes).
All-In | Principal | |||||||||||||||||||||||||||||||||||
interest | maturity | Balance outstanding | Scheduled maturities | |||||||||||||||||||||||||||||||||
Community | rate (1) | date | 12-31-07 | 3-31-08 | 2008 | 2009 | 2010 | 2011 | 2012 | Thereafter | ||||||||||||||||||||||||||
Tax-exempt bonds |
||||||||||||||||||||||||||||||||||||
Fixed rate |
||||||||||||||||||||||||||||||||||||
CountryBrook |
6.30% | Mar-2012 | $ | 15,356 | $ | 15,191 | $ | 511 | $ | 719 | $ | 766 | $ | 816 | $ | 12,379 | $ | | ||||||||||||||||||
Avalon at
Symphony Glen |
4.90% | Jul-2024 | 9,780 | 9,780 | | | | | | 9,780 | ||||||||||||||||||||||||||
Avalon at Lexington |
6.55% | Feb-2025 | 12,078 | 11,977 | 312 | 439 | 466 | 495 | 526 | 9,739 | ||||||||||||||||||||||||||
Avalon Campbell |
6.48% | Jun-2025 | 31,877 | 31,643 | (2) | | | | | | 31,643 | |||||||||||||||||||||||||
Avalon Pacifica |
6.48% | Jun-2025 | 14,460 | 14,353 | (2) | | | | | | 14,353 | |||||||||||||||||||||||||
Avalon Knoll |
6.95% | Jun-2026 | 11,654 | 11,576 | 245 | 347 | 371 | 398 | 426 | 9,789 | ||||||||||||||||||||||||||
Avalon Landing |
6.85% | Jun-2026 | 5,751 | 5,712 | 123 | 173 | 185 | 198 | 212 | 4,821 | ||||||||||||||||||||||||||
Avalon Fields |
7.55% | May-2027 | 10,224 | 10,182 | 194 | 275 | 295 | 316 | 339 | 8,763 | ||||||||||||||||||||||||||
Avalon Oaks |
7.45% | Jul-2041 | 17,077 | 17,044 | 103 | 147 | 157 | 168 | 180 | 16,289 | ||||||||||||||||||||||||||
Avalon Oaks West |
7.48% | Apr-2043 | 16,919 | 16,889 | 94 | 133 | 142 | 152 | 162 | 16,206 | ||||||||||||||||||||||||||
Avalon at Chestnut
Hill |
5.82% | Oct-2047 | 42,149 | 42,072 | 237 | 331 | 349 | 368 | 388 | 40,399 | ||||||||||||||||||||||||||
187,325 | 186,419 | 1,819 | 2,564 | 2,731 | 2,911 | 14,612 | 161,782 | |||||||||||||||||||||||||||||
Variable rate (3)
|
||||||||||||||||||||||||||||||||||||
The Promenade |
3.58% | Oct-2010 | 30,844 | 30,844 | 701 | 755 | 29,388 | | | | ||||||||||||||||||||||||||
Waterford |
2.27% | Jul-2014 | 33,100 | 33,100 | (4) | | | | | | 33,100 | |||||||||||||||||||||||||
Avalon at Mountain
View |
2.27% | Feb-2017 | 18,300 | 18,300 | (4) | | | | | | 18,300 | |||||||||||||||||||||||||
Avalon at Mission
Viejo |
2.68% | Jun-2025 | 7,635 | 7,635 | (4) | | | | | | 7,635 | |||||||||||||||||||||||||
Avalon at Nob Hill |
2.27% | Jun-2025 | 20,800 | 20,800 | (4) | | | | | | 20,800 | |||||||||||||||||||||||||
Avalon Campbell |
2.32% | Jun-2025 | 6,923 | 7,157 | (2) | | | | | | 7,157 | |||||||||||||||||||||||||
Avalon Pacifica |
2.32% | Jun-2025 | 3,140 | 3,247 | (2) | | | | | | 3,247 | |||||||||||||||||||||||||
Avalon at Fairway
Hills I |
2.88% | Jun-2026 | 11,500 | 11,500 | | | | | | 11,500 | ||||||||||||||||||||||||||
Avalon Bowery Place I |
2.02% | Nov-2037 | 93,800 | 93,800 | (5) | 396 | 576 | 636 | 703 | 777 | 90,712 | |||||||||||||||||||||||||
Avalon Bowery Place II |
2.35% | Nov-2039 | 48,500 | 48,500 | (5) | | | 270 | 298 | 329 | 47,603 | |||||||||||||||||||||||||
Avalon Acton |
2.98% | Jul-2040 | 45,000 | 45,000 | (5) | | | | | | 45,000 | |||||||||||||||||||||||||
Avalon Morningside Park |
8.07% | Nov-2040 | 100,000 | 100,000 | (5) | | | 138 | 302 | 340 | 99,220 | |||||||||||||||||||||||||
419,542 | 419,883 | 1,097 | 1,331 | 30,432 | 1,303 | 1,446 | 384,274 | |||||||||||||||||||||||||||||
Conventional loans (6) |
||||||||||||||||||||||||||||||||||||
Fixed rate |
||||||||||||||||||||||||||||||||||||
$50 million
unsecured notes |
6.63% | Jan-2008 | 50,000 | $ | | (7) | | | | | | | ||||||||||||||||||||||||
$150 million
unsecured notes |
8.38% | Jul-2008 | 146,000 | 146,000 | 146,000 | | | | | | ||||||||||||||||||||||||||
$150 million
unsecured notes |
7.63% | Aug-2009 | 150,000 | 150,000 | | 150,000 | (8) | | | | | |||||||||||||||||||||||||
$200 million
unsecured notes |
7.66% | Dec-2010 | 200,000 | 200,000 | | | 200,000 | | | | ||||||||||||||||||||||||||
$300 million
unsecured notes |
6.79% | Sep-2011 | 300,000 | 300,000 | | | | 300,000 | | | ||||||||||||||||||||||||||
$50 million
unsecured notes |
6.31% | Sep-2011 | 50,000 | 50,000 | | | | 50,000 | | | ||||||||||||||||||||||||||
$250 million
unsecured notes |
5.73% | Jan-2012 | 250,000 | 250,000 | | | | | 250,000 | | ||||||||||||||||||||||||||
$250 million
unsecured notes |
6.26% | Nov-2012 | 250,000 | 250,000 | | | | | 250,000 | | ||||||||||||||||||||||||||
$100 million
unsecured notes |
5.11% | Mar-2013 | 100,000 | 100,000 | | | | | | 100,000 | ||||||||||||||||||||||||||
$150 million
unsecured notes |
5.52% | Apr-2014 | 150,000 | 150,000 | | | | | | 150,000 | ||||||||||||||||||||||||||
$250 million
unsecured notes |
5.89% | Sep-2016 | 250,000 | 250,000 | | | | | | 250,000 | ||||||||||||||||||||||||||
Wheaton Development
Right |
6.99% | Oct-2008 | 4,432 | 4,410 | 4,410 | | | | | | ||||||||||||||||||||||||||
4600 Eisenhower
Avenue |
8.08% | Apr-2009 | 4,293 | 4,264 | 89 | 4,175 | | | | | ||||||||||||||||||||||||||
Avalon at Twinbrook |
7.25% | Oct-2011 | 8,007 | 7,957 | 157 | 222 | 239 | 7,339 | | | ||||||||||||||||||||||||||
Avalon at Tysons
West |
5.55% | Jul-2028 | 6,381 | 6,339 | 122 | 173 | 183 | 193 | 204 | 5,464 | ||||||||||||||||||||||||||
Avalon Orchards |
7.65% | Jul-2033 | 19,612 | 19,541 | 220 | 311 | 333 | 357 | 382 | 17,938 | ||||||||||||||||||||||||||
Avalon at Arlington
Square |
4.69% | Apr-2013 | | 170,125 | | | | | | 170,125 | ||||||||||||||||||||||||||
Avalon at Cameron
Court |
4.95% | Apr-2013 | | 94,572 | | | | | | 94,572 | ||||||||||||||||||||||||||
1,938,725 | 2,153,208 | 150,998 | 154,881 | 200,755 | 357,889 | 500,586 | 788,099 | |||||||||||||||||||||||||||||
Variable rate (3)
|
||||||||||||||||||||||||||||||||||||
Avalon Ledges |
5.08% | May-2009 | 17,990 | 17,770 | (4) | 519 | 17,251 | | | | | |||||||||||||||||||||||||
Avalon at Flanders
Hill |
5.08% | May-2009 | 20,510 | 20,255 | (4) | 592 | 19,663 | | | | | |||||||||||||||||||||||||
Avalon at Newton
Highlands |
5.02% | Dec-2009 | 36,335 | 35,995 | (4) | 1,054 | 34,941 | | | | | |||||||||||||||||||||||||
Avalon at Crane
Brook |
4.99% | Mar-2011 | 32,560 | 32,225 | (4) | 790 | 1,026 | 1,169 | 29,240 | | | |||||||||||||||||||||||||
Avalon at Bedford
Center |
5.02% | May-2012 | 16,816 | 16,706 | (4) | 354 | 501 | 527 | 560 | 14,764 | | |||||||||||||||||||||||||
124,211 | 122,951 | 3,309 | 73,382 | 1,696 | 29,800 | 14,764 | | |||||||||||||||||||||||||||||
Total indebtedness excluding unsecured credit
facility |
$ | 2,669,803 | $ | 2,882,461 | $ | 157,223 | $ | 232,158 | $ | 235,614 | $ | 391,903 | $ | 531,408 | $ | 1,334,155 | ||||||||||||||||||||
(1) | Includes credit enhancement fees, facility fees, trustees fees and other fees. | |
(2) | Financed by variable rate, tax-exempt debt, but the interest rate on a portion of this debt is effectively fixed at March 31, 2008 and December 31, 2007 through a swap agreement. The portion of the debt fixed through a swap agreement decreases (and therefore the variable portion of the debt increases) monthly as payments are made to a principal reserve fund. | |
(3) | Variable rates are given as of March 31, 2008. | |
(4) | Financed by variable rate debt, but interest rate is capped through an interest rate protection agreement. | |
(5) | Represents full amount of the debt as of March 31, 2008. Actual amounts drawn on the debt as of March 31, 2008 are $92,156 for Bowery Place I, $39,186 for Bowery Place II, $33,209 for Avalon Acton and $28,632 for Morningside Park. | |
(6) | Balances outstanding represent total amounts due at maturity, and are not net of $2,395 of debt discount as of March 31, 2008 and $2,501 of debt discount as of December 31, 2007, as reflected in unsecured notes on our Condensed Consolidated Balance Sheets included elsewhere in this report. | |
(7) | These notes were repaid at their scheduled maturity in January 2008. | |
(8) | In April 2008, we redeemed $10,000 aggregate principal amount of our $150,000 7.5% medium-term notes due in August 2009. |
35
Future Financing and Capital Needs Portfolio and Other Activity
As of March 31, 2008, we had 22 new communities under construction, for which a total estimated
cost of $798,659,000 remained to be invested. In addition, we had eight communities which we own,
or in which we have a direct or indirect interest, under reconstruction, for which a total
estimated cost of $46,866,000 remained to be invested. Substantially all of the capital
expenditures necessary to complete the communities currently under construction and reconstruction,
as well as development costs related to pursuing Development Rights, will be funded from:
| cash currently on hand invested in highly liquid overnight money market funds and repurchase agreements, and short-term investment vehicles; | ||
| the remaining capacity under our current $1,000,000,000 unsecured credit facility; | ||
| the net proceeds from sales of existing communities; | ||
| retained operating cash; | ||
| the issuance of debt or equity securities; and/or | ||
| private equity funding. |
Before planned reconstruction activity, including reconstruction activity related to communities
acquired by the Fund as discussed below, or the construction of a Development Right begins, we
intend to arrange adequate financing to complete these undertakings, although we cannot assure you
that we will be able to obtain such financing. In the event that financing cannot be obtained, we
may have to abandon Development Rights, write-off associated pre-development costs that were
capitalized and/or forego reconstruction activity. In such instances, we will not realize the
increased revenues and earnings that we expected from such Development Rights or reconstruction
activity and significant losses could be incurred.
We have invested in the Fund, a private, discretionary investment vehicle that acquires and
operates apartment communities in our markets. The Fund has invested $782,066,000 as of March 31,
2008. Management of the Fund expects to invest approximately $36,000,000 of additional funds to
redevelop the assets acquired. The Fund has nine institutional investors, including us, with a
combined capital equity commitment of $330,000,000. A significant portion of the investments made
in the Fund by its investors have been made through AvalonBay Value Added Fund, Inc., a Maryland
corporation that qualifies as a REIT under the Internal Revenue Code (the Fund REIT). A
wholly-owned subsidiary of the Company is the general partner of the Fund and has committed
$50,000,000 to the Fund and the Fund REIT (of which approximately $47,944,000 has been invested as
of April 30, 2008) representing a 15.2% combined general partner and limited partner equity
interest. The investment period for the Fund concluded in March 2008. Accordingly no new
acquisitions for the Fund will be considered. We are exploring various potential sources for
funding future acquisitions.
From time to time we use joint ventures to hold or develop individual real estate assets. We
generally employ joint ventures primarily to mitigate asset concentration or market risk and
secondarily as a source of liquidity. We may also use joint ventures related to mixed-use land
development opportunities where our partners bring development and operational expertise to the
venture. Each joint venture or partnership agreement has been and will continue to be individually
negotiated, and our ability to operate and/or dispose of a community in our sole discretion may be
limited to varying degrees depending on the terms of the joint venture or partnership agreement.
We cannot assure you that we will achieve our objectives through joint ventures.
36
In evaluating our allocation of capital within our markets, we sell assets that do not meet our
long-term investment criteria or when capital and real estate markets allow us to realize a portion
of the value created over the past business cycle and redeploy the proceeds from those sales to
develop and redevelop communities. Because the proceeds from the sale of communities may not be
immediately redeployed into revenue generating assets, the immediate effect of a sale of a
community for a gain is to increase net income, but reduce future total revenues, total expenses
and NOI. However, we believe that the absence of future cash flows from communities sold will have
a minimal impact on our ability to fund future liquidity and capital resource needs.
Off Balance Sheet Arrangements
In addition to the investment interests in consolidated and unconsolidated real estate entities, we
have certain off-balance sheet arrangements with the entities in which we invest. Additional
discussion of these entities can be found in Note 6, Investments in Real Estate Entities, of our
Condensed Consolidated Financial Statements located elsewhere in this report.
| CVP I, LLC has outstanding tax-exempt, variable rate bonds maturing in November 2036 in the amount of $117,000,000, which have permanent credit enhancement. We have agreed to guarantee, under limited circumstances, the repayment to the credit enhancer of any advances it may make in fulfillment of CVP I, LLCs repayment obligations under the bonds. We have also guaranteed to the credit enhancer that CVP I, LLC will obtain a final certificate of occupancy for the project (Chrystie Place in New York City) overall once tenant improvements related to a retail tenant are complete, which is expected in the first half of 2008. Our 80% partner in this venture has agreed that it will reimburse us its pro rata share of any amounts paid relative to these guaranteed obligations. The estimated fair value of, and our obligation under these guarantees, both at inception and as of March 31, 2008 were not significant. As a result we have not recorded any obligation associated with these guarantees at March 31, 2008. | ||
| The Fund has 23 loans secured by individual assets with amounts outstanding in the aggregate of $470,208,000. These mortgage loans have varying maturity dates (or dates after which the loans can be prepaid), ranging from October 2011 to September 2016. These mortgage loans are secured by the underlying real estate. The Fund has two credit facilities that mature in December 2008. The Fund did not have any amounts outstanding as of March 31, 2008 under its credit facilities. The mortgage loans and the credit facility are payable by the Fund with operating cash flow from the underlying real estate, and the credit facility is secured by capital commitments. We have not guaranteed the debt of the Fund, nor do we have any obligation to fund this debt should the Fund be unable to do so. | ||
In addition, as part of the formation of the Fund, we have provided to one of the limited partners a guarantee. 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 a minimum of the total capital contributions made by that partner, then we 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 $7,192,000 as of March 31, 2008). As of March 31, 2008, the fair value of the real estate assets owned by the Fund is considered adequate to cover such potential payment to that partner under a liquidation scenario. The estimated fair value of, and our obligation under this guarantee, both at inception and as of March 31, 2008 was not significant and therefore we have not recorded any obligation for this guarantee as of March 31, 2008. | |||
| In connection with the pursuit of a development right in Pleasant Hill, California, $125,000,000 in bond financing was issued by the Contra Costa County Redevelopment Agency (the Agency) in connection with the possible future construction of a multifamily rental community by PHVP I, LLC. The bond proceeds were immediately invested in their entirety in a guaranteed investment contract (GIC) administered by a trustee. This development right is planned as a mixed-use development, with residential, for-sale, retail and office components. The bond proceeds will remain in the GIC until the third quarter of 2008, at which time a loan will be made to PHVP I, LLC to fund construction of the multifamily portion of the development, or the bonds will be redeemed by the Agency. Although we do not have any equity or economic interest in PHVP I, LLC at this time, we do have an option to make a capital contribution to PHVP I, LLC in exchange for a 99% general partner interest in the entity. Should we decide not to exercise this option, bond proceeds will be released from escrow, the bonds will be redeemed without penalty and a loan will not be made to PHVP I, LLC. The bonds are payable from the proceeds of the GIC and are non-recourse to both PHVP I, LLC and to us. There is no loan payable outstanding by PHVP I, LLC as of March 31, 2008. |
37
In addition, as part of providing construction management services to PHVP I, LLC for the construction of a public garage, we have provided a construction completion guarantee to the related lender in order to fulfill their standard financing requirements related to the garage construction financing. Our obligations under this guarantee will terminate following construction completion of the garage once all of the lenders standard completion requirements have been satisfied, which we currently expect to occur in the first half of 2008. In the third quarter of 2006, significant modifications were requested by the local transit authority to change the garage structure design. We do not believe that the requested design changes impact the construction schedule. However, it is expected that these changes will increase the original budget by an amount up to $5,000,000. We believe that substantially all potential additional amounts are reimbursable from unrelated third parties. At this time we do not believe that it is probable that we will incur any additional costs. The estimated fair value of, and our obligation under this guarantee, both at inception and as of March 31, 2008 was not significant and therefore we have not recorded any obligation for this guarantee as of March 31, 2008. |
There are no other lines of credit, side agreements, financial guarantees or any other derivative
financial instruments related to or between our unconsolidated real estate entities and us. In
evaluating our capital structure and overall leverage, management takes into consideration our
proportionate share of this unconsolidated debt.
Contractual Obligations
We currently have contractual obligations consisting primarily of long-term debt obligations and
lease obligations for certain land parcels and regional and administrative office space. There
have not been any material changes outside the ordinary course of business to our contractual
obligations during the three months ended March 31, 2008.
Development Communities
As of March 31, 2008, we had 22 Development Communities under construction. We expect these
Development Communities, when completed, to add a total of 7,016 apartment homes to our portfolio
for a total capitalized cost, including land acquisition costs, of approximately $2,210,000,000.
You should carefully review Item 1a., Risk Factors, of our Form 10-K for a discussion of the
risks associated with development activity.
The following table presents a summary of the Development Communities. We hold a direct or
indirect fee simple ownership interest in these communities except as may be noted.
38
Total | ||||||||||||||||||
Number of | capitalized | |||||||||||||||||
apartment | cost (1) | Construction | Initial | Estimated | Estimated | |||||||||||||
homes | ($ millions) | start | occupancy (2) | completion | stabilization (3) | |||||||||||||
1. | Avalon Riverview North New York, NY |
602 | $ | 174.6 | Q3 2005 | Q3 2007 | Q2 2008 | Q2 2008 | ||||||||||
2. | Avalon Danvers Danvers, MA |
433 | 84.8 | Q4 2005 | Q1 2007 | Q3 2008 | Q1 2009 | |||||||||||
3. | Avalon on the Sound II New Rochelle, NY |
588 | 180.5 | Q1 2006 | Q2 2007 | Q2 2008 | Q4 2008 | |||||||||||
4. | Avalon Meydenbauer Bellevue, WA |
368 | 87.3 | Q1 2006 | Q1 2008 | Q3 2008 | Q1 2009 | |||||||||||
5. | Avalon at Dublin Station I Dublin, CA |
305 | 85.8 | Q2 2006 | Q4 2007 | Q2 2008 | Q4 2008 | |||||||||||
6. | Avalon at Lexington Hills Lexington, MA |
387 | 86.2 | Q2 2006 | Q2 2007 | Q3 2008 | Q1 2009 | |||||||||||
7. | Avalon Encino Los Angeles, CA |
131 | 61.5 | Q3 2006 | Q3 2008 | Q4 2008 | Q2 2009 | |||||||||||
8. | Avalon Warner Place Canoga Park, CA |
210 | 53.9 | Q4 2006 | Q1 2008 | Q3 2008 | Q1 2009 | |||||||||||
9. | Avalon Acton (4) Acton, MA |
380 | 68.8 | Q4 2006 | Q4 2007 | Q4 2008 | Q2 2009 | |||||||||||
10. | Avalon Morningside Park (4) New York, NY |
296 | 125.5 | Q1 2007 | Q2 2008 | Q1 2009 | Q3 2009 | |||||||||||
11. | Avalon White Plains White Plains, NY |
393 | 154.5 | Q2 2007 | Q3 2008 | Q4 2009 | Q2 2010 | |||||||||||
12. | Avalon at Tinton Falls Tinton Falls, NJ |
216 | 41.2 | Q2 2007 | Q2 2008 | Q4 2008 | Q2 2009 | |||||||||||
13. | Avalon Fashion Valley San Diego, CA |
161 | 64.7 | Q2 2007 | Q3 2008 | Q4 2008 | Q2 2009 | |||||||||||
14. | Avalon Anaheim Stadium Anaheim, CA |
251 | 102.7 | Q2 2007 | Q1 2009 | Q3 2009 | Q1 2010 | |||||||||||
15. | Avalon Union City Union City, CA |
438 | 125.2 | Q3 2007 | Q2 2009 | Q3 2009 | Q1 2010 | |||||||||||
16. | Avalon at the Hingham Shipyard Hingham, MA |
235 | 52.7 | Q3 2007 | Q3 2008 | Q1 2009 | Q2 2009 | |||||||||||
17. | Avalon Sharon Sharon, MA |
156 | 30.7 | Q3 2007 | Q2 2008 | Q4 2008 | Q1 2009 | |||||||||||
18. | Avalon Huntington Shelton, CT |
99 | 26.1 | Q4 2007 | Q4 2008 | Q2 2009 | Q3 2009 | |||||||||||
19. | Avalon at Mission Bay North III San Francisco, CA |
260 | 157.8 | Q4 2007 | Q3 2009 | Q4 2009 | Q2 2010 | |||||||||||
20. | Avalon Jamboree Village Irvine, CA |
279 | 78.3 | Q4 2007 | Q2 2009 | Q4 2009 | Q2 2010 | |||||||||||
21. | Avalon Fort Greene New York, NY |
628 | 320.4 | Q4 2007 | Q3 2009 | Q3 2010 | Q1 2011 | |||||||||||
22. | Avalon Charles Pond Corham, NY |
200 | 46.5 | Q1 2008 | Q4 2008 | Q2 2009 | Q4 2009 | |||||||||||
Total |
7,016 | $ | 2,209.7 | |||||||||||||||
(1) | Total capitalized cost includes all capitalized costs projected to be or actually incurred to develop the respective Development Community, determined in accordance with GAAP, including land acquisition costs, construction costs, real estate taxes, capitalized interest and loan fees, permits, professional fees, allocated development overhead and other regulatory fees. Total capitalized cost for communities identified as having joint venture ownership, either during construction or upon construction completion, represents the total projected joint venture contribution amount. | |
(2) | Future initial occupancy dates are estimates. There can be no assurance that we will pursue to completion any or all of these proposed developments. | |
(3) | Stabilized operations is defined as the earlier of (i) attainment of 95% or greater physical occupancy or (ii) the one-year anniversary of completion of development. | |
(4) | This community is being financed in part by third party, tax-exempt debt. |
39
Redevelopment Communities
As of March 31, 2008, we had five consolidated communities under redevelopment. We expect the
total capitalized cost to redevelop these communities to be $65,000,000, excluding costs incurred
prior to redevelopment. In addition, the Fund has three communities under redevelopment. We have
found that the cost and time schedule to redevelop an existing apartment community is more
difficult to budget and estimate than the cost to develop a new community. Accordingly, we expect
that actual costs may vary from our budget by a wider range than for a new development community.
We cannot assure you that we will meet our budget or schedule for reconstruction completion or
restabilized operations, either individually or in the aggregate. We anticipate increasing our
redevelopment activity related to Fund-owned communities, as well as communities in our current
operating portfolio. You should carefully review Item 1a.,
Risk Factors, of our Form 10-K for a
discussion of the risks associated with redevelopment activity.
The following presents a summary of these Redevelopment Communities:
Total cost | ||||||||||||||||||||
Number of | ($ millions) | Estimated | Estimated | |||||||||||||||||
apartment | Pre-redevelopment | Total capitalized | Reconstruction | reconstruction | restabilized | |||||||||||||||
homes | cost | cost (1) | start | completion | operations (2) | |||||||||||||||
Consolidated Communities | ||||||||||||||||||||
1. | Avalon at AutumnWoods Fairfax, VA |
420 | $ | 31.2 | $ | 38.3 | Q3 2006 | Q2 2008 | Q4 2008 | |||||||||||
2. | Essex Place Peabody, MA |
286 | 23.7 | 34.5 | Q3 2007 | Q2 2009 | Q4 2009 | |||||||||||||
3. | Avalon Redmond Place Redmond, WA |
222 | 26.3 | 31.3 | Q3 2007 | Q4 2008 | Q2 2009 | |||||||||||||
4. | Avalon Woodland Hills Woodland Hills, CA |
663 | 72.1 | 109.3 | Q4 2007 | Q1 2010 | Q3 2010 | |||||||||||||
5. | Avalon at Diamond Heights San Francisco, CA |
154 | 25.3 | 30.2 | Q4 2007 | Q4 2010 | Q2 2011 | |||||||||||||
Subtotal |
1,745 | $ | 178.6 | $ | 243.6 | |||||||||||||||
Fund Communities | ||||||||||||||||||||
1. | Avalon Paseo Place Fremont, CA |
134 | 19.8 | 25.5 | Q2 2007 | Q2 2008 | Q2 2008 | |||||||||||||
2. | Avalon Cedar Place Columbia, MD |
156 | 21.0 | 25.0 | Q3 2007 | Q4 2008 | Q2 2009 | |||||||||||||
3. | South Hills Apartments West Covina, CA |
85 | 20.9 | 25.3 | Q1 2008 | Q4 2008 | Q2 2009 | |||||||||||||
Subtotal |
375 | $ | 61.7 | $ | 75.8 | |||||||||||||||
Total |
2,120 | $ | 240.3 | $ | 319.4 | |||||||||||||||
(1) | Total capitalized cost includes all capitalized costs projected to be or actually incurred to develop the respective Redevelopment Community, including land acquisition costs, construction costs, real estate taxes, capitalized interest and loan fees, permits, professional fees, allocated development overhead and other regulatory fees, all as determined in accordance with GAAP. | |
(2) | Restabilized operations is defined as the earlier of (i) attainment of 95% or greater physical occupancy or (ii) the one-year anniversary of completion of redevelopment. |
40
Development Rights
As of March 31, 2008, we are evaluating the future development of 46 new apartment communities on
land that is either owned by us, under contract, subject to a leasehold interest or for which we
hold either a purchase or lease option. We generally hold Development Rights through options to
acquire land, although for 21 of the Development Rights we currently own the land on which a
community would be built if we proceeded with development. The Development Rights range from those
beginning design and architectural planning to those that have completed site plans and drawings
and can begin construction almost immediately. We estimate that the successful completion of all
of these communities would ultimately add 13,266 apartment homes to our portfolio. Substantially
all of these apartment homes will offer features like those offered by the communities we currently
own. At March 31, 2008, there were cumulative capitalized costs (including legal fees, design fees
and related overhead costs, but excluding land costs) of $62,529,000 relating to Development Rights
that we consider probable for future development. In addition, land costs related to the pursuit
of Development Rights (consisting of original land and additional carrying costs) of $305,669,000
are reflected as land held for development on the Condensed Consolidated Balance Sheet as of March
31, 2008.
The properties comprising the Development Rights are in different stages of the due diligence and
regulatory approval process. The decisions as to which of the Development Rights to invest in, if
any, or to continue to pursue once an investment in a Development Right is made, are business
judgments that we make after we perform financial, demographic and other analyses. In the event
that we do not proceed with a Development Right, we generally would not recover capitalized costs
incurred in the pursuit of those communities, unless we were to recover amounts in connection with
the sale of land; however, we cannot guarantee a recovery. Pre-development costs incurred in the
pursuit of Development Rights for which future development is not yet considered probable are
expensed as incurred. In addition, if the status of a Development Right changes, making future
development no longer probable, any capitalized pre-development costs are written-off with a charge
to expense.
You should carefully review Section 1a., Risk Factors, of our Form 10-K for a discussion of the
risks associated with Development Rights.
41
Total | ||||||||||||
Estimated | capitalized | |||||||||||
number | cost | |||||||||||
Location | of homes | ($ millions) (1) | ||||||||||
1. | Randolph, MA |
276 | $ | 47 | ||||||||
2. | Northborough, MA |
350 | 61 | |||||||||
3. | Pleasant Hill, CA |
422 | 153 | |||||||||
4. | Los Angeles, CA |
278 | 123 | |||||||||
5. | Bellevue, WA |
396 | 135 | |||||||||
6. | Norwalk, CT |
311 | 85 | |||||||||
7. | North Bergen, NJ |
164 | 48 | |||||||||
8. | Shelton, CT |
251 | 66 | |||||||||
9. | Rockville Centre, NY |
349 | 129 | |||||||||
10. | Chicago, IL Phase I |
491 | 173 | |||||||||
11. | Wilton, CT |
100 | 24 | |||||||||
12. | New York, NY |
678 | 307 | |||||||||
13. | Camarillo, CA |
309 | 66 | |||||||||
14. | Plymouth, MA Phase II |
69 | 17 | |||||||||
15. | Seattle, WA |
204 | 65 | |||||||||
16. | Dublin, CA Phase II |
405 | 126 | |||||||||
17. | Seattle, WA II |
234 | 76 | |||||||||
18. | West Long Branch, NJ |
180 | 34 | |||||||||
19. | Brooklyn, NY |
825 | 443 | |||||||||
20. | Cohasset, MA |
200 | 38 | |||||||||
21. | Greenburgh, NY Phase II |
444 | 112 | |||||||||
22. | Kirkland, WA Phase II |
189 | 60 | |||||||||
23. | Canoga Park, CA |
299 | 85 | |||||||||
24. | Irvine, CA Phase II |
179 | 57 | |||||||||
25. | Wheaton, MD |
320 | 107 | |||||||||
26. | Andover, MA |
115 | 21 | |||||||||
27. | Irvine, CA Phase III |
170 | 73 | |||||||||
28. | San Francisco, CA |
159 | 51 | |||||||||
29. | Milford, CT |
284 | 45 | |||||||||
30. | Highland Park, NJ |
119 | 36 | |||||||||
31. | Stratford, CT |
146 | 23 | |||||||||
32. | Oyster Bay, NY |
150 | 42 | |||||||||
33. | Yonkers, NY |
400 | 88 | |||||||||
34. | Concord, MA |
150 | 38 | |||||||||
35. | Bloomingdale, NJ |
173 | 38 | |||||||||
36. | North Andover, MA |
526 | 98 | |||||||||
37. | Tysons Corner, VA |
439 | 121 | |||||||||
38. | Roselle Park, NJ |
300 | 70 | |||||||||
39. | Gaithersburg, MD |
254 | 41 | |||||||||
40. | Chicago, IL Phase II |
491 | 141 | |||||||||
41. | Alexandria, VA |
283 | 73 | |||||||||
42. | Hackensack, NJ |
230 | 56 | |||||||||
43. | Garden City, NY |
160 | 58 | |||||||||
44. | Wanaque, NJ |
210 | 45 | |||||||||
45. | Yaphank, NY |
343 | 57 | |||||||||
46. | Rockville, MD |
241 | 62 | |||||||||
Total |
13,266 | $ | 3,914 | |||||||||
(1) | Total capitalized cost includes all capitalized costs incurred to date (if any) and projected to be incurred to develop the respective community, determined in accordance with GAAP, including land acquisition costs, construction costs, real estate taxes, capitalized interest and loan fees, permits, professional fees, allocated development overhead and other regulatory fees. |
42
Insurance and Risk of Uninsured Losses
We carry commercial general liability insurance and property insurance with respect to all of our
communities. These policies, and other insurance policies we carry, have policy specifications,
insured limits and deductibles that we consider commercially reasonable. There are, however,
certain types of losses (such as losses arising from acts
of war) that are not insured, in full or in part, because they are either uninsurable or the cost
of insurance makes it, in managements view, economically impractical. You should carefully review
the discussion under Item 1a., Risk Factors, of our Form 10-K for a discussion of risks
associated with an uninsured property or liability loss.
Many of our West Coast communities are located in the general vicinity of active earthquake faults.
Many of our communities are proximate to, and thus susceptible to, the major fault lines in
California, including the San Andreas Fault and the Hayward Fault. We cannot assure you that an
earthquake would not cause damage or losses greater than insured levels. We have in place with
respect to communities located in California, for any single occurrence and in the aggregate,
$75,000,000 of coverage with a deductible per building equal to five percent of the insured value
of that building. The five percent deductible is subject to a minimum of $100,000 per occurrence.
Earthquake coverage outside of California is subject to a $100,000,000 limit, except with respect
to the state of Washington, for which the limit is $65,000,000. Our earthquake insurance outside
of California provides for a $100,000 deductible per occurrence. In addition, up to a policy
aggregate of $2,000,000, the next $400,000 of loss per occurrence outside California will be
treated as an additional deductible.
On December 1, 2007, we elected to cancel and rewrite our property insurance policy for a 17 month
term in order to take advantage of declining insurance premium rates. As a result, our property
insurance premium decreased by approximately 15% with no material changes in coverage. The policy
now expires on May 1, 2009.
Our annual general liability policy and workmans compensation coverage renewed on August 1, 2007.
This policy is in effect until July 31, 2008.
Just as with office buildings, transportation systems and government buildings, there have been
reports that apartment communities could become targets of terrorism. In December 2007, Congress
passed the Terrorism Risk Insurance Program Reauthorization Act (TRIPRA) which is designed to
make terrorism insurance available through a federal back-stop program until 2014. In connection
with this legislation, we have purchased insurance for property damage due to terrorism up to
$200,000,000. Additionally, we have purchased insurance for certain terrorist acts, not covered
under TRIPRA, such as domestic-based terrorism. This insurance, often referred to as
non-certified terrorism insurance, is subject to deductibles, limits and exclusions. Our general
liability policy provides TRIPRA coverage (subject to deductibles and insured limits) for liability
to third parties that result from terrorist acts at our communities.
An additional consideration for insurance coverage and potential uninsured losses is mold growth.
Mold growth may occur when excessive moisture accumulates in buildings or on building materials,
particularly if the moisture problem remains undiscovered or is not addressed over a period of
time. If a significant mold problem arises at one of our communities, we could be required to
undertake a costly remediation program to contain or remove the mold from the affected community
and could be exposed to other liabilities. For further discussion of the risks and the Companys
related prevention and remediation activities, please refer to the discussion under Item 1a, Risk
Factors We may incur costs due to environmental contamination or non-compliance, of
environmental contamination in our Annual Report on Form 10-K for the year ended December 31, 2007.
We cannot provide assurance that we will have coverage under our existing policies for property
damage or liability to third parties arising as a result of exposure to mold or a claim of exposure
to mold at one of our communities.
We also carry a Crimeshield policy (also commonly referred to as a fidelity insurance policy or
employee dishonesty insurance policy) that protects the company, up to $3,000,000 per occurrence,
from employee theft of money, securities or property.
43
Inflation and Deflation
Substantially all of our apartment leases are for a term of one year or less. In an inflationary
environment, this may allow us to realize increased rents upon renewal of existing leases or the
beginning of new leases. Short-term leases generally minimize our risk from the adverse effects of
inflation, although these leases generally permit residents to leave at the end of the lease term
and therefore expose us to the effect of a decline in market rents. In a deflationary rent
environment, we may be exposed to declining rents more quickly under these shorter-term leases.
Forward-Looking Statements
This Form 10-Q contains forward-looking statements as that term is defined under the Private
Securities Litigation Reform Act of 1995. You can identify forward-looking statements by our use
of the words believe, expect, anticipate, intend, estimate, assume, project, plan,
may, shall, will and other similar expressions in this Form 10-Q, that predict or indicate
future events and trends and that do not report historical matters. These statements include,
among other things, statements regarding our intent, belief or expectations with respect to:
| our potential development, redevelopment, acquisition or disposition of communities; | ||
| the timing and cost of completion of apartment communities under construction, reconstruction, development or redevelopment; | ||
| the timing of lease-up, occupancy and stabilization of apartment communities; | ||
| the pursuit of land on which we are considering future development; | ||
| the anticipated operating performance of our communities; | ||
| cost, yield and earnings estimates; | ||
| our declaration or payment of distributions; | ||
| our joint venture and discretionary fund activities; | ||
| our policies regarding investments, indebtedness, acquisitions, dispositions, financings and other matters; | ||
| our qualification as a REIT under the Internal Revenue Code; | ||
| the real estate markets in Northern and Southern California and markets in selected states in the Mid-Atlantic, Midwest, New England, Metro NY/NJ and Pacific Northwest regions of the United States and in general; | ||
| the availability of debt and equity financing; | ||
| interest rates; | ||
| general economic conditions; and | ||
| trends affecting our financial condition or results of operations. |
We cannot assure the future results or outcome of the matters described in these statements;
rather, these statements merely reflect our current expectations of the approximate outcomes of the
matters discussed. You should not rely on forward-looking statements because they involve known and
unknown risks, uncertainties and other factors, some of which are beyond our control. These risks,
uncertainties and other factors may cause our actual results, performance or achievements to differ
materially from the anticipated future results, performance or achievements expressed or implied by
these forward-looking statements. You should carefully review the discussion under Item 1a, Risk
Factors, on our Form 10-K for a discussion of risks associated with forward-looking statements.
In addition, these forward-looking statements represent our estimates and assumptions only as of
the date of this report. We do not undertake a duty to update these forward-looking statements,
and therefore they may not represent our estimates and assumptions after the date of this report.
44
Some of the factors that could cause our actual results, performance or achievements to differ
materially from those expressed or implied by these forward-looking statements include, but are not
limited to, the following:
| we may fail to secure development opportunities due to an inability to reach agreements with third parties to obtain land at attractive prices or to obtain desired zoning and other local approvals; | ||
| we may abandon or defer development opportunities for a number of reasons, including changes in local market conditions which make development less desirable, increases in costs of development and increases in the cost of capital, resulting in losses; | ||
| construction costs of a community may exceed our original estimates; | ||
| we may not complete construction and lease-up of communities under development or redevelopment on schedule, resulting in increased interest costs and construction costs and a decrease in our expected rental revenues; | ||
| occupancy rates and market rents may be adversely affected by competition and local economic and market conditions which are beyond our control; | ||
| financing may not be available on favorable terms or at all, and our cash flows from operations and access to cost effective capital may be insufficient for the development of our pipeline which could limit our pursuit of opportunities; | ||
| our cash flows may be insufficient to meet required payments of principal and interest, and we may be unable to refinance existing indebtedness or the terms of such refinancing may not be as favorable as the terms of existing indebtedness; | ||
| we may be unsuccessful in our management of the Fund and the Fund REIT; and | ||
| we may be unsuccessful in managing changes in our portfolio composition. |
Critical Accounting Policies
The preparation of financial statements in conformity with GAAP requires management to use judgment
in the application of accounting policies, including making estimates and assumptions. If our
judgment or interpretation of the facts and circumstances relating to various transactions had been
different, or different assumptions were made, it is possible that different accounting policies
would have been applied, resulting in different financial results or a different presentation of
our financial statements. Below is a discussion of the accounting policies that we consider
critical to an understanding of our financial condition and operating results that may require
complex or significant judgment in their application or require estimates about matters which are
inherently uncertain. A discussion of our significant accounting policies, including further
discussion of the accounting policies described below, can be found in Note 1, Organization and
Significant Accounting Policies of our Condensed Consolidated Financial Statements.
Principles of Consolidation
We may enter into various joint venture agreements with unrelated third parties to hold or develop
real estate assets. We must determine for each of these ventures, whether to consolidate the
entity or account for our investment under the equity or cost basis of accounting.
45
We determine whether to consolidate certain entities based on our rights and obligations under the
joint venture agreements, applying the guidance of FIN 46(R), Consolidation of Variable Interest
Entities (as revised) and Emerging Issues Task Force 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. For investment interests that we do not
consolidate, we look to the guidance in AICPA Statement of Position 78-9, Accounting for
Investments in Real Estate Ventures, Accounting Principles Board Opinion No. 18, The Equity
Method of Accounting for Investments in Common Stock, and Emerging Issues Task Force Topic D-46,
Accounting for Limited Partnership Investments, to determine the accounting framework to apply.
The application of these rules in evaluating the accounting treatment for each joint venture is
complex and requires substantial management judgment. Therefore, we believe the decision to choose
an appropriate accounting framework is a critical accounting estimate.
If we were to consolidate the joint ventures that we accounted for using the equity method at March
31, 2008, our assets would have increased by $1,039,512,000 and our liabilities would have
increased by $758,311,000. We would be required to consolidate those joint ventures currently not
consolidated for financial reporting purposes if the facts
and circumstances changed, including but not limited to the following reasons, none of which are
currently expected to occur:
| For entities not considered to be variable interest entities under FIN 46(R), the nature of the entity changed such that it would be considered a variable interest entity. | ||
| For entities in which we do not hold a controlling voting and/or variable interest, the contractual arrangement changes resulting in our investment interest being either a controlling voting and/or variable interest. |
We evaluate our accounting for investments on a quarterly basis or when a significant change in the
design of an entity occurs.
Cost Capitalization
We capitalize costs during the development of assets beginning when we determine that development
of a future asset is probable until the asset, or a portion of the asset, is delivered and is ready
for its intended use. For redevelopment efforts, we capitalize costs either (i) in advance of
taking homes out of service when significant renovation of the common area has begun until the
redevelopment is completed, or (ii) when an apartment home is taken out of service for
redevelopment until the redevelopment is completed and the apartment home is available for a new
resident. Rental income and operating expenses incurred during the initial lease-up or
post-redevelopment lease-up period are fully recognized as they accrue.
During the development and redevelopment efforts we capitalize all direct and those indirect costs
which have been incurred as a result of the development and redevelopment activities. These costs
include interest and related loan fees, property taxes as well as other direct and indirect costs.
Interest is capitalized for any project specific financing, as well as for general corporate
financing to the extent of our aggregate investment in the projects. Indirect project costs,
which include personnel and office and administrative costs that are clearly associated with our
development and redevelopment efforts are also capitalized. The estimation of the direct and
indirect costs to capitalize as part of our development and redevelopment activities requires
judgment, and as such, we believe cost capitalization to be a critical accounting estimate.
There may be a change in our operating expenses in the event that there are changes in accounting
guidance governing capitalization or changes to development or redevelopment activity. If changes
in the accounting guidance limit our ability to capitalize costs or if we reduce our development
and redevelopment activities without a corresponding decrease in indirect project costs, there may
be an increase in our operating expenses. For example, if for the three months ended March 31,
2008 our development activities decreased by 10%, and there were no corresponding decrease in our
indirect project costs, our operating expenses would have increased by $716,000.
46
We capitalize pre-development costs incurred in pursuit of Development Rights for which we
currently believe future development is probable. These costs include legal fees, design fees and
related overhead costs. Future development of these pursuits 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 no longer probable, any
capitalized pre-development costs are written-off with a charge to expense.
Due to the subjectivity in determining whether a pursuit will result in the acquisition or
development of an apartment community, and therefore should be capitalized, the accounting for
pursuit costs is a critical accounting estimate. If it were determined that 10% of our capitalized
pursuits were no longer probable of occurring, net income for the quarter ended March 31, 2008
would have decreased by $6,253,000.
Asset Impairment Evaluation
We apply the provisions of SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived
Assets, to determine the need for performing impairment analyses, as well as to measure the loss
if an impairment has
occurred on a regular basis, considering qualitative economic factors. Because each asset is
unique, requiring significant management judgment, we believe that the asset impairment evaluation
is a critical accounting estimate.
Management judgment is required both to determine if a significant event has occurred, such that an
impairment analysis is necessary, as well as for the assessment and measurement of any potential
impairment. To perform the impairment analysis, we must estimate the undiscounted future cash
flows associated with the asset, which in the case of an apartment community would be the NOI, as
well as potential disposition proceeds for a given asset. Forecasting cash flows requires
assumptions about such variables as the estimated holding period, rental rates, occupancy and
operating expenses during the holding period as well as disposition proceeds. In addition, when an
impairment has occurred, we must estimate the discount factor, or market capitalization rate to
apply to the undiscounted cash flows to derive the fair value of the position. The market
capitalization rate is influenced by many factors, including national and local economic
conditions, as well as the location and quality of the asset.
Changes in the future cash flows associated with an asset have a direct, linear relationship to the
fair value of the position. For example, if there is a 10% decline in the estimated NOI for a
community, there would be a corresponding decrease in the fair value of that asset of 10%. Changes
in the market capitalization rate have an inverse relationship with the fair value of an asset,
with a decrease in the market capitalization rate resulting in an increase in the fair value of the
asset. For example, an asset that is valued at $80,000,000 when using a five percent market
capitalization rate will increase in value to $100,000,000 if the market capitalization rate
decreases by one percent to four percent, and to $133,000,000 if the market capitalization rate
decreases by two percent, to a three percent market capitalization rate.
For the three months ended March 31, 2008, we did not recognize any impairment in value associated
with our investments or long-lived assets. We cannot predict the occurrence of future events that
may cause an impairment assessment to be performed.
47
REIT Status
We are a Maryland corporation that has elected to be treated, for federal income tax purposes, as a
REIT. We elected to be taxed as a REIT under the Internal Revenue Code of 1986 (the Code), as
amended, for the year ended December 31, 1994 and have not revoked such election. A corporate REIT
is a legal entity which holds real estate interests and must meet a number of organizational and
operational requirements, including a requirement that it currently distribute at least 90% of its
adjusted taxable income to stockholders. As a REIT, we generally will not be subject to corporate
level federal income tax on taxable income if we distribute 100% of taxable income to our
stockholders over time periods allowed under the Code. If we fail to qualify as a REIT in any
taxable year, we will be subject to federal and state income taxes at regular corporate rates
(subject to any applicable alternative minimum tax) and may not be able to elect to qualify as a
REIT for four subsequent taxable years. For example, if we failed to qualify as a REIT in 2007,
our net income would have decreased by approximately $119,800,000.
Our qualification as a REIT requires management to exercise significant judgment and consideration
with respect to operational matters and accounting treatment. Therefore, we believe our REIT
status is a critical accounting estimate.
48
Part I. FINANCIAL INFORMATION
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
There have been no material changes to our exposures to market risk since December 31, 2007. |
Item 4. | Controls and Procedures |
(a) | Evaluation of disclosure controls and procedures. | ||
The Company carried out an evaluation under the supervision and with the participation of the Companys management, including the Companys Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Companys disclosure controls and procedures as of March 31, 2008. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Companys disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commissions rules and forms. | |||
We continue to review and document our disclosure controls and procedures, including our internal controls and procedures for financial reporting, and may from time to time make changes aimed at enhancing their effectiveness and to ensure that our systems evolve with our business. | |||
(b) | Changes in internal controls over financial reporting. | ||
None. |
Part II. OTHER INFORMATION
Item 1. | Legal Proceedings | |
As reported in our Form 10-K for the year ended December 31, 2007, we are seeking compensatory damages, as well as punitive and treble damages, in a complaint we filed in October 2007 in the U.S. District Court, Eastern District of Virginia (Alexandria) against a former vice president of the Company who had authority over repair and capital improvements at existing communities (AvalonBay Communities, Inc. v. James R. Willden, amended on April 16, 2008). The complaint alleges, among other things, that the former employee colluded to receive payments from San Jose Water Conservation Corp., a vendor (San Jose) in exchange for approving invoices. We previously filed a complaint in the same court against this vendor and its president (AvalonBay Communities, Inc. v. San Jose Water Conservation Corp. and Michael P. Schroll). On April 2, 2008, the court issued a summary judgment order in the San Jose/Schroll case, ruling in AvalonBays favor and awarding AvalonBay treble damages under the Federal Racketeer Influenced and Corrupt Organization Act (RICO). The defendants have filed a notice of appeal. Our fidelity bond insurer, as subrogee, will have a claim on portions of the amounts collected, if any. There is no guarantee that we or our insurer will be able to actually collect from San Jose or Schroll any portion of the judgment. Our lawsuit against James R. Willden, relating to the same matters, is still pending. We continue to investigate these and other payments approved by or under the supervision of this former employee and may amend this complaint or file additional complaints against other parties involved in these matters. We do not expect that the loss related to this matter will be material to our results of operations or financial condition. |
49
Item 1a. | Risk Factors | |
In addition to the other information set forth in this report, you should carefully consider the factors which could materially affect our business, financial condition or future results discussed in the Form 10-K in Part I, Item 1a. Risk Factors. The risks described in the Form 10-K are not the only risks that could affect the Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results in the future. There have been no material changes to our risk factors since December 31, 2007. |
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | |
None. | ||
Issuer Purchases of Equity Securities |
(d) | ||||||||||||||||
Maximum Dollar | ||||||||||||||||
(c) | Amount that May | |||||||||||||||
(a) | Total Number of | Yet be Purchased | ||||||||||||||
Total Number | (b) | Shares Purchased | Under the Plans or | |||||||||||||
of Shares | Average Price | as Part of Publicly | Programs | |||||||||||||
Purchased | Paid per | Announced Plans | (in thousands) | |||||||||||||
Period | (1) | Share | or Programs | (2) | ||||||||||||
January 1- January
31, 2008 |
483,036 | $ | 87.42 | 482,100 | | |||||||||||
February 1 - February 29, 2008 |
| | | $ | 200,000 | |||||||||||
March 1- March 31,
2008 |
35,899 | $ | 92.44 | | $ | 200,000 |
(1) | Includes 936 shares in January and 35,899 shares in March surrendered to the Company in connection with vesting of restricted stock as payment of exercise price or as payment of taxes. | |
(2) | On February 5, 2008, the Board of Directors voted to increase the aggregate purchase price of shares that may be purchased under the Companys Stock Repurchase Program by $200,000,000 to $500,000,000. In determining whether to repurchase shares, we consider a variety of factors, including among other things our liquidity needs, corporate and legal requirements, the then current market price of our shares, market conditions, and the effect of the share repurchases on our per share earnings and FFO. There is no scheduled expiration date to this program. |
50
Item 3. | Defaults Upon Senior Securities |
None. |
Item 4. | Submission of Matters to a Vote of Security Holders |
None. |
Item 5. | Other Information |
None. |
Item 6. | Exhibits |
51
Exhibit No. | Description | |||
3(i).1
|
| Articles of Amendment and Restatement of Articles of Incorporation of AvalonBay Communities (the Company), dated as of June 4, 1998. (Incorporated by reference to Exhibit 3(i).1 to Form 10-K of the Company filed on March 1, 2007.) | ||
3(i).2
|
| Articles of Amendment, dated as of October 2, 1998. (Incorporated by reference to Exhibit 3.1(ii) to Form 10-K of the Company filed on March 1, 2007.) | ||
3(i).3
|
| Articles Supplementary, dated as of October 13, 1998, relating to the 8.70% Series H Cumulative Redeemable Preferred Stock. (Incorporated by reference to Exhibit 3(i).3 to Form 10-K of the Company filed on March 1, 2007.) | ||
3(ii).1
|
| Amended and Restated Bylaws of the Company, as adopted by the Board of Directors on February 13, 2003. (Incorporated by reference to Exhibit 3(ii) to Form 10-K of the Company filed March 11, 2003.) | ||
4.1
|
| Second Supplemental Indenture of Avalon Properties, Inc. (hereinafter referred to as Avalon Properties) dated as of December 16, 1997. (Incorporated by reference to Exhibit 4.3 to Form 10-K of the Company filed March 11, 2003.) | ||
4.2
|
| Indenture for Senior Debt Securities, dated as of January 16, 1998, between the Company and State Street Bank and Trust Company, as Trustee. (Incorporated by reference to Exhibit 4.1 to Registration Statement on Form S-3 of the Company (File No. 333-139839), filed January 8, 2007.) | ||
4.3
|
| First Supplemental Indenture, dated as of January 20, 1998, between the Company and the State Street Bank and Trust Company as Trustee. (Incorporated by reference to Exhibit 4.2 to Registration Statement on Form S-3 of the Company (File No. 333-139839), filed January 8, 2007.) | ||
4.4
|
| Second Supplemental Indenture, dated as of July 7, 1998, between the Company and State Street Bank and Trust Company as Trustee. (Incorporated by reference to Exhibit 4.3 to Registration Statement on Form S-3 of the Company (File No. 333-139839), filed January 8, 2007.) | ||
4.5
|
| Amended and Restated Third Supplemental Indenture, dated as of July 10, 2000 between the Company and State Street Bank and Trust Company as Trustee. (Incorporated by reference to Exhibit 4.4 to Registration Statement on Form S-3 of the Company (File No. 333-139839), filed January 8, 2007.) | ||
4.6
|
| Fourth Supplemental Indenture, dated as of September 18, 2006 between the Company and U.S. Bank National Association as Trustee. (Incorporated by reference to Exhibit 4.5 to Registration Statement on Form S-3 of the Company (File No. 333-139839), filed January 8, 2007.) | ||
4.7
|
| Dividend Reinvestment and Stock Purchase Plan of the Company. (Incorporated by reference to Exhibit 8.1 to Registration Statement on Form S-3 of the Company (File No. 333-87063), filed September 14, 1999.) | ||
4.8
|
| Amendment to the Companys Dividend Reinvestment and Stock Purchase Plan filed on December 17, 1999. (Incorporated by reference to the Prospectus Supplement filed pursuant to Rule 424(b)(2) of the Securities Act of 1933 on December 17, 1999.) |
52
Exhibit No. | Description | |||
4.9
|
| Amendment to the Companys Dividend Reinvestment and Stock Purchase Plan filed on March 26, 2004. (Incorporated by reference to the Prospectus Supplement filed pursuant to Rule 424(b)(3) of the Securities Act of 1933 on March 26, 2004.) | ||
4.10
|
| Amendment to the Companys Dividend Reinvestment and Stock Purchase Plan filed on May 15, 2006. (Incorporated by reference to the Prospectus Supplement filed pursuant to Rule 424(b)(3) of the Securities Act of 1933 on May 15, 2006.) | ||
12.1
|
| Statements re: Computation of Ratios. (Filed herewith.) | ||
31.1
|
| Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Chief Executive Officer.) (Filed herewith.) | ||
31.2
|
| Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Chief Financial Officer.) (Filed herewith.) | ||
32
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| Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Executive Officer and Chief Financial Officer.) (Furnished herewith.) |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused
this report to be signed on its behalf by the undersigned thereunto duly authorized.
AVALONBAY COMMUNITIES, INC.
Date: May 8, 2008 | /s/ Bryce Blair | |||
Bryce Blair | ||||
Chief Executive Officer (Principal Executive Officer) |
||||
Date: May 8, 2008 | /s/ Thomas J. Sargeant | |||
Thomas J. Sargeant | ||||
Chief Financial Officer (Principal Financial Officer) |
||||
54