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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 March 31, 2012

 

Commission file number 1-12672

 

AVALONBAY COMMUNITIES, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Ballston Tower

671 N. Glebe Rd, Suite 800

Arlington, Virginia  22203

(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)

 

 

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 o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x  No o

 

Indicate by check mark whether the Exchange registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes o  No x

 

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:

 

95,352,207 shares of common stock, par value $0.01 per share, were outstanding as of April 30, 2012

 

 

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AVALONBAY COMMUNITIES, INC.

 

FORM 10-Q

 

INDEX

 

PART I - FINANCIAL INFORMATION
			Page
Item 1.	Condensed Consolidated Financial Statements
		Condensed Consolidated Balance Sheets as of March 31, 2012 (unaudited) and December 31, 2011	1
		Condensed Consolidated Statements of Comprehensive Income (unaudited) for the three months ended March 31, 2012 and 2011	2
		Condensed Consolidated Statements of Cash Flows (unaudited) for the three months ended March 31, 2012 and 2011	3
		Notes to Condensed Consolidated Financial Statements (unaudited)	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		19-39
Item 3.	Quantitative and Qualitative Disclosures About Market Risk		40
Item 4.	Controls and Procedures		40
	PART II - OTHER INFORMATION
Item 1.	Legal Proceedings		41
Item 1a.	Risk Factors		41
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		41
Item 3.	Defaults Upon Senior Securities		42
Item 4.	Mine Safety Disclosures		42
Item 5.	Other Information		42
Item 6.	Exhibits		42
Signatures			45

 

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AVALONBAY COMMUNITIES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except per share data)

 

		3-31-12			12-31-11
		(unaudited)
ASSETS
Real estate:
Land		$	1,375,068		$	1,345,976
Buildings and improvements		6,803,724			6,726,634
Furniture, fixtures and equipment		235,556			228,451
		8,414,348			8,301,061
Less accumulated depreciation		(1,900,698		)	(1,837,847		)
Net operating real estate		6,513,650			6,463,214
Construction in progress, including land		688,617			597,546
Land held for development		297,127			325,918
Operating real estate assets held for sale, net		38,060			38,352
Total real estate, net		7,537,454			7,425,030
Cash and cash equivalents		248,242			616,853
Cash in escrow		72,894			73,400
Resident security deposits		24,269			23,597
Investments in unconsolidated real estate entities		151,565			144,561
Deferred financing costs, net		31,198			33,653
Deferred development costs		31,108			24,770
Prepaid expenses and other assets		144,329			140,526
Total assets		$	8,241,059		$	8,482,390
LIABILITIES AND EQUITY
Unsecured notes, net		$	1,449,929		$	1,629,210
Variable rate unsecured credit facility		—			—
Mortgage notes payable, net		1,930,386			1,969,986
Dividends payable		92,508			84,953
Payables for construction		43,789			36,775
Accrued expenses and other liabilities		233,743			247,599
Accrued interest payable		21,220			34,210
Resident security deposits		37,975			36,827
Liabilities related to real estate assets held for sale		34,042			33,875
Total liabilities		3,843,592			4,073,435
Redeemable noncontrolling interests		7,197			7,063
Equity:
Preferred stock, $0.01 par value; $25 liquidation preference; 50,000,000 shares authorized at both March 31, 2012 and December 31, 2011; zero shares issued and outstanding at March 31, 2012 and December 31, 2011, respectively		—			—
Common stock, $0.01 par value; 140,000,000 shares authorized at both March 31, 2012 and December 31, 2011; 95,341,319 and 95,175,677 shares issued and outstanding at March 31, 2012 and December 31, 2011, respectively		953			952
Additional paid-in capital		4,666,536			4,652,457
Accumulated earnings less dividends		(208,304		)	(171,648		)
Accumulated other comprehensive loss		(76,012		)	(87,020		)
Total stockholders’ equity		4,383,173			4,394,741
Noncontrolling interests		7,097			7,151
Total equity		4,390,270			4,401,892
Total liabilities and equity		$	8,241,059		$	8,482,390

 

See accompanying notes to Condensed Consolidated Financial Statements.

 

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AVALONBAY COMMUNITIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF

COMPREHENSIVE INCOME

(unaudited)

(Dollars in thousands, except per share data)

 

		For the three months ended
		3-31-12			3-31-11
Revenue:
Rental and other income		$	249,905		$	226,210
Management, development and other fees		2,549			2,320
Total revenue		252,454			228,530
Expenses:
Operating expenses, excluding property taxes		65,905			63,767
Property taxes		24,530			24,140
Interest expense, net		33,626			42,971
Loss on extinguishment of debt		1,179			—
Depreciation expense		62,991			59,650
General and administrative expense		9,710			7,292
Total expenses		197,941			197,820
Equity in income of unconsolidated entities		2,175			503
Income from continuing operations		56,688			31,213
Discontinued operations:
Income (loss) from discontinued operations		921			(676		)
Total discontinued operations		921			(676		)
Net income		57,609			30,537
Net (income) loss attributable to noncontrolling interests		149			(196		)
Net income attributable to common stockholders		$	57,758		$	30,341
Other comprehensive income:
Unrealized gain (loss) on cash flow hedges		11,008			(84		)
Comprehensive income		$	68,766		$	30,257
Earnings per common share - basic:
Income from continuing operations attributable to common stockholders		$	0.60		$	0.36
Discontinued operations attributable to common stockholders		0.01			(0.01		)
Net income attributable to common stockholders		$	0.61		$	0.35
Earnings per common share - diluted:
Income from continuing operations attributable to common stockholders		$	0.59		$	0.36
Discontinued operations attributable to common stockholders		0.01			(0.01		)
Net income attributable to common stockholders		$	0.60		$	0.35
Dividends per common share:		$	0.9700		$	0.8925

 

See accompanying notes to Condensed Consolidated Financial Statements.

 

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AVALONBAY COMMUNITIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(Dollars in thousands)

 

		For the three months ended
		3-31-12			3-31-11
Net income		$	57,609		$	30,537
Adjustments to reconcile net income to cash provided by operating activities:
Depreciation expense		62,991			59,650
Depreciation expense from discontinued operations		321			1,649
Amortization of deferred financing costs and debt premium/discount		1,475			1,818
Amortization of stock-based compensation		1,984			1,733
Equity in income of unconsolidated entities, net of eliminations		(1,346		)	(228		)
Loss on extinguishment of debt		1,179			—
Increase in cash in operating escrows		(1,225		)	(4,217		)
Increase in resident security deposits, prepaid expenses and other assets		(8,167		)	(9,407		)
Decrease in accrued expenses, other liabilities and accrued interest payable		(9,481		)	(8,320		)
Net cash provided by operating activities		105,340			73,215
Cash flows from investing activities:
Development/redevelopment of real estate assets including land acquisitions and deferred development costs		(159,091		)	(110,644		)
Acquisition of communities		(7,442		)	—
Capital expenditures - existing real estate assets		(2,746		)	(2,974		)
Capital expenditures - non-real estate assets		(147		)	(2,982		)
Increase (decrease) in payables for construction		7,014			(1,736		)
(Increase) decrease in cash in construction escrows		1,731			(7,572		)
(Increase) decrease in investments in unconsolidated real estate entities		(5,659		)	1,225
Net cash used in investing activities		(166,340		)	(124,683		)
Cash flows from financing activities:
Issuance of common stock		8,956			150,157
Dividends paid		(84,926		)	(76,557		)
Repayments of mortgage notes payable		(52,038		)	(30,119		)
Repayment of unsecured notes		(179,400		)	—
Payment of deferred financing costs		(123		)	—
Acquisition of joint venture partner equity interest		—			(6,570		)
Distributions to DownREIT partnership unitholders		(7		)	(7		)
Distributions to joint venture and profit-sharing partners		(73		)	(62		)
Net cash provided by (used in) financing activities		(307,611		)	36,842
Net decrease in cash and cash equivalents		(368,611		)	(14,626		)
Cash and cash equivalents, beginning of the period		616,853			306,426
Cash and cash equivalents, end of the period		$	248,242		$	291,800
Cash paid during the year for interest, net of amount capitalized		$	42,684		$	47,462

 

See accompanying notes to Condensed Consolidated Financial Statements.

 

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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

 

Supplemental disclosures of non-cash investing and financing activities (amounts in whole dollars):

 

During the three months ended March 31, 2012:

 

·                  As described in Note 4, “Equity,” 91,471 shares of common stock valued at $12,161,000 were issued in connection with stock grants; 735 shares valued at $95,000 were issued through the Company’s dividend reinvestment plan; 39,054 shares valued at $5,119,000 were withheld to satisfy employees’ tax withholding and other liabilities; and 4,027 shares valued at $324,000 previously issued in connection with employee compensation were forfeited. In addition, the Company granted 113,804 options for common stock at a value of $3,306,000.

 

·                  The Company recorded a decrease to other liabilities and a corresponding increase to other comprehensive income of $11,008,000; and recorded a decrease to prepaid expenses and other assets of $11,000, with a corresponding offset to the basis of unsecured notes, net to record the impact of the Company’s hedge accounting activity.

 

·                  Common dividends declared but not paid totaled $92,508,000.

 

·                  The Company recorded an increase of $309,000 in redeemable noncontrolling interests with a corresponding decrease to accumulated earnings less dividends to adjust the redemption value associated with the put option held by a joint venture partner and DownREIT partnership units. For further discussion of the nature and valuation of these items, see Note 10, “Fair Value”.

 

·                  The Company assumed a 4.61% coupon fixed rate mortgage loan with an outstanding balance of $11,958,000 in conjunction with the acquisition of The Mark Pasadena.

 

During the three months ended March 31, 2011:

 

·                  88,124 shares of common stock valued at $10,207,000 were issued in connection with stock grants; 941 shares valued at $107,000 were issued through the Company’s dividend reinvestment plan; 38,349 shares valued at $4,490,000 were withheld to satisfy employees’ tax withholding and other liabilities; 505 shares valued at $35,000 previously issued in connection with employee compensation were forfeited.  In addition, the Company granted 144,827 options for common stock at a value of $4,258,000.

 

·                  7,500 units of limited partnership, valued at $365,000, were presented for redemption to the DownREIT partnerships that issued such units and were acquired by the Company in exchange for an equal number of shares of the Company’s common stock.

 

·                  The Company recorded a decrease to prepaid expenses and other assets and a corresponding decrease to other comprehensive income of $84,000 and recorded a decrease to prepaid expenses and other assets of $456,000, with a corresponding offset to the basis of unsecured notes, net to record the impact of the Company’s hedge accounting activity.

 

·                  Common dividends declared but not paid totaled $77,941,000.

 

·                  The Company recorded an increase of $981,000 in redeemable noncontrolling interests with a corresponding decrease to accumulated earnings less dividends to adjust the redemption value associated with the put options held by joint venture partners and DownREIT partnership units.

 

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AVALONBAY COMMUNITIES, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

 

1.  Organization, Basis of Presentation and Significant Accounting Policies

 

Organization and Basis of Presentation

 

AvalonBay Communities, Inc. (the “Company,” which term, unless the context otherwise requires, refers to AvalonBay Communities, Inc. together with its consolidated subsidiaries), is a Maryland corporation that elected to be taxed as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986 (the “Code”). The Company focuses on the development, acquisition, ownership and operation of apartment communities in high barrier to entry markets of the United States. These markets are located in the New England, Metro New York/New Jersey, Mid-Atlantic, Midwest, Pacific Northwest, and Northern and Southern California regions of the country.

 

At March 31, 2012, the Company owned or held a direct or indirect ownership interest in 179 operating apartment communities containing 53,315 apartment homes in ten states and the District of Columbia, of which 10 communities containing 2,580 apartment homes were under reconstruction. In addition, the Company owned or held a direct ownership interest in 20 communities under construction that are expected to contain an aggregate of 5,775 apartment homes when completed. The Company also owned or held a direct or indirect ownership interest in land or rights to land in which the Company expects to develop an additional 34 communities that, if developed as expected, will contain an estimated 9,415 apartment homes.

 

The interim unaudited financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and in conjunction with the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements required by GAAP have been condensed or omitted pursuant to such rules and regulations. These unaudited financial statements should be read in conjunction with the financial statements and notes included in the Company’s 2011 Annual Report on Form 10-K. The results of operations for the three months ended March 31, 2012 are not necessarily indicative of the operating results for the full year. Management believes the disclosures are adequate to ensure the information presented is not misleading.  In the opinion of management, all adjustments and eliminations, consisting only of normal, recurring adjustments necessary for a fair presentation of the financial statements for the interim periods, have been included.

 

Capitalized terms used without definition have the meaning as provided elsewhere in this Form 10-Q.

 

Earnings per Common Share

 

Basic earnings per share is computed by dividing net income attributable to common stockholders by the weighted average number of shares outstanding during the period. All outstanding unvested restricted share awards contain rights to non-forfeitable dividends and participate in undistributed earnings with common shareholders and, accordingly, are considered participating securities that are included in the two-class method of computing basic earnings per share (“EPS”). Both the unvested restricted shares and other potentially dilutive common shares, and the related impact to earnings, are considered when calculating earnings per share on a diluted basis. The Company’s earnings per common share are determined as follows (dollars in thousands, except per share data):

 

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		For the three months ended
		3-31-12			3-31-11
Basic and diluted shares outstanding
Weighted average common shares - basic		94,855,266			86,168,732
Weighted average DownREIT units outstanding		7,500			10,291
Effect of dilutive securities		791,013			818,507
Weighted average common shares - diluted		95,653,779			86,997,530
Calculation of Earnings per Share - basic
Net income attributable to common stockholders		$	57,758		$	30,341
Net income allocated to unvested restricted shares		(254		)	(83		)
Net income attributable to common stockholders, adjusted		$	57,504		$	30,258
Weighted average common shares - basic		94,855,266			86,168,732
Earnings per common share - basic		$	0.61		$	0.35
Calculation of Earnings per Share - diluted
Net income attributable to common stockholders		$	57,758		$	30,341
Add: noncontrolling interests of DownREIT unitholders in consolidated partnerships, including discontinued operations		7			7
Adjusted net income attributable to common stockholders		$	57,765		$	30,348
Weighted average common shares - diluted		95,653,779			86,997,530
Earnings per common share - diluted		$	0.60		$	0.35

 

Certain options to purchase shares of common stock in the amounts of 427,288 and 469,647 were outstanding at March 31, 2012 and 2011, respectively, but were not included in the computation of diluted earnings per share because such options were anti-dilutive.

 

The Company is required to estimate the forfeiture of stock options and recognize compensation cost net of the estimated forfeitures.  The estimated forfeitures included in compensation cost are adjusted to reflect actual forfeitures at the end of the vesting period.  The forfeiture rate at March 31, 2012 is based on the average forfeiture activity over a period equal to the estimated life of the stock options, and was 0.3%. The application of estimated forfeitures did not materially impact compensation expense for the three months ended March 31, 2012 or 2011.

 

Derivative Instruments and Hedging Activities

 

The Company enters into interest rate swap and interest rate cap agreements (collectively, the “Hedging Derivatives”) for interest rate risk management purposes and in conjunction with certain variable rate secured debt to satisfy lender requirements.  The Company does not enter into derivative transactions for trading or other speculative purposes. The Company assesses both at inception and on an on-going basis, the effectiveness of qualifying cash flow and fair value hedges. Hedge ineffectiveness is reported as a component of general and administrative expenses. The fair values of the Hedging Derivatives that are in an asset position are recorded in prepaid expenses and other assets. The fair value of the Hedging Derivatives that are in a liability position are included in accrued expenses and other liabilities. Fair value changes for derivatives that are not in qualifying hedge relationships are reported as a component of general and administrative expenses. For the derivative positions that the Company has determined qualify as effective cash flow hedges, the Company has recorded the effective portion of cumulative changes in the fair value of the Hedging Derivatives in other comprehensive income.  Amounts recorded in other comprehensive income will be reclassified into earnings in the periods in which earnings are affected by the hedged cash flow. The change in fair value of the Hedging Derivatives that the Company has determined qualified as effective fair value hedges is reported as an adjustment to the carrying amount of the corresponding debt being hedged.

 

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Legal and Other Contingencies

 

The Company accounts for recoveries from legal matters as a reduction in the legal and related costs incurred associated with the matter, with recoveries in excess of these costs reported as a gain or, where appropriate, a reduction in the basis of a community to which the suit related.

 

The Company is involved in various claims and/or administrative proceedings that arise in the ordinary course of the Company’s business. While no assurances can be given, the Company does not believe that any of these outstanding litigation matters, individually or in the aggregate, will have a material adverse effect on the Company’s financial position or results of operations.

 

Use of Estimates

 

The preparation of financial statements in conformity with GAAP requires management to make certain estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods.  Actual results could differ from those estimates.

 

Reclassifications

 

Certain reclassifications have been made to amounts in prior period financial statements to conform to current period presentations.

 

Recently Adopted Accounting Standards

 

In May 2011, The Financial Accounting Standards Board (“FASB”) issued guidance on fair value measurement and disclosure requirements, which became effective for interim and annual periods beginning after December 15, 2011. The adoption of this guidance resulted in the tabular disclosure of fair value of the Company’s financial assets and liabilities, classified by level in the fair value hierarchy, and did not impact the Company’s financial position or results of operations.

 

2.  Interest Capitalized

 

The Company capitalizes interest during the development and redevelopment of real estate assets. Capitalized interest associated with the Company’s development or redevelopment activities totaled $12,320,000 and $6,343,000 for the three months ended March 31, 2012 and 2011, respectively.

 

3.  Notes Payable, Unsecured Notes and Credit Facility

 

The Company’s mortgage notes payable, unsecured notes and Credit Facility, as defined below, as of March 31, 2012 and December 31, 2011, are summarized below (dollars in thousands).  The following amounts and discussion do not include the mortgage notes related to the communities classified as held for sale, if any, as of March 31, 2012 and December 31, 2011, as shown in the Condensed Consolidated Balance Sheets (see Note 6, “Real Estate Disposition Activities”).

 

		3-31-12			12-31-11
Fixed rate unsecured notes (1)		$	1,451,601		$	1,556,001
Variable rate unsecured notes (1)		—			75,000
Fixed rate mortgage notes payable - conventional and tax-exempt (2)		1,537,343			1,528,783
Variable rate mortgage notes payable - conventional and tax-exempt		391,601			440,241
Total notes payable and unsecured notes		3,380,545			3,600,025
Credit Facility		—			—
Total mortgage notes payable, unsecured notes and Credit Facility		$	3,380,545		$	3,600,025

 

(1)          Balances at March 31, 2012 and December 31, 2011 exclude $1,672 and $1,802, respectively, of debt discount, and $0 and $11, respectively, for basis adjustments, as reflected in unsecured notes, net on the Company’s Condensed Consolidated Balance Sheets.

(2)          Balances at March 31, 2012 and December 31, 2011 exclude $1,442 and $962, respectively of debt premium as reflected in mortgage notes payable, net on the Company’s Condensed Consolidated Balance Sheets.

 

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The following debt activity occurred during the three months ended March 31, 2012:

 

·                  In January 2012, the Company repaid $179,400,000 principal amount of its 5.5% coupon unsecured notes pursuant to their scheduled maturity.

·                  In February 2012, in conjunction with the acquisition of a community, the Company assumed the existing 4.61% fixed-rate mortgage note in the amount of $11,958,000 that matures in June 2018, and is secured by the community.

·                  Also in February 2012, the Company repaid a variable rate secured mortgage note in the amount of $48,500,000 in advance of its November 2039 scheduled maturity date. In conjunction with the early retirement the Company incurred a non-cash charge of $1,179,000 for the write off of deferred financing fees which was recognized as a loss on extinguishment of debt.

 

The Company has a variable rate unsecured credit facility (the “Credit Facility”) with a syndicate of commercial banks, which has an available borrowing capacity of $750,000,000 and a 4-year term, plus a one year extension option.  The Credit Facility was entered into in September 2011 and it bears interest at varying levels based on the London InterBank Offered Rate (“LIBOR”), rating levels achieved on the Company’s unsecured notes and on a maturity selected by the Company.  The current stated pricing is LIBOR plus 1.075% per annum (1.32% at March 31, 2012). The Company did not have any borrowings outstanding under the Credit Facility and had $46,135,000 and $52,659,000 outstanding in letters of credit that reduced the borrowing capacity as of March 31, 2012 and December 31, 2011, respectively.

 

In the aggregate, secured notes payable mature at various dates from May 2012 through July 2066, and are secured by certain apartment communities and improved land parcels (with a net carrying value of $1,567,946,000, excluding communities classified as held for sale, as of March 31, 2012).

 

As of March 31, 2012, the Company has guaranteed approximately $179,918,000 of mortgage notes payable held by wholly owned subsidiaries; all such mortgage notes payable are consolidated for financial reporting purposes.  The weighted average interest rate of the Company’s fixed rate mortgage notes payable (conventional and tax-exempt) was 5.7% at March 31, 2012 and December 31, 2011.  The weighted average interest rate of the Company’s variable rate mortgage notes payable and its Credit Facility, including the effect of certain financing related fees, was 2.3% at March 31, 2012 and December 31, 2011.

 

Scheduled payments and maturities of mortgage notes payable and unsecured notes outstanding at March 31, 2012, excluding mortgage notes secured by communities classified as held for sale, are as follows (dollars in thousands):

 

											Stated
		Secured			Secured			Unsecured			interest rate
		notes			notes			notes			of unsecured
Year		payments (1)			maturities			maturities			notes
2012		$	10,274		$	14,666		$	201,601		6.125	%
2013		13,376			223,473			100,000			4.950	%
2014		14,284			—			150,000			5.375	%
2015		12,170			406,019			—			—
2016		12,807			—			250,000			5.750	%
2017		13,709			18,300			250,000			5.700	%
2018		14,330			11,073			—			—
2019		2,597			610,813			—			—
2020		2,768			—			250,000			6.100	%
2021		2,952			—			250,000			3.950	%
Thereafter		86,698			458,635			—			—
		$	185,965		$	1,742,979		$	1,451,601

 

(1)  Secured note payments are comprised of the principal pay downs for amortizing mortgage notes.

 

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The Company was in compliance at March 31, 2012 with certain customary financial and other covenants under the Credit Facility and the Company’s unsecured notes.

 

4.  Equity

 

The following summarizes the changes in equity for the three months ended March 31, 2012 (dollars in thousands):

 

								Accumulated			Accumulated
					Additional			earnings			other			Total
		Common			paid-in			less			comprehensive			stockholders’			Noncontrolling			Total
		stock			capital			dividends			gain (loss)			equity			interests			equity
Balance at December 31, 2011		$	952		$	4,652,457		$	(171,648	)	$	(87,020	)	$	4,394,741		$	7,151		$	4,401,892
Net income attributable to common stockholders		—			—			57,758			—			57,758			(54		)	57,704
Unrealized gain on cash flow hedges		—			—			—			11,008			11,008			—			11,008
Change in redemption value of redeemable noncontrolling interest		—			—			(309		)	—			(309		)	—			(309		)
Dividends declared to common stockholders		—			—			(92,481		)	—			(92,481		)	—			(92,481		)
Issuance of common stock, net of withholdings		1			5,231			(1,624		)	—			3,608			—			3,608
Amortization of deferred compensation		—			8,848			—			—			8,848			—			8,848
Balance at March 31, 2012		$	953		$	4,666,536		$	(208,304	)	$	(76,012	)	$	4,383,173		$	7,097		$	4,390,270

 

During the three months ended March 31, 2012, the Company:

 

(i)                                     issued 116,517 shares of common stock in connection with stock options exercised;

(ii)                                  issued 735 common shares through the Company’s dividend reinvestment plan;

(iii)                               issued 91,471 common shares in connection with stock grants;

(iv)                              withheld 39,054 common shares to satisfy employees’ tax withholding and other liabilities; and

(v)                                 cancelled 4,027 shares of restricted common stock upon forfeiture.

 

In addition, the Company granted 113,804 options for common stock to employees.  Any deferred compensation related to the Company’s stock option and restricted stock grants during the three months ended March 31, 2012 is not reflected on the Company’s Condensed Consolidated Balance Sheet as of March 31, 2012, and will not be reflected until earned as compensation cost.

 

In November 2010, the Company commenced a second continuous equity program (“CEP II”), under which the Company may sell up to $500,000,000 of its common stock from time to time during a 36-month period. The Company did not sell any shares under CEP II during the three months ended March 31, 2012. From program inception in November 2010 through March 31, 2012, the Company sold 2,490,765 shares at an average price of $119.84 per share for aggregate net proceeds of $294,000,000.

 

5.  Investments in Real Estate Entities

 

Investments in consolidated entities

 

In February 2012, the Company acquired The Mark Pasadena, located in Pasadena, CA.  The Mark Pasadena contains 84 apartment homes and was acquired for a purchase price of $19,400,000. In conjunction with this acquisition, the Company assumed the existing 4.61% fixed-rate mortgage loan with an outstanding principal amount of $11,958,000 which matures in June 2018, and is secured by the community.

 

The Company accounted for the acquisition of The Mark Pasadena as a business combination and recorded the acquired assets and assumed liabilities, including identifiable intangibles, based on their fair values.  The Company looked to third party pricing for the value of the land, and an internal model to determine the fair value of the real estate assets, in place leases and mortgage loan.  Given the heterogeneous nature of multi-family real estate, the fair values for the land, real estate assets and in place leases incorporated significant unobservable inputs and therefore are considered to be Level 3 prices within the fair value hierarchy.  The Company used a discounted cash flow analysis on the

 

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expected cash flows of the mortgage note to determine its fair value, considering the contractual terms of the instrument and observable market-based inputs.  The fair value of the mortgage loan is considered a Level 2 price as the majority of the inputs used fall within Level 2 of the fair value hierarchy.

 

Investment in unconsolidated entities

 

As of March 31, 2012, the Company had investments in five unconsolidated real estate entities with ownership interest percentages ranging from 15.2% to 31.3%. The Company accounts for its investments in unconsolidated real estate entities under the equity method of accounting. The significant accounting policies of the Company’s unconsolidated real estate entities are consistent with those of the Company in all material respects.

 

During the three months ended March 31, 2012, AvalonBay Value Added Fund, LP (“Fund I”) sold two communities located in Chicago, IL:  Avalon Lakeside, containing 204 apartment homes, was sold for $20,500,000 and Avalon Poplar Creek, containing 196 apartment homes, was sold for $27,200,000.  The Company’s proportionate share of the aggregate gain in accordance with GAAP for these dispositions was $1,086,000.

 

During the three months ended March 31, 2012, AvalonBay Value Added Fund II, LP (“Fund II”) acquired Avalon Watchung, a 334 apartment home community located in Watchung, NJ, for $63,000,000.  This is the final asset acquisition for Fund II.

 

There were no other changes in the Company’s ownership interest in, or presentation of, its investments in unconsolidated real estate entities during the three months ended March 31, 2012.

 

The following is a combined summary of the financial position of the entities accounted for using the equity method, as of the dates presented (dollars in thousands):

 

		3-31-12			12-31-11
		(unaudited)			(unaudited)
Assets:
Real estate, net		$	1,597,083		$	1,583,397
Other assets		108,057			70,233
Total assets		$	1,705,140		$	1,653,630
Liabilities and partners’ capital:
Mortgage notes payable		$	1,097,846		$	1,074,429
Other liabilities		29,994			27,335
Partners’ capital		577,300			551,866
Total liabilities and partners’ capital		$	1,705,140		$	1,653,630

 

The following is a combined summary of the operating results of the entities accounted for using the equity method, for the periods presented (dollars in thousands):

 

		For the three months ended
		3-31-12			3-31-11
		(unaudited)			(unaudited)
Rental and other income		$	42,627		$	37,823
Operating and other expenses		(18,669		)	(17,554		)
Gain on sale of communities		8,909			—
Interest expense, net		(13,066		)	(12,301		)
Depreciation expense		(12,700		)	(11,603		)
Net income (loss)		$	7,101		$	(3,635	)

 

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In conjunction with the formation of Fund I and Fund II, as well as the acquisition and development of certain other investments in unconsolidated entities, the Company incurred costs in excess of its equity in the underlying net assets of the respective investments. These costs represent $8,671,000 at March 31, 2012 and $9,167,000 at December 31, 2011 of the respective investment balances.

 

As part of the formation of Fund I and Fund II, the Company provided separate and distinct guarantees to one of the limited partners in each of the ventures.  These guarantees are specific to the respective fund and any impacts or obligation of the Company to perform under one of the guarantees has no impact on the Company’s obligations with respect to the other guarantee. The guarantees provide that, if, upon final liquidation of Fund I or Fund II, the total amount of all distributions to the guaranteed partner during the life of the respective fund (whether from operating cash flow or property sales) does not equal the total capital contributions made by that partner, then the Company will pay the guaranteed partner an amount equal to the shortfall, but in no event more than 10% of the total capital contributions made by the guaranteed partner (maximum of approximately $7,500,000 for Fund I and approximately $8,910,000 for Fund II as of March 31, 2012).  As of March 31, 2012, the expected realizable values of the real estate assets owned by Fund I and Fund II are considered adequate to cover such potential payments under a liquidation scenario.  The estimated fair value of, and the Company’s obligation under these guarantees, both at inception and as of March 31, 2012, was not significant and therefore the Company has not recorded any obligation for either of these guarantees as of March 31, 2012.

 

Abandoned Pursuit Costs and Impairment of Long-Lived Assets

 

The Company capitalizes pre-development costs incurred in pursuit of new development opportunities for which the Company currently believes future development is probable (“Development Rights”). Future development of these Development Rights is dependent upon various factors, including zoning and regulatory approval, rental market conditions, construction costs and the availability of capital.  Initial pre-development costs incurred for pursuits for which future development is not yet considered probable are expensed as incurred.  In addition, if the status of a Development Right changes, making future development by the Company no longer probable, any capitalized pre-development costs are written off with a charge to expense.  The Company expensed costs related to abandoned pursuits, which includes the abandonment of Development Rights as well as costs incurred in pursuing the disposition of assets for which the disposition did not occur, in the amounts of $147,000 and $651,000 for the three months ended March 31, 2012 and 2011, respectively. These costs are included in operating expenses, excluding property taxes on the accompanying Condensed Consolidated Statements of Comprehensive Income. Abandoned pursuit costs can vary greatly, and the costs incurred in any given period may be significantly different in future periods.

 

The Company evaluates its real estate and other long-lived assets for impairment when potential indicators of impairment exist. Such assets are stated at cost, less accumulated depreciation and amortization, unless the carrying amount of the asset is not recoverable. If events or circumstances indicate that the carrying amount of a long-lived asset may not be recoverable, the Company assesses its recoverability by comparing the carrying amount of the long-lived asset to its estimated undiscounted future cash flows. If the carrying amount exceeds the aggregate undiscounted future cash flows, the Company recognizes an impairment loss to the extent the carrying amount exceeds the estimated fair value of the long-lived asset. Based on periodic tests of recoverability of long-lived assets, the Company did not record any impairment losses for the three months ended March 31, 2012 and 2011.

 

The Company assesses its portfolio of land held for development and for investment for impairment if the intent of the Company changes with respect to either the development of, or the expected holding period for the land.  The Company did not recognize any impairment charges on its investment in land for the three months ended March 31, 2012 and 2011.

 

The Company also evaluates its unconsolidated investments for impairment, considering both its carrying value of the investment, estimated as the expected proceeds that it would receive if the entity were dissolved and the net assets were liquidated at their current GAAP basis, as well as the Company’s proportionate share of any impairment of assets held by unconsolidated investments. There were no impairment losses recognized by any of the Company’s investments in unconsolidated entities during the three months ended March 31, 2012 and 2011.

 

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6.  Real Estate Disposition Activities

 

The Company did not sell any communities during the three months ended March 31, 2012. As of March 31, 2012, the Company had one real estate asset that qualified as held for sale.

 

The operations for any real estate assets sold from January 1, 2011 through March 31, 2012, as well as for assets classified as held for sale at March 31, 2012, have been presented as income from discontinued operations in the accompanying Condensed Consolidated Statements of Comprehensive Income. Accordingly, certain reclassifications have been made to prior years to reflect discontinued operations consistent with current year presentation.

 

The following is a summary of income (loss) from discontinued operations for the periods presented (dollars in thousands):

 

		For the three months ended
		3-31-12			3-31-11
		(unaudited)			(unaudited)
Rental income		$	2,033		$	7,278
Operating and other expenses		(711		)	(5,005		)
Interest expense, net		(80		)	(1,300		)
Depreciation expense		(321		)	(1,649		)
Income (loss) from discontinued operations		$	921		$	(676	)

 

7.  Segment Reporting

 

The Company’s reportable operating segments include Established Communities, Other Stabilized Communities, and Development/Redevelopment Communities.  Annually as of January 1st, the Company determines which of its communities fall into each of these categories and maintains that classification, unless disposition plans regarding a community change, throughout the year for the purpose of reporting segment operations.

 

In addition, the Company owns land for future development and has other corporate assets that are not allocated to an operating segment.

 

The Company’s segment disclosures present the measure(s) used by the chief operating decision maker for purposes of assessing each segments’ performance.  The Company’s chief operating decision maker is comprised of several members of its executive management team who use net operating income (“NOI”) as the primary financial measure for Established Communities and Other Stabilized Communities.  NOI is defined by the Company as total revenue less direct property operating expenses.  Although the Company considers NOI a useful measure of a community’s or communities’ operating performance, NOI should not be considered an alternative to net income or net cash flow from operating activities, as determined in accordance with GAAP.  NOI excludes a number of income and expense categories as detailed in the reconciliation of NOI to net income.

 

A reconciliation of NOI to net income for the three months ended March 31, 2012 and 2011 is as follows (dollars in thousands):

 

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		For the three months ended
		3-31-12			3-31-11
		(unaudited)			(unaudited)
Net income		$	57,609		$	30,537
Indirect operating expenses, net of corporate income		8,036			7,037
Investments and investment management expense		1,446			1,191
Expensed acquisition, development and other pursuit costs		239			651
Interest expense, net		33,626			42,971
Loss on extinguishment of debt		1,179			—
General and administrative expense		9,710			7,292
Equity in income of unconsolidated entities		(2,175		)	(503		)
Depreciation expense		62,991			59,650
(Income) loss from discontinued operations		(921		)	676
Net operating income		$	171,740		$	149,502

 

The primary performance measure for communities under development or redevelopment depends on the stage of completion.  While under development, management monitors actual construction costs against budgeted costs as well as lease-up pace and rent levels compared to budget.

 

The following table provides details of the Company’s segment information as of the dates specified (dollars in thousands). 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. Segment information for the three months ended March 31, 2012 and 2011 have been adjusted for the real estate assets that were sold from January 1, 2011 through March 31, 2012, or otherwise qualify as discontinued operations as of March 31, 2012, as described in Note 6, “Real Estate Disposition Activities.”

 

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		Total						% NOI change		Gross
		revenue			NOI			from prior year		real estate (1)
For the three months ended March 31, 2012
Established
New England		$	33,881		$	22,065		7.5	%	$	1,100,828
Metro NY/NJ		57,218			39,591			9.8	%	1,962,197
Mid-Atlantic		25,696			18,816			6.4	%	591,140
Pacific Northwest		7,905			5,572			11.9	%	301,793
Northern California		31,112			22,793			15.5	%	1,180,070
Southern California		23,747			16,559			11.9	%	931,512
Total Established		179,559			125,396			10.2	%	6,067,540
Other Stabilized		36,674			23,932			N/A		1,289,507
Development / Redevelopment		33,672			22,412			N/A		1,641,636
Land Held for Future Development		N/A			N/A			N/A		297,127
Non-allocated (2)		2,549			N/A			N/A		104,282
Total		$	252,454		$	171,740		14.9	%	$	9,400,092
For the three months ended March 31, 2011
Established
New England		$	41,027		$	25,482		6.7	%	$	1,293,907
Metro NY/NJ		47,691			31,559			5.5	%	1,527,764
Mid-Atlantic		26,852			19,242			8.8	%	658,249
Pacific Northwest		9,129			6,140			0.8	%	361,623
Northern California		22,826			16,208			5.4	%	866,694
Southern California		18,394			11,955			1.9	%	695,067
Total Established		165,919			110,586			5.6	%	5,403,304
Other Stabilized		31,570			20,027			N/A		1,557,988
Development / Redevelopment		28,721			18,889			N/A		1,324,743
Land Held for Future Development		N/A			N/A			N/A		193,593
Non-allocated (2)		2,320			N/A			N/A		79,037
Total		$	228,530		$	149,502		11.3	%	$	8,558,665

 

(1)          Does not include gross real estate assets held for sale of $64,000 and $62,230 as of March 31, 2012 and 2011, respectively.

 

(2)          Revenue represents third party management, asset management and developer fees and miscellaneous income which are not allocated to a reportable segment.

 

8.  Stock-Based Compensation Plans

 

Information with respect to stock options granted under the Company’s 1994 Stock Option and Incentive Plan (the “1994 Plan”) and under the AvalonBay Communities, Inc. 2009 Stock Option and Incentive Plan (the “2009 Plan”) are as follows (dollars in thousands, other than per share amounts):

 

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