10-Q: Quarterly report pursuant to Section 13 or 15(d)
Published on November 12, 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 September 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
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date:
65,737,629 shares outstanding as of November 1, 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
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 Bay
Apartment Communities, Inc. in June 1998 (the "Merger"), AvalonBay Communities,
Inc. (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 nine months ended September 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 nine months ended September 30, 1999, 117,178 units of limited
partnership in DownREIT partnerships, valued at $4,614, were issued in
connection with an acquisition for cash and units pursuant to a forward
purchase agreement signed in 1997 with an unaffiliated party. Also during the
nine months ended September 30, 1999, 22,623 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 September 30, 1999
and 1998 totaled $43,829 and $40,522 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 September 30, 1999, the Company owned or held an ownership interest in 127
operating apartment communities containing 37,435 apartment homes in fifteen
states and the District of Columbia of which 10 communities containing 3,193
apartment homes were under reconstruction. The Company also owned 10
communities with 2,464 apartment homes under construction and rights to develop
an additional 30 communities that, if developed as expected, will contain an
estimated 8,940 apartment homes.
During the third quarter of 1999, four new development communities, Avalon
Valley and Avalon Lake (both located in the Fairfield County, Connecticut
area), The Tower at Avalon Cove (located in the Northern New Jersey area) and
The Avalon (located in the Westchester, New York area), were completed. In the
aggregate, these communities contain 782 apartment homes for a total investment
of approximately $120,400.
The redevelopment of five communities, Arbor Heights, Westside Terrace and
Viewpointe (all located in the Los Angeles, California area), Amberway (located
in the Orange County, California area) and Gallery Place (located in the
Seattle, Washington area) were completed during the third quarter of 1999. In
the aggregate, these communities contain 1,871 apartment homes for a total
investment in redevelopment (i.e., excluding acquisition costs) of
approximately $30,500.
The development of two new communities, Avalon River Mews (located in the
Northern New Jersey area) and Avalon Haven (located in the Fairfield County,
Connecticut area) commenced during the third quarter of 1999. These two
communities are expected to contain a total of 536 apartment homes upon
completion with a projected total investment of $90,000.
The redevelopment of two existing communities, Crossbrook and Laguna Brisas,
(located in the San Francisco and Orange County, California areas) commenced
during the third quarter of 1999. The total projected investment in
redevelopment for these communities, which contain 402 apartment homes, is
$7,900.
During the third quarter of 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 forward purchase agreement signed in 1997
with an unaffiliated party.
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During the third quarter of 1999, the Company sold three communities. The
Pointe, located in the Napa/Solono, California area, and Avalon at Willow Lake
and Avalon at Geist, located in the Indianapolis, Indiana area, contained a
total of 672 apartment homes. The net proceeds from the sale of these
communities were approximately $47,900 resulting in a net gain of approximately
$7,032. The proceeds from the sale of these communities will be redeployed to
development and redevelopment communities. Pending such redeployment, the
proceeds from The Pointe were deposited into an escrow account to facilitate a
like-kind exchange transaction, and the proceeds from the sale of Avalon at
Willow Lake and Avalon at Geist were primarily used to repay amounts
outstanding under the Company's variable rate unsecured credit facility (the
"Unsecured Facility").
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 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 nine months
ended September 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. All significant intercompany
balances and transactions have been eliminated in consolidation.
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.
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
7
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 per
occurrence to $15 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.
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 nine months ended September 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
and Units 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 nine months ended September 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.
8
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 on 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 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 communities under development or
redevelopment totaled $5,208 and $4,847 for the three months ended September
30, 1999 and 1998, respectively, and $18,357 and $11,372 for the nine months
ended September 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:
9
Mortgage notes payable are collateralized by certain apartment communities and
mature at various dates from May 2001 through December 2036. The weighted
average interest rate of the Company's variable rate notes and credit facility
was 6.3% at September 30, 1999. The weighted average interest rate of the
Company's fixed rate notes (conventional and tax-exempt) was 6.9% at September
30, 1999.
The maturity schedule for the Company's unsecured senior notes consists of the
following:
The Company's unsecured senior notes contain a number of financial and other
covenants with which the Company must comply, including, but not limited to,
limits on the aggregate amount of total and secured indebtedness the Company
may have on a consolidated basis and limits on the Company's required debt
service payments.
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 0.6%
per annum. 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.
10
5. Stockholders' Equity
The following summarizes the changes in stockholders' equity for the nine
months ended September 30, 1999:
During the nine months ended September 30, 1999, the Company issued 450,142
Common Stock shares in connection with stock options exercised (the majority of
which related to the organization changes announced in February 1999), 663,284
shares through the Company's Dividend Reinvestment Plan, 22,623 shares that
were issued to acquire operating partnership units from third parties, 41,102
shares in connection with the Company's Employee Stock Purchase Plan and 97,479
shares in connection with restricted stock grants to employees.
6. Investments in Unconsolidated Joint Ventures
In connection with the Merger, the Company succeeded to certain investments in
unconsolidated joint ventures. At September 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% limited liability company
membership 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):
11
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
solicits competing bids from unrelated parties for these individual assets, and
considers the sales price and tax ramifications of each proposal. Management
sold seven communities in connection with this disposition strategy in 1998,
and nine communities during the first nine months of 1999. Management intends
to have additional selected assets actively marketed for sale during the fourth
quarter of 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 nine 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 September
30, 1999, total real estate, net of accumulated depreciation, subject to sale
totaled $120,299. 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 at September 30, 1999 of $1,953 and
$828 for the three months ended September 30, 1999 and 1998, respectively, and
$5,237 and $1,123 for the nine months ended September 30, 1999 and 1998,
respectively. Depreciation expense on these assets, which was not recognized
subsequent to the date of
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held-for-sale classification, totaled $1,075 and $3,229 for the three and nine
months ended September 30, 1999, respectively.
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 which completed development and
attained stabilized occupancy and expense levels during the prior 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 completed redevelopment and
attained stabilized occupancy and expense levels during the prior 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
13
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.
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. The
various locales within each individual region have similar economic and other
characteristics such that management finds it useful to review the performance
of the Company's communities in those locales on a regional, aggregated basis.
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 $6,029 and $5,378 for the three months ended September 30,
1999 and 1998, respectively, and $18,066 and $9,388 for the nine months ended
September 30, 1999 and 1998 of property management overhead costs
14
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 $4,858 and
$6,169 of accumulated depreciation as of September 30, 1999 and 1998,
respectively.
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 below on a pro forma basis
(unaudited) assuming the Merger had occurred as of January 1, 1998.
9. Subsequent Events
During October 1999, the Company sold four communities containing 1,214
apartment homes. The net proceeds of approximately $62,140 from the sale of
these communities will be redeployed 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 Unsecured Facility.
During October 1999, the Company sold a participating mortgage note secured by
a 288 apartment home community located in the Detroit, Michigan area. The net
proceeds from the sale of the participating mortgage note of $25,300 were used
to repay amounts outstanding under the Company's Unsecured Facility.
During October 1999, the Company completed a refinancing of approximately
$18,755 of tax exempt bonds related to the Avalon Ridge community. These bonds
bear a variable interest rate, will mature on May 1, 2026 and are credit
enhanced by the Company's credit enhancement facility with the Federal National
Mortgage Association.
15
During October 1999, the Company exercised its options to acquire a 19-acre
site in San Diego, California for approximately $11,800 and a 9.58-acre site in
Orange, Connecticut for approximately $1,200. The Company plans to develop
apartment home communities on each of these sites with up to 546 combined
apartment homes.
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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 or 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 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;
- the development, implementation and use of management
information systems; 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
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 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 development opportunities for a number of
reasons, including changes in local market conditions which make
development less desirable, increases in costs of development
and increases in the cost of capital;
- we may fail to secure development opportunities due to an
inability to reach agreements with third parties or to obtain
desired zoning and other local approvals;
- 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;
- the development, implementation and use of new management
information systems may cost more than anticipated or may be
delayed for a number of reasons, including unforeseen
technological or integration issues;
- we may, with our suppliers and service providers, experience
unanticipated delays or expenses in achieving Year 2000
compliance.
17
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
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.
Business Description and Community Information
AvalonBay is a Maryland corporation that elected to be treated as a real estate
investment trust, or 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 in-fill 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. with and into
Bay Apartment Communities, Inc. on June 4, 1998. The merger was accounted for
as a purchase of Avalon Properties by Bay Apartment Communities. 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 foreseeable 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 November 1, 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:
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(*) Represents an estimate
(**) Includes one community that is currently undergoing redevelopment
of its exterior. No homes will be taken out of service. Therefore,
the community is both an Established Community and a Redevelopment
Community. The community has only been included once in the Current
Communities total.
Current Communities are apartment communities that have been completed
and have reached occupancy of at least 95%, have been complete for one
year, are in the initial lease-up process or are 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, those
owned by Avalon 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, Midwest and
Pacific Northwest regions. At September 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.
19
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 begun. 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 as of November 1, 1999, we own:
- a fee simple, or absolute, ownership interest in 104
operating communities, one of which is on land subject to a
149 year land lease;
- a general partnership interest in five partnerships that hold
a fee simple interest in five 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, which allows us to share in part of
the rental income or resale proceeds of the community.
We also hold a fee simple ownership interest in each of the ten Development
Communities.
In each of the four partnerships structured as DownREITs, either AvalonBay or
one of our wholly-owned subsidiaries is the general partner, and there are one
or more limited partners whose interest in the partnership is represented by
units of limited partnership interest. For each DownREIT partnership, limited
partners are entitled to receive 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 so that it
is unlikely 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 November 1, 1999, there were 996,319 units outstanding. The
DownREIT partnerships are consolidated for financial reporting purposes.
At September 30, 1999, we had positioned our portfolio of Stabilized
Communities, excluding communities owned by unconsolidated joint ventures, to
an average physical occupancy level of 97.1%. The Established Communities, on a
pro forma basis, assuming the merger had occurred on January 1, 1998, had
achieved an average economic occupancy of 97.0% for the three months ended
September 30, 1999 and 96.4% for the nine months ended September 30, 1999.
Average economic occupancy for the Established Communities, on a pro forma
basis, assuming the merger had occurred on January 1, 1998, for the three
months ended September 30, 1998 was 97.4% and for the nine months ended
September 30, 1998 was 97.0%. Aggressive marketing efforts combined with
limited and targeted pricing adjustments are
20
responsible for this continued high occupancy. This positioning has resulted in
overall growth in rental revenue from Established Communities of 3.2% for the
three months ended September 30, 1999 from the comparable period of the
preceding year and 3.9% for the nine months ended September 30, 1999 from the
comparable period of the preceding year. Our strategy is to maximize total
rental revenue through management of rental rates and occupancy levels. 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 economies of scale due to
national and regional growth of our portfolio.
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. We were
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;
- Los Angeles, California;
- Minneapolis, Minnesota;
- Newport Beach, California;
- New York, New York;
- 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 effect this concentration, we are selling assets in markets where our current
presence is limited. Accordingly, we sold three communities totaling 672
apartment homes during the third quarter of 1999. Net proceeds from these sales
totaled $47,900,000 resulting in a net gain of $7,032,000. We sold four
additional communities containing 1,214 apartment homes in October 1999 in
connection with our disposition strategy. The net proceeds from the sale of
these communities were approximately $62,140,000. In addition, we sold a
participating mortgage note secured by an apartment home community for net
proceeds of $25,300,000. We intend to dispose of additional assets as described
more fully under "Future Financing and Capital Needs." 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.
Community Acquisition. We acquired one community, Avalon at Woodbury, during
July 1999 for approximately $26,000,000 in connection with a forward purchase
agreement signed in 1997 with an unaffiliated party. The community contains 224
apartment homes and is located in the Minneapolis, Minnesota area.
Construction and Completion of Development Communities. During the third
quarter of 1999, we began development of two new communities, Avalon River Mews
and Avalon Haven, that are expected to contain 536 apartment homes. These
communities are located in the Northern New Jersey and Fairfield,
21
Connecticut areas. The land parcels were acquired for a total purchase price of
$15,285,000 and the total projected investment in the two communities,
including the land acquisition costs, is projected to be approximately
$90,000,000.
During the third quarter of 1999, four new development communities, Avalon
Valley, Avalon Lake, The Tower at Avalon Cove and The Avalon were completed for
a total investment of $120,400,000. Two of these communities are located in the
Fairfield County, Connecticut area, and the remaining two are located in the
Northern New Jersey and the Westchester, New York areas. In the aggregate,
these four communities contain a total of 782 apartment homes.
Construction and Completion of Redevelopment Communities. The redevelopment of
two existing communities, Crossbrook and Laguna Brisas, began during the third
quarter of 1999. These communities are located in the San Francisco and Orange
County, California areas. The total projected investment in redevelopment for
these communities (i.e., excluding acquisition costs), which contain 402
apartment homes, is $7,900,000.
Five redevelopment communities were completed during the third quarter of 1999
for a total investment in redevelopment, excluding acquisition costs, of
$30,500,000. These communities, Arbor Heights, Westside Terrace, Viewpointe,
Amberway and Gallery Place, contain 1,871 apartment homes and are located in
the Los Angeles, California, Orange County, California and Seattle, Washington
areas.
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 or redeveloping 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 unconsolidated 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 nine
months ended September 30, 1999 and September 30, 1998.
Net income available to common stockholders increased $10,358,000 (43.6%) to
$34,129,000 for the three months ended September 30, 1999 compared to
$23,771,000 for the comparable period of the preceding year. Net income
available to common stockholders increased $21,740,000 (46.8%) to $68,209,000
for the nine months ended September 30, 1999 compared to $46,469,000 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 $3,420,000 for the three months ended September 30, 1999
and $26,088,000 for the nine months ended September 30, 1999 from the
comparable periods of 1998. The increase in net income, as adjusted, for the
three months ended September 30, 1999 is primarily attributable to additional
operating income from newly developed or redeveloped communities as well as
growth in operating income from Established Communities. The increase in net
income, as adjusted, for the nine months ended September 30, 1999 is primarily
attributable to additional operating income from the former Avalon communities
and secondarily, to additional operating income from newly developed or
redeveloped communities and growth in operating income from Established
Communities.
22
Rental income increased $12,616,000 (10.7%) to $130,373,000 for the three
months ended September 30, 1999 compared to $117,757,000 for the comparable
period of the preceding year. Rental income increased $137,845,000 (59.1%) to
$371,073,000 for the nine months ended September 30, 1999 compared to
$233,228,000 for the comparable period of the preceding year. Of the nine month
increase, $1,315,000 relates to rental revenue increases from Established
Communities and $136,530,000 relates to rental revenue attributable to newly
developed, redeveloped or acquired apartment homes, of which $94,135,000
relates to rental revenue attributable to currently stabilized communities
acquired in connection with the merger.
Overall Portfolio - The $137,845,000 increase in rental income 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 23,745 apartment homes for the
nine months ended September 30, 1998 to 36,628 apartment homes for the
nine months ended September 30, 1999 primarily as a result of additional
apartment homes from the former Avalon communities, as well as the
development, redevelopment and acquisition of new communities. For the
nine months ended September 30, 1999, the weighted average monthly revenue
per occupied apartment home increased $53 (5.1%) to $1,101 compared to
$1,048 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 $2,020,000 (3.2%)
for the three months ended September 30, 1999 compared to the comparable
period of the preceding year. Rental revenue increased $7,221,000 (3.9%)
for the nine months ended September 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 three months ended September 30, 1999, weighted average
monthly revenue per occupied apartment home increased $43 (3.6%) to $1,223
compared to $1,180 for the comparable period of the preceding year. The
average economic occupancy decreased from 97.4% for the three months ended
September 30, 1998 to 97.0% for the three months ended September 30, 1999.
For the nine months ended September 30, 1999, weighted average monthly
revenue per occupied apartment home increased $52 (4.5%) to $1,210
compared to $1,158 for the comparable period of the preceding year. The
average economic occupancy decreased from 97.0% for the nine months ended
September 30, 1998 to 96.4% for the nine months ended September 30, 1999.
Beginning in October 1998, the Northern California sub-markets that are
primarily dependent on Silicon Valley employment softened. These
sub-markets have experienced reduced rental rate growth and occupancy
declines as compared to other Northern California sub-markets and our
other markets as a whole.
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 decreased $65,000 to $277,000 for the three months ended
September 30, 1999 compared to $342,000 for the comparable period of the
preceding year. Management fees increased $473,000 to $930,000 for the nine
months ended September 30, 1999 compared to $457,000 for the comparable period
of the preceding year. Management fees represent revenue from third-party
contracts to which we succeeded in the merger. The decrease in management fees
for the three months ended September 30, 1999 is the result of terminated
third-party contracts. We anticipate that management fees will increase over
the next several years with the receipt of development and construction
management fees for joint venture development arrangements.
Operating expenses increased $2,237,000 (6.7%) to $35,649,000 for the three
months ended September 30, 1999 compared to $33,412,000 for the comparable
period of the preceding year. These expenses increased
23
$37,152,000 (57.9%) to $101,274,000 for the nine months ended September 30,
1999 compared to $64,122,000 for the comparable period of the preceding year.
Overall Portfolio - The increase for the three months ended September 30,
1999 is primarily due to the addition of newly developed and redeveloped
apartment homes. The increase for the nine months ended September 30, 1999
is primarily due to additional operating expenses from the former Avalon
communities, and secondarily, due to the addition of newly developed,
redeveloped and 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 $357,000 (2.7%)
to $13,730,000 for the three months ended September 30, 1999 compared to
$13,373,000 for the comparable period of the preceding year. These
expenses increased $1,565,000 (4.2%) to $39,006,000 for the nine months
ended September 30, 1999 compared to $37,441,000 for the comparable period
of the preceding year. The net changes are the result of higher
administrative, payroll and maintenance costs, offset by lower utility and
insurance costs.
Property taxes increased $684,000 (6.8%) to $10,718,000 for the three months
ended September 30, 1999 compared to $10,034,000 for the comparable period of
the preceding year. Property taxes increased $12,865,000 (67.0%) to $32,058,000
for the nine months ended September 30, 1999 compared to $19,193,000 for the
comparable period of the preceding year.
Overall Portfolio - The increase for the three months ended September 30,
1999 is primarily due to the addition of newly developed and redeveloped
apartment homes. The increase for the nine months ended September 30, 1999
is primarily due to additional expense from the former Avalon communities
and secondarily, due to the addition of newly developed, redeveloped or
acquired apartment homes. Property taxes on Development and Redevelopment
Communities are expensed as communities move from the initial construction
and lease-up phase to the stabilized operating phase.
Established Communities, on a pro forma basis, assuming the merger had
occurred on January 1, 1998 - Property taxes decreased $126,000 (2.3%) to
$5,332,000 for the three months ended September 30, 1999 compared to
$5,458,000 for the comparable period of the preceding year. Property taxes
increased $222,000 (1.4%) to $16,124,000 for the nine months ended
September 30, 1999 compared to $15,902,000 for the comparable period of
the preceding year. The quarter to quarter decrease is a result of base
year tax assessments indicating lower supplemental taxes for previously
renovated communities than originally projected. The year-to-date increase
is primarily the result of a net increase in property value assessments
and increased property tax rates in the Northeast and Mid-Atlantic
regions.
Interest expense increased $1,256,000 (6.8%) to $19,643,000 for the three
months ended September 30, 1999 compared to $18,387,000 for the comparable
period of the preceding year. Interest expense increased $18,844,000 (52.7%) to
$54,592,000 for the nine months ended September 30, 1999 compared to
$35,748,000 for the comparable period of the preceding year. The increase in
interest expense for the three months ended September 30, 1999 is primarily
attributable to higher debt balances offset by an increase in capitalized
interest. The increase for the nine months ended September 30, 1999 is
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.
Depreciation and amortization increased $4,352,000 (18.5%) to $27,930,000 for
the three months ended September 30, 1999 compared to $23,578,000 for the
comparable period of the preceding year.
24
Depreciation and amortization increased $33,289,000 (69.2%) to $81,371,000 for
the nine months ended September 30, 1999 compared to $48,082,000 for the
comparable period of the preceding year. The increase for the three months
ended September 30, 1999 is primarily attributable to newly developed and
redeveloped communities. The increase for the nine months ended September 30,
1999 is primarily attributable to additional expense from the former Avalon
communities and secondarily to newly developed and redeveloped communities in
1998 and 1999.
General and administrative decreased $229,000 (8.9%) to $2,349,000 for the
three months ended September 30, 1999 compared to $2,578,000 for the comparable
period of the preceding year. General and administrative increased $1,567,000
(28.4%) to $7,092,000 for the nine months ended September 30, 1999 compared to
$5,525,000 for the comparable period of the preceding year. The
quarter-to-quarter decrease reflects cost reductions associated with our
management realignment and related organizational adjustments announced in the
first quarter of 1999. The increase for the nine months ended September 30,
1999 is primarily due to costs incurred to support the increase in the size of
our portfolio that resulted from the merger.
Equity in income of unconsolidated joint ventures increased $252,000 to
$860,000 for the three months ended September 30, 1999 compared to $608,000 for
the comparable period of the preceding year and increased $1,420,000 to
$2,266,000 for the nine months ended September 30, 1999 compared to $846,000
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 $1,078,000 to $2,301,000 for the three months ended
September 30, 1999 compared to $1,223,000 for the comparable period of the
preceding year. Interest income increased $4,033,000 to $5,723,000 for the nine
months ended September 30, 1999 compared to $1,690,000 for the comparable
period of the preceding year. These increases are primarily from an increase in
interest from participating mortgage notes including the Avalon Arbor
promissory note that we succeeded to in connection with the merger and the
Fairlane Woods promissory note acquired in August 1998. The Fairlane Woods
promissory note was sold in October 1999.
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 usually expensed. The
application of these policies for the nine months ended September 30, 1999
resulted in non-revenue generating capitalized expenditures for Stabilized
Communities of approximately $126 per apartment home. For the nine months ended
September 30, 1999, we charged to maintenance expense,
25
including carpet and appliance replacements, a total of approximately
$27,219,000 for Stabilized Communities or $1,003 per apartment home. We
anticipate that capitalized costs per apartment home will gradually rise as the
average age of our communities increases.
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 are 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 $9,458,000 at September 30, 1998 to
$9,043,000 at September 30, 1999 due to a decrease in cash provided by
financing activities, offset by an increase in cash provided by operating
activities and a decrease in cash used in investing activities.
Net cash provided by operating activities increased by $28,878,000 from
$121,850,000 for the nine months ended September 30, 1998 to $150,728,000
for the nine months ended September 30, 1999. The increase is primarily
due to the addition of the former Avalon communities as well as an
increase in operating income from newly developed, redeveloped and
existing Bay communities.
Net cash used in investing activities decreased by $247,854,000 from
$489,665,000 for the nine months ended September 30, 1998 to $241,811,000
for the nine months ended September 30, 1999. This decrease in
expenditures reflects decreased acquisition activity and proceeds from the
sale of nine communities in the nine months ended September 30, 1999,
offset by increased construction and reconstruction activity. The decrease
in acquisition activity is attributable to a shift in our investment focus
away from acquisitions and towards higher yielding development
opportunities, primarily in response to the 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 $282,849,000 from
$374,085,000 for the nine months ended September 30, 1998 to $91,236,000
for the nine months ended September 30, 1999. The decrease is primarily
due to decreased borrowings under our unsecured facility, 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 regularly review 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;
- development and redevelopment activity in which we are currently
engaged;
- debt service payments;
- the distributions required with respect to our series of
preferred stock; and
26
- 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, some or all 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 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;
3. Operating in markets with growing demand, as measured by household
formation and job growth, and high barriers-to-entry. We believe these
characteristics generally 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.
Capital markets conditions have 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.
27
Unsecured Facility
Our unsecured facility is furnished by a consortium of banks and 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 0.6% per annum. The unsecured facility
matures in July 2001, however 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 .54% for balances most
recently placed under the competitive bid option. At November 1, 1999,
$170,500,000 was outstanding, $74,068,000 was used to provide letters of credit
and $355,432,000 was available for borrowing under the unsecured facility. We
intend to use borrowings under the unsecured facility for:
- capital expenditures;
- construction, development and redevelopment 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 some of our 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.
Financing Commitments/Transactions Completed
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 were used to repay amounts outstanding under our
unsecured facility.
We completed a refinancing of approximately $18,755,000 of tax exempt bonds
related to the Avalon Ridge community. These bonds bear a variable interest
rate, will mature on May 1, 2026 and are credit enhanced by our credit
enhancement facility with the Federal National Mortgage Association.
Future Financing and Capital Needs
As of September 30, 1999, we had 19 new communities under construction either
by us or by unaffiliated third parties with whom we have entered into forward
purchase commitments. As of September 30, 1999, a total estimated cost of
$269,890,000 remained to be invested in these communities. In addition, we had
a total of 10 communities that were under reconstruction, for which an
estimated $52,008,000 remained to be invested as of September 30, 1999.
Substantially all of the capital expenditures necessary to complete the
communities currently under construction and reconstruction will be funded
from:
- the remaining capacity under our $600,000,000 unsecured credit
facility;
- the net proceeds from the sale of existing communities;
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- 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 you 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 increased 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. The failure to complete
these transactions on a cost-effective basis 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 launched an aggressive disposition program, to sell assets in
markets where we have limited market presence. Under this program, we solicit
competing bids from unrelated parties for these individual assets, and consider
the sales price and tax ramifications of each proposal. In connection with this
disposition strategy, we have disposed of thirteen communities and a
participating mortgage note since January 1, 1999. The net proceeds from the
sale of these assets were approximately $252,495,000. We intend to actively
seek buyers for the remaining communities held for sale during the fourth
quarter of 1999. However, we cannot assure that these assets can be sold on
terms that we consider satisfactory.
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 September 30, 1999 totaled $120,299,000. 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 $1,953,000
for the three months ended September 30, 1999 and $5,237,000 for the nine
months ended September 30, 1999. Our Condensed Consolidated Statements of
Operations include net income from the communities held for sale for the three
months ended September 30, 1998 of $828,000 and $1,123,000 for the nine months
ended September 30, 1998, or $2,810,000 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 Funds from Operations. 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 the 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 Funds from Operations.
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Debt Maturities
The following table details debt maturities for the next five years, excluding
the unsecured facility:
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. We believe that 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.
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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 or vendors 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:
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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.
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 required 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 that 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. Together with our consultants, the Task Force has
conducted an assessment of these systems at all communities to identify and
evaluate the changes and
32
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 processes of verifying
inventory and obtaining information regarding Year 2000 compliance of detected
non-information embedded systems. We cannot assure, however, that the
completion of the process of verifying inventory and obtaining risk assurance
has identified all non-compliant systems.
We have completed testing of our information and non-information systems to
ensure Year 2000 compliance. Testing was 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 higher likelihood of failure than other systems;
- for which the Task Force was unable to obtain reliable third
party assurance that the detected system is Year 2000 compliant;
and
- which were not deemed to have acceptable contingency options.
While we believe such tests were successful in all material respects, the Task
Force intends to closely monitor our Year 2000 compliance progress and has
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 existing portfolio. For certain
communities, primarily communities with high-rise buildings, specific
contingency plans, referred to as site specific contingency plans, were
required. The Task Force will continue to review both compliance and
contingency plans throughout the remainder of the year to ensure all systems
will be Year 2000 compliant.
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 our
Year 2000 compliance efforts to date. 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 have responded to our inquiries and
represented that Year 2000 compliance plans are being implemented for their
systems. No assurance can be given that these third parties vendors 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
33
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, or FFO, to be an appropriate
measure of our operating performance because it helps investors understand our
ability to incur and service debt and to make capital expenditures. We believe
that to gain a clear understanding of our operating results, FFO should be
examined with net income as presented in the consolidated financial statements
included elsewhere in this report. FFO is determined based on 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.
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 by other REITs
may not be comparable to our calculation of FFO.
For the three months ended September 30, 1999, FFO increased to $54,957,000
from $47,492,000 for the three months ended September 30, 1998. This increase
is primarily due to the completion of new development and redevelopment
communities. Growth in earnings from Established Communities also contributed
to the increase.
FFO for the three months ended September 30, 1999 and the preceding four
quarters are summarized as follows (dollars in thousands):
34
(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 $568 for Year 2000 remediation costs.
Management Information Systems
We believe that an innovative 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. 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 AvalonBay's corporate information throughout the country from
all locations.
We are currently engaged in the development of an innovative 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 commercial software. We intend to enter into a formal joint
venture with another public multifamily real estate company, our joint venturer,
and to continue development of these systems and system software, which we
collectively refer to as the "system", through the joint venture entity. The
system 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 system 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 employees and related
overhead, and the costs of engaging third party consultants. These development
costs will be shared on an equal basis by us and the joint venturer. Once
developed, we intend to use the property management system in place of current
property management information software 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
35
implemented during the third and fourth quarters of 2000. The leasing
automation system is currently in beta testing at two communities.
We believe that once implemented the system will result in cost savings due to
increased data reliability and efficiencies in management time and overhead,
and that these savings will largely offset the expense associated with
amortizing the system development costs and maintaining the software. We also
believe that it is possible that other real estate companies may desire to use
the system concept and system software that we are developing and that
therefore there may be an opportunity to recover, in the future, a portion of
our investment by licensing the system 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 systems or system software
on this scale and have never licensed a system concept or system software to
others. There are a variety of risks associated with the development of the
system, 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 and implementation of the
software;
- we may be unable to implement the system with the functionality
and efficiencies we desire on commercially reasonable terms
- we may decide not to endeavor to license the system to other
enterprises, the system may not be attractive to other
enterprises, and we may not be able to effectively manage the
licensing of the system to other enterprises; and
- the system may not provide AvalonBay with meaningful cost
savings or a meaningful source of ancillary revenues.
The occurrence of any of the events described above could prevent us from
achieving increased efficiencies, realizing revenue growth produced by
ancillary revenues or recovering our initial investment.
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 is estimated to have 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 is
estimated to have 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
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;
36
- 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 1999, 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 subject to a minimum of $100,000 and a maximum of $25,000,000 per
occurrence. In addition, our general liability and property insurance program
provides coverage for public 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 September 30, 1999, there were 10 Development Communities under
construction. We expect these Development Communities to add a total of 2,464
apartment homes to our portfolio upon completion. The total capitalized cost of
the Development Communities, when completed, is expected to be approximately
$414.9 million. Statements regarding the future development or performance of
the Development Communities are forward-looking statements. We cannot assure
you 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 returns comparable to our past
developments.
You should carefully review the discussion under "Risks of Development and
Redevelopment" below.
We hold a fee simple ownership interest in each of the Development Communities.
The following page presents a summary of Development Communities:
37
(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) Future initial occupancy dates are estimates.
(3) Stabilized operations is defined as the first full quarter of 95% or
greater occupancy after completion of construction.
(4) Projected EBITDA represents gross potential earnings projected to be
achieved at completion of construction before interest, income taxes,
depreciation, amortization and extraordinary items, minus (a) projected
economic vacancy and (b) projected stabilized operating expenses. EBITDA
is relevant to an understanding of the economics of AvalonBay because it
indicates cash flow available from operations to service fixed
obligations. EBITDA should not be considered as an alternative to
operating income, as determined in accordance with GAAP, as an indicator
of our operating performance, or to cash flows from operating activities
(as determined in accordance with GAAP) as a measure of liquidity. EBITDA
as disclosed by other REITs may not be comparable to our calculation of
EBITDA.
38
Redevelopment Communities
As of September 30, 1999, we had 10 communities under redevelopment. The total
budgeted cost to complete these Redevelopment Communities, including the cost
of acquisition and redevelopment, is expected to be approximately $305.1
million, of which approximately $66.1 million is the additional capital
invested or expected to be invested above the original purchase cost.
Statements regarding the future redevelopment or performance of the
Redevelopment Communities are forward-looking statements. 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 you that we will meet our schedule for
reconstruction completion, that we will meet our 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:
(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) Reconstruction completion dates are estimates.
(4) Restabilized operations is defined as the first full quarter of 95% or
greater occupancy after completion of redevelopment.
(5) 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. EBITDA
is relevant to an understanding of the economics of AvalonBay because it
indicates cash flow available from operations to service fixed
obligations. EBITDA should not be considered as an alternative to
operating income, as determined in accordance with GAAP, as an indicator
of our operating performance, or to cash flows from operating activities
(as determined in accordance with GAAP) as a measure of liquidity. EBITDA
as disclosed by other REITs may not be comparable to our calculation of
EBITDA.
(6) Redevelopment consists of only exterior work.
39
Development Rights
As of September 30, 1999, we are considering the development of 30 new
apartment communities. These Development Rights range from land owned or under
contract for which design and architectural planning has just begun to land
owned or under contract 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 8,940
institutional-quality apartment homes to our portfolio. At September 30, 1999,
the cumulative capitalized costs incurred in pursuit of the 30 Development
Rights, including the cost of land acquired in connection with four of the
Development Rights, was approximately $52 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 September 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 you 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
- if construction of any particular community is undertaken, that
it will be completed at the total budgeted cost assumed in the
financial projections below.
40
(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.
41
Risks of Development and Redevelopment
We intend to continue to pursue the development and redevelopment of apartment
home communities. Our development and redevelopment activities may be exposed
to the following industry 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 affect our payment of 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 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
42
experienced in the future. We cannot assure 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 or
reconstruction 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 September 30, 1999
totaled $5,208,000 and for the nine months ended September 30, 1999 totaled
$18,357,000. Capitalized interest during the three months ended September 30,
1998 totaled $4,847,000 and during the nine months ended September 30, 1998
totaled $11,372,000.
43
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
(a) None
(b) None
(c) On August 25, 1999, the Company issued 1,524 shares of
Common Stock in exchange for 1,524 units in a DownREIT
partnership. The issuance was exempt under Section 4(2)
of the Securities Act.
On September 2, 1999, the Company issued 3,500 shares of
Common Stock in exchange for 3,500 units in a DownREIT
partnership. The issuance was exempt under Section 4(2)
of the Securities Act.
(d) None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) EXHIBITS
Exhibit No. Description
- ----------- -----------
3(i).1 -- Articles of Amendment and Restatement of Articles of
Incorporation of AvalonBay Communities, Inc. (the
"Company"), dated as of June 4, 1998. (Incorporated by
reference to Exhibit 3(i).1 to Form 10-Q of the Company
filed August 14, 1998.)
3(i).2 -- Articles of Amendment, dated as of October 2, 1998.
(Incorporated by reference to Exhibit 3.1(ii) to Form
8-K of the Company filed on October 6, 1998.)
44
3(i).3 -- Articles Supplementary, dated as of October 13, 1998,
relating to the 8.70% Series H Cumulative Redeemable
Preferred Stock. (Incorporated by reference to Exhibit 1
to Form 8-A of the Company filed October 14, 1998.)
3(ii).1 -- Bylaws of the Company, as amended and restated, dated as
of July 24, 1998. (Incorporated by reference to Exhibit
3(ii).1 to Form 10-Q of the Company filed August 14,
1998.)
3(ii).2 -- Amendment, dated February 10, 1999, to Bylaws of the
Company (Incorporated by reference to Exhibit 3(ii).2 to
Form 10-K of the Company filed March 31, 1999.)
3(ii).3 -- Amendment, dated May 5, 1999, to Bylaws of the Company.
4.1 -- Indenture of Avalon dated as of September 18, 1995.
(Incorporated by reference to Form 8-K of Avalon dated
September 18, 1995.)
4.2 -- First Supplemental Indenture of Avalon dated as of
September 18, 1995. (Incorporated by reference to
Avalon's Current Report on Form 8-K dated September 18,
1995.)
4.3 -- Second Supplemental Indenture of Avalon dated as of
December 16, 1997. (Incorporated by reference to
Avalon's Current Report on Form 8-K filed on January 26,
1998.)
4.4 -- Third Supplemental Indenture of Avalon dated as of
January 22, 1998. (Incorporated by reference to Avalon's
Current Report on Form 8-K filed on January 26, 1998.)
4.5 -- Indenture, dated as of January 16, 1998, between the
Company and State Street Bank and Trust Company, as
Trustee. (Incorporated by reference to Exhibit 4.1 to
Form 8-K of the Company filed on January 21, 1998.)
4.6 -- First Supplemental Indenture, dated as of January 20,
1998, between the Company and the Trustee. (Incorporated
by reference to Exhibit 4.2 to Form 8-K of the Company
filed on January 21, 1998.)
4.7 -- Second Supplemental Indenture, dated as of July 7, 1998,
between the Company and the Trustee. (Incorporated by
reference to Exhibit 4.2 to Form 8-K of the Company
filed on July 9, 1998.)
4.8 -- Third Supplemental Indenture, dated as of December 21,
1998, between the Company and the Trustee, including
forms of Floating Rate Note and Fixed Rate Note.
(Incorporated by reference to Exhibit 4.4 to the
Company's Form 8-K filed on December 21, 1998.)
4.9 -- Dividend Reinvestment and Stock Purchase Plan of the
Company filed October 8, 1998. (Incorporated by
reference to Form S-3 of the Company, File No.
333-16647.)
4.10 -- Shareholder Rights Agreement, dated March 9, 1998,
between the Company and First Union National Bank (a
successor to American Stock Transfer and Trust Company)
as Rights Agent (including the form of Rights
Certificate as Exhibit B). (Incorporated by reference to
Exhibit 4.1 to Form 8-A of the Company filed March 11,
1998.)
12.1 -- Statements re: Computation of Ratios.
27.1 -- Financial Data Schedule
(b) REPORTS ON FORM 8-K
There were no reports filed by the Company on Form 8-K during the
quarter ending September 30, 1999.
45
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.
Date: November 12, 1999 /s/ Richard L. Michaux
----------------------------------------------
Richard L. Michaux
President, Chief Executive Officer and Director
Date: November 12, 1999 /s/ Thomas J. Sargeant
-----------------------------------------------
Thomas J. Sargeant
Chief Financial Officer and Treasurer
46