As of March 31, 2001, our communities were classified as follows:

There were no changes to our community portfolios during the month of April.  Of the Current Communities as of May 1, 2001, we owned:

We also hold a fee simple ownership interest in twelve of the Development Communities and a membership interest in a limited liability company that holds a fee simple interest in one Development Community.

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 per unit paid to the holders of units of limited partnership interests approximate the current AvalonBay common stock dividend amount.  Each DownREIT partnership has been structured so that it is unlikely the limited partners will be entitled to a distribution greater than the initial distribution provided for 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 cash, we may elect to acquire any unit presented for redemption for one share of our common stock.  As of March 31, 2001, there were 671,083 units outstanding.  The DownREIT partnerships are consolidated for financial reporting purposes.

At March 31, 2001, we had positioned our portfolio of Stabilized Communities, excluding communities owned by unconsolidated joint ventures, to an average physical occupancy level of 97.0%.  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 cities:

Recent Developments

Sales of Existing Communities. We seek to increase our geographical concentration in selected high barrier-to-entry markets where we believe we can:

To effect this increased concentration, we are selling assets in certain submarkets and intend to redeploy the proceeds from those sales to develop and redevelop communities currently under construction or reconstruction.  Pending such redeployment, we will generally use the proceeds from the sale of these communities to reduce amounts outstanding under our variable rate unsecured credit facility.  On occasion, we will set aside the proceeds from the sale of communities into a cash escrow account to facilitate a like-kind exchange transaction.  Accordingly, we sold one community containing 226 apartment homes in connection with our capital redeployment strategy during the three months ended March 31, 2001.  Net proceeds from this sale totaled approximately $14,500,000.  We intend to dispose of additional assets as described more fully under “Future Financing and Capital Needs.”

Development, Redevelopment and Acquisition Activities.  During the three months ended March 31, 2001, we completed the development of one community, Avalon Estates, for a total investment of $20,500,000.  This community, which is located in Hull, Massachusetts, contains 162 apartment homes.

We also acquired three communities in the Seattle, Washington area (Avalon Wynhaven, Avalon Brandemoor, and Avalon WildWood) for a total acquisition price of $129,300,000.  These communities, which contain an aggregate of 995 apartment homes, were purchased pursuant to a forward purchase contract agreed to in 1997 with an unaffiliated party.

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.

In February 2001, we announced the departure of a senior executive.  As a result of this departure, we recorded a charge of approximately $2,500,000 during the first quarter of 2001.

Results of Operations and Funds From Operations

A comparison of our operating results for the three months ended March 31, 2001 and March 31, 2000 follows (dollars in thousands):

Net income available to common stockholders increased $4,427,000 (11.9%) to $41,654,000 for the three months ended March 31, 2001 compared to $37,227,000 for the preceding year.  Excluding separation costs and gain on sale of communities, net income available to common stockholders increased by $9,929,000 for the three months ended March 31, 2001 compared to the same period of the preceding year.  The increase in net income, as adjusted, for the three months ended March 31, 2001 is primarily attributable to additional operating income from newly developed and redeveloped communities as well as growth in operating income from Established Communities.

As discussed in “Recent Developments – Sales of Existing Communities” and “Future Financing and Capital Needs,” we funded a portion of our development and redevelopment activities through the sale of assets which do not meet our long-term strategic objectives.  The short-term effect of a sale of a community is that net operating income will be negatively impacted because that community’s contribution to net operating income has been eliminated and the development or redevelopment community in which the proceeds from the sale are being invested is not yet complete.  Interest expense will also decrease as the proceeds from the sale of communities are initially used to repay amounts outstanding on our unsecured credit facility.  The historical effect of this strategy has been that net operating income attributable to newly developed and redeveloped communities is higher than net operating income of assets identified for sale.

The increase in net operating income of $12,639,000 for the three months ended March 31, 2001 as compared to 2000 is attributable to:

Depreciation expense is impacted by the timing of asset sales, acquisitions and completion of development or redevelopment activities.  Gain on sale of communities is impacted by the number of assets sold in a given period, the carrying value of those assets, and the local market conditions in which the individual assets are located.

Rental income increased ($20,544,000 or 15.2%) primarily due to an increase in the weighted average monthly rental income per occupied apartment home and an increase in the weighted average number of occupied apartment homes.

Management fees increased ($83,000 or 33.5%) primarily due to receipt of fees pursuant to joint venture arrangements.

Operating expenses, excluding property taxes increased  ($6,462,000 or 19.4%) primarily due to the addition of newly developed, redeveloped and acquired apartment homes and separation costs of $2,493,000 due to the departure of a senior executive.  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.

Property taxes increased  ($1,568,000 or 14.0%) primarily due to the addition of newly developed, redeveloped or acquired apartment homes, partially offset by the sale of communities.  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.

Interest expense increased ($3,057,000 or 15.2%) primarily due to the issuance of $350,000,000 of unsecured notes during the second half of 2000.  This reflects our strategy to mitigate the risk of floating rate debt by repaying floating rate debt under the unsecured credit facility (with relatively lower current interest rates) with longer dated fixed rate unsecured debt that has a higher current interest rate.

Depreciation expense increased ($1,710,000 or 5.8%) due to the addition of newly developed, redeveloped and acquired apartment homes, partially offset by the sale of communities.

General and administrative increased ($858,000 or 29.1%) primarily due to an increase in consulting fees as well as compensation expense for a senior officer whose salary was expensed in the current period but capitalized a year ago while he served the company in a different capacity.

Equity in income of unconsolidated joint ventures decreased ($588,000 or 84.7%). The decrease is primarily attributable to a valuation allowance of $310,000 recorded for an investment in a technology company accounted for under the cost method, as well as our pro rata share of losses from a technology investment accounted for under the equity method.

Interest income increased (796,000 or 78.0%) due to an increase in average cash balances invested.

Gain on sale of communities of $4,901,000 for the three months ended March 31, 2001 was attributable to the sale of one community.

Funds from Operations

We 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 understand our operating results, FFO should be examined with net income as presented in the Condensed Consolidated Statements of Operations and Other Comprehensive Income 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 Trustsâ (NAREIT), and is defined as:

FFO does not represent cash generated from operating activities in accordance with GAAP. 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 GAAP 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 March 31, 2001, FFO increased to $67,699,000 from $58,614,000 for the comparable period of the preceding year.  This increase is primarily due to the completion of new development and redevelopment communities as well as growth in earnings from Established Communities.

Capitalization of Fixed Assets and Community Improvements

Our policy with respect to capital expenditures is generally to capitalize only non-recurring expenditures.  We capitalize improvements and upgrades only if the item:

Under this policy, virtually all capitalized costs are non-recurring, as recurring make-ready costs are expensed as incurred. Recurring make-ready costs include the following:

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.  We generally expense purchases of personal property made for replacement purposes.  The application of these policies for the three months ended March 31, 2001 resulted in non-revenue generating capitalized expenditures for Stabilized Communities of approximately $16 per apartment home.  For Stabilized Communities, we charged $275 per apartment home to maintenance expense for the three months ended March 31, 2001, including carpet and appliance replacements.  We anticipate that capitalized costs per apartment home will gradually increase as the average age of our communities increases.

Liquidity and Capital Resources

Liquidity.  The primary source of liquidity is our cash flows from operations.  Operating cash flows have historically been determined by:

The timing, source and amount of cash flows provided by financing activities and used in investing activities are sensitive to the capital markets environment, particularly to changes in interest rates that are charged to us as changes in interest rates affect our decision as to whether to issue debt securities, borrow money and invest in real estate.  Thus, changes in the capital markets environment affect our plans for the undertaking of construction and development as well as acquisition activity.

Cash and cash equivalents increased $417,000 to $57,651,000 for the three months ended March 31, 2001 compared to an increase in cash and cash equivalents of $455,000 to $8,076,000 for the three months ended March 31, 2000.

We regularly review our short and long-term liquidity needs and the adequacy of Funds from Operations, as defined above, and other expected liquidity sources to meet these needs.  We believe our principal short–term liquidity needs are to fund:

We anticipate that we can fully satisfy these needs from a combination of cash flows provided by operating activities and capacity under the unsecured credit facility.

We believe our principal long-term liquidity needs are the reduction of medium and long-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 will have the capacity to meet our long-term liquidity needs, we cannot assure you that additional debt financing or debt or equity offerings will be available or, if available, that they will be on terms we consider satisfactory.

Capital Resources. We intend to match the long-term nature of our real estate assets with long-term cost effective capital to the extent permitted by prevailing market conditions.  We follow a focused strategy to help facilitate uninterrupted access to capital.  This strategy includes:

We believe these strategies provide a disciplined approach to capital access to help position AvalonBay to fund portfolio growth.

Capital markets conditions over the past several years have limited our access to cost-effective capital.  See “Future Financing and Capital Needs” for a discussion of our response to the current capital markets environment.

Variable Rate Unsecured Facility

Our unsecured revolving credit 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 credit facility bears interest at varying levels tied to the London Interbank Offered Rate (LIBOR) based on ratings levels achieved on our unsecured notes and on a maturity selected by us.  The current stated pricing is LIBOR plus 0.60% per annum.  A competitive bid option is available for borrowings of up to $400,000,000.  This option allows banks that are part of the lender consortium to bid to provide us loans at a rate that is lower than the stated pricing provided by the unsecured credit facility.  The competitive bid option may result in lower pricing if market conditions allow.  Pricing under the competitive bid option resulted in average pricing of LIBOR plus 0.50% for balances most recently placed under the competitive bid option.  At May 1, 2001, $42,000,000 was outstanding, $82,203,000 was used to provide letters of credit and $475,797,000 was available for borrowing under the unsecured credit facility.  The unsecured credit facility matures in July 2001, and the company is currently in the process of negotiating a new facility which it believes will be in place prior to the maturity date of the existing facility.  In addition, the Company expects the new facility will have substantially the same terms and conditions as the existing facility.  We intend to use borrowings under the unsecured credit facility for:

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 approximately $168 million of our variable rate 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.

Future Financing and Capital Needs

As of March 31, 2001, we had 14 new communities under construction either by us or by an unaffiliated third parties with whom we have entered into forward purchase commitments.  As of March 31, 2001, a total estimated cost of $455,642,000 remained to be invested in these communities.  In addition, we had four other communities under reconstruction, for which an estimated $30,690,000 remained to be invested as of March 31, 2001.

Substantially all of the capital expenditures necessary to complete the communities currently under construction and reconstruction will be funded from:

We expect to continue to fund deferred development costs related to future developments from retained operating cash and borrowings under the unsecured credit facility.  We believe 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 since the third quarter of 1998.  While the capital market environment has improved, 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 financing to complete these undertakings, although we cannot assure you that we will be able to obtain such financing.  In the event that financing cannot be obtained, we may have to abandon Development Rights, writeoff associated pursuit costs and/or forego reconstruction activity.   In such instances, we will not realize the increased revenues and earnings that we expected from such pursuits, and the related write-off of costs will increase current period expenses.

Our liquidity could be adversely impacted by expanding development activities and/or reduced capital (as compared to prior years) available from asset sales.  To meet the balance of our liquidity needs under such conditions, we would need to arrange additional capacity under our existing unsecured credit 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 you that we will be successful in completing these arrangements, sales or offerings.  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.

To increase our concentration of communities in selected high barrier-to-entry markets, we are selling assets which do not meet our long-term strategic objectives and redeploying the proceeds.  Under our disposition program, we solicit competing bids from unrelated parties for these individual assets and consider the sales price and tax ramifications of each proposal.   We intend to actively seek buyers for communities held for sale.  However, we cannot assure you that these assets can be sold on terms that we consider satisfactory.

The assets that we have 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 March 31, 2001 totaled $185,493,000.  Certain individual assets are secured by mortgage indebtedness which may be assumed by the purchaser or repaid from our net sales proceeds.  Our Consolidated Statements of Operations and Other Comprehensive Income include net income from these communities of $4,044,000 and $2,839,000 for the three months ended March 31, 2001 and 2000, respectively.

Because the proceeds from the sale of communities are used initially to reduce borrowings under our unsecured credit facility, the immediate effect of a sale of a community is to have a negative effect on earnings.  This is because the yield on a community that is sold exceeds the interest rate on the borrowings that are repaid from such net proceeds.  Therefore, changes in the number and timing of dispositions, and the redeployment of the resulting net proceeds, may have a material and adverse effect on our earnings.

We are a member of Constellation Real Technologies LLC, an entity formed by a number of real estate investment trusts and real estate operating companies for the purpose of investing in multi-sector real estate technology opportunities. Our capital commitment to Constellation Real Technologies is $4.0 million. Although we have made no capital contributions to date, we expect to contribute approximately $910,000 by the end of May 2001.

Debt Maturities

The table on the following page details debt maturities for the next five years, excluding the unsecured credit facility:

⁽¹⁾              Includes credit enhancement fees, facility fees, trustees, etc.
⁽²⁾              The remaining loan balance was repaid in connection with the disposition of the property during 2001.

Announced Redemption of Preferred Stock

On May 11, 2001, the Company published and mailed notice that it will redeem all 4,455,000 outstanding shares of its 9.00% Series F Cumulative Redeemable Preferred Stock (the "Series F Preferred Stock") on June 11, 2001 at a price of $25.00 per share, plus $0.1625 in accrued and unpaid dividends to the redemption date, for an aggregate redemption price of $25.1625 per share of Series F Preferred Stock. The aggregate redemption price for the Series F Preferred Stock does not exceed the aggregate amount of sale proceeds of other capital stock issued since the date of issuance of the Series F Preferred Stock. The Company expects that to the extent cash balances on June 11, 2001 are less than the aggregate redemption price of the Series F Preferred Stock the Company will increase its borrowings under its unsecured credit facility."

Inflation

Substantially all of our leases 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, results in rents and cash flow which provide an attractive inflation hedge.