10-Q: Quarterly report pursuant to Section 13 or 15(d)
Published on August 16, 1999
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1999
Commission file number 1-12672
AVALONBAY COMMUNITIES, INC.
(Exact name of registrant as specified in its charter)
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Maryland 77-0404318
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2900 Eisenhower Avenue, Suite 300
Alexandria, Virginia 22314
(Address of principal executive offices, including zip code)
(703) 329-6300
(Registrant's telephone number, including area code)
(Former name, if changed since last report)
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding twelve (12) months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past ninety (90) days.
Yes [X] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS
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Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date:
65,091,307 shares outstanding as of August 2, 1999
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AVALONBAY COMMUNITIES, INC.
FORM 10-Q
INDEX
1
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
AVALONBAY COMMUNITIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share data)
The accompanying notes are an integral part of these condensed consolidated
financial statements.
2
AVALONBAY COMMUNITIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Dollars in thousands, except share data)
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
AVALONBAY COMMUNITIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands)
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
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.
During the six months ended June 30, 1998, the Company assumed $10,400 of debt
in connection with acquisitions, issued $3,851 in operating partnership units
for acquisitions, and converted 2,308,800 shares of Series A Preferred Stock and
405,022 shares of Series B Preferred Stock into an aggregate of 2,713,822 shares
of Common Stock.
During the six months ended June 30, 1999, 17,598 units of limited partnership
were presented for redemption to the DownREIT partnership that issued such units
and were acquired by the Company for an equal number of shares of the Company's
Common Stock.
Common and preferred dividends declared but not paid as of June 30, 1999 and
1998 totaled $43,011 and $40,978, respectively.
5
AVALONBAY COMMUNITIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA)
1. Organization and Significant Accounting Policies
Organization and Recent Developments
AvalonBay Communities, Inc. (the "Company," which term is often used to refer to
AvalonBay Communities, Inc. together with its subsidiaries) is a Maryland
corporation that has elected to be taxed as a real estate investment trust
("REIT") under the Internal Revenue Code of 1986, as amended. The Company
focuses on the ownership and operation of 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 June 30, 1999, the Company owned or held an ownership interest in 125
operating apartment communities containing 37,101 apartment homes in sixteen
states and the District of Columbia of which 13 communities containing 4,662
apartment homes were under reconstruction. The Company also owned 12 communities
with 2,710 apartment homes under construction and rights to develop an
additional 31 communities that will contain an estimated 8,939 apartment homes.
During the second quarter of 1999, three new development communities, Rosewalk
at Waterford Park II and Avalon on the Alameda (both located in the San Jose,
California area) and Avalon Oaks (located in the Boston, Massachusetts area)
were completed containing 665 apartment homes for a total investment of $99,500.
One redevelopment community, Avalon Westhaven, was completed during the second
quarter of 1999 for a total investment in redevelopment of $3,400. This
community contains 190 apartment homes and is located in the Seattle, Washington
area.
The development of two new communities (located in the Boston, Massachusetts and
Northern New Jersey areas) commenced during the second quarter of 1999. These
two communities are expected to contain a total of 424 apartment homes upon
completion with a projected total investment of $62,400.
The redevelopment of two existing communities (located in the Chicago, Illinois
and Orange County, California areas) commenced during the second quarter of
1999. The total projected investment in redevelopment for these communities,
which contain 694 apartment homes, is $13,600.
During the second quarter of 1999, the Company disposed of five communities in
the Mid-Atlantic region. The net proceeds from the sale of these communities,
which contained a total of 1,536 apartment homes, were approximately $104,200
resulting in a net gain of approximately $225. The proceeds will be re-deployed
to development and redevelopment communities. Pending such redeployment, the
proceeds from the sale of these communities were primarily used to repay amounts
outstanding under the Company's variable rate unsecured credit facility (the
"Unsecured Facility") or deposited in escrow accounts to facilitate Section 1031
exchange transactions.
The interim unaudited financial statements have been prepared in accordance with
generally accepted accounting principles ("GAAP") for interim financial
information and in conjunction with the rules and
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regulations of the Securities and Exchange Commission. Certain information and
footnote disclosures normally included in financial statements required by GAAP
have been condensed or omitted pursuant to such rules and regulations. These
unaudited financial statements should be read in conjunction with the financial
statements and notes included in the Company's Annual Report on Form 10-K for
the year ended December 31, 1998. The results of operations for the three and
six months ended June 30, 1999 are not necessarily indicative of the operating
results for the full year. Management believes the disclosures are adequate to
make the information presented not misleading. In the opinion of Management, all
adjustments and eliminations, consisting only of normal, recurring adjustments
necessary for a fair presentation of the financial statements for the interim
periods have been included.
Principles of Consolidation
The accompanying condensed consolidated financial statements include the
accounts of the Company and its wholly-owned partnerships as well as four
subsidiary partnerships structured as DownREITs. In each of the four
partnerships structured as DownREITs, the Company (or one of its wholly-owned
subsidiaries) 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. Although the partnership agreements for each of the DownREITs are
different, currently the Stated Distributions that are paid in respect of the
DownREIT Units in general approximate the dividend rate applicable to shares of
Common Stock of the Company. Each DownREIT partnership has been structured in a
manner that makes it unlikely that the limited partners 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. In lieu of a cash redemption of a Unit, the Company may acquire
any Unit presented for redemption for one share of Common Stock. All significant
intercompany balances and transactions have been eliminated in consolidation.
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 their development, redevelopment and acquisition.
Expenditures for maintenance and repairs are charged to operations as incurred.
The capitalization of costs during the development of assets (including interest
and related loan fees, property taxes and other direct and indirect costs)
begins when active development commences and ends when the asset is delivered
and a final certificate of occupancy is issued. Cost capitalization during
redevelopment of assets (including interest and related loan fees, property
taxes and other direct and indirect costs) begins when an apartment home is
taken out-of-service for redevelopment and ends when the apartment home
redevelopment is completed and the apartment home is placed in-service. The
Company increased the West Coast portfolio's threshold for capitalization of
community improvements from $5,000 per occurrence to $15,000 per occurrence
effective January 1, 1999, in order to conform to the Company-wide threshold for
capitalization of community improvements. The accompanying condensed
consolidated financial statements include a charge to expense for unrecoverable
deferred development costs related to pre-development communities that are
unlikely to be developed.
Depreciation is calculated on buildings and improvements using the straight-line
method over their estimated useful lives, which range from seven to thirty
years. Furniture, fixtures and equipment are generally depreciated using the
straight-line method over their estimated useful lives, which range from three
years, for computers, to seven years.
7
Lease terms for apartment homes are generally one year or less. Rental income
and operating costs incurred during the initial lease-up or post-redevelopment
lease-up period are fully recognized as they accrue.
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 three and six months ended June 30, 1999 and
1998 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
three and six months ended June 30, 1999 and 1998 are as follows:
Use of Estimates
The preparation of financial statements in conformity with GAAP requires
management to make certain estimates and assumptions. These estimates and
assumptions affect the reported amounts of assets and liabilities and disclosure
of contingent assets and liabilities at the dates of the financial statements
and the reported amounts of revenue and expenses during the reporting periods.
Actual results could differ from those estimates.
Reclassifications
Certain reclassifications have been made to amounts in prior years' financial
statements to conform with current year presentations.
Newly Issued Accounting Standards
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities." This
pronouncement establishes accounting and reporting standards requiring that
every derivative instrument be recorded 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. In June 1999, the Financial Accounting
Standards Board issued SFAS No. 137, "Accounting for Derivative Instruments and
Hedging Activities Deferral of the Effective date of SFAS No. 133." SFAS No. 137
delays the effective date of SFAS No. 133 for one year, to fiscal years
beginning after June 15, 2000. The Company currently plans to
8
adopt this pronouncement effective January 1, 2001, 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.
As part of the fair value adjustment discussed above, management made certain
estimates related to individual community real estate asset values. Subsequent
to the Merger, the Company sold several assets previously owned by Avalon, which
would have resulted in the recognition of material gains prior to the Merger,
but resulted in no gain due to each asset's fair value allocation.
3. Interest Capitalized
Capitalized interest associated with projects under development or redevelopment
totaled $5,866 and $3,561 for the three months ended June 30, 1999 and 1998,
respectively, and $13,149 and $6,525 for the six months ended June 30, 1999 and
1998, 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:
Mortgage 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 4.7% at June 30,
1999. The weighted average interest rate of fixed rate notes (conventional and
tax-exempt) was 6.8% at June 30, 1999.
9
The maturity schedule for the Company's unsecured senior notes consists of the
following:
Year of
Maturity Principal Interest Rate
-------- --------- -------------
2002 $ 100,000 7.375%
2003 $ 50,000 6.25%
$ 100,000 6.5%
2004 $ 125,000 6.58%
2005 $ 100,000 6.625%
$ 50,000 6.5%
2006 $ 150,000 6.8%
2007 $ 110,000 6.875%
2008 $ 50,000 6.625%
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.
The Company's $600,000 Unsecured Facility is 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 stated pricing is LIBOR plus .6% per annum.
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 (which allows banks that are part of the lender consortium to bid to
make loans to the Company at a rate that is lower than the stated rate provided
by the Unsecured Facility) for up to $400,000. The Company is subject to certain
customary covenants under the Unsecured Facility, including, but not limited to,
maintaining certain maximum leverage ratios, a minimum fixed charges coverage
ratio, minimum unencumbered assets and equity levels and restrictions on paying
dividends in amounts that exceed 95% of the Company's Funds from Operations, as
defined therein. The Unsecured Facility matures in July 2001 and has two,
one-year extension options.
5. Stockholders' Equity
The following summarizes the changes in stockholders' equity for the six months
ended June 30, 1999:
10
During the six months ended June 30, 1999, the Company issued 406,827 Common
Stock shares in connection with stock options exercised (the majority of which
related to the organization changes announced in February 1999), 421,994 shares
through the Company's Dividend Reinvestment Plan, 17,598 shares that were
issued to acquire operating partnership units from third parties, 14,846 shares
in connection with the Company's Employee Stock Purchase Plan and 97,479
shares in connection with restricted stock grants.
6. Investments in Unconsolidated Joint Ventures
In connection with the Merger, the Company succeeded to certain investments in
unconsolidated joint ventures. At June 30, 1999, these investments consisted of
a 50% general partnership interest in Falkland Partners, a 49% general
partnership interest in Avalon Run and a 50% general partnership interest in
Avalon Grove. 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 operating results of these joint
ventures for the periods presented (which includes the periods prior to the
Merger):
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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. 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
sold seven communities in connection with this disposition strategy in 1998, and
six communities during the first six months of 1999. Management intends to have
additional selected assets actively marketed for sale during 1999. However,
there can be no assurance that such assets can be sold, or that such sales will
prove to be beneficial to the Company.
The communities sold during the first six months of 1999 and the respective
sales price and net proceeds are summarized below:
The assets targeted for sale include land, buildings and improvements and
furniture, fixtures and equipment, and are recorded at the lower of cost or fair
value less estimated selling costs. The Company has not recognized a write down
in its real estate to arrive at net realizable value. At June 30, 1999, total
real estate, net of accumulated depreciation, subject to sale totaled $136,442.
Certain individual assets are secured by mortgage indebtedness which may be
assumed by the purchaser or repaid by the Company from the net sales proceeds.
The Company's condensed consolidated statements of operations include net income
of the communities held for sale of $2,537 and $397 for the three months ended
June 30, 1999 and 1998, respectively, and $3,019 and $717 for the six months
ended June 30, 1999 and 1998, respectively. Depreciation expense on these
assets, which was not recognized subsequent to the date of held-for-sale
classification, totaled $1,301 and $2,606 for the three and six months ended
June 30, 1999, respectively.
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8. 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:
- - Stable Communities are communities that 1) have attained stabilized
occupancy levels (at least 95% occupancy) and operating costs since the
beginning of the prior calendar year (these communities are also known as
Established Communities); or 2) were acquired 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.
Net Operating Income for each community is generally equal to that community's
contribution to Funds from Operations ("FFO"), except that interest expense
related to indebtedness secured by an individual community and depreciation and
amortization on non-real estate assets are not included in the community's NOI
although such expenses decrease the Company's consolidated net income and FFO.
13
The segments are classified based on the individual community's status as of the
beginning of the given calendar year. Therefore, each year the composition of
communities within each business segment is adjusted. Accordingly, the amounts
between years are not directly comparable.
In addition to reporting segments based on the above property types, the Company
previously reported results within these segments based on the West and East
Coast geographic areas. This disclosure was provided as the West and East Coast
geographic areas substantially reflected the operating communities of Bay and
Avalon, respectively, prior to the Merger. Management currently reviews its
operating segments by geographic regions, including Northern and Southern
California, Pacific Northwest, Northeast, Mid-Atlantic and Midwest regions.
These individual regions contain similar economic characteristics and also meet
the other criteria which permit the regions to be aggregated into one reportable
region.
The accounting policies applicable to the operating segments described above are
the same as those described in the summary of significant accounting policies in
the Company's Form 10-K.
Operating expenses as reflected on the Condensed Consolidated Statements of
Operations include $6,349 and $2,843 for the three months ended June 30, 1999
and 1998, respectively, and $12,037 and $4,010 for the six months ended June 30,
1999 and 1998 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
Condensed Consolidated Balance Sheets is net of $6,535 of accumulated
depreciation as of June 30, 1999.
14
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 operating
information for the Company is presented on the following page on a pro forma
basis (unaudited) assuming the Merger had occurred as of January 1, 1998.
9. Subsequent Events
During July 1999, the Company sold The Pointe, a 296 apartment home community
located in the Napa/Solono Valley, California area. The net proceeds of
approximately $23,900 from the sale of the community were deposited into an
escrow account to facilitate a like-kind exchange transaction.
During July 1999, the Company purchased Avalon at Woodbury, a 224 apartment home
community located in the Minneapolis, Minnesota area for approximately $26,000
pursuant to a presale agreement signed in 1997 with an unaffiliated company.
During July 1999, the Company issued $150,000 of unsecured notes. The notes bear
interest at 7.50% per annum and will mature August 1, 2009. The net proceeds of
approximately $148,400 to the Company were used to reduce amounts outstanding
under the Company's Unsecured Facility.
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PART I. FINANCIAL INFORMATION (CONTINUED)
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Forward-Looking Statements
This Form 10-Q, including the footnotes to the Company's condensed consolidated
financial statements, contains "forward-looking statements" as that term is
defined under the Private Securities Litigation Reform Act of 1995. You can
identify forward-looking statements by our use of the words "believe," "expect,"
"anticipate," "intend," "estimate," "assume," and other similar expressions in
this Form 10-Q, that predict or indicate future events and trends and that do
not relate to historical matters. We cannot assure the future results or outcome
of the matter described in these statements; rather, these statements merely
reflect our current expectations of the approximate outcome of the matter
discussed. In addition, information concerning the following are forward-looking
statements:
- the completion, and the timing and cost of completion, of apartment
communities under construction, reconstruction, development or
redevelopment;
- the timing of lease-up and occupancy of apartment communities;
- the pursuit of communities which we are considering for future
development;
- cost, yield and earnings estimates; and
- the timing and effectiveness of Year 2000 compliance.
You should not rely on forward-looking statements since they involve known and
unknown risks, uncertainties and other factors, some of which are beyond our
control. These risks, uncertainties and other factors may cause our actual
results, performance or achievements to differ materially from the anticipated
future results, performance or achievements expressed or implied by such
forward-looking statements. Some of the factors that could cause our actual
results, performance or achievements to differ materially from those expressed
or implied by such forward-looking statements include, but are not limited to,
the following:
- we may be unsuccessful in managing our current growth in the number of
apartment communities and the related growth of our business
operations;
- our previous or possible future expansion into new geographic market
areas may not produce financial results that are consistent with our
historical performance;
- we may abandon or fail to secure development opportunities;
- construction costs of a community may exceed our original estimates;
- construction and lease-up of communities under development or
redevelopment may not be completed on schedule, resulting in increased
interest 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 our control;
- financing may not be available on favorable terms and our cash flow
from operations and access to cost effective capital may be
insufficient for the development of our pipeline and could limit our
pursuit of opportunities;
- our cash flow may be insufficient to meet required payments of
principal and interest, and we may be unable to refinance existing
indebtedness or the terms of such refinancing may not be as favorable
as the terms of existing indebtedness;
- we may, with our suppliers and service providers, experience
unanticipated delays or expenses in achieving Year 2000 compliance.
You should read our unaudited condensed consolidated financial statements and
notes included in this report and the audited financial statements for the year
ended December 31, 1998 and the notes included in our annual report on Form 10-K
in conjunction with the following discussion. These forward looking
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statements represent our estimates and assumptions only as of the date of this
report, and we do not undertake to update these forward looking statements.
General
AvalonBay is a Maryland corporation that elected to be treated as a real estate
investment trust ("REIT") for federal income tax purposes. We focus on the
ownership and operation of institutional-quality apartment communities in high
barrier-to-entry markets of the United States. This is because we believe that
the limited new supply of apartment homes in these markets helps assure more
predictable cash flows. These barriers-to-entry include a difficult and lengthy
entitlement process with local jurisdictions and dense infill locations where
zoned and entitled land is not available. 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. AvalonBay is the surviving
corporation from the merger of Avalon Properties, Inc. ("Avalon") with and into
Bay Apartment Communities, Inc. ("Bay") 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.
We are a fully-integrated real estate organization with in-house expertise in
the following areas:
- acquisition;
- development and redevelopment;
- construction and reconstruction;
- financing;
- marketing;
- leasing and management; and
- information technologies.
With our experience and in-house capabilities, we believe we are well-positioned
to continue to pursue opportunities to develop and acquire upscale apartment
homes in our target markets. Our ability to pursue attractive opportunities may
be constrained by capital market conditions that limit the availability of cost
effective capital to finance these activities. We have acquired fewer
communities in 1999 than in prior years due to these capital constraints, and
expect to direct most of our invested capital to new developments for the
forseeable future.
We believe apartment communities present an attractive investment opportunity
compared to other real estate investments because a broad potential resident
base results in relatively stable demand during all phases of a real estate
cycle. We intend to pursue appropriate new investments, including both new
developments and acquisitions of communities, in markets where constraints to
new supply exist and where new household formations have out-paced multifamily
permit activity in recent years.
Our real estate investments as of August 2, 1999 consist primarily of stabilized
operating apartment communities and communities in various stages of the
development cycle and land or land options held for development. We classify
these investments into the following categories:
17
(*) Represents an estimate
Current Communities are apartment communities where construction is
complete and the community has reached stabilized occupancy (at least 95%
occupied or completed for one year), is in the initial lease-up process or
is under redevelopment. Current Communities consist of the following:
Stabilized Communities. Represents all Current Communities that have
completed initial lease-up by attaining physical occupancy levels of
at least 95% or have been completed for one year, whichever occurs
earlier. Stabilized Communities are categorized as either Established
Communities or Other Stabilized Communities.
- Established Communities. Represents all Stabilized Communities
owned by Bay (or, on a pro forma basis, by Avalon which we
subsequently acquired in connection with the merger) as of
January 1, 1998, with stabilized operating costs as of January 1,
1998 such that a comparison of 1998 operating results to 1999
operating results is meaningful. Each of the Established
Communities falls into one of six geographic areas including
Northern California, Southern California, Mid-Atlantic, Northeast
and Midwest regions. At June 30, 1999, there were no Established
Communities in the Pacific Northwest.
- Other Stabilized Communities. Represents Stabilized Communities
as defined above, but which became stabilized or were acquired
after January 1, 1998.
18
Lease-Up Communities. Represents all communities where construction
has been complete for less than one year and where occupancy of at
least 95% has not been reached.
Redevelopment Communities. Represents all communities where
substantial redevelopment has either begun or is scheduled to begin.
Redevelopment is considered substantial when capital invested during
the reconstruction effort exceeds the lesser of $5 million or 10% of
the community's acquisition cost.
Development Communities are communities that are under construction and for
which a final certificate of occupancy has not been received. These
communities may be partially complete and operating.
Development Rights are development opportunities in the early phase of the
development process for which we have an option to acquire land or where we
own land to develop a new community. We capitalize all related
pre-development costs incurred in pursuit of these new developments.
Of the Current Communities, we own:
- a fee simple ownership interest in 107 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.
We hold a fee simple ownership interest in each of the Development Communities
except for two communities that are owned by partnerships in which we hold a
general partnership interest.
In each of the four partnerships structured as DownREITs, we (or one of our
wholly-owned subsidiaries) are the general partner and there are one or more
limited partners whose interest in the partnership is represented by units of
limited partnership interest. For each DownREIT partnership, limited partners
are entitled to receive certain distributions before any distribution is made to
the general partner. Although the partnership agreements for each of the
DownREITs are different, generally the distributions paid to the holders of
units of limited partnership interests approximate the current AvalonBay common
stock dividend rate. Each DownREIT partnership has been structured such that it
is unlikely that the limited partners will be entitled to a distribution greater
than that stated in the partnership agreement. The holders of units of limited
partnership interest have the right to present each unit of limited partnership
interest for redemption for cash equal to the fair market value of a share of
AvalonBay common stock on the date of redemption. In lieu of a cash redemption
of a unit, we may acquire any unit presented for redemption for one share of
common stock. As of August 2, 1999, there were 876,546 units outstanding. The
DownREIT partnerships are consolidated for financial reporting purposes.
At June 30, 1999, we had positioned our portfolio of Stabilized Communities,
excluding communities owned by joint ventures, to an average physical occupancy
level of 96.1%. The Established Communities had achieved an average economic
occupancy of 96.2% for the three and six months ended June 30, 1999. Average
economic occupancy for the Established Communities for the three months ended
June 30, 1998 was 97.1% and for the six months ended June 30, 1998 was 96.8%.
Our aggressive marketing efforts combined with limited and targeted pricing
adjustments are responsible for this continued high occupancy. This positioning
has resulted in overall growth in rental revenue from Established Communities
between
19
periods. Our strategy is to maximize total rental revenue through management of
rental rates and occupancy levels. If market and economic conditions change, our
strategy of maximizing total rental revenue could lead to lower occupancy
levels. Given the current high occupancy level of our portfolio, we believe that
any rental revenue and net income gains from our Established Communities would
be achieved primarily through higher rental rates and the lower average
operating costs per apartment home that result from high occupancy.
We elected to be taxed as a REIT for federal income tax purposes for the year
ended December 31, 1994 and we have not revoked that election. The Company was
incorporated under the laws of the State of California in 1978, and we were
reincorporated in the State of Maryland in July 1995. Our principal executive
offices are located at 2900 Eisenhower Avenue, Suite 300, Alexandria, Virginia
22314, and our telephone number at that location is (703) 329-6300. We also
maintain regional offices and administrative or specialty offices in or near the
following metropolitan areas:
- San Jose, California
- Wilton, Connecticut
- Boston, Massachusetts;
- Chicago, Illinois;
- Minneapolis, Minnesota;
- New York, New York;
- Newport Beach, California;
- Los Angeles, California;
- Princeton, New Jersey; and
- Seattle, Washington.
Recent Developments
Sales of Existing Communities. During 1998, we completed a strategic planning
effort that resulted in our decision to increase our concentration in selected
high barrier-to-entry markets where we believe we can:
- bring sufficient market and management presence to enhance revenue
growth;
- reduce operating expenses;
- and leverage management talent.
To affect this concentration, we are selling assets in markets that have few
high barrier characteristics. Accordingly, we sold five communities, totaling
1,536 apartment homes during the second quarter of 1999. Net proceeds from these
sales totaled $104,200,000 resulting in a net gain of $225,000. We sold one
additional community, The Pointe, a 296 apartment home community located in the
Napa/Solono Valley, California area, in July 1999 in connection with our
disposition strategy. The net proceeds from the sale of this community were
approximately $23,900,000. We intend to redeploy the proceeds from sales to
develop and redevelop communities currently under construction or
reconstruction. Pending such redeployment, the proceeds from the sale of these
communities will be used to repay amounts outstanding under our variable rate
unsecured credit facility or deposited in escrow accounts to facilitate
like-kind exchange transactions.
Community Acquisition. We acquired one community, Avalon at Woodbury, during
July 1999 for approximately $26,000,000 pursuant to a presale agreement signed
in 1997 with an unaffiliated company. The community contains 224 apartment
homes, and is located in the Minneapolis, Minnesota area.
Commencement and Completion of Development Communities. During the second
quarter of 1999, we began development of two new communities that will contain
424 apartment homes. These communities are located in the Boston,
Massachusetts and Northern New Jersey areas. The land parcels were acquired
for a total purchase price of $11,280,000, and the total projected investment
in the two communities (including the land acquisition costs) is projected to
be approximately $62,400,000.
During the second quarter of 1999, three new development communities, Rosewalk
at Waterford Park II and Avalon on the Alameda (both located in the San Jose,
California area) and Avalon Oaks (located in the Boston, Massachusetts area)
were completed containing 665 apartment homes for a total investment of
$99,500,000.
Commencement and Completion of Redevelopment Communities. The redevelopment of
two existing communities (located in the Chicago, Illinois and Orange County,
California areas) commenced during the second quarter of 1999. The total
projected investment in redevelopment for these communities, which contain 694
apartment homes, is $13,600,000.
One redevelopment community, Avalon Westhaven, was completed during the second
quarter of 1999 for a total investment in redevelopment of $3,400,000. This
community contains 190 apartment homes and is located in the Seattle,
Washington area.
20
The development and redevelopment of communities involves risks that the
investment will fail to perform in accordance with expectations. See "Risks of
Development and Redevelopment" for our discussion of these and other risks
inherent in developing new communities.
Results of Operations
Historically, the changes in our operating results from period-to-period have
been primarily the result of increases in the number of apartment homes owned.
Where appropriate, period-to-period comparisons of the number of occupied
apartment homes are made on a weighted average basis to adjust for changes in
the number of apartment homes during the period. For Stabilized Communities,
excluding communities owned by joint ventures, all occupied apartment homes are
included in the calculation of weighted average occupied apartment homes for
each reporting period. For communities in the initial lease-up phase, only
apartment homes of communities that are completed and occupied are included in
the weighted average number of occupied apartment homes calculation for each
reporting period.
The analysis that follows compares our operating results for the three and six
months ended June 30, 1999 and June 30, 1998.
Net income available to common stockholders increased $10,470,000 (76.2%) to
$24,218,000 for the three months ended June 30, 1999 compared to $13,748,000 for
the comparable period of the preceding year. Net income available to common
stockholders increased $11,382,000 (50.1%) to $34,080,000 for the six months
ended June 30, 1999 compared to $22,698,000 for the comparable period of the
preceding year. Excluding non-recurring charges and gain on sale of communities,
net income available to common stockholders, as adjusted, increased by
$10,311,000 for the three months ended June 30, 1999 and $22,668,000 for the six
months ended June 30, 1999 from the comparable periods of 1998. The primary
reason for the increases in net income, as adjusted, is additional operating
income from the communities we acquired in the merger. The increases are also
attributable to additional operating income from communities developed or
acquired during 1998 and the first six months of 1999 as well as growth in
operating income from Established Communities.
Rental income increased $52,174,000 (74.5%) to $122,242,000 for the three months
ended June 30, 1999 compared to $70,068,000 for the comparable period of the
preceding year. Rental income increased $124,962,000 (108.2%) to $240,433,000
for the six months ended June 30, 1999 compared to $115,471,000 for the
comparable period of the preceding year. Of the six month increase, $1,202,000
relates to rental revenue increases from Established Communities and
$123,760,000 relates to rental revenue attributable to newly developed,
redeveloped or acquired apartment homes, of which $61,649,000 relates to rental
revenue attributable to communities acquired in connection with the merger.
Overall Portfolio - The $124,962,000 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 17,820 apartment homes for the six months ended June 30,
1998 to 34,145 apartment homes for the six months ended June 30, 1999 as a
result of additional apartment homes from the former Avalon communities and
the development, redevelopment and acquisition of new communities. For the
six months ended June 30, 1999, the weighted average monthly revenue per
occupied apartment home increased $97 (9.0%) to $1,172 compared to $1,075
for the comparable period of the preceding year.
Established Communities (on a pro forma basis, assuming the merger had
occurred on January 1, 1998) - Rental revenue increased $2,460,000 (4.0%)
for the three months ended June 30, 1999
21
compared to the comparable period of the preceding year. Rental revenue
increased $5,201,000 (4.2%) for the six months ended June 30, 1999 compared
to the comparable period of the preceding year. The increases are due to
market conditions that allowed for higher average rents, but lower economic
occupancy levels. For the six months ended June 30, 1999, weighted average
monthly revenue per occupied apartment home increased $57 (4.8%) to $1,201
compared to $1,144 for the comparable period of the preceding year. The
average economic occupancy decreased from 96.8% for the six months ended
June 30, 1998 to 96.2% for the six months ended June 30, 1999. We believe
that, beginning in October 1998, the Northern California sub-markets that
are primarily dependent on Silicon Valley employment have softened. These
sub-markets have experienced reduced rent growth and occupancy compared
to other Northern California sub-markets.
Established Communities on a pro forma basis include the Established
Communities as well as the communities owned by Avalon at January 1, 1998
with stabilized occupancy levels and operating costs as of that date, so
that a comparison of 1998 operating results to 1999 operating results is
meaningful. Established Communities on a pro forma basis include
communities located in the Northeast, Mid-Atlantic and Midwest in addition
to those communities located in Northern California and Southern
California.
Management fees increased $199,000 to $314,000 for the three months
ended June 30, 1999 compared to $115,000 for the comparable period of the
preceding year. Management fees increased $538,000 to $653,000 for the
six months ended June 30, 1999 compared to $115,000 for the comparable period of
the preceding year. Management fees represent revenue from third-party contracts
to which we succeeded in the merger.
Operating expenses increased $13,682,000 (71.5%) to $32,817,000 for the three
months ended June 30, 1999 compared to $19,135,000 for the comparable period of
the preceding year. These expenses increased $34,742,000 (114.0%) to $65,218,000
for the six months ended June 30, 1999 compared to $30,476,000 for the
comparable period of the preceding year.
Overall Portfolio - The increase in operating expenses for the three and
six months ended June 30, 1999 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.
Established Communities, on a pro forma basis, assuming the merger had
occurred on January 1, 1998 - Operating expenses increased $512,000 (4.2%)
to $12,730,000 for the three months ended June 30, 1999 compared to
$12,218,000 for the comparable period of the preceding year. These expenses
increased $1,210,000 (5.0%) to $25,261,000 for the six months ended June
30, 1999 compared to $24,051,000 for the comparable period of the preceding
year. The net changes are the result of higher administrative and
maintenance costs, offset by lower utility and insurance costs.
Property taxes increased $5,451,000 (96.7%) to $11,090,000 for the three months
ended June 30, 1999 compared to $5,639,000 for the comparable period of the
preceding year. Property taxes increased $12,354,000 (131.5%) to $21,747,000 for
the six months ended June 30, 1999 compared to $9,393,000 for the comparable
period of the preceding year.
Overall Portfolio - The increases for the three and six months ended June
30, 1999 are primarily due to additional expense from the former Avalon
communities and secondarily due to the
22
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.
Established Communities, on a pro forma basis, assuming the merger had
occurred on January 1, 1998 - Property taxes increased $84,000 (1.6%) to
$5,323,000 for the three months ended June 30, 1999 compared to $5,239,000
for the comparable period of the preceding year. Property taxes increased
$342,000 (3.3%) to $10,807,000 for the six months ended June 30, 1999
compared to $10,465,000 for the comparable period of the preceding year.
The increases are primarily the result of increased assessments of property
values and increased property tax rates in the Northeast and Mid-Atlantic
regions.
Interest expense increased $7,462,000 (66.9%) to $18,612,000 for the three
months ended June 30, 1999 compared to $11,150,000 for the comparable period of
the preceding year. Interest expense increased $17,588,000 (101.3%) to
$34,949,000 for the six months ended June 30, 1999 compared to $17,361,000 for
the comparable period of the preceding year. The increases are primarily
attributable to debt assumed in connection with the merger and the issuance of
unsecured notes in 1998 and 1999, offset by an increase in capitalized interest.
The increase in capitalized interest is due to an increase in the number of
apartment homes under construction or reconstruction.
Depreciation and amortization increased $11,341,000 (77.7%) to $25,938,000 for
the three months ended June 30, 1999 compared to $14,597,000 for the comparable
period of the preceding year. Depreciation and amortization increased
$28,937,000 (118.1%) to $53,441,000 for the six months ended June 30, 1999
compared to $24,504,000 for the comparable period of the preceding year. These
increases are primarily attributable to additional expense from the former
Avalon communities and secondarily to acquisitions, development and
redevelopment of communities in 1998 and 1999.
General and administrative expenses increased $598,000 (33.6%) to $2,376,000 for
the three months ended June 30, 1999 compared to $1,778,000 for the comparable
period of the preceding year. General and administrative expenses increased
$1,796,000 (60.9%) to $4,743,000 for the six months ended June 30, 1999 compared
to $2,947,000 for the comparable period of the preceding year. These increases
are primarily due to costs incurred to support our current portfolio as a result
of the merger.
Equity in income of unconsolidated joint ventures increased $442,000 to
$680,000 for the three months ended June 30, 1999 compared to $238,000 for the
comparable period of the preceding year and increased $1,168,000 to $1,406,000
for the six months ended June 30, 1999 compared to $238,000 for the comparable
period of the preceding year. Equity in income of unconsolidated joint ventures
represents our share of income of joint ventures that we succeeded to in
connection with the merger.
Interest income increased $1,397,000 to $1,757,000 for the three months ended
June 30, 1999 compared to $360,000 for the comparable period of the preceding
year. Interest income increased $2,955,000 to $3,422,000 for the six months
ended June 30, 1999 compared to $467,000 for the comparable period of the
preceding year. These increases are primarily due to the interest on the Avalon
Arbor promissory note that we succeeded to in connection with the merger and on
the Fairlane Woods promissory note acquired in August 1998.
23
Capitalization of Fixed Assets and Community Improvements
Our policy with respect to capital expenditures 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.
Effective January 1, 1999, we increased the West Coast portfolio's threshold for
capitalization of community improvements from $5,000 per occurrence to $15,000
per occurrence. This increase was necessary in order to conform our West Coast
portfolio to our company-wide threshold for capitalization of community
improvements. Under this policy, virtually all capitalized costs are
non-recurring, and recurring make-ready costs are expensed as incurred.
Recurring make-ready costs include the following:
- carpet and appliance replacements;
- floor coverings;
- interior painting; and
- other redecorating costs.
We capitalize purchases of personal property, such as computers and furniture,
only if the item is a new addition and the item exceeds $2,500. Purchases of
personal property made for replacement purposes are expensed. The application of
these policies for the six months ended June 30, 1999 resulted in non-revenue
generating capitalized expenditures for Stabilized Communities of approximately
$75 per apartment home. For the six months ended June 30, 1999, we charged to
maintenance expense, including carpet and appliance replacements, a total of
approximately $15,350,000 for Stabilized Communities or $511 per apartment home.
We anticipate that capitalized costs per apartment home will gradually rise as
our portfolio of communities matures.
Liquidity and Capital Resources
Liquidity. A primary source of liquidity is our cash flows from operations.
Operating cash flows have historically been determined by:
- the number of apartment homes;
- rental rates;
- occupancy levels; and
- our expenses with respect to these apartment homes.
The timing, source and amount of cash flows provided by financing activities and
used in investing activities have historically been sensitive to the capital
markets environment. Thus, changes in the capital markets environment will
affect our plans for the undertaking of construction and development as well as
acquisition activity.
Cash and cash equivalents decreased from $15,060,000 at June 30, 1998 to
$14,610,000 at June 30, 1999 due to a decrease in 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 $38,542,000 from
$72,767,000 for the six months ended June 30, 1998 to $111,309,000 for the
six months ended June 30, 1999. The increase is due to the addition of the
former Avalon communities as well as an increase in operating income of the
existing Bay communities.
24
Cash used in investing activities decreased by $119,877,000 from
$272,863,000 for the six months ended June 30, 1998 to $152,986,000 for the
six months ended June 30, 1999. This decrease in expenditures reflects
decreased acquisition activity and proceeds from the sale of six
communities in the six months ended June 30, 1999 offset by increased
construction and reconstruction activity. The decrease in acquisition
activity is attributable to a lack of available properties that meet our
yield requirements combined with a decrease in the availability of
cost-effective capital.
Net cash provided by financing activities decreased by $164,571,000 from
$211,968,000 for the six months ended June 30, 1998 to $47,392,000 for the
six months ended June 30, 1999. The decrease is primarily due to decreased
borrowings under our unsecured facility and an increase in dividends paid
as a result of additional common and preferred shares issued in connection
with the merger as well as reduced capital markets activity in response to
market conditions.
We review regularly our short and long-term liquidity needs and the adequacy of
Funds from Operations (as defined below) and other expected liquidity sources to
meet these needs. We believe our principal short-term liquidity needs are to
fund:
- normal recurring operating expenses;
- debt service payments;
- the distributions required with respect to our series of preferred
stock; and
- the minimum dividend payments required to maintain our REIT
qualification under the Internal Revenue Code of 1986.
We anticipate 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 will be funded from our unsecured facility.
We believe our principal long-term liquidity needs are the repayment of medium
and long-term debt, as well as the procurement of long-term debt to refinance
construction and other development related short-term debt. We anticipate that
no significant portion of the principal of any indebtedness will be repaid prior
to maturity. If we do not have funds on hand sufficient to repay our
indebtedness, it will be necessary for us to refinance this debt. This
refinancing may be accomplished through additional debt financing, which may be
collateralized by mortgages on individual communities or groups of communities,
by uncollateralized private or public debt offerings or by additional equity
offerings. We also anticipate having significant retained cash flow in each year
so that when a debt obligation matures, a portion of each maturity can be
satisfied from this retained cash. Although we believe we are well positioned
and that we will have the capacity to meet our long-term liquidity needs, we
cannot assure you that additional debt financing or debt or equity offerings
will be available or, if available, that they will be on terms we consider
satisfactory.
Capital Resources. We intend to match the long-term nature of our real estate
assets with long-term cost effective capital. We follow a focused strategy to
help facilitate uninterrupted access to capital. This strategy includes:
1. Hiring, training and retaining associates with a strong resident service
focus, which should lead to higher rents, lower turnover and reduced
operating costs;
2. Managing, acquiring and developing institutional quality communities with
in-fill locations that should provide consistent, sustained earnings
growth;
25
3. Operating 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 we believe 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. Maintaining a conservative capital structure largely comprised of equity
and with modest, cost-effective leverage. We generally avoid secured debt
except in order to obtain low cost, tax-exempt debt. We believe that such a
structure should promote an environment whereby current ratings levels can
be maintained;
5. Following accounting practices that provide a high level of quality to
reported earnings; and
6. Providing timely, accurate and detailed disclosures to the investment
community.
We believe these strategies provide a disciplined approach to capital access to
help position AvalonBay to fund portfolio growth.
Recent volatility in the capital markets has decreased our access to cost
effective capital. See "Future Financing and Capital Needs" for a discussion of
our response to the current capital markets environment.
The following is a discussion of specific capital transactions, arrangements and
agreements that are important to our capital resources.
Unsecured Facility
Our unsecured facility is furnished by a consortium of banks that provides
$600,000,000 in short-term credit. We pay these banks an annual facility fee of
$900,000 in equal quarterly installments. The unsecured facility bears interest
at varying levels tied to the London Interbank Offered Rate based on ratings
levels achieved on our senior unsecured notes and on a maturity selected by us.
The current stated pricing is LIBOR plus .6% per annum. The unsecured facility
matures in July 2001, although we have two options to extend the credit facility
for one-year periods. Therefore, subject to certain conditions, we may extend
the maturity to July 2003. A competitive bid option is available for up to
$400,000,000. This option allows banks that are part of the lender consortium to
bid to give us loans at a rate that is lower than the stated pricing provided by
the unsecured facility. The competitive bid option may result in lower pricing
if market conditions allow. Pricing under the competitive bid option resulted in
average pricing of LIBOR plus .53% for balances most recently placed under the
competitive bid option. At August 2, 1999, $240,500,000 was outstanding,
$71,892,000 was used to provide letters of credit and $287,608,000 was available
for borrowing under the unsecured facility. We intend to use borrowings under
the unsecured facility for:
- capital expenditures;
- construction, development and renovation costs;
- acquisitions of developed or undeveloped communities;
- credit enhancement for tax-exempt bonds; and
- working capital purposes.
Interest Rate Protection Agreements
We are not a party to any long-term interest rate agreements, other than
interest rate protection and swap agreements on certain tax-exempt indebtedness.
We intend, however, to evaluate the need for long-term interest rate protection
agreements as interest rate market conditions dictate, and we have engaged a
consultant to assist in managing our interest rate risks and exposure.
26
Financing Commitments/Transactions Completed
Although there was no capital markets activity in the second quarter of 1999, we
issued $150,000,000 of unsecured notes in July 1999 that bear interest at 7.50%
per annum and will mature August 1, 2009. The net proceeds of approximately
$148,400,000 was used to repay amounts outstanding under our unsecured facility.
Future Financing and Capital Needs
As of June 30, 1999, we had 22 new communities under construction either by us
or by unaffiliated third parties with whom we have entered into forward purchase
commitments. As of June 30, 1999, a total estimated cost of $294,566,000
remained to be invested. In addition, we had a total of 13 communities that were
under reconstruction, for which an estimated $41,765,000 remained to be invested
as of June 30, 1999.
Substantially all of the capital expenditures necessary to complete the
communities currently under construction and reconstruction will be funded from:
- our $600,000,000 unsecured credit facility;
- the net proceeds from the sale of existing communities;
- retained operating cash; or
- the issuance of debt or equity securities.
We expect to continue to fund deferred development costs related to future
developments from retained operating cash and borrowings under the unsecured
facility. We believe that these sources of capital will be adequate to take the
proposed communities to the point in the development cycle where construction
can begin.
We have observed and been impacted by a reduction in the availability of cost
effective capital over the last twelve months. We cannot assure that cost
effective capital will be available to meet future expenditures required to
begin planned reconstruction activity or the construction of the Development
Rights. Before planned reconstruction activity or the construction of a
Development Right begins, we intend to arrange adequate capital sources to
complete these undertakings, although we cannot assure that we will be able
to obtain such financing. In the event that financing cannot be obtained, we may
have to abandon Development Rights, write-off associated pursuit costs and
forego reconstruction activity which we believe would have enhanced revenues.
We estimate that a significant portion of our liquidity needs will be met from
retained operating cash and borrowings under our unsecured facility. To meet the
balance of our liquidity needs, we will need to arrange additional capacity
under our existing unsecured facility, sell additional existing communities
and/or issue additional debt or equity securities. While we believe we have the
financial position to expand our short term credit capacity and support our
capital markets activity, we cannot assure that we will be successful in
completing these arrangements, offerings or sales. If these transactions cannot
be completed on a cost-effective basis, then a continuation of the current
capital market conditions described in this report could have a material adverse
impact on our operating results and financial condition, including the
abandonment of deferred development costs and a resultant charge to earnings.
During 1998, we determined to sell assets in markets that have few high barrier
characteristics. We will solicit competing bids from unrelated parties for these
individual assets, and will consider the sales price and tax ramifications of
each proposal. We intend to actively seek buyers for these assets during 1999.
However, we cannot assure that these assets can be sold on terms that we
consider satisfactory. In
27
connection with this disposition strategy, we have disposed of seven communities
since January 1, 1999. The net proceeds from the sale of these communities were
approximately $141,100,000.
The remaining assets that have been identified for disposition include land,
buildings and improvements and furniture, fixtures and equipment. Total real
estate, net of accumulated depreciation, of all communities identified for sale
at June 30, 1999 totaled $136,442,000. Certain individual assets are secured by
mortgage indebtedness which may be assumed by the purchaser or repaid from our
net sales proceeds. Our Condensed Consolidated Statements of Operations include
net income from the communities held for sale of $2,537,000 for the three months
ended June 30, 1999 and $3,019,000 for the six months ended June 30, 1999. Our
Condensed Consolidated Statements of Operations include net income from the
communities held for sale for the three months ended June 30, 1998 of $397,000,
or $555,000 on a pro forma basis assuming the merger had occurred on January 1,
1998, and $717,000 for the six months ended June 30, 1998, or $1,485,000 on a
pro forma basis assuming the merger had occurred on January 1, 1998.
Because the proceeds from the sale of communities are used initially to reduce
borrowings under our unsecured facility, the immediate effect of a sale of a
community is to reduce earnings. This is because the yield on a community that
is sold (as measured against the net proceeds from the sale of the community)
exceeds the interest rate on borrowings under our unsecured facility. Therefore,
changes in the number and timing of dispositions, and the redeployment of the
resulting net proceeds, may have a material and adverse effect on our earnings.
Debt Maturities
The following table details debt maturities for the next five years, excluding
the unsecured facility:
28
Inflation
Substantially all of the leases at the Current Communities are for a term of one
year or less. This may enable us to realize increased rents upon renewal of
existing leases or the beginning of new leases. Short-term leases generally
minimize our risk from the adverse effects of inflation, although these leases
generally permit residents to leave at the end of the lease term without
penalty. Short-term leases combined with relatively consistent demand allow
rents, and therefore cash flow, from our portfolio of apartments to provide an
attractive inflation hedge.
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.
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.
We have been taking steps to determine the nature and extent of the work
required to make our information computer systems, or IT Systems, and
non-information embedded systems, or Non-IT Systems, Year 2000 compliant. We are
also working to determine what effects non-compliance by our significant
business partners may have on us. We have assigned key personnel to our Year
2000 Task Force to coordinate compliance efforts. Our Task Force is represented
by executive, financial and community operation functions. We have engaged an
outside consulting firm to assist the Task Force in detecting Non-IT Systems
that are not Year 2000 compliant. The consultants have aided in assessing the
compliance of our Non-IT Systems and, for non-compliant systems, have
recommended 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.
We have identified certain phases necessary to become Year 2000 compliant and
have established an estimated timetable for completion of those phases, as shown
below:
29
Our Year 2000 Task Force has completed the Inventory System Phase for
computerized information systems. The assessment determined that it was
necessary to modify, update or replace limited portions of our computer
hardware and software applications.
30
We have completed the replacement and upgrade of our existing hardware and
software information systems in the normal course of business resulting in Year
2000 compliance. The vendor that provided our previous accounting software has a
compliant version of its product, but growth in our operations requires a
general ledger system with scope and functionality that is not present in either
the system we previously used or the Year 2000 compliant version of that system.
Accordingly, we replaced the current general ledger system with an enhanced
system that, in addition to increased functionality, is believed to be Year 2000
compliant. The implementation of the new general ledger system was completed
July 1, 1999. We are not treating the cost of this new system as a Year 2000
expense because the implementation date was not 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
our financial condition or results of operations.
Our Task Force has also completed the Inventory System Phase of our
non-information embedded systems, such as security, heating and cooling, and
fire and elevator systems, at each community that may not be Year 2000
compliant. The Task Force 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 our consultants, the Task Force has conducted 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 has completed the Follow-up Review of the
Inventory System Phase to ensure all non-information embedded systems are
addressed for Year 2000 compliance.
Some believe the world's Year 2000 problem, if uncorrected, may result in a
major economic crisis and cause major dislocations of business and governmental
organizations. We are unable to determine whether such predictions are true or
false. As mentioned above, we expect that the nature of our income, rent from
residents under leases that are generally one year or less, should serve as a
hedge against any short term disruptions of business. However, if a general
worst case scenario proves true, all companies, including AvalonBay, will
experience the effects.
We, together with our consultants, have completed the process of verifying
inventory and have substantially completed the process of obtaining risk
assurance regarding Year 2000 compliance of detected non-information embedded
systems. The Task Force and consultants have prioritized the non-compliant
systems and are proceeding according to the phases described above. We cannot
assure, however, that the completion of the process of verifying inventory
and obtaining risk assurance has identified all non-compliant systems.
Upon completion of each of the above described upgrades and replacements of our
information and non-information systems, we will begin 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.
We currently expect our testing to be completed during the fourth quarter of
1999. While we anticipate such tests will be successful in all material
respects, the Task Force intends to closely monitor our Year 2000 compliance
progress and has substantially completed development of contingency plans in the
event non-information embedded systems are not compliant. The Task Force has
created functional contingency plans by community type, or general community
contingency plans, that encompass substantially all of our
31
existing portfolio. For certain communities, primarily communities with
high-rise buildings, specific contingency plans, referred to as site specific
contingency plans, may be required. 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.
We currently anticipate that the costs of becoming Year 2000 compliant for all
impacted systems will be approximately $750,000, based on the completion of the
Prioritize and Budget Phase. Based on available information, we believe that the
ultimate cost of achieving Year 2000 compliance will not have a material adverse
effect on our business, financial condition or results of operations. However,
we cannot assure that we will be Year 2000 compliant by December 31, 1999 or
that we will not incur significant additional costs pursuing Year 2000
compliance.
The third parties with which we have material relationships include our utility
providers and the vendor that has provided our new accounting software system.
Together with the consultants, we have communicated 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.
Substantially all of the vendors that have responded to our inquiries have
represented that Year 2000 compliance plans are being implemented for their
systems. No assurance can be given that our utility providers will be Year 2000
compliant based on the responses received. As described above, we expect that
our accounting software will be Year 2000 compliant.
We are not aware of third parties, other than our residents and owners of
communities for which we provide community management services, to which we
could have potential material liabilities should our information or
non-information systems be non-compliant on January 1, 2000. The inability of
AvalonBay to achieve Year 2000 compliance on its non-information 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, we have not delayed any information technology or non-information
technology projects due to the Year 2000 compliance efforts. However, we can
neither assure 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 our operations.
Funds from Operations
We generally consider Funds from Operations ("FFO") to be an appropriate measure
of our operating performance because it provides investors an understanding of
our ability to incur and service debt and to make capital expenditures. We
believe that in order to facilitate a clear understanding of our operating
results, 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 or loss computed in accordance with generally accepted
accounting principles, except that excluded from net income or loss
are gains or losses from debt restructuring, other non-recurring items
and sales of property;
- plus depreciation of real estate assets; and
- after adjustments for unconsolidated partnerships and joint ventures.
32
FFO does not represent cash generated from operating activities in accordance
with generally accepted accounting principles. Therefore it should not be
considered an alternative to net income as an indication of our performance. FFO
should also not be considered an alternative to net cash flows from operating
activities as determined by generally accepted accounting principles as a
measure of liquidity. Additionally, it is not necessarily indicative of cash
available to fund cash needs. Further, FFO as calculated for other REITs may not
be comparable to our calculation of FFO.
For the three months ended June 30, 1999, FFO increased to $50,559,000 from
$28,314,000 for the three months ended June 30, 1998. This increase is primarily
due to the acquisition of additional communities in connection with the merger
and to delivery of new development and redevelopment communities. Growth in
earnings from Established Communities as well as acquisition activity in 1998
also contributed to the increase.
FFO for the three months ended June 30, 1999 and the preceding four quarters are
summarized as follows (dollars in thousands):
(1) Represents the amortization of pre-1986 bond issuance costs carried forward
to AvalonBay and costs associated with the reissuance of tax-exempt bonds
incurred prior to the initial public offering of Bay in March 1994 in order
to preserve the tax-exempt status of the bonds at the initial public
offering.
(2) Consists of $16,076 related to a management and other organizational change
announced during 1998 and $514 for Year 2000 remediation costs.
Management Information Systems
We believe that a state-of-the-art management information systems infrastructure
will be an important element in managing our future growth. This is because
timely and accurate collection of financial and resident profile data will
enable us to maximize revenue through careful leasing decisions and financial
management. Accordingly, we currently employ a proprietary company-wide
intranet using a digital network with high-speed digital lines. This network
connects all of our communities and offices to central servers in
Alexandria, Virginia, providing access to our associates and to Company
information throughout the country from all locations. This infrastructure also
allows us to employ new "network computers" that are less expensive to purchase
and support, which reduces our "total cost of ownership" for each work station.
During 1998, we began the development of a new on-site property management
system and a leasing automation system to enable management to capture, review
and analyze data to a greater extent than is possible using available existing
33
commercial software. We intend to enter into a joint venture with another
public multifamily real estate company (our "joint venturer") and to continue
development of these systems through the joint venture entity. The software
development process is currently managed by our employees who have significant
related project management experience and the employees of the joint venturer.
The actual programming and documentation of the software is being conducted by
our employees and third party consultants under the supervision of these
experienced project managers. We currently expect that the total development
costs over a three-year period will be approximately $7.5 million (including
hardware costs and expenses, the costs of employee and related overhead, and
the costs of engaging third party consultants) and that such development costs
will be shared on an equal basis by us and the joint venture. Once developed,
we intend to use the property management system in place of current property
management information systems for which we pay a license fee to third parties
and we intend to use the leasing automation system to make the lease
application process easier for residents and more efficient for us to manage.
We currently project that the property management system will undergo an
on-site test (i.e., a "beta test") during the second quarter of 2000 and that
the system will be functional and implemented during the third and fourth
quarters of 2000. The leasing automation system is currently in beta testing at
two communities, and if such testing is successful, we intend to implement the
system during the first quarter of 2000.
We believe that once implemented these software systems will result in cost
savings due to added efficiencies in management time and overhead, and that
these savings will largely offset the expense associated with amortizing the
software development costs and maintaining the software. We also believe that
it is possible that other real estate companies may desire to use the software
we are developing and that therefore there may be an opportunity to recover, in
the future, a portion of our investment by licensing the software to others.
However, at the present time these potential cost savings and ancillary revenue
are speculative and we cannot assure that the system will provide sufficient
benefits to offset the cost of development and maintenance.
We have never before engaged in the development of software on this scale and
have never licensed software to others. There are a variety of risks associated
with the development of software both for internal use and for potential sale
or licensing to third parties. Among the principal risks associated with this
undertaking are the following:
- we may not be able to maintain the schedule or budget that we have
projected for the development of the software;
- the software may not provide the functionality and efficiency we have
projected;
- we may decide not to endeavor to license the software to other
enterprises, the software may not be attractive to other enterprises
and we may not be able to effectively manage the licensing of the
software to other enterprises; and
- the software may not provide AvalonBay with meaningful cost savings
or a meaningful source of ancillary revenues.
Natural Disasters
Many of our West Coast communities are located in the general vicinity of active
earthquake faults. In July 1998, we obtained a seismic risk analysis from an
engineering firm which estimated the probable maximum damage for each of the 60
West Coast communities that we owned at that time and for each of the five West
Coast communities under development at that time. The seismic risk analysis was
obtained for each individual community and for all of those communities
combined. To establish a probable maximum damage, the engineers first define a
severe earthquake event for the applicable geographic area, which is an
earthquake that has only a 10% likelihood of occurring over a 50-year period.
The probable maximum damage is determined as the structural and architectural
damage and business interruption loss that has only a 10% probability of being
exceeded in the event of such an earthquake. Because a significant number of our
communities are located in the San Francisco Bay Area, the engineers' analysis
defined an earthquake on the Hayward Fault with a Richter Scale magnitude of 7.1
as a severe earthquake with a 10% probability of occurring within a 50-year
period. The engineers then established an aggregate probable maximum damage at
that time of $113 million for the 60 West Coast communities that we owned at
that time and the five West
34
Coast communities under development. The $113 million probable maximum damage
for those communities was a probable maximum level that the engineers expected
to be exceeded only 10% of the time in the event of such a severe earthquake.
The actual aggregate probable maximum damage could be higher or lower as a
result of variations in soil classifications and structural vulnerabilities. For
each community, the engineers' analysis calculated an individual probable
maximum damage as a percentage of the community's replacement cost and projected
revenues. We cannot assure that:
- an earthquake would not cause damage or losses greater than the
probable maximum damage assessments indicate;
- future probable maximum damage levels will not be higher than the
current probable maximum damage levels described above for our
communities located on the West Coast; or
- future acquisitions or developments will not have probable maximum
damage assessments indicating the possibility of greater damage or
losses than currently indicated.
In August 1998, we renewed our earthquake insurance, both for physical damage
and lost revenue, with respect to all communities we owned at that time and all
of the communities under development. For any single occurrence, we have in
place $75,000,000 of coverage with a five percent deductible. The five percent
deductible is a minimum of $100,000 and a maximum of $25,000,000 per occurrence.
In addition, our 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, we could lose our
capital invested in the affected community, as well as anticipated future
revenue from that community. We would also continue to be obligated to repay any
mortgage indebtedness or other obligations related to the community. Any such
loss could materially and adversely affect our business and our financial
condition and results of operations.
Development Communities
As of June 30, 1999, there were 12 Development Communities under construction.
These Development Communities are expected to add a total of 2,710 apartment
homes to our portfolio upon completion. The total capitalized cost of the
Development Communities, when completed, is expected to be approximately $448.5
million. Statements regarding the future development or performance of the
Development Communities are forward-looking statements. We cannot assure that:
- we will complete the Development Communities;
- our budgeted costs or estimates of occupancy rates or "Projected
EBITDA as a % of Total Budgeted Cost" will be realized;
- our schedule of leasing start dates or construction completion dates
will be achieved; or
- future developments will realize comparable returns.
See the discussion under "Risks of Development and Redevelopment" below.
We hold a fee simple ownership interest in each of the Development Communities
except for two communities that are owned by partnerships in which we hold a
general partnership interest. The following page presents a summary of
Development Communities:
35
AVALONBAY COMMUNITIES, INC.
DEVELOPMENT COMMUNITIES SUMMARY
(1) Total budgeted cost includes all capitalized costs projected to be incurred
to develop the respective Development Community, including land acquisition
costs, construction costs, real estate taxes, capitalized interest and loan
fees, permits, professional fees, allocated development overhead and other
regulatory fees determined in accordance with generally accepted accounting
principles.
(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.
(4) Represents a combined yield for Avalon Valley and Avalon Lake.
36
Redevelopment Communities
As of June 30, 1999, we had 13 communities under redevelopment. The total
budgeted cost to complete these Redevelopment Communities, including the cost of
acquisition and redevelopment, is expected to be approximately $456.9 million,
of which approximately $89.4 million is the additional capital invested or
expected to be invested above the original purchase cost. Statements regarding
the future redevelopment or performance of the Redevelopment Communities are
forward-looking statements. We have found that the cost to redevelop an existing
apartment community is more difficult to budget and estimate than the cost to
develop a new community. Accordingly, we expect that actual costs may vary over
a wider range than for a new development community. We cannot assure that we
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" below.
The following presents a summary of Redevelopment Communities:
AVALONBAY COMMUNITIES, INC.
REDEVELOPMENT COMMUNITIES SUMMARY (1)
(1) Redevelopment Communities are communities acquired for which redevelopment
costs are expected to exceed 10% of the original acquisition cost or
$5,000,000.
(2) 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 generally
accepted accounting principles.
(3) Restabilized operations is defined as the first full quarter of 95% or
greater occupancy after completion of redevelopment.
(4) 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.
(5) Formerly named "Bay Pointe."
(6) Formerly named "Pacifica Club."
37
Development Rights
As of June 30, 1999, we are considering the development of 31 new apartment
communities. These Development Rights range from land owned or under contract
for which design and architectural planning has just begun to land under
contract or owned by us with completed site plans and drawings where
construction can begin almost immediately. We estimate that the successful
completion of all of these communities would ultimately add 8,939
institutional-quality apartment homes to our portfolio. At June 30, 1999, the
cumulative capitalized costs incurred in pursuit of the 31 Development Rights,
including the cost of land acquired in connection with five of the Development
Rights, was approximately $64 million. Substantially all of these apartment
homes will offer features like those offered by the communities we currently
own.
We generally hold Development Rights through options to acquire land, although
one Development Right located in New Canaan, CT is controlled through a joint
venture partnership that owns land. The properties comprising the Development
Rights are in different stages of the due diligence and regulatory approval
process. The decisions as to which of the Development Rights to pursue, if any,
or to continue to pursue once an investment in a Development Right is made are
business judgments that we make after financial, demographic and other analysis
is performed. Finally, we currently intend to limit the percentage of debt used
to finance new developments. To comply with our policy on the use of debt, other
financing alternatives may be required to finance the development of those
Development Rights scheduled to start construction after June 30, 1999. Although
the development of any particular Development Right cannot be assured, we
believe that the Development Rights, in the aggregate, present attractive
potential opportunities for future development and growth of our FFO.
Statements regarding the future development of the Development Rights are
forward-looking statements. We cannot assure that:
- we will succeed in obtaining zoning and other necessary governmental
approvals or the financing required to develop these communities, or
that we will decide to develop any particular community; or
- 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.
38
AVALONBAY COMMUNITIES, INC.
DEVELOPMENT RIGHTS SUMMARY
(1) AvalonBay owns land, but construction has not yet begun.
(2) The land is owned by Town Close Associates Limited Partnership in which
AvalonBay is a majority partner. It is currently anticipated that the land
seller will retain a minority limited partner interest.
39
Risks of Development and Redevelopment
We intend to continue to pursue the development and redevelopment of apartment
home communities in accordance with our business and financial policies. Our
development and redevelopment activities may be exposed to the following risks:
- we may abandon opportunities we have already begun to explore based on
further financial, demographic or other analysis;
- we may encounter liquidity constraints, including the unavailability
of financing on favorable terms for the development or redevelopment
of a community;
- we may be unable to obtain, or we may experience delays in obtaining,
all necessary zoning, land-use, building, occupancy, and other
required governmental permits and authorizations;
- we may incur construction or reconstruction costs for a community that
exceed our original estimates due to increased materials, labor or
other expenses, which could make completion or redevelopment of the
community uneconomical;
- occupancy rates and rents at a newly completed or redevelopment
community may fluctuate depending on a number of factors, including
market and general economic conditions, and may not be sufficient to
make the community profitable; and
- we may be unable to complete construction and lease-up on schedule,
resulting in increased debt service expense and construction costs.
The occurrence of any of the events described above could adversely affect our
ability to achieve our projected yields on communities under development or
redevelopment and could prevent us from paying distributions to our
stockholders.
For each Development and Redevelopment Community, we establish 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 projected economic vacancy and
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 and/or property acquisition costs;
- construction costs;
- real estate taxes;
- capitalized interest;
- loan fees;
- permits;
- professional fees;
- allocated development overhead; and
- other regulatory fees determined in accordance with GAAP.
Gross potential earnings and construction costs are projected by us based on
market conditions prevailing in the community's market at the time our budgets
are prepared and reflect changes to those market conditions that we anticipated
at that time. Although we attempt to anticipate changes in market conditions, we
cannot
40
predict with certainty what those changes will be. Construction costs have been
increasing and, for some of our Development Communities, the total construction
costs have been or are expected to be higher than the original budget.
Nonetheless, because of increases in prevailing market rents we believe that, in
the aggregate, we will still achieve our targeted projected EBITDA as a
percentage of total budgeted cost for those communities experiencing costs in
excess of the original budget. We believe that we could experience similar
increases in construction costs and market rents with respect to other
development communities resulting in total construction costs that exceed
original budgets. Likewise, costs to redevelop communities that have been
acquired have, in some cases, exceeded our original estimates and similar
increases in costs may be experienced in the future. We cannot assure you 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, we capitalize interest expense during construction or
reconstruction until a building obtains a certificate of occupancy. Thereafter,
the interest allocated to that completed building within the community is
expensed. Capitalized interest during the three months ended June 30, 1999
totaled $5,866,000 and for the six months ended June 30, 1999 totaled
$13,149,000. Capitalized interest during the three months ended June 30, 1998
totaled $3,561,000 and during the six months ended June 30, 1998 totaled
$6,525,000.
41
PART I. FINANCIAL INFORMATION (CONTINUED)
Item 3. Quantitative and Qualitative Disclosures About Market
Risk
Not Applicable
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
We are involved in certain ordinary routine litigation
incidental to the conduct of our business. While the
outcome of such litigation cannot be predicted with
certainty, we do not expect any current litigation to
have a material effect on our business or financial
condition.
Item 2. Changes in Securities
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
The Company held its 1999 Annual Meeting of Stockholders on May 5,
1999. The stockholders voted to elect Gilbert M. Meyer, Richard L.
Michaux, Bruce A. Choate, Michael A. Futterman, John J. Healy,
Jr., Richard W. Miller, Brenda J. Mixson, Lance R. Primis and
Allan D. Schuster to serve as directors of the Company until the
2000 Annual Meeting of Stockholders and until their respective
successors are duly elected and qualified.
55,079,397 votes were cast for, and 40,942 votes were
withheld from the election of Mr. Meyer.
55,089,247 votes were cast for, and 31,092 votes were
withheld from the election of Mr. Michaux.
55,090,483 votes were cast for, and 29,856 votes were
withheld from the election of Mr. Choate.
55,092,893 votes were cast for, and 27,446 votes were
withheld from the election of Mr. Futterman.
55,088,211 votes were cast for, and 32,128 votes were
withheld from the election of Mr. Healy.
55,089,264 votes were cast for, and 31,075 votes were
withheld from the election of Mr. Miller.
55,090,283 votes were cast for, and 30,056 votes were
withheld from the election of Ms. Mixson.
54,294,504 votes were cast for, and 825,835 votes were
withheld from the election of Mr. Primis.
55,090,505 votes were cast for, and 29,834 votes were
withheld from the election of Mr. Schuster.
42
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) EXHIBITS
43
(b) REPORTS ON FORM 8-K
There were no reports filed by the Company on Form 8-K during the quarter
ending June 30, 1999.
44
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
AVALONBAY COMMUNITIES, INC.
45