10-K: Annual report pursuant to Section 13 and 15(d)
Published on March 31, 1999
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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
Commission file number 1-12672
AVALONBAY COMMUNITIES, INC.
(Exact name of registrant as specified in its charter)
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2900 Eisenhower Avenue, Suite 300
Alexandria, Virginia 22314
(Address of principal executive office, including zip code)
(703) 329-6300
(Registrant's telephone number, including area code)
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Securities registered pursuant to Section 12(b) of the Act:
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding twelve (12) months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past ninety (90) days.
Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
The aggregate market value of the voting stock held by nonaffiliates of the
Registrant, as of March 1, 1999 was $2,015,257,270.
The number of shares of the Registrant's Common Stock, par value $.01 per share,
outstanding as of March 1, 1999 was 64,103,611.
Documents Incorporated by Reference
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Portions of AvalonBay Communities Inc.'s Proxy Statement
for the 1999 annual meeting of stockholders, a definitive
copy of which will be filed with the SEC within 120 days
after the end of the year covered by this Form 10-K, are
incorporated by reference herein as portions of Part III
of this Form 10-K.
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TABLE OF CONTENTS
PART I
This Form 10-K contains forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. The Company's actual results could differ materially from
those set forth in each forward-looking statement. Certain factors that might
cause such a difference are discussed in the section entitled "Forward-Looking
Statements" on page 34 of this Form 10-K.
ITEM 1. BUSINESS
General
AvalonBay Communities, Inc. (together with its subsidiaries, except as
the context may otherwise require, the "Company") is a Maryland corporation that
has elected to be taxed as a real estate investment trust ("REIT") under the
Internal Revenue Code of 1986, as amended. The Company focuses on the ownership
and operation of institutional-quality apartment communities in high
barrier-to-entry markets of the United States. These markets are located in
Northern and Southern California and selected states in the Mid-Atlantic,
Northeast, Midwest and Pacific Northwest regions of the country. The Company is
the surviving corporation from the merger (the "Merger") of Avalon Properties,
Inc. ("Avalon") with and into the Company (sometimes hereinafter referred to as
"Bay" before the Merger) on June 4, 1998. In connection with the Merger, the
Company changed its name from Bay Apartment Communities, Inc. to AvalonBay
Communities, Inc.
As of March 1, 1999, the Company owned or had an interest in 127
apartment communities containing 37,910 apartment homes in sixteen states and
the District of Columbia, of which 13 communities containing 4,854 apartment
homes were under redevelopment. The Company also owned 14 communities under
development that will contain 3,262 apartment homes and rights to develop an
additional 27 communities that, if developed, will contain an estimated 7,239
apartment homes. The Company obtains ownership in an apartment community by
developing vacant land into a new community or by acquiring and either
repositioning or redeveloping an existing community. In selecting sites for
development, redevelopment or acquisition, the Company favors locations with
close proximity to expanding employment centers and convenience to recreation
areas, entertainment, shopping and dining.
The Company's principal operating objectives are to increase operating
cash flow and Funds from Operations ("FFO") and, as a result, long-term
stockholder value. Management's strategies to achieve these objectives include:
- - generating consistent, sustained earnings growth at each community
through increased revenue (balancing high occupancy with premium pricing)
and increased operating margins (from aggressive operating expense
management);
- - investing selectively in new acquisition, development and redevelopment
communities in certain targeted market areas with high barriers-to-entry
and, when appropriate, selectively disposing of communities which no
longer meet the Company's investment objectives; and
- - maintaining a conservative capital structure to provide continued access
to capital markets at a low cost.
Management believes that these strategies are generally best implemented
by acquiring, building, rebuilding and managing institutional-quality assets in
supply-constrained markets while maintaining the financial discipline to ensure
balance sheet flexibility. Management believes that these strategies will lead
to higher occupancy levels, increased rental rates and predictable and growing
cash flow, although the Company cannot provide assurance that such results will
be achieved.
Acquisition and Disposition Strategy. The Company's acquisition strategy
generally has focused on individual, opportunistic investments. During 1997,
however, Bay and Avalon each completed significant portfolio acquisitions, Bay
in Southern California and Avalon in the Midwest. In addition, during March
1998, Avalon announced that it had agreed to purchase ten communities to be
developed (i.e., a purchase on a presale basis) from
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an unaffiliated developer primarily in the Pacific Northwest and Midwest
regions of the country. The presale acquisitions are expected to close during
the next 9 to 42 months. The ten presale communities are to be acquired for an
estimated aggregate purchase price of $387 million. Together, these communities
are expected to contain 2,980 apartment homes when completed. The Company will
manage these communities after acquiring ownership. This expansion is
consistent with the Company's strategy to achieve long term earnings growth by
providing a high quality platform for expansion while also providing additional
economic and geographic diversity. These portfolio acquisitions achieved rapid
penetration into supply-constrained markets new to Avalon and Bay. Management
believes that through the Company's acquisition strategy, the Company has now
targeted and penetrated many of the high barrier-to-entry markets of the United
States.
The Company expects to continue the disposition of assets that do not
meet its long-term strategic vision. While current market conditions prevail,
Management anticipates reinvesting capital obtained from dispositions into
development and redevelopment of existing communities that offer greater
investment returns and long-term growth potential than those communities
identified for disposition. However, the Company cannot provide assurance that
it will be able to complete its disposition strategy or that assets identified
for sale can be sold on terms that are satisfactory to the Company.
Development Strategy. Management's development strategy is to carefully
select land for development and to follow established procedures that are
designed to minimize both the cost and the risks of development. As one of the
largest developers of multifamily apartment communities in high barrier-to-entry
markets of the United States, the Company's regional offices identify
development opportunities through their local market presence and access to
local market information. In addition to the Company's principal executive
offices in Alexandria, Virginia, the Company maintains super-regional offices in
San Jose, California and Wilton, Connecticut. The Company also has regional
acquisition, development, redevelopment, construction, reconstruction or
administrative offices in or near Boston, Massachusetts; Chicago, Illinois;
Minneapolis, Minnesota; New York, New York; Newport Beach, California;
Princeton, New Jersey; Richmond, Virginia; and Seattle, Washington.
After selecting a target site, the Company negotiates for the right to
acquire the site either through an option or a long-term conditional contract.
After land is acquired, the focus is generally shifted to construction. Except
for certain mid-rise and high-rise apartment communities where third-party
general contractors have historically been used, the Company has acted as its
own general contractor. Management believes this achieves higher quality,
greater control over schedules and significant cost savings. Construction
progress is monitored by the development team and the property management team
to ensure high quality workmanship and a smooth and timely transition into the
leasing and operational phase.
Redevelopment Strategy. The Company's redevelopment strategy is to
selectively seek existing under-managed apartment communities in fully-developed
neighborhoods and create value by substantially re-building them at
significantly below replacement cost to a quality which is believed to be the
highest quality apartment community or best rental value for an
institutional-quality apartment community in its local area. Procedures have
been established that are designed to minimize both the cost and risks of
redevelopment. Redevelopment progress is monitored by redevelopment teams,
which include key redevelopment, construction and property management
personnel. The Company's Management believes significant cost savings are
achieved by acting as its own general contractor. More importantly, this
ensures high quality design and workmanship and a smooth and timely transition
into the lease-up and re-stabilization phase.
Property Management Strategy. Management intends to increase earnings
through innovative, proactive property management that will result in higher
revenue from communities. Intense focus on resident satisfaction, increasing
rents as market conditions permit and managing community occupancy for optimal
rental revenue levels comprise the Company's principal strategies for maximizing
revenue. Generally, lease terms are staggered based on vacancy exposure by
apartment type, so that lease expirations are better matched to each community's
traffic patterns. On-site property management teams receive bonuses based
largely upon the net operating income produced at their respective communities.
The Company is also pursuing ancillary services which could provide additional
revenue sources.
Controlling operating expenses is another way in which Management intends
to increase earnings growth. An increase in growth in the Company's portfolio
and the resulting increase in revenue allows for fixed operating costs to be
spread over a larger volume of revenue, thereby increasing operating margins.
The Company also
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aggressively pursues real estate tax appeals and scrutinizes other operating
costs. Invoices are recorded on-site to ensure the careful monitoring of
budgeted versus actual expenses, supplies are purchased in bulk where possible,
third-party contracts are bid on a volume basis, turnover work is performed
in-house or by third-parties generally depending upon the least costly
alternative and preventive maintenance is undertaken regularly to maximize
resident satisfaction and property and equipment life. In addition, the Company
strives to retain residents through high levels of service in order to eliminate
the cost of preparing an apartment home for a new resident and to reduce
marketing and utilities costs.
The Company also manages properties for third parties, believing that
doing so will provide information about new markets or provide an acquisition
opportunity, thereby enhancing opportunities for growth.
Financing Strategy. The Company has consistently maintained, and intends
to continue to maintain, a conservative capital structure, largely comprised of
common equity. At December 31, 1998, debt-to-total market capitalization was
35.7%, and permanent long-term floating rate debt (not including borrowings
under the Unsecured Facility) was only 1.4% of total market capitalization.
Management currently intends to limit long-term floating rate debt to less than
10% of total market capitalization, although that policy may change from time
to time.
The industry and the Company have seen a reduction in the availability of
cost effective capital over the last nine months. No assurance can be provided
that cost effective capital will be available to meet future expenditures
required to commence planned reconstruction activity or the construction of the
Development Rights (as hereinafter defined). Before planned reconstruction
activity or the construction of a Development Right commences, the Company
intends to arrange adequate liquidity sources to complete such undertakings,
although no assurance can be given in this regard.
Management estimates that a significant portion of the Company's
liquidity needs will be met from retained operating cash and borrowings under
the Company's $600,000,000 variable rate unsecured credit facility (the
"Unsecured Facility"). At March 1, 1999, $285,500,000 was outstanding,
$30,200,000 was used to provide letters of credit and $284,300,000 was available
for borrowing under the Unsecured Facility. To meet the balance of the Company's
liquidity needs, it will be necessary to arrange additional capacity under the
Company's existing Unsecured Facility, sell existing communities and/or issue
additional debt or equity securities. While Management believes the Company has
the financial position to expand its short term credit capacity and support such
capital markets activity, no assurance can be provided that the Company will be
successful in completing these arrangements, sales or offerings. If these
transactions cannot be completed on a cost-effective basis, then a continuation
of the current capital market conditions described herein could have a material
adverse impact on the operating results and financial condition of the Company,
including the abandonment of deferred development costs and a charge to
earnings.
Strong Earnings Growth Record. Earnings growth for 1998 was greater than
the two predecessor companies would have achieved separately. This is reflected
in the 17.5% increase in dividends declared for 1998 as compared to Bay's
dividends for 1997 and a 21% quarter-to-quarter increase. Additionally, for the
year ended December 31, 1998, FFO (reflecting the operating results for Bay
through June 4, 1998 and for the combined company after that date) increased
to $144,152,000 from $62,417,000 for the year ended December 31, 1997.
Management generally considers FFO to be an appropriate measure of the
Company's operating performance because it provides investors with an
understanding of the Company's ability to incur and service debt and to make
capital expenditures. Management believes that in order to facilitate a clear
understanding of the Company's operating results, FFO should be examined in
conjunction with net income as presented in the Company's consolidated financial
statements.
FFO is determined in accordance with a definition adopted by the Board of
Governors of the National Association of Real Estate Investment Trusts, and is
defined as net income (loss) computed in accordance with generally accepted
accounting principles ("GAAP"), excluding gains (or losses) from debt
restructuring and sales of property, plus depreciation of real estate assets and
after adjustments for unconsolidated partnerships and joint
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ventures. FFO does not represent cash generated from operating activities in
accordance with GAAP and therefore should not be considered an alternative to
net income as an indication of the Company's performance or to net cash flows
from operating activities as determined by GAAP as a measure of liquidity and is
not necessarily indicative of cash available to fund cash needs. Further, FFO as
disclosed by other REITs may not be comparable to the Company's calculation of
FFO.
Inflation and Tax Matters
Substantially all of the leases at the Current Communities (as
hereinafter defined) are for a term of one year or less, which may enable the
Company to realize increased rents upon renewal of existing leases or
commencement of new leases. Such short-term leases generally minimize the risk
to the Company of the adverse effects of inflation, although as a general rule
these leases permit residents to leave at the end of the lease term without
penalty. The Company's current policy is to permit residents to terminate leases
upon a 60-day written notice and payment of one month's rental as compensation
for early termination. Short-term leases combined with relatively consistent
demand allow rents, and therefore, cash flow from the portfolio to provide an
attractive inflation hedge.
The Company filed an election with its initial federal income tax return
to be taxed as a REIT under the Internal Revenue Code of 1986, as amended, and
intends to maintain its qualification as a REIT in the future. As a qualified
REIT, with limited exceptions, the Company will not be taxed under federal and
certain state income tax laws at the corporate level on its net income to the
extent net income is distributed to the Company's stockholders. In addition, due
to non-cash charges such as depreciation and amortization, the Company expects
that the cash it will distribute to its stockholders will exceed its net income.
Under current tax law, this excess, to the extent distributed, will be treated
by stockholders as a non-taxable return of capital that will reduce the
stockholders' basis in the shares of the Company's Common Stock.
Environmental Matters
Under various federal, state and local environmental laws, ordinances and
regulations, a current or previous owner or operator of real estate may be
required (in many instances regardless of knowledge or responsibility) to
investigate and remediate the effects of hazardous or toxic substances or
petroleum product releases at such property and may be held liable to a
governmental entity or to third parties for property damage and for
investigation and remediation costs incurred by such parties in connection with
the contamination, which may be substantial. The presence of such substances (or
the failure to properly remediate the contamination) may adversely affect the
owner's ability to borrow against, sell or rent such property. In addition, some
environmental laws create a lien on the contaminated site in favor of the
government for damages and costs it incurs in connection with the contamination.
Certain federal, state and local laws, regulations and ordinances govern
the removal, encapsulation or disturbance of asbestos-containing materials
("ACMs") when such materials are in poor condition or in the event of
construction, remodeling, renovation or demolition of a building. Such laws may
impose liability for release of ACMs and may provide for third parties to seek
recovery from owners or operators of real properties for personal injury
associated with ACMs. In connection with its ownership and operation of the
communities, the Company potentially may be liable for such costs. The Company
is not aware that any ACMs were used in connection with the construction of the
communities developed by the Company or by Avalon prior to the Merger. However,
the Company is aware that ACMs were used in connection with the construction of
certain communities acquired by the Company. The Company does not anticipate
that it will incur any material liabilities in connection with the presence of
ACMs at these communities. The Company currently has or intends to implement an
operations and maintenance program for ACMs at each of the communities at which
ACMs have been detected.
All of the Company's stabilized operating communities, and all of the
communities that are currently being developed or redeveloped, have been
subjected to a Phase I or similar environmental assessment (which generally does
not involve invasive techniques such as soil or ground water sampling). These
assessments have not revealed any environmental conditions that the Company
believes will have a material adverse effect on its business, assets, financial
condition or results of operations. The Company is not aware of any other
environmental conditions which would have such a material adverse effect.
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However, the Company is aware that the migration of contamination from an
upgradient landowner near Toscana, a community owned by the Company, has
affected the groundwater there. The upgradient landowner is undertaking remedial
response actions and the Company expects that the upgradient landowner will take
all necessary remediation actions. The upgradient landowner has also provided an
indemnity that runs to current and future owners of the Toscana property and
upon which the Company may be able to rely if it incurs environmental liability
arising from the groundwater contamination. The Company is also aware that
certain communities have lead paint and the Company is undertaking or intends
to undertake appropriate remediation or management activity.
Additionally, prior to their respective initial public offerings, Bay and
Avalon had each been occasionally involved in developing, managing, leasing and
operating various properties for third parties. Consequently, each may be
considered to have been an operator of such properties and, therefore,
potentially liable for removal or remediation costs or other potential costs
which could relate to hazardous or toxic substances. The Company is not aware of
any material environmental liabilities with respect to properties managed or
developed by either Bay or Avalon for such third parties.
The Company cannot provide assurance that:
- the environmental assessments identified all potential
environmental liabilities;
- no prior owner created any material environmental condition
not known to the Company or the consultants who prepared the
assessments;
- no environmental liabilities developed since such
environmental assessments were prepared;
- the condition of land or operations in the vicinity of the
Company's communities (such as the presence of underground storage
tanks) will not affect the environmental condition of such
communities; or
- future uses or conditions (including, without limitation,
changes in applicable environmental laws and regulations) will not
result in the imposition of environmental liability.
ITEM 2. COMMUNITIES
The Company's real estate investments as of March 1, 1999 consist
primarily of apartment communities in various stages of the development cycle
and land or land options held for development. Such investments can be divided
into three categories:
(*) Represents an estimate
"Current Communities" are apartment communities where construction is
complete and the community has either reached stabilized occupancy or
is in the initial lease-up process or under redevelopment. Current
Communities include the following sub-classifications:
Stabilized Communities. Represents all Current Communities that
have completed initial lease-up by attaining physical occupancy
levels of at least 95% or have been completed for one year,
whichever
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occurs earlier. For evaluation purposes, the Company regards each
Stabilized Community as falling into one of three categories:
- West Coast Established Communities. Represents all
Stabilized Communities owned by Bay as of January 1, 1997,
with stabilized operating costs as of January 1, 1997 such
that a comparison of 1997 operating results to 1998
operating results is meaningful. As of March 1, 1999, there
were 22 West Coast Established Communities containing 5,702
apartment homes.
- East Coast Established Communities. Represents all
Stabilized Communities owned by Avalon as of January 1,
1997 and subsequently acquired by the Company in connection
with the Merger, with stabilized operating costs as of
January 1, 1997 such that a comparison of 1997 operating
results to 1998 operating results is meaningful. As of
March 1, 1999, there were 34 East Coast Established
Communities containing 10,171 apartment homes.
- Other Stabilized Communities. Represents Stabilized
Communities as defined above, but which attained such
classification or were acquired after January 1, 1997. As
of March 1, 1999, there were 57 Other Stabilized
Communities containing 16,473 apartment homes.
Lease-Up Communities. Represents all Current Communities where
construction has been complete for less than one year and the
communities are in the initial lease-up process. As of March 1,
1999, there was currently one Lease-Up Community containing 710
apartment homes.
Redevelopment Communities. Represents all Current Communities
where substantial redevelopment has either begun or is scheduled
to begin. Redevelopment is considered substantial when additional
capital invested during the reconstruction effort exceeds the
lesser of $5 million or 10% of the community's acquisition cost.
As of March 1, 1999, there were 13 Redevelopment Communities
containing 4,854 apartment homes.
"Development Communities" are communities that are under construction and
may be partially complete and operating and for which a final certificate
of occupancy has not been received.
"Development Rights" are development opportunities in the early phase of
the development process for which the Company has an option to acquire
land or owns land to develop a new community and where related
pre-development costs have been incurred and capitalized in pursuit of
these new developments.
The Company's holdings under each of the above categories are discussed
on the following pages.
Current Communities
The Current Communities are primarily garden-style apartment
communities consisting of two-and three-story buildings in landscaped settings.
The Current Communities, as of March 1, 1999, include 109 garden-style, 13
high-rise and 5 mid-rise apartment communities. The Current Communities offer
many attractive amenities including vaulted ceilings, lofts, fireplaces,
patios/decks and modern appliances. Other features, at various communities,
include swimming pools, fitness centers, tennis courts and business centers.
The Company also has an extensive and ongoing maintenance program to keep all
communities and apartment homes free of deferred maintenance and, where vacant,
available for immediate occupancy. Management believes that excellent design
and service oriented property management focused on the specific needs of
residents enhances market appeal to discriminating residents and will
ultimately achieve higher rental rates and occupancy levels while minimizing
resident turnover and operating expenses. These Current Communities are
institutional-quality multifamily apartment communities located in the
following six geographic markets:
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All of the Current Communities are managed and operated by the Company.
During the year ended December 31, 1998, the Company completed construction of
1,770 apartment homes in four communities for a total cost of $224.8 million.
The average age of the Current Communities, on a weighted average basis
according to number of apartment homes, is approximately nine years.
Of the Current Communities, the Company held a fee simple ownership
interest in 109 operating communities (one of which is on land subject to a 149
year land lease); a general partnership interest in four partnerships that hold
a fee simple interest in four other operating communities; a general partnership
interest in four partnerships structured as "DownREITs" that own 13 communities;
and a 100% interest in a senior participating mortgage note secured by one
community. In each of the four partnerships structured as "DownREITs", the
Company is the general partner and there are one or more limited partners whose
interest in the partnership is denominated in "units of limited partnership
interest" ("Units"). For each DownREIT partnership, limited partners who hold
Units are entitled to receive certain distributions (a "Stated Distribution")
prior to any distribution that such DownREIT partnership makes to the general
partner. The Stated Distributions that are paid in respect of the DownREIT
Units currently approximate the dividend rate applicable to shares of Common
Stock of the Company. Each DownREIT partnership has been
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structured in a manner that makes it unlikely that the limited partners thereof
will be entitled to any greater distribution than the Stated Distribution. Each
holder of Units has the right to require the DownREIT partnership that issued a
Unit to redeem that Unit at a cash price equal to the then fair market value of
a share of Common Stock of the Company, except that the Company has the right to
acquire any Unit so presented for redemption for one share of Common Stock. As
of March 1, 1999, there were 894,144 Units outstanding. The DownREIT
partnerships are consolidated for financial reporting purposes.
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PROFILE OF CURRENT AND DEVELOPMENT COMMUNITIES
(DOLLARS IN THOUSANDS, EXCEPT PER APARTMENT HOME DATA)
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PROFILE OF CURRENT AND DEVELOPMENT COMMUNITIES
(DOLLARS IN THOUSANDS, EXCEPT PER APARTMENT HOME DATA)
10
PROFILE OF CURRENT AND DEVELOPMENT COMMUNITIES
(DOLLARS IN THOUSANDS, EXCEPT PER APARTMENT HOME DATA)
11
PROFILE OF CURRENT AND DEVELOPMENT COMMUNITIES
(DOLLARS IN THOUSANDS, EXCEPT PER APARTMENT HOME DATA)
12
FEATURES AND RECREATIONAL AMENITIES - CURRENT AND DEVELOPMENT COMMUNITIES
13
FEATURES AND RECREATIONAL AMENITIES - CURRENT AND DEVELOPMENT COMMUNITIES
14
FEATURES AND RECREATIONAL AMENITIES - CURRENT AND DEVELOPMENT COMMUNITIES
15
FEATURES AND RECREATIONAL AMENITIES - CURRENT AND DEVELOPMENT COMMUNITIES
16
FEATURES AND RECREATIONAL AMENITIES - CURRENT AND DEVELOPMENT COMMUNITIES
(CONTINUED)
17
FEATURES AND RECREATIONAL AMENITIES - CURRENT AND DEVELOPMENT COMMUNITIES
(CONTINUED)
18
FEATURES AND RECREATIONAL AMENITIES - CURRENT AND DEVELOPMENT COMMUNITIES
(CONTINUED)
19
FEATURES AND RECREATIONAL AMENITIES - CURRENT AND DEVELOPMENT COMMUNITIES
(CONTINUED)
20
Notes to Community Information tables on pages 9 through 20
(1) Represents the average rental revenue per occupied apartment home.
(2) Property EBITDA is defined as property earnings before interest,
income taxes, depreciation, amortization, extraordinary items,
gain/(loss) on sale of a community, minority interest and before
considering corporate general and administrative expenses and
central property management overhead. Gross EBITDA discussed in
Note (5) to the Selected Financial Data represents consolidated
earnings (net of general and administrative expenses and central
property management overhead), and including minority interests,
but before depreciation and amortization. EBITDA should not be
considered as an alternative to operating income (as determined
in accordance with GAAP) as an indicator of the Company's
operating performance, or to cash flows from operating activities
(as determined in accordance with GAAP) as a measure of
liquidity. EBITDA as disclosed by other REITs may not be
comparable to the Company's calculation of EBITDA.
(3) Costs are presented in accordance with GAAP. For Development
Communities, cost represents total costs incurred through December
31, 1998.
(4) For purposes of these tables, Current Communities include only
communities for which the Company held fee simple ownership
interests or held through DownREIT partnerships.
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Development Communities
As of March 1, 1999, 14 Development Communities were under construction
which are expected to add a total of 3,262 apartment homes to the Company's
portfolio upon completion. The total capitalized cost of the Development
Communities, when completed, is expected to be approximately $532.5 million.
Statements regarding the future development or performance of the Development
Communities are forward-looking statements. There can be no assurance that the
Company will complete the Development Communities, that the Company's budgeted
costs, leasing, start dates, completion dates, occupancy or estimates of "EBITDA
as a % of Total Budgeted Cost" will be realized or that future developments will
realize comparable returns. See the discussion under "Risks of Development and
Redevelopment".
The Company holds a fee simple ownership interest in each of the Development
Communities except for two communities that are owned by partnerships in which
the Company holds a general partnership interest. The following is a summary of
the Development Communities:
(1) Budgeted cost includes all capitalized costs projected to be incurred to
develop the respective Development Community, including land acquisition
costs, construction costs, real estate taxes, capitalized interest and
loan fees, permits, professional fees, allocated development overhead and
other regulatory fees determined in accordance with GAAP.
(2) Stabilized operations is defined as the first full quarter of 95% or
greater occupancy after completion of construction.
(3) Projected EBITDA represents gross potential earnings projected to be
achieved at completion of construction before interest, income taxes,
depreciation, amortization and extraordinary items, minus (a) projected
economic vacancy and (b) projected stabilized operating expenses. EBITDA
is relevant to an understanding of the economics of the Company because
it indicates cash flow available from Company operations to service fixed
obligations. EBITDA should not be considered as an alternative to
operating income, as determined in accordance with GAAP, as an indicator
of the Company's operating performance, or to cash flows from operating
activities (as determined in accordance with GAAP) as a measure of
liquidity. EBITDA as disclosed by other REITs may not be comparable to
the Company's calculation of EBITDA.
(4) Represents a combined yield for Avalon Valley and Avalon Lake.
(5) Financed with tax-exempt bonds.
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Redevelopment Communities
As of March 1, 1999, the Company had 13 Redevelopment Communities. The
total budgeted cost of these Redevelopment Communities, including the cost of
acquisition and redevelopment when completed, is expected to be approximately
$462.5 million, of which approximately $98.1 million is the additional capital
invested or expected to be invested above the original purchase cost.
Statements regarding the future redevelopment or performance of the
Redevelopment Communities are forward-looking statements. The Company has found
that the cost to redevelop an existing apartment community is more difficult to
budget and estimate than the cost to develop a new community. Accordingly, the
Company expects that actual costs may vary over a wider range than for a new
development community. The Company cannot provide any assurance that the Company
will not exceed budgeted costs, either individually or in the aggregate, or that
projected unleveraged returns on cost will be achieved. See the discussion
under "Risks of Development and Redevelopment".
The following is a summary of the Redevelopment Communities:
(1) Total budgeted cost includes all capitalized costs projected to be
incurred to redevelop the respective Redevelopment Community,
including costs to acquire the community, reconstruction costs, real
estate taxes, capitalized interest and loan fees, permits, professional
fees, allocated redevelopment overhead and other regulatory fees
determined in accordance with GAAP.
(2) Restabilized operations is defined as the first full quarter of 95% or
greater occupancy after completion of redevelopment.
(3) Projected EBITDA represents gross potential earnings projected to be
achieved at completion of redevelopment before interest, income taxes,
depreciation, amortization and extraordinary items, minus (a) projected
economic vacancy and (b) projected stabilized operating expenses.
23
Development Rights
The Company is considering the development of 27 new apartment
communities. These Development Rights range from land owned or under contract
for which design and architectural planning has just commenced to land under
contract or owned by the Company with completed site plans and drawings where
construction can commence almost immediately. Management estimates that the
successful completion of all of these communities would ultimately add 7,239
institutional-quality apartment homes to the Company's portfolio. At December
31, 1998, the cumulative capitalized costs incurred in pursuit of the 27
Development Rights, including the cost of land acquired in connection with
three of the Development Rights, was approximately $41.0 million. Many of these
apartment homes will offer features like those offered by the communities
currently owned by the Company.
The Company generally holds Development Rights through options to acquire
land, although one development right is controlled through a joint venture
partnership that owns land (New Canaan, CT). The properties comprising the
Development Rights are in different stages of the due diligence and regulatory
approval process. The decisions as to which of the Development Rights to pursue,
if any, or to continue to pursue once an investment in a Development Right is
made are business judgments to be made by Management after continued financial,
demographic and other analysis is performed. Finally, Management intends to
limit the percentage of debt used to finance new developments. To comply with
Management's self-imposed limitation on the use of debt, other financing
alternatives may be required to finance the development of those Development
Rights scheduled to start construction after January 1, 1999. Although the
development of any particular Development Right cannot be assured, Management
believes that the Development Rights, in the aggregate, present attractive
potential opportunities for future development and growth of the Company's FFO.
Statements regarding the future development of the Development Rights are
forward-looking statements. There can be no assurance that:
- the Company will succeed in obtaining zoning and other
necessary governmental approvals or the financing required to
develop these communities, or that the Company will decide to
develop any particular community; or
- construction of any particular community will be undertaken
or, if undertaken, will begin at the expected times assumed in the
financial projections or be completed by the anticipated date
and/or at the total budgeted cost assumed in the financial
projections;
The 27 Development Rights the Company is currently pursuing are
summarized on the following table:
24
(1) Company owns land, but construction has not yet begun.
(2) Currently anticipated that the land seller will retain a minority limited
partner interest.
Risks of Development and Redevelopment
The Company intends to continue to pursue the development and
redevelopment of apartment home communities in accordance with the Company's
underwriting policies. Risks associated with the Company's development and
redevelopment activities may include:
25
- - the abandonment of opportunities explored by the Company based on further
financial, demographic or other analysis or because of liquidity
constraints;
- - the inability to obtain, or delays in obtaining, all necessary zoning,
land-use, building, occupancy, and other required governmental permits
and authorizations;
- - construction or reconstruction costs of a community may exceed original
estimates due to increased materials, labor or other expenses, which
could make completion or redevelopment of a community uneconomical;
- - occupancy rates and rents at a newly completed or redevelopment community
are dependent on a number of factors, including market and general
economic conditions, and may not be sufficient to make the community
profitable;
- - financing may not be available on favorable terms for the development or
redevelopment of a community; and construction and lease-up may not be
completed on schedule, resulting in increased debt service expense and
construction costs.
The occurrence of any of the events described above could adversely
affect the Company's ability to achieve its projected yields on communities
under development or redevelopment and could prevent the Company from paying
distributions to its stockholders.
For each Development and Redevelopment Community, the Company
establishes a target for projected EBITDA as a percentage of total budgeted
cost. Projected EBITDA represents gross potential earnings projected to be
achieved at completion of development or redevelopment before interest, income
taxes, depreciation, amortization and extraordinary items, minus (a) projected
economic vacancy and (b) projected stabilized operating expenses. Total
budgeted cost includes all capitalized costs projected to be incurred to
develop the respective Development or 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 determined in accordance with GAAP. Gross potential
earnings and construction costs reflect market conditions prevailing in the
community's market at the time the Company's budgets are prepared taking into
consideration certain changes to those market conditions anticipated by the
Company at the time. Although the Company attempts to anticipate changes in
market conditions, the Company cannot predict with certainty what those changes
will be. Construction costs have been increasing and, for certain of the
Company's Development Communities, the total construction costs have been or
are expected to be higher than the original budget. Nonetheless, because of
increases in prevailing market rents Management believes that, in the
aggregate, the Company will still achieve its targeted projected EBITDA as a
percentage of total budgeted cost for those communities experiencing costs in
excess of the original budget. Management believes that it could experience
similar increases in construction costs and market rents with respect to other
development communities resulting in total construction costs that exceed
original budgets. Likewise, costs to redevelop communities that have been
acquired have, in some cases, exceeded Management's original estimates and
similar increases in costs may be experienced in the future. There can be no
assurances that market rents in effect at the time new development communities
or repositioned communities complete lease-up will be sufficient to fully
offset the effects of any increased construction costs.
Capitalized Interest
In accordance with GAAP, the Company capitalizes interest expense during
construction or reconstruction until each building obtains a certificate of
occupancy; thereafter, interest for each completed building is expensed.
Capitalized interest during the years ended December 31, 1998, 1997 and 1996
totaled $16,977,000, $6,985,000 and $2,567,000, respectively.
Acquisition Activities and Other Recent Developments
Acquisitions of Existing Communities. In 1998, Avalon, Bay and,
following the Merger, the Company acquired an aggregate of 13 communities
containing 4,166 apartment homes. These communities are summarized as follows:
26
On January 7, 1998, Avalon purchased Avalon at Town Centre, a 246
apartment home community, and Avalon at Town Square, a 160 apartment home
community, both of which are located in the Minneapolis, Minnesota area, for an
aggregate purchase price of approximately $27,625,000.
On April 30, 1998, Avalon purchased Avalon at Oxford Hill, a 480
apartment home community located in St. Louis, Missouri, for approximately
$29,760,000.
On May 29, 1998, Avalon purchased The Gates of Edinburgh, a 198 apartment
home community located in the Minneapolis, Minnesota area, for approximately
$17,950,000.
On January 14, 1998, Bay purchased Warner Oaks, a 227 apartment home
community located in the Los Angeles, California area, for approximately
$20,100,000.
On January 28, 1998, Bay purchased Amberway, a 272 apartment home
community located in Orange County, California, and Arbor Park, a 260 apartment
home community located in the Los Angeles, California area, for approximately
$17,500,000 and $12,400,000, respectively.
On February 11, 1998, Bay purchased Laguna Brisas, a 176 apartment home
community located in the Los Angeles, California area, for approximately
$17,400,000.
On March 2, 1998, Bay purchased Cabrillo Square, a 293 apartment home
community located in San Diego, California, for approximately $22,900,000.
On May 1, 1998, Bay purchased Avalon Ridge, a 421 apartment home
community, located in the Seattle, Washington area, for approximately
$25,100,000.
On June 16, 1998, the Company purchased The Verandas at Bear Creek, a 264
apartment home community located in the Seattle, Washington area, for
approximately $34,290,000.
On July 16, 1998, the Company purchased the residential portion of the
Prudential Center, a 781 apartment home community located in Boston,
Massachusetts, for approximately $130,000,000.
On December 1, 1998, the Company purchased Hanover Hall, a 388 apartment
home community located in the Hartford, Connecticut area, for approximately
$37,500,000.
Sales of Existing Communities. During 1998, the Company completed a
strategic planning effort resulting in a decision to pursue a disposition
strategy for certain assets in markets that did not meet its long-term strategic
direction. In connection with this disposition strategy, during 1998 the Company
sold seven communities, totaling 2,039 apartment homes for a gross sales price
of $126,200,000. Net proceeds from the sale of these communities totaled
$73,900,000 resulting in a net gain of $3,970,000.
In connection with an agreement executed by Avalon in March 1998 which provided
for the buyout of certain limited partners in DownREIT V Limited Partnership,
the Company sold two communities in July 1998. Net proceeds from the sale of the
two communities, containing an aggregate of 758 apartment homes, were
approximately $44,000,000.
Land Acquisitions for New Developments. During February 1998, Avalon
purchased a 17.1 acre site in Danbury, Connecticut for the development of 268
luxury apartment homes to be known as Avalon Valley. Avalon Valley is budgeted
to cost $26,100,000. Construction on Avalon Valley commenced during the first
quarter of 1998 and is expected to be completed in the third quarter of 1999.
During February 1998, Avalon purchased a 32 acre site in Danbury,
Connecticut for the development of 135 luxury apartment homes to be known as
Avalon Lake. Avalon Lake is budgeted to cost $17,000,000. Construction on Avalon
Lake commenced during the second quarter of 1998 and is expected to be
completed in the third quarter of 1999.
During March 1998, Avalon acquired a 22
acre site in Wilmington, Massachusetts for the development of 204 luxury
apartment homes to be known as Avalon Oaks. Avalon Oaks is budgeted to cost
$21,900,000. Construction on Avalon Oaks commenced during the second quarter of
1998 and is expected to be completed in the second quarter of 1999.
During April 1998, Bay acquired a 5.05 acre site on the Alameda in
downtown San Jose, California on which it plans to build, subject to certain
governmental approvals, an
27
apartment home community with up to 278 apartment homes and approximately 8,500
square feet of retail space. This future development community is budgeted to
cost $52,900,000.
Seismic Concerns
Many of the Company's West Coast communities are located in the general
vicinity of active earthquake faults. In July 1998, the Company obtained a
seismic risk analysis from an engineering firm which estimated the probable
maximum damage ("PMD") for each of the 60 West Coast communities that the
Company owned at that time and for each of the five West Coast communities under
development at that time, individually and for all of those communities
combined. To establish a PMD, the engineers first define a severe earthquake
event for the applicable geographic area, which is an earthquake that has only a
10% likelihood of occurring over a 50-year period. The PMD is determined as the
structural and architectural damage and business interruption loss that has a
10% probability of being exceeded in the event of such an earthquake. Because a
significant number of the Company's communities are located in the San Francisco
Bay Area, the engineers' analysis defined an earthquake on the Hayward Fault
with a Richter Scale magnitude of 7.1 as a severe earthquake with a 10%
probability of occurring within a 50-year period. The engineers then established
an aggregate PMD at that time of $113 million for the 60 West Coast communities
that the Company owned at that time and the five West Coast communities under
development. The $113 million PMD for those communities was a PMD level that the
engineers expected to be exceeded only 10% of the time in the event of such a
severe earthquake. The actual aggregate PMD could be higher or lower as a result
of variations in soil classifications and structural vulnerabilities. For each
community, the engineers' analysis calculated an individual PMD as a percentage
of the community's replacement cost and projected revenues. No assurance can be
given that an earthquake would not cause damage or losses greater than the PMD
assessments indicate, that future PMD levels will not be higher than the current
PMD levels described above for the Company's communities located on the West
Coast, or that future acquisitions or developments will not have PMD assessments
indicating the possibility of greater damage or losses than currently indicated.
In August 1998, the Company renewed its earthquake insurance, both for
physical damage and lost revenue, with respect to all communities it owned at
that time and all of the communities under development. For any single
occurrence, the Company has in place $75,000,000 of coverage, with a 5 percent
deductible not to exceed $25,000,000 and not less than $100,000, above this
amount. In addition, the Company's general liability and property casualty
insurance provides coverage for personal liability and fire damage. In the
event an uninsured disaster or a loss in excess of insured limits were to
occur, the Company could lose its capital invested in the affected community,
as well as anticipated future revenue from that community, and would continue
to be obligated to repay any mortgage indebtedness or other obligations related
to the community. Any such loss could materially and adversely affect the
business of the Company and its financial condition and results of operations.
Americans with Disabilities Act
The apartment communities owned by the Company and any newly acquired
apartment communities must comply with Title III of the Americans with
Disabilities Act (the "ADA") to the extent that such properties are "public
accommodations" and/or "commercial facilities" as defined by the ADA. Compliance
with the ADA requirements could require removal of structural barriers to
handicapped access in certain public areas of the Company's properties where
such removal is readily achievable. The ADA does not, however, consider
residential properties, such as apartment communities, to be public
accommodations or commercial facilities, except to the extent portions of such
facilities, such as leasing offices, are open to the public. The Company
believes its properties comply in all material respects with all present
requirements under the ADA and applicable state laws. Noncompliance could result
in imposition of fines or an award of damages to private litigants.
28
ITEM 3. LEGAL PROCEEDINGS
Neither the Company nor any of the communities is presently subject to
any material litigation nor, to the Company's knowledge, is any litigation
threatened against the Company or any of the communities, other than routine
actions for negligence or other claims and administrative proceedings arising in
the ordinary course of business, or other claims for damages where the amount
involved, exclusive of interest and costs, does not exceed ten percent of the
current assets of the Company and its subsidiaries on a consolidated basis. Some
of these claims and proceedings are expected to be covered by liability
insurance and all, collectively, are not expected to have a material adverse
effect on the business or financial condition of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS
On October 2, 1998, the Company held a Special Meeting of Stockholders
(the "Special Meeting") at which the holders of record of the Company's Common
Stock, par value $.01 per share (the, "Common Stock"), as of the close of
business on August 26, 1998 (the "Record Date") were asked to vote on certain
amendments to the Company's charter (the "Charter"). As of the Record Date,
there were 63,649,121 shares of Common Stock outstanding and entitled to vote.
Specifically, the stockholders were asked to vote to approve an amendment to
the Charter that would:
(i) an amendment to the Charter that would reduce the number of
authorized shares of the Company's Common Stock which the Company
may issue from 300,000,000 to 140,000,000. This amendment to the
Charter was approved by a vote of 46,049,160 shares for and
46,981 shares against the amendment. The number of abstentions
was 44,206.
(ii) enable the Company's stockholders to remove directors from office
with or without cause upon the affirmative vote of a majority of
the shares then entitled to vote at a meeting of the stockholders
called for such purpose. This amendment to the Charter was not
approved because the number of votes cast in favor of such
amendment did not meet the required two thirds of all issued and
outstanding shares of the Company's Common Stock. The votes
totaled 35,219,839 shares for and 1,530,077 shares against the
amendment. The number of abstentions was 69,610.
(iii) change the name of the Company from "Avalon Bay Communities,
Inc." to "AvalonBay Communities, Inc." This amendment was
approved by a vote of 46,075,627 shares for and 20,828 shares
against the amendment. The number of abstentions was 43,891.
Immediately following the Special Meeting on October 2, 1998, the Company
caused Articles of Amendment to the Charter to be filed with, and accepted for
record by, the State Department of Assessments and Taxation of the State of
Maryland. Accordingly, the Company is now authorized to issue 140,000,000 shares
of Common Stock and its name has been changed to "AvalonBay Communities, Inc."
29
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on the New York Stock Exchange
(the "NYSE") and the Pacific Stock Exchange (the "PCX") under the ticker symbol
"AVB." The following table sets forth the quarterly high and low sales prices
per share of the Company's Common Stock on the NYSE for the years ended December
31, 1998 and 1997, as reported by the NYSE. On March 1, 1999, there were 921
holders of record of 64,103,611 shares of the Company's Common Stock.
The Company expects to continue its policy of paying regular quarterly
cash dividends. However, dividend distributions will be declared at the
discretion of the Board of Directors and will depend on actual Funds from
Operations of the Company, its financial condition, capital requirements, the
annual distribution requirements under the REIT provisions of the Code and such
other factors as the Board of Directors may deem relevant. The Board of
Directors may modify the Company's dividend policy from time-to-time.
The Company has an optional Dividend Reinvestment and Stock Purchase
Plan (the "Plan") which provides a simple and convenient method for stockholders
to invest cash dividends and optional cash payments in shares of Common Stock of
the Company. All holders of Capital Stock are eligible to participate in the
Plan, including stockholders, whose shares are held in the name of a nominee or
broker (the "Participants"). Participants in the Plan may purchase additional
shares of Common Stock by (i) having the cash dividends on all or part of their
shares of Capital Stock automatically reinvested, (ii) receiving directly, as
usual, their cash dividends, if as and when declared, on their shares of Capital
Stock and investing in the Plan by making cash payments of not less than $100 or
more than $25,000 (or such larger amount as the Company may approve) per
quarter, or (iii) investing both their cash dividends and such optional cash
payments in shares of Common Stock.
Common Stock is acquired pursuant to the Plan at a price equal to 97%
of the closing price on the NYSE for such shares of Common Stock on the higher
of the dividend payment date or the applicable trading day. Generally, no
brokerage commissions, fees or service charges are paid by Participants in
connection with purchases under the Plan. Stockholders who do not participate
in the Plan continue to receive cash dividends as declared.
30
ITEM 6. SELECTED FINANCIAL DATA
The following table below provides historical consolidated financial,
operating and other data for the Company and the Greenbriar Group. The table
should be read with the consolidated financial statements of the Company and the
notes included in this report.
31
Notes to Selected Financial Data
- ---------------------------
(1) See consolidated financial statements of the Company and the related notes
included in this report.
(2) The Greenbriar Group is the Company's predecessor.
(3) Share and per share information is only presented for the Company because
no common stock was outstanding during periods presented for the Greenbriar
Group. The first full year operating as a public company was 1995.
(4) Management generally considers Funds from Operations ("FFO") to be an
appropriate measure of the operating performance of the Company because it
provides investors an understanding of the ability of the Company to incur
and service debt and to make capital expenditures. The Company believes
that in order to facilitate a clear understanding of the operating results
of the Company, FFO should be examined in conjunction with net income as
presented in the consolidated financial statements included elsewhere in
this report. FFO is determined in accordance with a definition adopted by
the Board of Governors of the National Association of Real Estate
Investment Trusts ("NAREIT") and is defined as net income (loss) computed
in accordance with generally accepted accounting principles ("GAAP")
excluding gains (or losses) from debt restructuring and sales of property,
plus depreciation of real estate assets, and after adjustments for
unconsolidated partnerships and joint ventures. FFO does not represent cash
generated from operating activities in accordance with GAAP and therefore
should not be considered an alternative to net income an indication of the
Company's performance, or to net cash flows from operating activities as
determined by GAAP as a measure of liquidity and is not necessarily
indicative of cash available to fund cash needs. Further, FFO as calculated
by other REITs may not be comparable to the Company's calculation of FFO.
The calculation of FFO for the periods presented is reflected in the
following table:
32
SUMMARY CALCULATION OF FUNDS FROM OPERATIONS
(Dollars in thousands)
(5) Gross EBITDA represents earnings before interest, income taxes,
depreciation and amortization, gain on sale of communities and
extraordinary items. Gross EBITDA is relevant to an understanding of the
economics of the Company because it indicates cash flow available from
Company operations to service fixed obligations. Gross EBITDA should not be
considered as an alternative to operating income, as determined in
accordance with GAAP, as an indicator of the Company's operating
performance, or to cash flows from operating activities (as determined in
accordance with GAAP) as a measure of liquidity. See "Communities" for
property EBITDA and the related definition.
(6) These amounts include communities only after stabilized occupancy has
occurred. A community is considered by the Company to have achieved
stabilized occupancy on the earlier of (i) the first day of any month in
which the community reaches 95% physical occupancy or (ii) one year after
completion of construction. These amounts also include joint venture
investments.
33
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Forward-Looking Statements
Certain statements in this Annual Report, including the footnotes to the
Company's financial statements, constitute "forward-looking statements" as that
term is defined under the Private Securities Litigation Reform Act of 1995 (the
"Reform Act"). The words "believe," "expect," "anticipate," "intend,"
"estimate," "assume" and other similar expressions which are predictions of or
indicate future events and trends and which do not solely report historical
matters identify forward-looking statements. In addition, information concerning
construction, occupancy and completion of Development and Redevelopment
Communities and Development Rights (as each term is hereinafter defined) and
related cost, yield and EBITDA estimates, as well as the cost, timing and
effectiveness of Year 2000 compliance, are forward-looking statements. Reliance
should not be placed on forward-looking statements as they involve known and
unknown risks, uncertainties and other factors, which are in some cases beyond
the control of the Company and which may cause the actual results, performance
or achievements of the Company to differ materially from the anticipated future
results, performance or achievements expressed or implied by such
forward-looking statements.
Certain factors that might cause such differences include, but are not limited
to, the following: the Company may not be successful in managing its current
growth in the number of apartment communities and the related growth of its
business operations; the Company's expansion into new geographic market areas
may not produce financial results that are consistent with its historical
performance; acquisitions of portfolios of apartment communities may result in
the Company acquiring communities that are more expensive to manage and
portfolio acquisitions may not be successfully completed, resulting in charges
to earnings; the Company may fail to secure or may abandon development
opportunities; construction costs of a community may exceed original estimates;
construction and lease-up of Development and Redevelopment Communities may not
be completed on schedule, resulting in increased debt service expense,
construction costs and reduced rental revenues; occupancy rates and market rents
may be adversely affected by local economic and market conditions which are
beyond management's control; financing may not be available on favorable terms,
and reliance on cash flow from operations and access to cost effective capital
may be insufficient to enable the Company to pursue opportunities or develop its
pipeline of Development Rights; the Company's cash flow may be insufficient to
meet required payments of principal and interest, and existing indebtedness may
not be able to be refinanced or the terms of such refinancing may not be as
favorable as the terms of existing indebtedness; and the Company and its
suppliers and service providers may experience unanticipated delays or expenses
in achieving Year 2000 compliance.
The following discussion should be read in conjunction with the consolidated
financial statements and notes included in this report.
General
The Company is a real estate investment trust ("REIT") that is focused on the
ownership and operation of institutional-quality apartment communities in high
barrier-to-entry markets of the United States. These markets are located in
Northern and Southern California and selected states in the Mid-Atlantic,
Northeast, Midwest and Pacific Northwest regions of the country. The Company is
the surviving corporation from the merger (the "Merger") of Avalon Properties,
Inc. ("Avalon") with and into the Company (sometimes hereinafter referred to as
"Bay" before the Merger) on June 4, 1998. The Merger was accounted for as a
purchase of Avalon by Bay. In conjunction with the Merger, the Company changed
its name from Bay Apartment Communities, Inc. to AvalonBay Communities, Inc.
The Company is a fully-integrated real estate organization with in-house
acquisition, development, redevelopment, construction, reconstruction,
financing, marketing, leasing and management expertise. With its experience and
in-house capabilities, the Company believes it is well-positioned to continue to
pursue opportunities to develop and
34
acquire upscale apartment homes in its target markets, although the Company may
be constrained by the need to access cost effective capital to finance this
activity.
The Company's real estate investments as of March 1, 1999 consist primarily of
apartment communities in various stages of the development cycle and land or
land options held for development. Such investments can be divided into three
categories:
(*) Represents an estimate
"Current Communities" are apartment communities where construction is
complete and the community has either reached stabilized occupancy or
is in the initial lease-up process or under redevelopment. Current
Communities include the following sub-classifications:
Stabilized Communities. Represents all Current Communities that
have completed initial lease-up by attaining physical occupancy
levels of at least 95% or have been completed for one year,
whichever occurs earlier. For evaluation purposes, the Company
regards each Stabilized Community as falling into one of three
categories:
- West Coast Established Communities. Represents all Stabilized
Communities owned by Bay as of January 1, 1997, with
stabilized operating costs as of January 1, 1997 such that a
comparison of 1997 operating results to 1998 operating results
is meaningful. As of March 1, 1999, there were 22 West Coast
Established Communities containing 5,702 apartment homes. When
used in connection with a comparison of 1997 and 1996 results,
the term "Established Communities" refers to communities that
were stabilized as of January 1, 1996.
- East Coast Established Communities. Represents all Stabilized
Communities owned by Avalon as of January 1, 1997 and
subsequently acquired by the Company in connection with the
Merger, with stabilized operating costs as of January 1, 1997
such that a comparison of 1997 operating results to 1998
operating results is meaningful. As of March 1, 1999, there
were 34 East Coast Established Communities containing 10,171
apartment homes.
- Other Stabilized Communities. Represents Stabilized
Communities as defined above, but which attained such
classification or were acquired after January 1, 1997. As of
March 1, 1999, there were 57 Other Stabilized Communities
containing 16,473 apartment homes.
Lease-Up Communities. Represents all Current Communities where
construction has been complete for less than one year and the
communities are in the initial lease-up process. As of March 1,
1999, there was one Lease-Up Community containing 710 apartment
homes.
Redevelopment Communities. Represents all Current Communities
where substantial redevelopment has either begun or is scheduled
to begin. Redevelopment is considered substantial when additional
capital invested during the reconstruction effort exceeds the
35
lesser of $5 million or 10% of the community's acquisition cost.
As of March 1, 1999, there were 13 Redevelopment Communities
containing 4,854 apartment homes.
"Development Communities" are communities that are under construction
and may be partially complete and operating and for which a final
certificate of occupancy has not been received.
"Development Rights" are development opportunities in the early phase
of the development process for which the Company has an option to
acquire land or owns land to develop a new community and where related
pre-development costs have been incurred and capitalized in pursuit of
these new developments.
Of the Current Communities, the Company holds a fee simple ownership interest
in 109 operating communities (one of which is on land subject to a 149 year
land lease); a general partnership interest in four partnerships that hold a
fee simple interest in four other operating communities; a general partnership
interest in four partnerships structured as "DownREITs" (as described more
fully below) that own 13 communities; and a 100% interest in a senior
participating mortgage note secured by one community. The Company holds a fee
simple ownership interest in each of the Development Communities except for two
communities that are owned by partnerships in which the Company holds a general
partnership interest. In each of the four partnerships structured as
"DownREITs," the Company is the general partner and there are one or more
limited partners whose interest in the partnership is denominated in "units of
limited partnership interest" ("Units"). For each DownREIT partnership, limited
partners who hold Units are entitled to receive certain distributions (a
"Stated Distribution") prior to any distribution that such DownREIT partnership
makes to the general partner. The Stated Distributions that are paid in respect
of the DownREIT Units currently approximate the dividend rate applicable to
Common Stock of the Company. Each DownREIT partnership has been structured in a
manner that makes it unlikely that the limited partners thereof will be
entitled to any greater distribution than the Stated Distribution. Each holder
of Units has the right to require the DownREIT partnership that issued a Unit
to redeem that Unit at a cash price equal to the then fair market value of a
share of Common Stock of the Company, except that the Company has the right to
acquire any Unit so presented for redemption for one share of Common Stock. As
of March 1, 1999, there were 894,144 Units outstanding. The DownREIT
partnerships are consolidated for financial reporting purposes.
The Company's management ("Management") believes apartment communities present
an attractive investment opportunity compared to other real estate investments
because a broad potential resident base results in relatively stable demand
during all phases of a real estate cycle. The Company intends to pursue
appropriate new investments (both acquisitions of communities and new
developments) in markets where constraints to new supply exist and where new
household formations have out-paced multifamily permit activity in recent
years.
At December 31, 1998, Management had positioned the Company's portfolio of
Stabilized Communities, excluding communities owned by joint ventures, to an
average physical occupancy level of 95.3% and achieved an average economic
occupancy of 96.2% and 95.7% for the years ended December 31, 1998 and 1997,
respectively. This continued high occupancy was achieved through aggressive
marketing efforts combined with limited and targeted pricing adjustments. This
positioning has resulted in overall growth in rental revenue from Established
Communities between periods. It is Management's strategy to maximize total
rental revenue through management of rental rates and occupancy levels. If
market and economic conditions change, Management's strategy of maximizing total
rental revenue could lead to lower occupancy levels. Given the high occupancy
level of the portfolio, Management anticipates that any rental revenue and net
income gains from the Company's Established Communities would be achieved
primarily through higher rental rates and enhanced operating cost leverage
provided by high occupancy.
The Company elected to be taxed as a REIT for federal income tax purposes for
the year ended December 31, 1994 and has not revoked that election. The Company
was incorporated under the laws of the State of California in 1978 and was
reincorporated in the State of Maryland in July 1995. Its principal executive
offices are located at 2900 Eisenhower Avenue, Suite 300, Alexandria, Virginia
22314, and its telephone number at that location is (703) 329-6300. The Company
also maintains super-regional offices in San Jose, California and Wilton,
Connecticut and acquisition, development, redevelopment, construction,
reconstruction or administrative offices in or near Boston,
36
Massachusetts; Chicago, Illinois; Minneapolis, Minnesota; New York, New York;
Newport Beach, California; Princeton, New Jersey; Richmond, Virginia; and
Seattle, Washington.
Recent Developments
Sales of Existing Communities. During 1998, the Company completed a strategic
planning effort resulting in a decision to pursue a disposition strategy for
certain assets in markets that did not meet its long-term strategic direction.
In connection with this disposition strategy, during 1998 the Company sold seven
communities, totaling 2,039 apartment homes. Net proceeds from the sale of these
communities totaled $73.9 million resulting in a net gain of $4.0 million. The
proceeds from the sale of these communities will be directed to the development
and redevelopment of communities currently under construction or reconstruction.
In connection with an agreement executed by Avalon in March 1998 which provided
for the buyout of certain limited partners in DownREIT V Limited Partnership,
the Company sold two communities in July 1998. Net proceeds from the sale of the
two communities, containing an aggregate of 758 apartment homes, were
approximately $44 million.
Special Meeting of Stockholders. On October 2, 1998, the Company held a Special
Meeting of Stockholders at which stockholders approved (i) amendments to the
charter reducing the number of authorized shares of the Company's common stock
from 300,000,000 to 140,000,000, and (ii) an amendment to the charter changing
the Company's name from "Avalon Bay Communities, Inc." to "AvalonBay
Communities, Inc."
Preferred Offering. On October 15, 1998, the Company completed the sale of
4,000,000 shares of 8.7% Series H Cumulative Redeemable Preferred Stock at a
public offering price of $25 per share (the "Offering"). The net proceeds from
the Offering of approximately $96.2 million were used to reduce borrowings under
the Company's Unsecured Facility. These shares of Preferred Stock may not be
redeemed by the Company until October 15, 2008 except in order to preserve the
Company's status as a REIT.
Medium-Term Notes. In January 1999, the Company issued $125 million of
medium-term notes. Interest on the notes is payable semi-annually on February 15
and August 15 and the notes will mature on February 15, 2004. The notes bear
interest at 6.58%. The net proceeds of approximately $124.3 million were used to
repay amounts outstanding under the Company's variable rate unsecured credit
facility (the "Unsecured Facility").
Organizational Changes. In February 1999, the Company announced certain
management changes. The management changes included the departures of Charles
H. Berman, the Company's President, Chief Operating Officer and a director;
Jeffrey B. Van Horn, Senior Vice President - Investments; and Max L. Gardner,
Senior Vice President - Development/Acquisitions. Other announced management
changes included the promotion of Bryce Blair, then Senior Vice President -
Development/Acquisitions, to Chief Operating Officer, and the promotion of
Robert H. Slater, then Senior Vice President - Property Operations, to
Executive Vice President. Messrs. Berman, Gardner and Van Horn are entitled to
severance benefits in accordance with the terms of their employment agreements
with the Company dated as of March 9, 1998. The Company expects to record a
non-recurring charge in the first quarter of 1999 relating to this management
realignment and certain related organizational adjustments. Because a complete
plan of management realignment was not in existence on June 4, 1998, the date
of the Company's merger with Avalon, this charge is not considered a part of
the Company's purchase price for Avalon and, accordingly, the expenses
associated with the management realignment will be treated as a non-recurring
charge. Management and the terminated officers are currently determining the
amount of severance that each terminated officer is entitled to receive
pursuant to their employment agreements and the valuations, if any, that must
be performed pursuant to the terms of their employment agreements. Management
is also completing an evaluation of the additional charge related to the other
organizational changes. However, management currently estimates that the
non-recurring charge that will be incurred in connection with these
organizational adjustments, including severance payments and contract
termination costs, costs to relocate accounting functions and office space
reductions, will be approximately $16 million. The recurring cost reductions
associated with the organizational adjustments giving rise to such
non-recurring charge are estimated by management to total approximately $3.5
million annually (which estimate does not include any value assigned to the
probable annual grants of stock options that would have been made to the
terminated officers). No assurance can be given as to the amount of such
non-recurring charge or the amount of the recurring cost reductions which could
arise therefrom which could be greater or less than the estimates provided.
37
Results of Operations
The changes in operating results from period-to-period (on a historical basis)
are primarily the result of increases in the number of apartment homes owned due
to the Merger as well as the development and acquisition of additional
communities. Where appropriate, comparisons are made on a weighted average basis
for the number of occupied apartment homes in order to adjust for such changes
in the number of apartment homes. For Stabilized Communities (excluding
communities owned by joint ventures), all occupied apartment homes are included
in the calculation of weighted average occupied apartment homes for each
reporting period. For communities in the initial lease-up phase, only apartment
homes of communities that are completed and occupied are included in the
weighted average number of occupied apartment homes calculation for each
reporting period.
Comparisons are also made between West and East Coast Established Communities
for rental income, operating expenses and property taxes. East Coast Established
Communities are compared on a pro forma basis for the years ended December 31,
1998 and 1997, as if the Merger had occurred as of January 1, 1997. Management
closely reviews these results as an indication of market strength and the
effectiveness with which the communities are operated.
COMPARISON OF YEAR ENDED DECEMBER 31, 1998 TO YEAR ENDED DECEMBER 31, 1997
Net income increased $55,493,000 (142.5%) to $94,434,000 for the year ended
December 31, 1998 compared to $38,941,000 for the year ended December 31, 1997.
The primary reason for the increase is additional operating income from the
communities owned by Avalon prior to the Merger. The increase is also
attributable to additional operating income from communities developed or
acquired during 1998 and 1997, as well as growth in operating income from West
Coast Established Communities.
Rental income increased $225,642,000 (178.5%) to $352,017,000 for the year ended
December 31, 1998 compared to $126,375,000 for the year ended December 31, 1997.
Of the increase, $4,991,000 relates to rental revenue increases from West Coast
Established Communities, $144,213,000 relates to rental revenue attributable to
the former Avalon communities and $76,438,000 is attributable to the addition of
newly completed or acquired apartment homes.
Overall Portfolio - The $225,642,000 increase is primarily due to increases
in the weighted average number of occupied apartment homes as well as an
increase in the weighted average monthly rental income per occupied
apartment home. The weighted average number of occupied apartment homes
increased from 8,084 apartment homes for the year ended December 31, 1997
to 20,524 apartment homes for the year ended December 31, 1998 as a result
of additional apartment homes from the former Avalon communities and the
development and acquisition of new communities. For the year ended December
31, 1998, the weighted average monthly revenue per occupied apartment home
increased $42 (3.8%) to $1,137 compared to $1,095 for the year ended
December 31, 1997.
West Coast Established Communities - Rental revenue increased $4,991,000
(6.8%) for the year ended December 31, 1998 compared to the preceding year
due to market conditions that allowed for higher average rents, but lower
economic occupancy levels. For the year ended December 31, 1998, weighted
average monthly revenue per occupied apartment home increased $81 (7.4%) to
$1,172 compared to $1,091 for the preceding year. The average economic
occupancy decreased from 97.7% for the year ended December 31, 1997 to
97.1% for the year ended December 31, 1998.
The Company's West Coast Established Communities consist entirely of
communities located within the Northern California market. Compared to the
prior year, most of the sub-markets within Northern California where the
Company's communities are located have maintained a strong economic
environment that has allowed for high occupancy levels and rent growth.
However, Management believes that, beginning in October 1998, certain
Northern California sub-markets that are primarily dependent on
38
Silicon Valley employment have softened, in part due to Asian economic
difficulties. These impacted sub-markets have experienced reduced rent
growth and occupancy compared to other Northern California sub-markets.
East Coast Established Communities - Rental revenue (on a pro forma basis)
increased $5,079,000 (4.7%) for the year ended December 31, 1998 compared
to the preceding year due to market conditions that allowed for higher
average rents at higher economic occupancy levels. For the year ended
December 31, 1998, weighted average monthly revenue per occupied apartment
home increased $40 (4.4%) to $969 compared to $929 for the preceding year.
The average economic occupancy increased from 96.0% for the year ended
December 31, 1997 to 96.3% for the year ended December 31, 1998.
Management fees totaling $793,000 for the year ended December 31, 1998
represent revenue from certain third-party contracts the Company succeeded to
in connection with the Merger.
Operating expenses increased $63,546,000 (195.9%) to $95,980,000 for the year
ended December 31, 1998 compared to $32,434,000 for the preceding year.
Overall Portfolio - The increase in operating expenses for the year ended
December 31, 1998 is primarily due to additional operating expenses from
the former Avalon communities and, secondarily, due to the addition of
newly developed, redeveloped or acquired apartment homes. Maintenance,
insurance and other costs associated with Development and Redevelopment
Communities are expensed as communities move from the initial construction
and lease-up phase to the stabilized operating phase.
West Coast Established Communities - Operating expenses for the West Coast
Established Communities increased $97,000 (.6%) to $15,127,000 for the year
ended December 31, 1998 compared to $15,030,000 for the preceding year. The
net change is the result of higher payroll and maintenance costs, offset by
lower utility, administrative and insurance costs. Lower insurance costs
are directly attributable to better pricing and risk sharing provided by
the merger with Avalon.
East Coast Established Communities - Operating expenses for the East Coast
Established Communities (on a pro forma basis) increased $597,000 (2.3%) to
$26,251,000 for the year ended December 31, 1998 compared to $25,654,000
for the preceding year. The net change is the result of higher payroll and
maintenance costs, offset by lower utility and insurance costs. Lower
insurance costs are also attributable to the Merger due to better pricing.
Property taxes increased $20,239,000 (212.2%) to $29,778,000 for the year ended
December 31, 1998 compared to $9,539,000 for the preceding year.
Overall Portfolio - The increase in 1998 property taxes is primarily due to
additional expense from the former Avalon communities and secondarily due
to the addition of newly developed, redeveloped or acquired apartment
homes. Property taxes on Development and Redevelopment Communities are
expensed as communities move from the initial construction and lease-up
phase to the stabilized operating phase.
West Coast Established Communities - Property taxes for the West Coast
Established Communities increased $230,000 (4.6%) to $5,246,000 for the
year ended December 31, 1998 compared to $5,016,000 for the comparable
period of the preceding year. The increase is primarily the result of lower
than estimated property tax assessments that resulted in a reduction in
1997 of previously accrued expenses.
East Coast Established Communities - Property taxes for the East Coast
Established Communities (on a pro forma basis) increased $348,000 (3.6%) to
$10,062,000 for the year ended December 31, 1998 compared to $9,714,000 for
the preceding year. The increase is primarily the result of increased
assessments of property values and increased property tax rates.
39
Interest expense increased $39,890,000 (282.6%) to $54,003,000 for the year
ended December 31, 1998 compared to $14,113,000 for the comparable period of the
preceding year. The increase is primarily attributable to $643,410,000 of debt
assumed in connection with the Merger and secondarily due to the issuance of
unsecured senior notes in 1998 and 1997.
Depreciation and amortization increased $51,350,000 (190.1%) to $78,359,000 for
the year ended December 31, 1998 compared to $27,009,000 for the preceding year.
The increase is primarily attributable to additional expense from the former
Avalon communities and secondarily to acquisitions and development of
communities in 1998 and 1997.
General and administrative expenses increased $3,568,000 (86.9%) to $7,674,000
for the year ended December 31, 1998 compared to $4,106,000 for the preceding
year. The increase is primarily due to the Merger.
Equity in income of unconsolidated joint ventures of $1,525,000 for the year
ended December 31, 1998 represents the Company's share of income of certain
joint ventures that the Company succeeded to in connection with the Merger.
Interest income increased $2,985,000 to $3,191,000 for the year ended December
31, 1998 compared to $206,000 for the preceding year. The increase is primarily
due to the interest on the Avalon Arbor promissory note that the Company
succeeded to in connection with the Merger and on the Fairlane Woods promissory
note acquired in August 1998.
COMPARISON OF YEAR ENDED DECEMBER 31, 1997 TO YEAR ENDED DECEMBER 31, 1996
Net income increased $19,315,000 (98.4%) to $38,941,000 for the year ended
December 31, 1997 compared to $19,626,000 for the year ended December 31, 1996.
The primary reason for the increase is additional rental income from communities
acquired during the latter half of 1996 and throughout 1997, as well as growth
in operating income from Established Communities.
Rental income increased $43,542,000 (52.6%) to $126,375,000 for the year ended
December 31, 1997 compared to $82,833,000 for the year ended December 31, 1996.
Of the increase, $6,539,000 relates to rental revenue increases from Established
Communities and $37,003,000 is attributable to the addition of newly completed
or acquired apartment homes.
Overall Portfolio - The $43,542,000 increase is primarily due to increases
in the weighted average number of occupied apartment homes as well as an
increase in the weighted average monthly rental income per occupied
apartment home. The weighted average number of occupied apartment homes
increased from 7,545 apartment homes for the year ended December 31, 1996
to 8,084 apartment homes for the year ended December 31, 1997 as a result
of the development and acquisition of new communities. For the year ended
December 31, 1997, the weighted average monthly revenue per occupied
apartment home increased $112 (11.4%) to $1,095 compared to $983 for the
year ended December 31, 1996.
Established Communities - Rental revenue increased $6,539,000 (10.0%) for
the year ended December 31, 1997 compared to the preceding year primarily
due to an increase in rental rates and increased occupancy. For the year
ended December 31, 1997, weighted average monthly revenue per occupied
apartment home increased $87 (9.3%) to $1,020 compared to $933 for the
preceding year. The average economic occupancy increased from 96.8% for the
year ended December 31, 1996 to 97.5% for the year ended December 31, 1997.
Operating expenses increased $11,043,000 (51.6%) to $32,434,000 for the year
ended December 31, 1997 compared to $21,391,000 for the preceding year.
40
Overall Portfolio - The increase for the year ended December 31, 1997 is
primarily due to additional expense from the acquisition of new communities
as well as the addition of newly completed homes for which maintenance,
insurance and other costs are expensed as communities move from the initial
construction and lease-up phase to the stabilized operating phase.
Established Communities - Operating expenses increased $1,034,000 (7.1%) to
$15,675,000 for the year ended December 31, 1997 compared to $14,641,000
for the preceding year. The net change is primarily attributable to the
completion of certain redevelopment communities and to higher maintenance
costs, and secondarily to increased earthquake insurance costs due to the
purchase of portfolio wide coverage.
Property taxes increased $3,158,000 (49.5%) to $9,539,000 for the year ended
December 31, 1997 compared to $6,381,000 for the preceding year.
Overall Portfolio - The increase in 1997 is primarily due to additional
expense from the acquisition of new communities as well as the addition of
newly completed homes for which property taxes are expensed as communities
move from the initial construction and lease-up phase to the stabilized
operating phase.
Established Communities - Property taxes decreased $50,000 (1.0%) to
$4,950,000 for the year ended December 31, 1997 compared to $5,000,000 for
the comparable period of the preceding year. The decrease is primarily the
result of lower than estimated property tax assessments that resulted in a
reduction in 1997 of previously accrued expenses.
Interest expense decreased $163,000 (1.1%) to $14,113,000 for the year ended
December 31, 1997 compared to $14,276,000 for the twelve months ended December
31, 1996. The decrease is primarily attributable to higher capitalization of
interest from increased development, construction and reconstruction activity
financed primarily with common and preferred stock issuances, offset in part by
increased borrowing for new acquisitions.
Depreciation and amortization increased $8,320,000 (44.5%) to $27,009,000 for
the year ended December 31, 1997 compared to $18,689,000 for the preceding year.
The increase reflects additional expense from the acquisitions, development and
redevelopment of communities in 1997 and 1996.
General and administrative expenses increased $2,283,000 (125.2%) to $4,106,000
for the year ended December 31, 1997 compared to $1,823,000 for the preceding
year. The increase is primarily due to staff additions and other costs related
to the growth of the Company's portfolio.
Interest income increased $28,000 (15.7%) to $206,000 for the twelve months
ended December 31, 1997 compared to $178,000 for the preceding year, primarily
due to higher average cash balances during 1997 as compared to 1996.
Capitalization of Fixed Assets and Community Improvements
The Company maintains a policy with respect to capital expenditures that
generally provides that only non-recurring expenditures are capitalized.
Improvements and upgrades are capitalized only if the item exceeds $15,000,
extends the useful life of the asset and is not related to making an apartment
home ready for the next resident. Under this policy, virtually all capitalized
costs are non-recurring, as recurring make ready costs are expensed as incurred,
including costs of carpet and appliance replacements, floor coverings, interior
painting and other redecorating costs. Purchases of personal property (such as
computers and furniture) are capitalized only if the item is a new addition
(i.e., not a replacement) and only if the item exceeds $2,500. The application
of these policies for the year ended December 31, 1998 resulted in non-revenue
generating capitalized expenditures for Stabilized Communities of approximately
$158 per apartment home on a pro forma basis for the Merger. For the year ended
December 31, 1998 the Company charged to maintenance expense, including carpet
and appliance replacements, a total of
41
approximately $24,500,000 for Stabilized Communities or $946 per apartment home
on a pro forma basis. Management anticipates that capitalized costs per
apartment home will gradually rise as the Company's portfolio of communities
matures.
Liquidity and Capital Resources
Liquidity. A primary source of liquidity to the Company is cash flows from
operations. Operating cash flows have historically been determined by the number
of apartment homes, rental rates, occupancy levels and the Company's expenses
with respect to such apartment homes. The cash flows provided by financing
activities and used in investing activities have historically been dependent on
the capital markets environment, and thus the number of apartment homes under
active development and construction as well as those that were acquired during
any given period.
Cash and cash equivalents increased from $3,188,000 at December 31, 1997 to
$8,890,000 at December 31, 1998 due to the excess of cash provided by financing
and operating activities over cash flow used in investing activities.
Net cash provided by operating activities increased by $128,579,000 from
$62,650,000 for the year ended December 31, 1997 to $191,229,000 for the
year ended December 31, 1998 primarily due to an increase in operating
income from the former Avalon communities as well as the existing Bay
communities.
Cash used in investing activities increased $44,259,000 from $574,970,000
for the year ended December 31, 1997 to $619,229,000 for the year ended
December 31, 1998. This increase in expenditures reflects increased
construction and reconstruction activity, net of a decrease in acquisition
activity (which is attributable to the purchase of the Southern California
Travelers portfolio in 1997 not present in 1998 combined with higher yield
requirements in 1998 that constrained investing activity) and the proceeds
from the sale of communities in 1998.
Net cash provided by financing activities decreased by $80,886,000 from
$514,588,000 for the year ended December 31, 1997 to $433,702,000 for the
year ended December 31, 1998 primarily due to reduced financing activity in
response to unfavorable capital markets. The increase is also attributable
to an increase in dividends paid, as a result of a 21% Common Stock
dividend increase in July 1998 and additional common and preferred shares
issued in connection with the Merger.
Cash and cash equivalents increased from $920,000 at December 31, 1996 to
$3,188,000 at December 31, 1997 due to the excess of cash provided by financing
and operating activities over cash flow used in investing activities.
Net cash provided by operating activities increased by $23,426,000 from
$39,224,000 for the year ended December 31, 1996 to $62,650,000 for the
year ended December 31, 1997 primarily due to an increase in operating
income from acquisition and existing communities.
Cash used in investing activities increased by $358,970,000 from
$216,000,000 for the year ended December 31, 1996 to $574,970,000 for the
year ended December 31, 1997. This increase reflects the increase in
expenditures for communities acquired in Southern California, and the
amounts used to acquire, develop, construct and reconstruct the Development
and Redevelopment Communities.
Net cash provided by financing activities increased by $338,569,000 from
$176,019,000 for the year ended December 31, 1996 to $514,588,000 for the
year ended December 31, 1997 primarily due to higher net proceeds from
securities offerings and borrowings under the unsecured credit facility in
1997 as compared to 1996, offset by an increase in dividends paid.
The Company regularly reviews its short-term liquidity needs and the adequacy of
Funds from Operations ("FFO") and other expected liquidity sources to meet these
needs. The Company believes that its principal short-term
42
liquidity needs are to fund normal recurring operating expenses, debt service
payments, the distribution required with respect to the Preferred Stock and the
minimum dividend payments required to maintain the Company's REIT qualification
under the Internal Revenue Code of 1986, as amended. Management anticipates
that these needs will be fully funded from cash flows provided by operating
activities. Any short-term liquidity needs not provided by current operating
cash flows would be funded from the Company's Unsecured Facility.
Management anticipates that no significant portion of the principal of any
indebtedness will be repaid prior to maturity and if the Company does not have
funds on hand sufficient to repay such indebtedness, it will be necessary for
the Company to refinance this debt. Such refinancing may be accomplished through
additional debt financing, which may be collateralized by mortgages on
individual communities or groups of communities, by uncollateralized private or
public debt offerings or by additional equity offerings. There can be no
assurance that such additional debt financing or debt or equity offerings will
be available or, if available, that they will be on terms satisfactory to the
Company.
Capital Resources. Management intends to match the long-term nature of its real
estate assets with long-term cost effective capital. The Company has benefited
from regular and continuous access to the capital markets since its initial
public offering, raising approximately $2.5 billion, on a pro forma basis.
Approximately $800 million, on a pro forma basis, has been raised in capital
markets offerings since January, 1998. The following table summarizes capital
market activity for both Avalon and the Company since January 1, 1998:
Management follows a focused strategy to help facilitate uninterrupted access to
capital. This strategy includes:
1. Hire, train and retain associates with a strong resident service focus,
which should lead to higher rents, lower turnover and reduced operating
costs;
2. Manage, acquire and develop institutional quality communities with in-fill
locations that should provide consistent, sustained earnings growth;
3. Operate in markets with growing demand (as measured by household formation
and job growth) and high barriers-to-entry. These characteristics combine
to provide a favorable demand-supply balance, which the Company believes
will create a favorable environment for future rental rate growth while
protecting existing and new communities from new supply. This strategy is
expected to result in a high level of quality to the revenue stream;
4. Maintain a conservative capital structure largely comprised of equity and
with modest, cost-effective leverage. Secured debt will generally be
avoided and used primarily to secure low cost, tax-exempt debt. Management
believes that such a capital structure should promote an environment
whereby current ratings levels can be maintained;
5. Follow accounting practices that provide a high level of quality to
reported earnings; and
6. Provide timely, accurate and detailed disclosures to the investment
community.
43
Management believes these strategies provide a disciplined approach to capital
access to help position the Company to fund portfolio growth.
Recent volatility in the capital markets has decreased the Company's access to
cost effective capital. See "Future Financing and Capital Needs" for a
discussion of Management's response to the current capital markets environment.
The following is a discussion of specific capital transactions, arrangements and
agreements that are important to the capital resources of the Company.
Unsecured Facility
The Company's Unsecured Facility is furnished by a consortium of banks that
provides for $600,000,000 in short-term credit and is subject to an annual
facility fee of $900,000. The Unsecured Facility bears interest at varying
levels tied to the London Interbank Offered Rate ("LIBOR") based on ratings
levels achieved on the Company's senior unsecured notes and on a maturity
selected by the Company. The current pricing is LIBOR plus .6% per annum and
matures in July 2001, with two one-year extension options. The Unsecured
Facility, which was put into place during June 1998, replaced three separate
credit facilities previously available to the separate companies prior to the
Merger that had terms similar to the Unsecured Facility. A competitive bid
option (which allows banks that are part of the lender consortium to bid to make
loans to the Company at a rate that is lower than the stated rate provided by
the Unsecured Facility) is available for up to $400,000,000 which may result in
lower pricing if market conditions allow. Pricing under the competitive bid
option resulted in average pricing of LIBOR plus .48% for balances most recently
placed under the competitive bid option. At March 1, 1999, $285,500,000 was
outstanding, $30,200,000 was used to provide letters of credit and $284,300,000
was available for borrowing under the Unsecured Facility. The Company will use
borrowings under the Unsecured Facility for capital expenditures, acquisitions
of developed or undeveloped communities, construction, development and
renovation costs, credit enhancement for tax-exempt bonds and for working
capital purposes.
Interest Rate Protection Agreements
The Company is not a party to any long-term interest rate agreements, other than
interest rate protection and swap agreements on certain tax-exempt indebtedness.
The Company intends, however, to evaluate the need for long-term interest rate
protection agreements as interest rate market conditions dictate and has engaged
a consultant to assist in managing the Company's interest rate risks and
exposure.
Financing Transactions Completed
In January 1998, Avalon completed a $100,000,000 offering of unsecured senior
notes. The notes bear interest at 6.625% payable semi-annually on January 15 and
July 15 and will mature on January 15, 2005. The Company used the net proceeds
of approximately $99,000,000 to repay amounts outstanding under Avalon's
unsecured credit facilities.
In January 1998, Avalon completed the sale of 923,856 shares of common stock to
The Prudential Insurance Company of America at a net purchase price of $29.09
per share. The net proceeds of approximately $27,000,000 were used to retire
indebtedness under Avalon's unsecured credit facilities.
In January 1998, Bay issued $150,000,000 of senior unsecured notes, of which
$50,000,000 of the notes bear interest at 6.25% and will mature in January 2003,
$50,000,000 of the notes bear interest at 6.5% and will mature in January 2005
and $50,000,000 of the notes bear interest at 6.625% and will mature in January
2008. Semi-annual interest payments are payable on January 15 and July 15. The
net proceeds of approximately $149,000,000 were used to reduce borrowings under
Bay's then existing unsecured credit facility.
44
In April 1998, Bay sold 1,244,147 shares of Common Stock in an underwritten
public offering at a public offering price of $37.375 per share. The net
proceeds to Bay of approximately $44,000,000 were used to reduce borrowings
under the Company's unsecured credit facility.
In July 1998, the Company issued $250,000,000 of senior unsecured notes, of
which $100,000,000 of the notes bear interest at 6.5% and will mature in July
2003 and $150,000,000 of the notes bear interest at 6.8% and will mature in July
2006. Semi-annual interest payments are payable on January 15 and July 15. The
net proceeds of $248,000,000 were used to reduce borrowings under the Company's
Unsecured Facility.
In October 1998, the Company completed an underwritten public offering of
4,000,000 shares of 8.7% Series H Cumulative Redeemable Preferred Stock at a
public price of $25 per share. Quarterly dividends are payable on March 15, June
15, September 15 and December 15. The net proceeds of approximately $97,000,000
were used to reduce borrowings under the Company's Unsecured Facility.
In January 1999, the Company issued $125,000,000 of medium-term unsecured notes
bearing interest at 6.58% and maturing in February 2004. Semi-annual interest
payments are payable on February 15 and August 15. The net proceeds of
approximately $124,000,000 were used to reduce borrowings under the Company's
Unsecured Facility.
Registration Statements Filed in Connection with Financings
On August 18, 1998, the Company filed a shelf registration statement on Form S-3
with the Securities and Exchange Commission relating to the sale of up to
$750,000,000 of securities. The registration statement provides for the issuance
of Common Stock, Preferred Stock and debt securities.
Future Financing and Capital Needs
As of December 31, 1998, the Company had 24 new communities under construction
by the Company or by others for the Company (for which the Company has entered
into forward purchase commitments) with a total estimated cost of $497,000,000
remaining to be invested as of that date. In addition, the Company had a total
of 13 communities that were under reconstruction of which an estimated
$68,000,000 remained to be invested as of that date.
Substantially all of the capital expenditures to complete the communities
currently under construction and reconstruction will be funded from the
Unsecured Facility, the sale of existing communities, retained operating cash or
the issuance of debt or equity securities. Management expects to continue to
fund deferred development costs related to future developments from FFO and
borrowings under the Unsecured Facility as these sources of capital are expected
to be adequate to take the proposed communities to the point in the development
cycle where construction can commence.
The industry and the Company have seen a reduction in the availability of cost
effective capital over the last nine months. No assurance can be provided that
cost effective capital will be available to meet future expenditures required to
commence planned reconstruction activity or the construction of the Development
Rights. Before planned reconstruction activity or the construction of a
Development Right commences, the Company intends to arrange adequate liquidity
sources to complete such undertakings, although no assurance can be given in
this regard.
Management estimates that a significant portion of the Company's liquidity needs
will be met from retained operating cash and borrowings under the Company's
Unsecured Facility. To meet the balance of the Company's liquidity needs, it
will be necessary to arrange additional capacity under the Company's existing
Unsecured Facility, sell additional existing communities and/or issue additional
debt or equity securities. While Management believes the Company has the
financial position to expand its short term credit capacity and support such
capital markets activity, no assurance can be provided that the Company will be
successful in completing these arrangements, offerings or sales. If these
transactions cannot be completed on a cost-effective basis, then a
45
continuation of the current capital market conditions described herein could
have a material adverse impact on the operating results and financial condition
of the Company, including the abandonment of deferred development costs and the
a charge to earnings.
During 1998, the Company determined that it would pursue a disposition strategy
for certain assets in markets that did not meet its long-term strategic
direction. In connection with this decision, the Company's Board of Directors
authorized Management to pursue the disposition of certain communities. The
Company will solicit competing bids from unrelated parties for these individual
assets, and will consider the sales price and tax ramifications of each
proposal. Management intends to actively seek buyers for these assets during
1999. However, there can be no assurance that such assets can be sold on terms
that are satisfactory to the Company. The Company disposed of the following
communities in connection with this disposition strategy (dollars in thousands)
as of March 1, 1999:
To facilitate the sale of Sommerset, the Company provided short-term financing
to the purchaser for 80% of the gross sales price. Accordingly, $6,320,000 of
the net proceeds will be received at maturity of this financing.
The proceeds from the sale of these communities will be re-deployed to the
development and redevelopment communities currently under construction or
reconstruction. Pending such redeployment, the proceeds from the sale of these
communities were primarily used to repay amounts outstanding under the Company's
Unsecured Facility.
The remaining assets that have been identified for disposition include land,
buildings and improvements and furniture, fixtures and equipment. At December
31, 1998, total real estate, net of accumulated depreciation, of all
communities currently identified for sale totaled $231,492,000. Certain
individual assets are secured by mortgage indebtedness which may be assumed by
the purchaser or repaid by the Company from the net sales proceeds. The
Company's consolidated statements of operations includes net income from the
communities held for sale of $3,916,000, $1,633,000 and $1,301,000 for the
years ended December 31, 1998, 1997 and 1996, respectively.
In connection with an agreement executed by Avalon in March 1998 which provided
for the buyout of certain limited partners in DownREIT V Limited Partnership,
the Company sold two communities in July 1998. Gross proceeds from the sale of
the two communities, containing an aggregate of 758 apartment homes, were
approximately $44 million.
Because the proceeds from the sale of communities are used initially to reduce
borrowings under the Unsecured Facility, the immediate effect of a sale of a
community is to reduce earnings, as the yield on a community that is sold
exceeds the interest rate on borrowings under the Unsecured Facility. Therefore,
changes in the timing, number of dispositions and the redeployment of the net
proceeds therefrom may have a material and adverse effect on the Company's
earnings.
46
Debt Maturities
The table on the following page summarizes debt maturities for the next five
years (excluding the Unsecured Facility):
(Dollars in thousands)
Inflation
Substantially all of the leases at the Current Communities are for a term of
one year or less, which may enable the Company to realize increased rents upon
renewal of existing leases or commencement of new leases. Such short-term
leases generally minimize the risk to the Company of the adverse effects of
inflation, although these leases generally permit residents to leave at the end
of the lease term without penalty. Short-term leases combined with relatively
consistent demand allow rents, and, therefore, cash flow from the Company's
portfolio of apartments, to provide an attractive inflation hedge.
Year 2000 Compliance
The statements in the following section include "Year 2000 readiness disclosure"
within the meaning of the Year 2000 Information and Readiness Disclosure Act of
1998.
47
The Year 2000 compliance issue concerns the inability of computer systems to
accurately calculate, store or use a date after December 31, 1999. This could
result in a system failure causing disruptions of operations or create erroneous
results. The Year 2000 issue affects virtually all companies and organizations.
Management has been taking steps to understand the nature and extent of the work
required to make its information computer systems ("IT Systems") and
non-information embedded systems ("Non-IT Systems") Year 2000 compliant, as well
as to determine what effects non-compliance by the Company's significant
business partners may have on the Company. Management has assigned key personnel
to the Company's Year 2000 Task Force ("the Task Force") to coordinate
compliance efforts. The Task Force is represented by executive, financial and
community operation functions. An outside consulting firm ("Y2K Consultants")
has been engaged by the Company to assist the Task Force in detecting Non-IT
Systems that are not Year 2000 compliant. The Y2K Consultants will aid in
assessing the compliance of the Company's Non-IT Systems and, for non-compliant
systems, will recommend replacement, upgrades or alternative solutions based on
the system's importance to business operations or financial impact, likelihood
of failure, life safety concerns and available contingency options.
Management has identified certain phases necessary to become Year 2000 compliant
and has established an estimated timetable for completion of those phases, as
shown below:
(continued on next page)
48
The Year 2000 Task Force has completed the Inventory System Phase for
computerized IT Systems. The assessment determined that it will be necessary to
modify, update or replace limited portions of the Company's computer hardware
and software applications.
The Company anticipates that replacing and upgrading certain existing IT Systems
(both hardware and software) in the normal course of business will result in
Year 2000 compliance by the end of the second quarter of 1999. The vendor that
provides the Company's existing accounting software has a compliant version of
its product, but growth in the Company's operations requires a general ledger
system with scope and functionality that is not present in either the system
currently in use or the Year 2000 compliant version of that system. Accordingly,
the Company is replacing the current general ledger system with an enhanced
system that, in addition to increased functionality, is Year 2000 compliant. The
new general ledger system has been selected and is expected to be implemented by
the third quarter of 1999. The Company is not treating the cost of this new
system as a Year 2000 expense because the implementation date has not been
accelerated due to Year 2000 compliance concerns. The cost of the new general
ledger system, after considering anticipated efficiencies provided by the new
system, is not currently expected to have a material effect (either beneficial
or adverse) on the Company's financial condition or results of operations.
49
The Task Force has also completed the Initial Review of the Inventory System
Phase of the Company's Non-IT Systems (e.g., security, heating and cooling, fire
and elevator systems) at each community that may not be Year 2000 compliant and
has identified areas of risks for non-compliance by community type. The
high-rises, mid-rises and newer garden communities represent the greatest risk
of non-compliant systems as they have the most systems per community. In
conjunction with the Y2K Consultants, the Task Force is currently conducting an
assessment of these systems at all communities to identify and evaluate the
changes and modifications necessary to make these systems compliant for Year
2000 processing. The Task Force is currently conducting the Follow-up Review of
the Inventory System Phase to ensure any previously undetected Non-IT Systems
are addressed for Year 2000 compliance. This review is expected to be completed
by March 31, 1999.
The Y2K Consultants are currently in the process of verifying inventory and
obtaining risk assurance regarding Year 2000 compliance of detected Non-IT
Systems, and this process is expected to be completed by April 15, 1999. The
Task Force and Y2K Consultants will prioritize the non-compliant systems, if
any, and proceed according to the phases described above. No assurance, however,
can be given that completion of the above phases will identify all non-compliant
systems.
Upon completion of each of the above described upgrades and replacements of the
Company's IT and Non-IT Systems, the Company will commence testing to ensure
Year 2000 compliance. Testing will be performed on systems:
- which are critical to business operations or life safety;
- which entail a material financial impact in the event of
non-compliance;
- with a high likelihood of failure;
- for which the Task Force is unable to obtain reliable third party
assurance that the detected system is Year 2000 compliant; and
- which are not deemed to have acceptable contingency options.
The Company currently expects its testing to be completed during the fourth
quarter of 1999. While the Company anticipates such tests will be successful in
all material respects, the Task Force intends to closely monitor the Company's
Year 2000 compliance progress and will develop contingency plans in the event
Non-IT Systems are not compliant. The Task Force will create functional
contingency plans by community type that will encompass substantially all of the
Company's existing portfolio, discussed above as General Community contingency
plans. For certain communities, primarily communities with high-rise buildings,
specific contingency plans will be required, discussed above as Site Specific
contingency plans. The Task Force will continue to review both compliance and
contingency plans, throughout all of the above phases, in an effort to detect if
any systems will not be compliant on time.
Management currently anticipates that the costs of becoming Year 2000 compliant
for all impacted Non-IT Systems will be approximately $750,000, based on the
current progress towards the completion of the Prioritize and Budget Phase.
Based on available information, the Company believes that the ultimate cost of
achieving Year 2000 compliance will not have a material adverse effect on its
business, financial condition or results of operations. However, no assurance
can be given that the Company will be Year 2000 compliant by December 31, 1999
or that the Company will not incur significant costs pursuing Year 2000
compliance.
The third parties with which the Company has material relationships include the
Company's utility providers and the vendor that will provide the Company's new
accounting software system. The Company, together with the Y2K Consultants, is
communicating with these and other third party vendors to determine the efforts
being made on their part for compliance and to request representation that their
systems will be Year 2000 compliant. No assurance can be given that such
representations will be received by the Company or that they will prove to be
accurate. As described above, the Company expects that its accounting software
will be Year 2000 compliant.
50
The Company is not aware of third parties, other than its residents and owners
of communities for which the Company provides community management services, to
which it could have potential material liabilities should its IT or Non-IT
Systems be non-compliant on January 1, 2000. The inability of the Company to
achieve Year 2000 compliance on its Non-IT Systems by January 1, 2000 may cause
disruption in services that could potentially lead to declining occupancy
rates, rental concessions, or higher operating expenses, and other material
adverse effects, which are not quantifiable at this time. These disruptions may
include, but are not limited to, disabled fire control systems, lighting
controls, utilities, telephone and elevator operations.
Currently, the Company has not delayed any information technology or
non-information technology projects due to the Year 2000 compliance efforts.
However, the Company can neither provide assurance that future delays in such
projects will not occur as a result of Year 2000 compliance efforts, nor
anticipate the effects of such delays on the Company's operations.
Funds from Operations
Management generally considers Funds from Operations to be an appropriate
measure of the operating performance of the Company because it provides
investors an understanding of the ability of the Company to incur and service
debt and to make capital expenditures. The Company believes that in order to
facilitate a clear understanding of the operating results of the Company, FFO
should be examined in conjunction with net income as presented in the
consolidated financial statements included elsewhere in this report. FFO is
determined in accordance with a definition adopted by the Board of Governors of
the National Association of Real Estate Investment Trusts(R), and is defined as
net income (loss) computed in accordance with generally accepted accounting
principles ("GAAP"), excluding gains (or losses) from debt restructuring and
sales of property, plus depreciation of real estate assets and after adjustments
for unconsolidated partnerships and joint ventures. FFO does not represent cash
generated from operating activities in accordance with GAAP and therefore should
not be considered an alternative to net income as an indication of the Company's
performance or to net cash flows from operating activities as determined by GAAP
as a measure of liquidity and is not necessarily indicative of cash available to
fund cash needs. Further, FFO as calculated by other REITs may not be comparable
to the Company's calculation of FFO.
For the year ended December 31, 1998, FFO increased to $144,152,000 from
$62,417,000 for the year ended December 31, 1997. This increase is primarily due
to the acquisition of additional communities in connection with the Merger and
secondarily to delivery of new development and redevelopment communities. Growth
in earnings from West Coast Established Communities as well as acquisition
activity in 1998 and 1997 also contributed to the increase.
FFO for the three and twelve months ended December 31, 1998 and 1997 are
summarized on the following page (dollars in thousands):
51
ANALYSIS OF 1998 AND 1997 FUNDS FROM OPERATIONS
(1) Represents the amortization of pre-1986 bond issuance costs carried forward
to the Company and costs associated with the reissuance of tax-exempt bonds
incurred prior to the initial public offering of Bay in March 1994 (the
"Initial Offering") in order to preserve the tax-exempt status of the bonds
at the Initial Offering.
Management Information Systems
The Company believes that a state-of-the-art management information systems
infrastructure will be a key element in managing the Company's future growth.
The Company employs a proprietary company-wide intranet using a digital network
with high-speed digital lines. This network connects all communities and offices
back to central servers in Alexandria, Virginia, providing access to Company
associates throughout the country from all locations. This infrastructure also
allows the Company to employ new "network computers" that are less expensive to
purchase and support, which reduces the Company's "total cost of ownership" for
each work station. The Company believes that timely and accurate collection of
financial and resident profile data will enable the Company to maximize revenue
through careful leasing decisions and financial management. During 1998, the
Company began the development of a new property management system to enable the
capture and analysis of data to an extent that would not be available using
existing commercial software. The Company intends to develop this system through
a joint venture with one or more public multifamily real estate companies. The
Company currently expects that the total development costs over a three-year
period will be approximately $7.0 million, and such development costs will be
shared on a pro rata basis by those companies that participate in the joint
venture. Once developed the Company intends to use the system in place of
current property management information systems for which the Company pays
license fees to third parties.
52
ITEM 7a. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is exposed to certain financial market risks, the most predominant
being fluctuations in interest rates. Interest rate fluctuations are monitored
by Management as an integral part of the Company's overall risk management
program, which recognizes the unpredictability of financial markets and seeks to
reduce the potentially adverse effect on the Company's results of operations.
The effect of interest rate fluctuations historically has been small relative to
other factors affecting operating results, such as rental rates and occupancy.
The specific market risks and the potential impact on the Company's operating
results are described below.
The Company's operating results are affected by changes in interest rates as a
result of borrowing under the Company's Unsecured Facility as well as issuing
bonds with variable interest rates. If interest rates under the Unsecured
Facility and other variable rate indebtedness had been one percent higher
throughout 1998, the Company's annual interest costs would have increased by
approximately $2,500,000, based on balances outstanding during the year ending
December 31, 1998. Changes in interest rates also impact the fair value of the
Company's fixed rate debt. If the market interest rate applicable to fixed rate
indebtedness with maturities similar to the Company's fixed rate indebtedness
had been one percent higher, the fair value of the Company's fixed debt on
December 31, 1998 would have decreased by approximately $67,000,000, based on
balances outstanding at December 31, 1998.
The Company currently uses interest rate swap agreements to reduce the impact of
interest rate fluctuations on variable rate indebtedness. Under swap agreements,
(i) the Company agrees to pay to a counterparty the interest that would have
been incurred on a fixed principal amount at a fixed interest rate (generally,
the interest rate on a particular treasury bond on the date the agreement is
entered into, plus a fixed increment thereto), and (ii) the counterparty agrees
to pay to the Company the interest that would have been incurred on the same
principal amount at an assumed floating interest rate tied to a particular
market index. As of December 31, 1998, the effect of swap agreements is to fix
the interest rate on approximately $200 million of the Company's variable rate
tax-exempt debt. The swap agreements were not electively entered into by the
Company but, rather, were a requirement of either the bond issuer or the credit
enhancement provider related to certain of the Company's tax-exempt bond
financings. In addition, because the counterparties providing the swap
agreements are major financial institutions with AAA credit ratings by the
Standard & Poor's Ratings Group and the interest rates fixed by the swap
agreements are significantly higher than current market rates for such
agreements, the Company does not believe there is exposure at this time to
a default by a counterparty.
53
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The response to this Item 8 is included as a separate section of this
Annual Report on Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
On November 11, 1998, PricewaterhouseCoopers LLP was dismissed and
Arthur Andersen LLP was engaged as the principal independent public
accountant for the Company. The decision to change accountants was
unanimously approved by the Company's Board of Directors.
The reports of PricewaterhouseCoopers LLP on the financial statements
of the Company for the years ended December 31, 1996 and 1997 did not contain
any adverse opinion or disclaimer of opinion, nor were they qualified or
modified as to uncertainty, audit scope, or accounting principles. During
the Company's fiscal years ended December 31, 1996 and 1997, and the
subsequent interim period through November 11, 1998, there were no
disagreements with PricewaterhouseCoopers LLP on any matter of accounting
principles or practices, financial statement disclosure, or auditing scope or
procedures, which disagreements, if not resolved to the satisfaction of
PricewaterhouseCoopers LLP, would have caused them to make reference thereto
in their reports on the financial statements for such years.
During the Company's fiscal years ended December 31, 1996 and 1997, and
the subsequent interim period through November 11, 1998, Arthur Andersen LLP
was not engaged as an independent accountant to audit either the Company's
financial statements or the financial statements of any of its subsidiaries,
nor was it consulted regarding the application of the Company's accounting
principles to a specified transaction, either completed or proposed, or the
type of audit opinion that might be rendered on the Company's financial
statements.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT
Information pertaining to directors and executive officers of the
registrant is incorporated herein by reference to the registrant's Proxy
Statement to be filed with the Securities and Exchange Commission within 120
days after the end of the year covered by this Form 10-K with respect to the
Annual Meeting of Stockholders to be held on May 5, 1999.
ITEM 11. EXECUTIVE COMPENSATION
Information pertaining to executive compensation is incorporated herein
by reference to the registrant's Proxy Statement to be filed with the
Securities and Exchange Commission within 120 days after the end of the year
covered by this Form 10-K with respect to the Annual Meeting of Stockholders
to be held on May 5, 1999.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information pertaining to security ownership of Management and certain
beneficial owners of the registrant's Common Stock is incorporated herein by
reference to the registrant's Proxy Statement to be filed with the Securities
and Exchange Commission within 120 days after the end of the year covered by
this Form 10-K with respect to the Annual Meeting of Stockholders to be held
on May 5, 1999.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information pertaining to certain relationships and related transactions
is incorporated herein by reference to the registrant's Proxy Statement to be
filed with the Securities and Exchange Commission within 120 days after the
end of the year covered by this Form 10-K with respect to the Annual Meeting
of Stockholders to be held on May 5, 1999.
54
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULE AND REPORTS ON FORM 8-K
14(a)(1) FINANCIAL STATEMENTS
INDEX TO FINANCIAL STATEMENTS
Consolidated Financial Statements and Financial Statement Schedule:
Report of Independent Accountants F-1
Consolidated Balance Sheets as of December 31, 1998 and 1997 F-3
Consolidated Statements of Operations for
the years ended December 31, 1998, 1997 and 1996 F-4
Consolidated Statements of Stockholders' Equity for
the years ended December 31, 1998, 1997 and 1996 F-5
Consolidated Statements of Cash Flows for
the years ended December 31, 1998, 1997 and 1996 F-6
Notes to Consolidated Financial Statements F-8
14(a)(2) FINANCIAL STATEMENT SCHEDULE
Schedule III - Real Estate and Accumulated Depreciation F-28
14(a)(3) EXHIBITS
The exhibits listed on the accompanying Index to Exhibits are
filed as a part of this report.
14(b) REPORTS ON FORM 8-K
On October 6, 1998, the Company filed a Current Report on Form 8-K relating
to (i) a Special Meeting of Stockholders, held on October 2, 1998, at which
the holders of record of the Company's Common Stock as of the close of
business on August 26, 1998 were asked to vote on certain amendments; and
(ii) an agreement to acquire Hanover Hall and Summer Terrace (a combined
community known as Hanover Hall). This Form 8-K contained financial statements
under Rule 3-14 of Regulation S-X and pro forma financial statements.
On October 21, 1998, the Company filed a Current Report on Form 8-K relating
to the completion of the sale of 4,000,000 shares of 8.7% Series H Cumulative
Redeemable Preferred Stock.
On November 18, 1998, the Company filed a Current Report on From 8-K relating
to a change in the Company's certifying accountant.
On December 21, 1998, the Company filed a Current Report on Form 8-K relating
to the offering and sale of $400,000,000 aggregate principal amount of the
Company's medium-term-notes due nine months from the date of issue.
55
INDEX TO EXHIBITS
EXHIBIT NO. DESCRIPTION
2.1 -- Merger Agreement, dated as of March 9, 1998, by and between
Avalon Properties, Inc. (hereinafter referred to as "Avalon")
and Bay Apartment Communities, Inc. (hereinafter referred to
as "Bay"). (Incorporated by reference from Bay's Current
Report on Form 8-K filed on March 11, 1998.)
3(i).1 -- Articles of Amendment and Restatement of Articles of
Incorporation of AvalonBay Communities, Inc. (the "Company"),
dated as of June 4, 1998. (Incorporated by reference to Exhibit
3(i).1 to Form 10-Q of the Company filed August 14, 1998.)
3(i).2 -- Articles of Amendment, dated as of October 2, 1998.
(Incorporated by reference to Exhibit 3.1(ii) to Form 8-K of
the Company filed on October 6, 1998.)
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 1 to Form 8-A of the
Company filed October 14, 1998.)
3(ii).1 -- Bylaws of the Company, as amended and restated, dated as of July
24, 1998. (Incorporated by reference to Exhibit 3(ii).1 to Form
10-Q of the Company filed August 14, 1998.)
3(ii).2 -- Amendment to Bylaws of the Company dated February 10, 1999.
4.1 -- Indenture of Avalon dated as of September 18, 1995.
(Incorporated by reference to Form 8-K of Avalon dated September
18, 1995.)
4.2 -- First Supplemental Indenture of Avalon dated as of September
18, 1995. (Incorporated by reference to Avalon's Current Report
on Form 8-K dated September 18, 1995.)
4.3 -- Second Supplemental Indenture of Avalon dated as of December 16,
1997. (Incorporated by reference to Avalon's Current Report on
Form 8-K filed January 26, 1998.)
4.4 -- Third Supplemental Indenture of Avalon dated as of January 22,
1998. (Incorporated by reference to Avalon's Current Report on
Form 8-K filed on January 26, 1998.)
4.5 -- Indenture, 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 Form 8-K of the
Company filed on January 21, 1998.)
4.6 -- First Supplemental Indenture, dated as of January 20, 1998,
between the Company and the Trustee. (Incorporated by
reference to Exhibit 4.2 to Form 8-K of the Company filed on
January 21, 1998.)
4.7 -- Second Supplemental Indenture, dated as of July 7, 1998,
between the Company and the Trustee. (Incorporated by
reference to Exhibit 4.2 to Form 8-K of the Company filed on
July 9, 1998.)
4.8 -- Third Supplemental Indenture, dated as of December 21, 1998
between the Company and the Trustee, including forms of Floating
Rate Note and Fixed Rate Note (Incorporated by reference to
Exhibit 4.4 to Form 8-K filed on December 21, 1998.)
4.9 -- The Company's 7.375% Senior Note due 2002. (Incorporated by
reference to Avalon's Current Report on Form 8-K filed on
September 18, 1995.)
4.10 -- The Company's 6.250% Senior Note due 2003. (Incorporated by
reference to Exhibit 4.3 to Form 8-K of the Company filed
January 21, 1998.)
4.11 -- The Company's 6.500% Senior Note due 2005. (Incorporated by
reference to Exhibit 4.4 to Form 8-K filed January 21, 1998.)
4.12 -- The Company's 6.625% Senior Note due 2008. (Incorporated by
reference to Exhibit 4.5 to Form 8-K filed January 21, 1998.)
4.13 -- The Company's 6.50% Senior Note due 2003. (Incorporated by
reference to Exhibit 4.3 to Form 8-K of the Company filed July
9, 1998.)
4.14 -- The Company's 6.625% Senior Note due 2005. (Incorporated by
reference to Avalon's Current Report on Form 8-K dated
September 18, 1995.)
4.15 -- The Company's 6.80% Senior Note due 2006. (Incorporated by
reference to Exhibit 4.4 to Form 8-K of the Company filed July
9, 1998.)
4.16 -- The Company's 6.875% Senior Note due 2007. (Incorporated by
reference to Exhibit 4.1 to Avalon's Current Report on Form 8-K
filed December 22, 1997.)
4.17 -- Dividend Reinvestment and Stock Purchase Plan of the Company
filed October 8, 1998. (Incorporated by reference to Form S-3
of the Company, File No. 333-16647.)
4.18 -- Shareholder Rights Agreement, dated March 9, 1998, between the
Company and First Union National Bank (a successor to American
Stock Transfer and Trust Company) as Rights Agent (including the
form of Rights Certificate as Exhibit B). (Incorporated by
reference to Exhibit 4.1 to Form 8-A of the Company filed March
11, 1998.)
56
10.1 + -- Employment agreement, dated as of March 9, 1998, between the
Company and Richard L. Michaux. (Incorporated by reference to
Exhibit 10.1 to Form 10-Q of the Company filed August 14,
1998.)
10.2 + -- Employment agreement, dated as of March 9, 1998, between the
Company and Charles H. Berman. (Incorporated by reference to
Exhibit 10.2 to Form 10-Q of the Company filed August 14,
1998.)
10.3 + -- Employment agreement, dated as of March 9, 1998, between the
Company and Robert H. Slater. (Incorporated by reference to
Exhibit 10.3 to Form 10-Q of the Company filed August 14,
1998.)
10.4 + -- Employment agreement, dated as of March 9, 1998, between the
Company and Thomas J. Sargeant. (Incorporated by reference to
Exhibit 10.4 to Form 10-Q of the Company filed August 14,
1998.)
10.5 + -- Employment agreement, dated as of March 9, 1998, between the
Company and Bryce Blair. (Incorporated by reference to
Exhibit 10.5 to Form 10-Q of the Company filed August 14,
1998.)
10.6 + -- Employment agreement, dated as of March 9, 1998, between the
Company and Gilbert M. Meyer. (Incorporated by reference to
Exhibit 10.1 to Form 10-Q of the Company filed May 15, 1998.)
10.7 + -- Employment agreement, dated as of March 9, 1998, between the
Company and Jeffrey B. Van Horn. (Incorporated by reference to
Exhibit 10.2 to Form 10-Q of the Company filed May 15, 1998.)
10.8 + -- Employment agreement, dated as of March 9, 1998, between the
Company and Max L. Gardner. (Incorporated by reference to
Exhibit 10.3 to Form 10-Q of the Company filed May 15, 1998.)
10.9 + -- Employment agreement, dated as of March 9, 1998, between the
Company and Morton L. Newman. (Incorporated by reference to
Exhibit 10.4 to Form 10-Q of the Company filed May 15, 1998.)
10.10+ -- Employment agreement, dated as of March 9, 1998, between the
Company and Debra L. Shotwell. (Incorporated by reference to
Exhibit 10.5 to Form 10-Q of the Company filed May 15, 1998.)
10.11 -- Promissory Note, dated July 26, 1996, between the Company and
Jeffrey B. Van Horn. (Incorporated by reference to Exhibit 10.2
to Form 8-K of the Company filed January 21, 1997.)
10.12+ -- Avalon Properties, Inc. 1993 Stock Option and Incentive Plan.
(Incorporated by reference to Exhibit 10.1 to Avalon's Annual
Report to Form 10-K for the year ended December 31, 1993.)
10.13+ -- Avalon Properties, Inc. 1995 Equity Incentive Plan (Incorporated
by reference to Avalon's Proxy Statement for the Annual Meeting
of Stockholders held on May 9, 1995.)
10.14+ -- AvalonBay Communities, Inc. 1994 Stock Incentive Plan, as
amended and restated on April 13, 1998 and subsequently amended
on July 24, 1998. (Incorporated by reference to Exhibit 10.1 to
the Company's Form 10-Q filed November 16, 1998.)
10.15+ -- 1996 Non-Qualified Employee Stock Purchase Plan, dated
June 26, 1997, as amended and restated. (Incorporated by
reference to Exhibit 99.1 to Post-effective Amendment No. 1 to
Form S-8 of the Company filed June 26, 1997, File No. 333-16837.)
10.16+ -- 1996 Non-Qualified Employee Stock Purchase Plan - Plan
Information Statement dated June 26, 1997. (Incorporated by
reference to Exhibit 99.2 to Form S-8 of the company, File No.
333-16837.)
10.17 -- Interest Rate Swap Agreement. (Incorporated by reference to
Exhibit 10.1 to Form 10-Q of the Company dated May 13, 1994.)
10.18 -- Registration Rights Agreement between the Company and certain
stockholders. (Incorporated by reference to Exhibit 10.2 to
Form 10-Q of the Company dated May 13, 1994.)
10.19 -- Registration Rights Agreement, dated as of September 15, 1995
by and between the Company and Purchaser. (Incorporated by
reference to Exhibit 4.1 to Form 8-K of the Company, dated
September 25, 1995.)
10.20 -- Office lease dated January 4, 1995. (Incorporated by reference
to Exhibit 10.21 to Form 10-Q of the Company dated May 10,
1995.)
57
10.21 -- Form of Agreement of Limited Partnership of Bay Countrybrook,
L.P., by and among Bay GP, Inc., the Company and certain other
defined Persons. (Incorporated by reference to Exhibit 10.5 to
Form 8-K/A of Bay Apartment Communities, Inc. filed July 5,
1996.)
10.22 -- Agreement dated as of May 16, 1997, between the Company J.E.
Butler & Associates, Inc.and AP Companies, Ltd. relating to the
formation of Bay Rincon, L.P. (Incorporated by reference to
Exhibit 10.1 to Form 10-Q of Bay Apartment Communities, Inc.
filed August 14, 1997.)
10.23 -- Severance Agreement and Mutual General Release, dated July 31,
1997, between the Company and Geoffrey L. Baker. (Incorporated by
reference to Exhibit 10.1 to Form 10-Q of Bay Apartment
Communities, Inc. filed November 13, 1997.)
10.24 -- Agreement of Limited Partnership of Bay Pacific Northwest,
L.P. dated as of September 12, 1997, between the Company and
certain other defined Persons. (Incorporated by reference to
Exhibit 10.1 to Form 8-K of Bay Apartment Communities, Inc.
filed October 28, 1997.)
10.25 -- Registration Rights Agreement, dated as of September 23, 1997,
between the Company and certain defined Holders of units of
limited partnership interests in Bay Pacific Northwest, L.P.
(Incorporated by reference to Exhibit 10.2 to Form 8-K of the
Company filed October 28, 1997.)
10.26 -- Second Amended and Restated Revolving Loan Agreement dated
November 21, 1997, between the Company, Union Bank of
Switzerland, as Co-Agent and Bank, Union Bank of California,
N.A., as Co-Agent and Bank, Union Bank of Switzerland, as
Administrative Agent and the other Banks signatory thereto.
(Incorporated by reference to Exhibit 10.1 to Form 8-K of the
Company dated December 16, 1997.)
10.27 -- Revolving Loan Agreement, dated as of June 23, 1998, between
the Company and Fleet National Bank, Morgan Guaranty Trust
Company of New York and Union Bank of Switzerland, each as
co-agents. (Incorporated by reference to Exhibit 10.6 to Form
10-Q of the Company filed August 14, 1998.)
10.28 -- Contribution and Exchange Agreement dated November 7, 1997.
(Incorporated by reference to Avalon Properties, Inc.'s
Current Report on Form 8-K filed November 24, 1997.)
10.29 -- Umbrella Agreement, among the Company, certain subsidiaries of
the Company, Citibank, N.A., as collateral agent, and
Financial Guaranty Insurance Company. (Incorporated by
reference to Exhibit 10.7 to Form 10-Q of the Company dated
May 13, 1994.)
10.30 -- Cash Collateral Account, Security, Pledge and Assignment
Agreement among the Company, certain subsidiaries of the
Company, Citibank, N.A., as collateral agent, and Financial
Guaranty Insurance Company. (Incorporated by reference to
Exhibit 10.8 to Form 10-Q of the Company dated May 13, 1994.)
10.31 -- Reimbursement Agreements among certain subsidiaries of the
Company, Citibank, N.A., as collateral agent, and Financial
Guaranty Insurance Company. (Incorporated by reference to Exhibit
10.9 to Form 10-Q of the Company dated May 13, 1994.)
10.32 -- Guaranty Agreements by Bay Asset Group, Inc., a subsidiary of
the Company, in favor of Citibank, N.A., as collateral agent for
Financial Guaranty Insurance Company. (Incorporated by reference
to Exhibit 10.10 to Form 10-Q of the Company dated May 13, 1994.)
10.33 -- Limited Guaranty Agreements by certain subsidiaries of the
Company in favor of Citibank, N.A., as collateral agent, and
Financial Guaranty Insurance Company. (Incorporated by
reference to Exhibit 10.11 to Form 10-Q of the Company dated
May 13, 1994.)
10.34 -- Pledge Agreement between Bay Asset Group, Inc., a subsidiary
of the Company and Citibank, N.A., as collateral agent for
Financial Guaranty Insurance Company. (Incorporated by reference
to Exhibit 10.12 to Form 10-Q of the Company dated May 13, 1994.)
10.35 -- Master Reimbursement Agreement between Avalon and certain
Management stockholders. (Incorporated by reference to
Avalon's Annual Report on Form 10-K for the year ended
December 31, 1993.)
10.36 -- Master Reimbursement Agreement. (Incorporated by reference to
Exhibit 10.23 to Form 10-Q of the Company dated August 11,
1995.)
10.37 -- ISDA Master Agreement (Interest rate swap agreement).
(Incorporated by reference to Exhibit 10.24 to Form 10-Q of
the Company dated August 11, 1995.)
10.38 -- Cash Collateral Pledge, Security and Custody Agreement.
(Incorporated by reference to Exhibit 10.25 to Form 10-Q of
the Company dated August 11, 1995.)
10.39 -- Indemnification Agreements between the Company and the
Directors of the Company.
10.40 -- Distribution Agreement dated December 21, 1998 among the Company
and the Agents, including Administrative Procedures, relating
to the medium-term notes. (Incorporated by reference to Exhibit
1.1 to Form 8-K of the Company filed on December 21, 1998.)
58
12.1 -- Statements re: Computation of Ratios.
16.1 -- Letter re: Change in certifying accountant (Incorporated by
reference to Exhibit 16.2 to Form 8-K filed November 18, 1998.)
21.1 -- Schedule of Subsidiaries of the Company
23.1 -- Consent of Arthur Andersen LLP
23.2 -- Consent of Coopers & Lybrand, L.L.P.
27.1 -- Financial Data Schedule
- --------------
+ Management contract or compensatory plan or arrangement required to be
filed or incorporated by reference as an exhibit to this Form 10-K
pursuant to Item 14(c) of Form 10-K.
59
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
60
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
AvalonBay Communities, Inc:
We have audited the accompanying consolidated balance sheet of AvalonBay
Communities, Inc. (a Maryland corporation, the "Company") and subsidiaries as
of December 31, 1998, and the related consolidated statements of operations,
stockholders' equity and cash flows for the year then ended. These consolidated
financial statements and the schedule referred to below are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements and schedule based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audit provides a reasonable basis
for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of AvalonBay
Communities, Inc. and subsidiaries as of December 31, 1998, and the results of
their operations and their cash flows for the year then ended in conformity
with generally accepted accounting principles.
Our audit was made for the purpose of forming an opinion on the basic financial
statements taken as a whole. The Schedule of Real Estate and Accumulated
Depreciation is presented for purposes of complying with the rules of the
Securities and Exchange Commission and is not a required part of the basic
financial statements. This schedule has been subjected to the auditing
procedures applied in our audit of the basic financial statements and, in our
opinion, is fairly stated in all material respects in relation to the basic
financial statements taken as a whole.
Washington, D.C.
January 18, 1999
/s/ ARTHUR ANDERSEN LLP
F-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
AvalonBay Communities, Inc.
We have audited the accompanying consolidated balance sheet of AvalonBay
Communities, Inc. (formerly Bay Apartment Communities, Inc.) and its
subsidiaries as of December 31, 1997 and the related consolidated statements of
operations, stockholders' equity and cash flows for the years ended December
31, 1997 and 1996. These financial statements are the responsibility of the
management of AvalonBay Communities, Inc. Our responsibility is to express an
opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of AvalonBay
Communities, Inc. as of December 31, 1997 and the consolidated results of their
operations and their cash flows for the years ended December 31, 1997 and 1996
in conformity with generally accepted accounting principles.
San Francisco, California
January 30, 1998
/s/ COOPERS & LYBRAND L.L.P.
F-2
AVALONBAY COMMUNITIES, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share data)
See accompanying notes to consolidated financial statements.
F-3
AVALONBAY COMMUNITIES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollars in thousands, except per share data)
See accompanying notes to consolidated financial statements.
F-4
AVALONBAY COMMUNITIES, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(Dollars in thousands, except share data)
See accompanying notes to consolidated financial statements.
F-5
AVALONBAY COMMUNITIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
See accompanying notes to consolidated financial statements.
F-6
Supplemental disclosures of non-cash investing and financing activities (dollars
in thousands):
In connection with the merger of Avalon Properties, Inc. with and into the
Company (the "Merger") in June 1998, the Company issued shares of Common and
Preferred Stock valued at $1,439,513 in exchange for all of the outstanding
capital stock of Avalon Properties, Inc. As a result of the Merger, the Company
acquired all of the assets of Avalon Properties, Inc. and also assumed or
acquired $643,410 in debt, $6,221 in deferred compensation expense, $67,073 in
net other assets, $1,013 in cash and cash equivalents and minority interest of
$19,409.
The Company assumed debt in connection with acquisitions totaling $10,400,
$39,797 and $27,868 during the years ended December 31, 1998, 1997 and 1996,
respectively. The Company issued $3,851, $6,201 and $7,270 in operating
partnership units for acquisitions during 1998, 1997 and 1996, respectively.
During the years ending December 31, 1998, 1997 and 1996, respectively, 6,818,
162,330 and 3,812 operating partnership units were converted into the Company's
Common Stock.
During the year ended December 31, 1998, 2,308,800 shares of Series A Preferred
Stock and 405,022 shares of Series B Preferred Stock totaling a par value of $28
were converted into an aggregate of 2,713,822 shares of Common Stock.
Dividends declared but not paid as of December 31, 1998, 1997 and 1996 totaled
$43,323, $12,591 and $8,939, respectively.
F-7
AVALONBAY COMMUNITIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)
1. Organization and Significant Accounting Policies
Organization and Recent Developments
AvalonBay Communities, Inc. (together with its subsidiaries, except as the
context may otherwise require, the "Company") is a Maryland corporation that
has elected to be taxed as a real estate investment trust ("REIT") under the
Internal Revenue Code of 1986, as amended. The Company focused on the ownership
and operation of institutional-quality apartment communities in high
barrier-to-entry markets of the United States. These markets include Northern
and Southern California and selected states in the Mid-Atlantic, Northeast,
Midwest and Pacific Northwest regions of the country. The Company is the
surviving corporation from the merger (the "Merger") of Avalon Properties, Inc.
("Avalon") with and into the Company (sometimes hereinafter referred to as
"Bay" before the Merger) on June 4, 1998. The Merger was accounted for as a
purchase of Avalon by Bay. In connection with the Merger, the Company changed
its name from Bay Apartment Communities, Inc. to AvalonBay Communities, Inc.
At December 31, 1998, the Company owned or held an ownership interest in 127
apartment communities containing 37,911 apartment homes in sixteen states and
the District of Columbia of which 13 communities containing 4,855 apartment
homes were under reconstruction. The Company also owned 14 communities with
3,262 apartment homes under construction and rights to develop an additional 27
communities that will contain an estimated 7,239 apartment homes.
During the period January 1, 1996 through December 31, 1997, the Company
acquired 28 existing operating communities containing a total of 8,271 apartment
homes from unrelated third parties for an aggregate acquisition price of
approximately $651,843 (cumulative capitalized cost of $766,980 as of December
31, 1998).
During the period prior to the Merger, January 1, 1998 through June 4, 1998, the
Company acquired five communities containing a total of 1,388 apartment homes
from unrelated third parties for an aggregate acquisition price of approximately
$103,047 (cumulative capitalized cost of $110,228). The Company also acquired
one community during this period which was sold prior to December 31, 1998.
Subsequent to the Merger, the Company acquired three communities containing a
total of 1,433 apartment homes from unrelated third parties for an aggregate
acquisition price of approximately $201,800 (cumulative capitalized costs of
$202,747 as of December 31, 1998). The Company also acquired a participating
mortgage note for $24,000.
During 1998, the Company completed development of four communities, containing
1,770 apartment homes at a total cost of $224,800. Also, eight communities were
redeveloped during 1998, at a total cost of $64,300.
Subsequent to the Merger, the Company disposed of nine communities, containing
2,797 apartment homes. The net proceeds from these dispositions will be directed
to the development and redevelopment of communities currently under construction
or reconstruction. Pending such redeployment, the proceeds from the sale of
these communities (approximately $118,000 after repayment of certain secured
indebtedness) were primarily used to repay amounts outstanding under the
Company's unsecured credit facility.
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the
Company and its wholly-owned partnerships and subsidiaries and the operating
partnerships structured as DownREITs. All significant intercompany balances and
transactions have been eliminated in consolidation.
F-8
Real Estate
Significant expenditures which improve or extend the life of the asset are
capitalized. The operating real estate assets are stated at cost and consist of
land, buildings and improvements, furniture, fixtures and equipment, and other
costs incurred during development, redevelopment and acquisition. Expenditures
for maintenance and repairs are charged to expense as incurred.
The capitalization of costs during the development of assets (including interest
and related loan fees, property taxes and other direct and indirect costs)
begins when active development commences and ends when the asset is delivered
and a final certificate of occupancy is issued. Cost capitalization during
redevelopment of assets (including interest and related loan fees, property
taxes and other direct and indirect costs) begins when active and substantial
redevelopment at a community commences and apartment homes are taken
out-of-service for redevelopment and ends when the community's redevelopment is
substantially completed, and apartment homes are back in service. The
accompanying consolidated financial statements include a provision for deferred
development costs related to communities for which the Company's management
("Management") has concluded completion of development is not probable.
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
to seven years.
Lease terms for apartment homes are generally one year or less. Rental income
and operating costs incurred during the initial lease-up or post-redevelopment
lease-up period are fully recognized in operations as they accrue, as such
income and costs relate to apartment homes available for lease.
If there is an event or change in circumstance that indicates an impairment in
the value of a community has occurred, the Company's policy is to assess any
impairment in value by making a comparison of the current and projected
operating cash flows of the community over its remaining useful life, on an
undiscounted basis, to the carrying amount of the community. If such carrying
amounts are in excess of the estimated projected operating cash flows 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 has not recognized an impairment loss in 1998, 1997 or 1996
on any of its real estate.
Investments in Unconsolidated Joint Ventures
Investments in real estate joint ventures are accounted for under the equity
method as the Company does not control the significant operating and financial
decisions of the joint ventures. The joint venture agreements require that a
majority voting interest of the partners approve potential sales, liquidations,
significant refinancings, as well as operating budget and capital and financing
plans.
Income Taxes
The Company elected to be taxed as a REIT under the Internal Revenue Code of
1986, as amended, for the year ended December 31, 1994 and has not revoked such
election. A corporate REIT is a legal entity which holds real estate interests
and, if certain conditions are met (including but not limited to the payment of
a minimum level of dividends to stockholders), the payment of federal and state
income taxes at the corporate level is avoided or reduced. Management believes
that all such conditions for the avoidance of taxes have been met for the
periods presented. Accordingly, no provision for federal and state income taxes
has been made.
The following summarizes the tax components to stockholders of the Company's
common dividends declared for the years ending December 31, 1998, 1997 and 1996:
F-9
All dividends declared on all series of the Company's Preferred Stock
represented ordinary income to preferred stockholders for tax purposes in the
year declared.
Deferred Financing Costs
Deferred financing costs include fees and costs incurred to obtain debt
financing and are amortized on a straight-line basis, which approximates the
effective interest method, over the shorter of the term of the loan or the
related credit enhancement facility, if applicable. Unamortized financing costs
are written-off when debt is retired before the maturity date. Accumulated
amortization related to deferred financing costs was $4,916 and $3,561 as of
December 31, 1998 and 1997, respectively.
Cash and Cash Equivalents
Cash and cash equivalents include all cash and liquid investments with an
original maturity of three months or less from the date acquired. The majority
of the Company's cash, cash equivalents, and cash in escrows is held at major
commercial banks.
Earnings per Common Share
The Company has adopted Statement of Financial Accounting Standards ("SFAS") No.
128, "Earnings per Share." In accordance with the provisions of SFAS No. 128,
basic earnings per share for the years ended December 31, 1998, 1997 and 1996 is
computed by dividing earnings available to common shares (net income less
preferred stock dividends) by the weighted average number of shares outstanding
during the period. Additionally, other potentially dilutive common shares are
considered when calculating earnings per share on a diluted basis. The Company's
basic and diluted weighted average shares outstanding for the years ended
December 31, 1998, 1997 and 1996 are as follows:
F-10
On a weighted average basis, at December 31, 1997 and 1996, respectively there
were 2,713,822 and 2,571,068 shares of convertible Preferred Stock, 322,093 and
261,395 Common Stock options and 228,230 and 140,987 operating partnership units
that were antidilutive. Therefore, for the years ended December 31, 1997 and
1996, there were effectively no dilutive common share equivalents outstanding.
Use of Estimates
The preparation of financial statements in conformity with generally accepted
accounting principles ("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 years' financial
statements to conform with current year presentations.
Newly Issued Accounting Standards
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131
"Disclosure about Segments of an Enterprise and Related Information." SFAS No.
131 establishes standards for determining an entity's operating segments and the
type and level of financial information to be disclosed. SFAS No. 131 became
effective for the Company for the fiscal year ending December 31, 1998. The
Company has adopted SFAS No. 131 effective with the December 31, 1998 reporting
period.
In March 1998, the Emerging Issues Task Force of the Financial Accounting
Standards Board issued Ruling 97-11 entitled "Accounting for Internal Costs
Relating to Real Estate Property Acquisitions," which requires that internal
costs of identifying and acquiring operating property be expensed as incurred.
Costs associated with the acquisition of non-operating property may still be
capitalized. The ruling is effective for acquisitions completed subsequent to
March 19, 1998. At December 31, 1998, this ruling does not have a material
effect on the Company's consolidated financial statements.
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." This
pronouncement establishes accounting and reporting standards requiring that
every derivative instrument be recorded in the balance sheet as either an asset
or liability measured at its fair value. SFAS No. 133 requires that changes in
the derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. SFAS No. 133 is effective for fiscal years
beginning after June 15, 1999 and cannot be applied retroactively. The Company
currently plans to adopt this pronouncement effective January 1, 2000, and will
determine both the method and impact of adoption prior to that date.
2. Merger between Bay and Avalon
In June 1998, the Company completed the Merger with Avalon. The Merger and
related transactions were accounted for using the purchase method of accounting
in accordance with GAAP. Accordingly, the assets and liabilities of Avalon were
adjusted to fair value for financial accounting purposes and the results of
operations of Avalon prior to June 4, 1998 are not included in the results of
operations of the Company.
In connection with the Merger, the following related transactions occurred:
The Company issued .7683 of a share of Common Stock for each outstanding
share of Avalon common stock;
F-11
The Company issued one share of Series F and G Preferred Stock for each
outstanding share of Avalon Series A and B Preferred Stock, respectively.
The following unaudited pro forma information has been prepared as if the Merger
and related transactions had occurred on January 1, 1997. The pro forma
financial information is presented for informational purposes only and is not
necessarily indicative of what actual results would have been nor does it
purport to represent the results of operations for future periods had the Merger
been consummated on January 1, 1997.
3. Interest Capitalized
Capitalized interest associated with projects under development or redevelopment
totaled $16,977, $6,985 and $2,567 for the years ended December 31, 1998, 1997
and 1996, respectively.
4. Notes Payable, Unsecured Senior Notes and Credit Facility
The Company's notes payable, unsecured senior notes and credit facility are
summarized as follows:
Fixed and variable rate notes payable are collateralized by certain apartment
communities and mature at various dates from July 1999 through December 2036.
The weighted average interest rate of variable rate notes (tax-exempt) was 4.8%
at December 31, 1998. The weighted average interest rate of fixed rate notes
(conventional and tax-exempt) was 6.7% and 6.4% at December 31, 1998 and 1997,
respectively.
F-12
The Company's unsecured senior notes consist of the following:
The Company's unsecured senior notes contain a number of financial and other
covenants with which the Company must comply, including, but not limited to,
limits on the aggregate amount of total and secured indebtedness the Company may
have on a consolidated basis and limits on the Company's required debt service
payments.
Scheduled maturities of notes payable and unsecured senior notes are as follows
for the years ending December 31:
The Company has a $600,000 variable rate unsecured credit facility (the
"Unsecured Facility") with Morgan Guaranty Trust Company of New York, Union Bank
of Switzerland and Fleet National Bank, serving as co-agents for a syndicate of
commercial banks. The Unsecured Facility bears interest at a spread over the
London Interbank Offered Rate ("LIBOR") based on rating levels achieved on the
Company's senior unsecured notes and on a maturity selected by the Company. The
current pricing is LIBOR plus .6% per annum (6.2% at December 31, 1998). The
Unsecured Facility, which was put into place during June 1998, replaced three
separate credit facilities previously available to the separate companies prior
to the Merger. The terms of the retired facilities were similar to the Unsecured
Facility. In addition, the Unsecured Facility includes a competitive bid option
for up to $400,000. The Company is subject to certain customary covenants under
the Unsecured Facility, including, but not limited to, maintaining certain
maximum leverage ratios, a minimum fixed charge coverage ratio, minimum
unencumbered assets and equity levels and restrictions on paying dividends in
amounts that exceed 95% of the Company's Funds from Operations, as defined
therein. The Unsecured Facility matures in July 2001 and has two, one-year
extension options.
5. Stockholders' Equity
As of December 31, 1997 the Company had authorized for issuance 40,000,000 and
25,000,000 shares of Common and Preferred Stock, respectively. In connection
with the Merger, authorized Common and Preferred Stock was increased to
300,000,000 and 50,000,000 shares, respectively. In October 1998, the Company
held a Special Meeting of Stockholders at which stockholders approved an
amendment to the Company's charter reducing the number of authorized shares of
the Company's Common Stock from 300,000,000 to 140,000,000.
F-13
Dividends on the Series C, Series D, Series F, Series G and Series H Preferred
Stock are cumulative from the date of original issue and are payable quarterly
in arrears on or before the 15th day of each month as stated in the table below.
None of the Series of Preferred Stock are redeemable prior to the date stated in
the table below, but on or after the stated date, may be redeemed for cash at
the option of the Company in whole or in part, at a redemption price of $25 per
share, plus all accrued and unpaid dividends, if any. The Series of Preferred
Stock have no stated maturity and are not subject to any sinking fund or
mandatory redemptions. In addition, the Preferred Stock are not convertible into
any other securities of the Company and may be redeemed solely from proceeds of
other capital stock of the Company, which may include shares of other series of
preferred stock.
The Company also has 1,000,000 shares of Series E Junior Participating
Cumulative Preferred Stock authorized for issuance pursuant to the Company's
Shareholder Rights Agreement. As of December 31, 1998, there were no shares of
Series E Preferred Stock outstanding.
During April 1998, the Company completed an offering of Common Stock totaling
1,244,147 shares. The net proceeds of approximately $44,000 were used to retire
indebtedness under the Company's then-existing unsecured revolving credit
facility. During 1997, the Company completed five offerings of Common Stock
totaling 6,733,187 shares. The net proceeds of approximately $244,340 were used
to retire indebtedness under the Company's then-existing unsecured revolving
credit facility.
6. Investments in Unconsolidated Joint Ventures
In connection with the Merger, the Company succeeded to certain investments in
unconsolidated joint ventures. At December 31, 1998, these investments consisted
of a 50% general partnership interest in Falkland Partners, a 49% equity
interest in Avalon Run and a 50% partnership interest in Avalon Grove.
F-14
The following is a combined summary of the financial position of these joint
ventures as of the dates presented (which includes the period prior to the
Merger):
The following is a combined summary of the results of operations of these joint
ventures for the periods presented (which includes the periods prior to the
Merger):
7. Communities Held for Sale
During 1998, the Company completed a strategic planning effort resulting in a
decision to pursue a disposition strategy for certain assets in markets that did
not meet its long-term strategic direction. In connection with this decision,
the Company's Board of Directors authorized Management to pursue the disposition
of selected communities within specific markets. The Company will solicit
competing bids from unrelated parties for these individual assets, and will
consider the sales price and tax ramifications of each proposal. Management
anticipates these assets will be sold during 1999. However, there can be no
assurance that such assets can be sold on terms that are satisfactory to the
Company. Several of the communities authorized for disposition were sold in
1998.
F-15
The communities sold in 1998 and the respective sales price and net proceeds
are summarized below:
To facilitate the sale of Sommerset, the Company provided short-term financing
to the purchaser for 80% of the gross sales price. Accordingly, $6,320 of the
net proceeds will be received at maturity of this financing.
The assets targeted for sale include land, buildings and improvements and
furniture, fixtures and equipment, and are recorded at the lower of cost or fair
value less estimated selling costs. The Company recognized no write down in its
real estate to arrive at net realizable value. At December 31, 1998, total real
estate, net of accumulated depreciation, subject to sale totaled $231,492.
Certain individual assets are secured by mortgage indebtedness which may be
assumed by the purchaser or repaid by the Company from the net sales proceeds.
The Company's consolidated statements of operations includes net income of the
communities held for sale of $3,916, $1,633 and $1,301 for the years ended
December 31, 1998, 1997 and 1996, respectively. Depreciation expense on these
assets, which was not recognized subsequent to the date of held-for-sale
classification, totaled $1,332.
In connection with an agreement executed by Avalon in March 1998 which provided
for the buyout of certain limited partners in DownREIT V Limited Partnership,
the Company sold two communities in July 1998. Net proceeds from the sale of
the two communities, containing an aggregate of 758 apartment homes, were
approximately $44,000.
8. Commitments and Contingencies
Employment Agreements
The Company entered into three year employment agreements with nine executives
and a one year employment agreement with one executive, all of which became
effective as of June 4, 1998, the date of the Merger. With the exception of the
one year agreement, the employment agreements provide for one-year automatic
renewal after the third year unless an advance notice of non-renewal is provided
by either party. Upon a change in control, the agreements provide for an
automatic extension of three years. The employment agreements provide for base
salary and incentive compensation in the form of cash awards, stock options and
stock grants subject to the discretion of, and attainment of performance goals
established by, the Compensation Committee of the Board of Directors.
Each of the three year employment agreements also provides for base salary
increases during the initial term in amounts determined by the Compensation
Committee. During any renewal term base salary increases will be equal to the
greater of 5% of the prior year's base salary, a factor based on increases in
the consumer price index, or an amount determined at the discretion of the
Compensation Committee. Certain of these employment agreements were terminated
in accordance with the Company's announced organizational changes. See Footnote
13, Subsequent Events, for further information.
F-16
Presale Commitments
The Company occasionally enters into forward purchase commitments with unrelated
third parties which allow the Company to purchase communities upon completion of
construction. As of December 31, 1998, the Company has an agreement to purchase
ten communities with an estimated 2,980 homes for an estimated aggregate
purchase price of $386,500. The acquisition of one of these communities is
expected to close in the third quarter of 1999, and the acquisition of the
remaining communities are expected to close in 2000, 2001 and 2002. However,
there can be no assurance that such acquisitions will be consummated or, if
consummated on the schedule currently contemplated. As of December 31, 1998, the
Company had provided interim construction financing of $67,129 for these
communities.
Contingencies
The Company is subject to various legal proceedings and claims that arise in the
ordinary course of business. These matters are generally covered by insurance.
While the resolution of these matters cannot be predicted with certainty,
Management believes that 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. Value of Financial Instruments
The Company has historically used interest rate swap agreements (the "Swap
Agreements") to reduce the impact of interest rate fluctuations on its variable
rate tax-exempt bonds. The Swap Agreements are held for purposes other than
trading. The amortization of the cost of the Swap Agreements is included in
amortization expense. The remaining unamortized cost of the Swap Agreements is
included in prepaid expenses and other assets on the balance sheet and is
amortized over the remaining life of the agreements. As of December 31, 1998,
the effect of these Swap Agreements is to fix $202,283 of the Company's
tax-exempt debt at an average interest rate of 6.1% with an average maturity of
8 years.
The off-balance-sheet risk in these contracts includes the risk of a
counterparty not performing under the terms of the contract. The counterparties
to these contracts are major financial institutions with AAA credit ratings by
the Standard & Poor's Ratings Group. The Company monitors the credit ratings of
counterparties and the amount of the Company's debt subject to swap agreements
with any one party. Therefore, the Company believes the likelihood of realizing
material losses from counterparty nonperformance is remote.
The Company has not entered into any interest rate hedge agreements or treasury
locks for its conventional unsecured debt.
Cash and cash equivalent balances are held with various financial institutions
and may at times exceed the applicable Federal Deposit Insurance Corporation
limit. The Company monitors credit ratings of these financial institutions and
the concentration of cash and cash equivalent balances with any one financial
institution and believes the likelihood of realizing material losses from the
excess of cash and cash equivalent balances over insurance limits is remote.
The following estimated fair values of financial instruments were determined by
Management using available market information and established valuation
methodologies, including discounted cash flows. Accordingly, the estimates
presented are not necessarily indicative of the amounts the Company could
realize on disposition of the financial instruments. The use of different market
assumptions and/or estimation methodologies may have a material effect on the
estimated fair value amounts.
- - Cash equivalents, rents receivable, accounts payable and accrued expenses,
and other liabilities are carried at their face amounts, which reasonably
approximate their fair values.
F-17
- - The Company's unsecured credit facility with an aggregate carrying value of
$329,000 and $224,200 at December 31, 1998 and 1997, respectively
approximates fair value.
- - Bond indebtedness and notes payable with an aggregate carrying value of
$1,155,371 and $263,284 had an estimated aggregate fair value of $1,137,411
and $291,293 at December 31, 1998 and 1997, respectively.
10. Segment Reporting
The Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise
and Related Information," during 1998. SFAS No. 131 established standards for
reporting financial and descriptive information about operating segments in
annual financial statements. Operating segments are defined as components of an
enterprise about which separate financial information is available that is
evaluated regularly by the chief operating decision maker, or decision making
group, in deciding how to allocate resources and in assessing performance. The
Company's chief operating decision making group consists primarily of the
Company's senior officers.
The Company's reportable operating segments include Stable Communities,
Developed Communities and Redeveloped Communities. Furthermore, each of these
operating segments are measured within either the West Coast geographic area
(consisting of the Northern California, Southern California and Pacific
Northwest regions) or the East Coast geographic area (consisting of the
Northeast, Mid-Atlantic and Midwest regions):
- - Stable Communities are communities that 1) have attained stabilized
occupancy levels (95% occupancy) and operating costs since the
beginning of the prior calendar year (these communities are also known
as Established Communities; or 2) were acquired subsequent to the
beginning of the previous calendar year but were stabilized in terms of
occupancy levels and operating costs at the time of acquisition, and
remained stabilized throughout the end of the current calendar year.
Stable Communities do not include communities where planned
redevelopment or development activities have not yet commenced. The
primary financial measure for this business segment is Net Operating
Income ("NOI"), which represents total revenue less operating expenses
and property taxes. With respect to Established Communities, an
additional financial measure of performance is NOI for the current year
as compared against the prior year and against current year budgeted
NOI. With respect to other Stable Communities, performance is primarily
based on reviewing growth in NOI for the current period as compared
against prior periods within the calendar year and against current year
budgeted NOI.
- - Developed Communities are communities that were under active development
during any portion of the preceding calendar year that attained stabilized
occupancy and expense levels during the current calendar year of
presentation. The primary financial measure for this business segment is
Operating Yield (defined as NOI divided by total capitalized costs).
Performance of Developed Communities is based on comparing Operating
Yields against projected yields as determined by Management prior to
undertaking the development activity.
- - Redeveloped Communities are communities that were under active
redevelopment during any portion of the preceding calendar year that
attained stabilized occupancy and expense levels during the current
calendar year of presentation. The primary financial measure for this
business segment is Operating Yield. Performance for Redeveloped
Communities is based on comparing Operating Yields against projected
yields as estimated by Management prior to undertaking the redevelopment
activity.
Other communities owned by the Company which are not included in the above
segments are communities that were under development or redevelopment or
lease-up at any point in time during the applicable calendar year. The primary
performance measure for these assets depends on the stage of development or
redevelopment of the community. While under development or redevelopment,
Management monitors actual construction costs against budgeted costs as well as
economic occupancy. While under lease-up, the primary performance measures for
these assets are projected Operating Yield as defined above, lease-up pace
compared to budget and rent levels compared to budget.
F-18
The segments are classified based on the individual community's status as of the
end of the given 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 the summary of significant accounting policies.
F-19
(1) Operating Yield calculations are based on annualized NOI for
acquisitions during respective years.
(2) Operating Yield calculations are based on a) annualized NOI for
mid-year acquisitions and b) adjusted gross real estate to exclude
step-up adjustments recorded in connection with the Merger.
F-20
Operating expenses as reflected on the Consolidated Statement of Operations
include $15,244, $3,913 and $2,332 for the years ended December 31, 1998, 1997
and 1996, respectively, of property management overhead costs that are not
allocated to individual communities. These costs are not reflected in Net
Operating Income as shown in the above tables. Communities held for sale as
reflected on the Consolidated Balance Sheets is net of $8,687 of accumulated
depreciation as of December 31, 1998.
In June 1998, the Company completed the Merger with Avalon. The Merger and
related transactions were accounted for using the purchase method of accounting
in accordance with GAAP. Accordingly, the results of operations of the Avalon
communities prior to June 4, 1998 are not included in the results of operations
of the Company. Avalon communities are included in Established Communities for
Management's decision making purposes although the results of operations prior
to the Merger are not included in the Company's historical operating results
determined in accordance with GAAP. For comparative purposes, the 1998, 1997 and
1996 operating information for East Coast segments are presented on the
following page on a pro forma basis (unaudited) assuming the Merger had
occurred as of January 1, 1996.
F-21
(1) Operating Yield calculations are based on a) annualized NOI for
acquisitions during respective years and b) adjusted gross real estate
in 1998 to exclude step-up adjustments recorded in connection with the
Merger.
11. Stock-Based Compensation Plans
The Company has adopted the 1994 Stock Incentive Plan (the "Plan") as amended
and restated on April 13, 1998 and subsequently amended on July 24, 1998, for
the purpose of encouraging and enabling the Company's officers, associates and
directors to acquire a proprietary interest in the Company. Individuals who are
eligible to participate in the 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 Plan authorizes (i) the grant of stock options
that qualify as incentive stock options under Section 422 of the Code, (ii) the
grant of stock options that do not so qualify, (iii) grants of shares of
F-22
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.
Under the Plan, a maximum of 2,500,000 shares of Common Stock, plus 9.9% of any
net increase in the total number of shares of Common Stock actually outstanding
from time to time after April 13, 1998, may be issued. Notwithstanding the
foregoing, the maximum number of shares of stock for which Incentive Stock
Options may be issued under the Plan shall not exceed 2,500,000 and no awards
shall be granted under the Plan after April 13, 2008. For purposes of this
limitation shares of Common Stock which are forfeited, canceled, reacquired by
the Company, satisfied without the issuance of Common Stock or otherwise
terminated (other than by exercise) shall be added back to the shares of Common
Stock available for issuance under the Plan. Stock Options with respect to no
more than 300,000 shares of stock may be granted to any one individual
participant during any one calendar year period. Options granted to officers and
employees under the Plan vest over periods determined by the Compensation
Committee of the Board of Directors and expire ten years from the date of grant.
Options granted to non-employee directors under the Plan are subject to
accelerated vesting under certain limited circumstances and become exercisable
on the first anniversary of the date of grant and expire ten years from the date
of grant. Restricted stock granted to officers and employees under the Plan
generally has a vesting period of at least three years, as determined by the
Compensation Committee of the Board of Directors. Restricted stock granted to
non-employee directors vests 20% on the date of issuance and 20% on each of the
first four anniversaries of the date of issuance.
Information with respect to stock options granted under the Plan is as follows:
F-23
The following table summarizes information concerning currently outstanding and
exercisable options:
Options to purchase 4,488,189, 348,400 and 786,125 shares of Common Stock were
available for grant under the Plan at December 31, 1998, 1997 and 1996,
respectively.
Before the Merger, Avalon had adopted its 1995 Equity Incentive Plan (the "1995
Incentive Plan"). The 1995 Incentive Plan authorized the grant of (i) stock
options that qualified as incentive stock options under Section 422 of the Code,
(ii) stock options that did not so qualify, (iii) shares of restricted and
unrestricted common stock, (iv) shares of unrestricted common stock and (v)
dividend equivalent rights.
Under the 1995 Incentive Plan, a maximum number of 3,315,054 shares of common
stock were issuable, plus any shares of common stock represented by awards under
Avalon's 1993 Stock Option and Incentive Plan (the "1993 Plan") that were
forfeited, canceled, reacquired by Avalon, satisfied without the issuance of
common stock or otherwise terminated (other than by exercise). Options granted
to officers, non-employee directors and associates under the 1995 Incentive Plan
generally vested over a three-year term, expired ten years from the date of
grant and were exercisable at the market price on the date of grant.
The 1995 Incentive Plan was not terminated as a result of the Merger, but
options are no longer being granted under the 1995 Incentive Plan. In
connection with the Merger, the exercise prices of options under the 1995
Incentive Plan were adjusted to reflect the conversion ratio of Avalon common
stock into Bay Common Stock. Officers, non-employee directors and associates
with 1995 Incentive Plan options may exercise their options for the Company's
Common Stock at the revalued exercise price.
F-24
Information with respect to stock options granted under the 1995 Incentive Plan
and the 1993 Plan is as follows:
The following table summarizes information concerning currently outstanding and
exercisable options under the 1995 Incentive Plan and the 1993 Plan:
F-25
The Company applies Accounting Principles Board Opinion No. 25, "Accounting for
Stock Issued to Employees," and related interpretations in accounting for its
Plans. Accordingly, no compensation expense has been recognized for the stock
option portion of the stock-based compensation plan. Had compensation expense
for the Company's stock option plan been determined based on the fair value at
the grant date for awards under the Plan consistent with the methodology
prescribed under SFAS No. 123, "Accounting for Stock-Based Compensation," the
Company's net income and earnings per share would have been reduced to the
following pro forma amounts (unaudited):
The fair value of the options granted during 1998 is estimated at $3.67 per
share on the date of grant using the Black-Scholes option pricing model with the
following assumptions: dividend yield of 5.96%, volatility of 16.77%, risk free
interest rates of 5.55%, actual forfeitures, and an expected life of
approximately 4 years. The fair value of the options granted during 1997 is
estimated at $5.48 per share on the date of grant using the Black-Scholes option
pricing model with the following assumptions: dividend yield of 4.44%,
volatility of 18.30%, risk free interest rates of 6.34%, actual forfeitures, and
an expected life of approximately 4 years. The fair value of the options granted
during 1996 is estimated at $3.17 per share on the date of grant using the
Black-Scholes option pricing model with the following assumptions: dividend
yield of 6.50%, volatility of 20.18%, risk free interest rates of 6.17%, actual
forfeitures, and an expected life of approximately 4 years.
The Company has adopted the 1996 Non-Qualified Employee Stock Purchase Plan, as
amended and restated (the "1996 ESP Plan"). The primary purpose of the 1996 ESP
Plan is to encourage Common Stock ownership by eligible directors and
associates (the "Participants") in the belief that such ownership will increase
each Participant's interest in the success of the Company. The 1996 ESP Plan
provides for two purchase periods per year. A purchase period is a six month
period beginning each January 1 and July 1 and ending each June 30 and December
31, respectively. Participants may contribute portions of their compensation
during a purchase period and purchase Common Stock at the end thereof. One
million shares of Common Stock are reserved for issuance under the 1996 ESP
Plan. Participation in the 1996 ESP Plan entitles each Participant to purchase
Common Stock at a price which is equal to the lesser of 85% of the closing
price for a share of stock on the first day of such purchase period or 85% of
the closing price on the last day of such purchase period. The Company issued
23,396 and 13,863 shares under the 1996 ESP Plan as of December 31, 1998 and
1997, respectively. No shares were issued under the 1996 ESP Plan as of
December 31, 1996.
F-26
12. Quarterly Financial Information (Unaudited)
The following summary represents the quarterly results of operations for the
years ended December 31, 1998 and 1997:
The sum of the quarterly net income per common share, basic and diluted, for
1998 and 1997, and the net income available to common stockholders for 1997 are
not equal to the full year amounts primarily because the computations for each
quarter and the full year are made independently.
13. Subsequent Events (Unaudited)
In January 1999, the Company issued $125,000 of medium-term notes. Interest on
the notes is payable semi-annually on February 15 and August 15; and the notes
will mature on February 15, 2004. The notes bear interest at 6.58%. The net
proceeds of approximately $124,300 to the Company were used to repay amounts
outstanding under the Company's Unsecured Facility.
In February 1999, the Company announced certain management changes. The Company
expects to record a non-recurring charge in the first quarter of 1999 relating
to this management realignment including severance costs and certain related
organizational adjustments. Because a complete plan of management realignment
was not in existence on June 4, 1998, the date of the Company's merger with
Avalon, this charge is not considered a part of the Company's purchase price
for Avalon and, accordingly, the expenses associated with the management
realignment will be treated as a non-recurring charge. Management and the
terminated officers are currently determining the amount of severance that each
terminated officer is entitled to receive pursuant to their employment
agreements and the valuations, if any, that must be performed pursuant to the
terms of their employment agreements. Management is also completing an
evaluation of the additional charge related to the other organizational
changes. However, management currently estimates that the non-recurring charge
that will be incurred in connection with these organizational adjustments,
including severance payments and contract termination costs, costs to relocate
accounting functions and office space reductions, will be approximately $16
million. No assurance can be given as to the amount of such non-recurring charge
which could be greater or less than the estimate provided.
F-27
SCHEDULE III
AVALONBAY COMMUNITIES, INC.
REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 1998
(Dollars in thousands)
F-28
AVALONBAY COMMUNITIES, INC.
REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 1998
(Dollars in thousands)
F-29
AVALONBAY COMMUNITIES, INC.
REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 1998
(Dollars in thousands)
F-30
AVALONBAY COMMUNITIES, INC.
REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 1998
(Dollars in thousands)
Depreciation of AvalonBay Communities, Inc. building, improvements, upgrades
and furniture, fixtures and equipment (FF&E) is calculated over the following
estimated useful lives, on a straight line basis:
Building - 30 years
Improvements, upgrades and FF&E - not to exceed 7 years
The aggregate cost of total real estate for Federal income tax purposes was
approximately $2.9 billion at December 31, 1998.
The changes in total real estate assets for the years ended December 31, 1998,
1997 and 1996 are as follows:
The changes in accumulated depreciation for the years ended December 31, 1998,
1997 and 1996 are as follows:
F-31