Form: 10-Q

Quarterly report pursuant to Section 13 or 15(d)

August 2, 2013

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2013

 

Commission file number 1-12672

 

AVALONBAY COMMUNITIES, INC.

(Exact name of registrant as specified in its charter)

 


 

Maryland

 

77-0404318

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

 

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):

 

Large accelerated filer x

Accelerated filer o

Non-accelerated filer (Do not check if a smaller reporting company) o

Smaller reporting company o

 

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:

 

129,402,894 shares of common stock, par value $0.01 per share, were outstanding as of July 31, 2013

 

 

 



Table of Contents

 

AVALONBAY COMMUNITIES, INC.

FORM 10-Q

INDEX

 

 

Page

PART I - FINANCIAL INFORMATION

 

 

Item 1. Condensed Consolidated Financial Statements

 

 

 

 

Condensed Consolidated Balance Sheets as of June 30, 2013 (unaudited) and December 31, 2012

1

 

 

 

 

Condensed Consolidated Statements of Comprehensive Income (unaudited) for the three and six months ended June 30, 2013 and 2012

2

 

 

 

 

Condensed Consolidated Statements of Cash Flows (unaudited) for the six months ended June 30, 2013 and 2012

3-4

 

 

 

 

Notes to Condensed Consolidated Financial Statements (unaudited)

5-24

 

 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

25-53

 

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

53

 

 

Item 4. Controls and Procedures

54

 

 

PART II - OTHER INFORMATION

 

 

Item 1. Legal Proceedings

54

 

 

Item 1a. Risk Factors

54

 

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

55

 

 

Item 3. Defaults Upon Senior Securities

55

 

 

Item 4. Mine Safety Disclosures

55

 

 

Item 5. Other Information

55

 

 

Item 6. Exhibits

55

 

 

Signatures

58

 



Table of Contents

 

AVALONBAY COMMUNITIES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except per share data)

 

 

 

6-30-13

 

12-31-12

 

 

 

(unaudited)

 

 

 

ASSETS

 

 

 

 

 

Real estate:

 

 

 

 

 

Land

 

$

3,310,543

 

$

1,430,532

 

Buildings and improvements

 

11,249,812

 

7,112,763

 

Furniture, fixtures and equipment

 

325,288

 

254,378

 

 

 

14,885,643

 

8,797,673

 

Less accumulated depreciation

 

(2,326,132

)

(2,021,703

)

Net operating real estate

 

12,559,511

 

6,775,970

 

Construction in progress, including land

 

1,146,805

 

802,857

 

Land held for development

 

409,930

 

316,037

 

Operating real estate assets held for sale, net

 

—

 

120,256

 

Total real estate, net

 

14,116,246

 

8,015,120

 

 

 

 

 

 

 

Cash and cash equivalents

 

111,147

 

2,733,618

 

Cash in escrow

 

94,400

 

50,033

 

Resident security deposits

 

27,886

 

24,748

 

Investments in unconsolidated real estate entities

 

365,521

 

129,352

 

Deferred financing costs, net

 

35,726

 

38,700

 

Deferred development costs

 

37,260

 

24,665

 

Prepaid expenses and other assets

 

183,999

 

143,842

 

Total assets

 

$

14,972,185

 

$

11,160,078

 

 

 

 

 

 

 

LIABILITIES AND EQUITY

 

 

 

 

 

Unsecured notes, net

 

$

1,846,113

 

$

1,945,798

 

Variable rate unsecured credit facility

 

142,000

 

—

 

Mortgage notes payable

 

3,865,206

 

1,905,235

 

Dividends payable

 

138,456

 

110,966

 

Payables for construction

 

84,984

 

53,677

 

Accrued expenses and other liabilities

 

224,189

 

223,651

 

Accrued interest payable

 

39,735

 

33,056

 

Resident security deposits

 

48,225

 

38,328

 

Liabilities related to real estate assets held for sale

 

—

 

1,547

 

Total liabilities

 

6,388,908

 

4,312,258

 

 

 

 

 

 

 

Redeemable noncontrolling interests

 

19,514

 

7,027

 

 

 

 

 

 

 

Equity:

 

 

 

 

 

Preferred stock, $0.01 par value; $25 liquidation preference; 50,000,000 shares authorized at both June 30, 2013 and December 31, 2012; zero shares issued and outstanding at June 30, 2013 and December 31, 2012, respectively

 

—

 

—

 

Common stock, $0.01 par value; 280,000,000 shares authorized at June 30, 2013 and 140,000,000 shares authorized at December 31, 2012; 129,398,867 and 114,403,472 shares issued and outstanding at June 30, 2013 and December 31, 2012, respectively

 

1,294

 

1,144

 

Additional paid-in capital

 

8,972,852

 

7,086,407

 

Accumulated earnings less dividends

 

(308,938

)

(142,329

)

Accumulated other comprehensive loss

 

(105,042

)

(108,007

)

Total equity

 

8,560,166

 

6,837,215

 

Noncontrolling interest

 

3,597

 

3,578

 

Total equity

 

8,563,763

 

6,840,793

 

Total liabilities and equity

 

$

14,972,185

 

$

11,160,078

 

 

See accompanying notes to Condensed Consolidated Financial Statements.

 

1



Table of Contents

 

AVALONBAY COMMUNITIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF

COMPREHENSIVE INCOME

(unaudited)

(Dollars in thousands, except per share data)

 

 

 

For the three months ended

 

For the six months ended

 

 

 

6-30-13

 

6-30-12

 

6-30-13

 

6-30-12

 

Revenue:

 

 

 

 

 

 

 

 

 

Rental and other income

 

$

386,321

 

$

249,675

 

$

694,415

 

$

491,501

 

Management, development and other fees

 

2,913

 

2,770

 

5,185

 

5,319

 

Total revenue

 

389,234

 

252,445

 

699,600

 

496,820

 

 

 

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

 

 

 

 

Operating expenses, excluding property taxes

 

90,056

 

66,751

 

163,748

 

130,788

 

Property taxes

 

42,038

 

24,528

 

74,753

 

48,171

 

Interest expense, net

 

43,169

 

33,191

 

81,342

 

66,814

 

Loss on extinguishment of debt, net

 

—

 

—

 

—

 

1,179

 

Depreciation expense

 

196,106

 

63,224

 

305,280

 

124,137

 

General and administrative expense

 

11,345

 

8,316

 

21,384

 

18,026

 

Expensed acquisition, development, and other pursuit costs

 

3,768

 

901

 

43,827

 

1,141

 

Total expenses

 

386,482

 

196,911

 

690,334

 

390,256

 

 

 

 

 

 

 

 

 

 

 

Equity in income (loss) of unconsolidated entities

 

(940

)

2,073

 

(19,503

)

4,248

 

Gain on sale of land

 

240

 

280

 

240

 

280

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations

 

2,052

 

57,887

 

(9,997

)

111,092

 

 

 

 

 

 

 

 

 

 

 

Discontinued operations:

 

 

 

 

 

 

 

 

 

Income from discontinued operations

 

363

 

3,885

 

3,394

 

8,289

 

Gain on sale of real estate assets

 

33,682

 

95,049

 

118,173

 

95,049

 

Total discontinued operations

 

34,045

 

98,934

 

121,567

 

103,338

 

 

 

 

 

 

 

 

 

 

 

Net income

 

36,097

 

156,821

 

111,570

 

214,430

 

Net loss attributable to noncontrolling interests

 

121

 

88

 

78

 

237

 

 

 

 

 

 

 

 

 

 

 

Net income attributable to common stockholders

 

$

36,218

 

$

156,909

 

$

111,648

 

$

214,667

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income:

 

 

 

 

 

 

 

 

 

Unrealized gain (loss) on cash flow hedges

 

—

 

(27,798

)

—

 

(16,789

)

Cash flow hedge losses reclassified to earnings

 

1,574

 

—

 

2,965

 

—

 

Comprehensive income

 

$

37,792

 

$

129,111

 

$

114,613

 

$

197,878

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share - basic:

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations attributable to common stockholders

 

$

0.02

 

$

0.61

 

$

(0.08

)

$

1.17

 

Discontinued operations attributable to common stockholders

 

0.26

 

1.03

 

0.98

 

1.08

 

 

 

 

 

 

 

 

 

 

 

Net income attributable to common stockholders

 

$

0.28

 

$

1.64

 

$

0.90

 

$

2.25

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share - diluted:

 

 

 

 

 

 

 

 

 

Income (loss) from continuing operations attributable to common stockholders

 

$

0.02

 

$

0.60

 

$

(0.08

)

$

1.16

 

Discontinued operations attributable to common stockholders

 

0.26

 

1.03

 

0.97

 

1.08

 

 

 

 

 

 

 

 

 

 

 

Net income attributable to common stockholders

 

$

0.28

 

$

1.63

 

$

0.89

 

$

2.24

 

 

 

 

 

 

 

 

 

 

 

Dividends per common share:

 

$

1.07

 

$

0.97

 

$

2.14

 

$

1.94

 

 

See accompanying notes to Condensed Consolidated Financial Statements.

 

2



Table of Contents

 

AVALONBAY COMMUNITIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(Dollars in thousands)

 

 

 

For the six months ended

 

 

 

6-30-13

 

6-30-12

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

111,570

 

$

214,430

 

Adjustments to reconcile net income to cash provided by operating activities:

 

 

 

 

 

Depreciation expense

 

305,280

 

124,137

 

Depreciation expense from discontinued operations

 

875

 

4,194

 

Amortization of deferred financing costs and debt (premium) discount

 

(8,390

)

3,040

 

Amortization of stock-based compensation

 

3,581

 

4,268

 

Equity in (income) loss of, and return on, unconsolidated entities and noncontrolling interests, net of eliminations

 

33,134

 

(3,182

)

Loss on extinguishment of debt, net

 

—

 

1,781

 

Gain on sale of real estate assets

 

(118,413

)

(95,329

)

Gain on sale of joint venture real estate assets

 

(10,824

)

—

 

Increase in cash in operating escrows

 

(8,291

)

(1,988

)

Increase in resident security deposits, prepaid expenses and other assets

 

(43,499

)

(20,732

)

(Increase) decrease in accrued expenses, other liabilities and accrued interest payable

 

2,188

 

(8,151

)

Net cash provided by operating activities

 

267,211

 

222,468

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Development/redevelopment of real estate assets including land acquisitions and deferred development costs

 

(591,894

)

(341,144

)

Acquisition of real estate assets, including partnership interest

 

(749,275

)

(37,105

)

Capital expenditures - existing real estate assets

 

(1,986

)

(6,606

)

Capital expenditures - non-real estate assets

 

(2,721

)

(588

)

Proceeds from sale of real estate, net of selling costs

 

432,380

 

182,225

 

Increase in payables for construction

 

31,307

 

6,582

 

Decrease in cash in construction escrows

 

—

 

1,697

 

(Increase) decrease in investments in unconsolidated real estate entities

 

(2,161

)

2,188

 

Net cash used in investing activities

 

(884,350

)

(192,751

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Issuance of common stock

 

2,605

 

175,682

 

Dividends paid

 

(249,267

)

(177,322

)

Net borrowings under unsecured credit facility

 

142,000

 

—

 

Issuance of mortgage notes payable

 

71,210

 

—

 

Repayments of mortgage notes payable, including prepayment penalties

 

(1,786,130

)

(103,621

)

Settlement of interest rate contract

 

(51,000

)

—

 

Repayment of unsecured notes

 

(100,000

)

(179,400

)

Payment of deferred financing costs and issuance discounts

 

(524

)

(123

)

Acquisition of joint venture partner equity interest

 

(1,965

)

(3,350

)

Redemption of preferred interest obligation

 

(32,086

)

—

 

Distributions to DownREIT partnership unitholders

 

(16

)

(15

)

Distributions to joint venture and profit-sharing partners

 

(159

)

(158

)

Net cash used by financing activities

 

(2,005,332

)

(288,307

)

 

 

 

 

 

 

Net decrease in cash and cash equivalents

 

(2,622,471

)

(258,590

)

 

 

 

 

 

 

Cash and cash equivalents, beginning of period

 

2,733,618

 

616,853

 

 

 

 

 

 

 

Cash and cash equivalents, end of period

 

$

111,147

 

$

358,263

 

 

 

 

 

 

 

Cash paid during the period for interest, net of amount capitalized

 

$

75,648

 

$

62,012

 

 

3



Table of Contents

 

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

 

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

 

During the six months ended June 30, 2013:

 

·                  As described in Note 4, “Equity,” 14,889,706 shares of common stock valued at $1,875,210,000 were issued as partial consideration for the Archstone Acquisition (as defined in this Form 10-Q); 123,977 shares of common stock valued at $16,019,000 were issued in connection with stock grants;  1,030 shares valued at $140,000 were issued through the Company’s dividend reinvestment plan; 44,222 shares valued at $5,638,000 were withheld to satisfy employees’ tax withholding and other liabilities; and 5,214 shares valued at $516,000 previously issued in connection with employee compensation were cancelled upon forfeiture. In addition, the Company granted 215,230 options for common stock at a value of $5,768,000.

 

·                  The Company recorded a decrease to other liabilities and a corresponding decrease to interest expense, net of $2,484,000; and reclassified $2,965,000 of deferred cash flow hedge losses from other comprehensive income to interest expense, net to record the impact of the Company’s derivative and hedge accounting activity.

 

·                  Common dividends declared but not paid totaled $138,456,000.

 

·                  The Company recorded $13,262,000 in redeemable noncontrolling interests associated with consolidated joint ventures acquired as part of the Archstone Acquisition.  The Company also recorded an increase of $329,000 in redeemable noncontrolling interest 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 11, “Fair Value.”

 

·                  The Company assumed secured indebtedness with a principal amount of $3,512,202,000 in conjunction with the Archstone Acquisition, discussed further in Note 3, “Notes Payable, Unsecured Notes and Credit Facility.” The Company also assumed an obligation related to outstanding preferred interests of approximately $66,500,000, included in accrued expenses and other liabilities, and discussed further in Note 5, “Archstone Acquisition.”

 

During the six months ended June 30, 2012:

 

·                  95,941 shares of common stock valued at $12,786,000 were issued in connection with stock grants; 1,336 shares valued at $180,000 were issued through the Company’s dividend reinvestment plan; 120,078 shares valued at $15,458,000 were withheld to satisfy employees’ tax withholding and other liabilities; and 7,558 shares and options valued at $393,000 previously issued in connection with employee compensation were cancelled upon forfeiture. In addition, the Company granted 113,804 options for common stock at a value of $3,306,000.

 

·                  The Company recorded an increase to other liabilities and a corresponding decrease to other comprehensive income of $16,789,000; 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 $93,698,000.

 

·                  The Company recorded an increase of $521,000 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.

 

·                  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.

 

4



Table of Contents

 

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 primarily in high barrier to entry markets of the United States. The Company’s primary markets are located in the New England, Metro New York/New Jersey, Mid-Atlantic, Pacific Northwest, and Northern and Southern California regions of the country.

 

At June 30, 2013, excluding real estate investments owned through the Residual JV discussed in this Form 10-Q, the Company owned or held a direct or indirect ownership interest in 246 operating apartment communities containing 73,564 apartment homes in 12 states and the District of Columbia, of which six communities containing 2,248 apartment homes were under reconstruction. In addition, the Company owned or held a direct or indirect ownership interest in 27 communities under construction that are expected to contain an aggregate of 7,935 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 47 communities that, if developed as expected, will contain an estimated 13,649 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 2012 Annual Report on Form 10-K. The results of operations for the three and six months ended June 30, 2013 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):

 

5



Table of Contents

 

 

 

For the three months ended

 

For the six months ended

 

 

 

6-30-13

 

6-30-12

 

6-30-13

 

6-30-12

 

Basic and diluted shares outstanding

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares - basic

 

129,179,471

 

95,308,163

 

124,456,232

 

95,082,172

 

 

 

 

 

 

 

 

 

 

 

Weighted average DownREIT units outstanding

 

7,500

 

7,500

 

7,500

 

7,500

 

 

 

 

 

 

 

 

 

 

 

Effect of dilutive securities

 

408,428

 

677,162

 

415,931

 

730,531

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares - diluted

 

129,595,399

 

95,992,825

 

124,879,663

 

95,820,203

 

 

 

 

 

 

 

 

 

 

 

Calculation of Earnings per Share - basic

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income attributable to common stockholders

 

$

36,218

 

$

156,909

 

$

111,648

 

$

214,667

 

Net income allocated to unvested restricted shares

 

(59

)

(547

)

(193

)

(845

)

Net income attributable to common stockholders, adjusted

 

$

36,159

 

$

156,362

 

$

111,455

 

$

213,822

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares - basic

 

129,179,471

 

95,308,163

 

124,456,232

 

95,082,172

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share - basic

 

$

0.28

 

$

1.64

 

$

0.90

 

$

2.25

 

 

 

 

 

 

 

 

 

 

 

Calculation of Earnings per Share - diluted

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income attributable to common stockholders

 

$

36,218

 

$

156,909

 

$

111,648

 

$

214,667

 

Add: noncontrolling interests of DownREIT unitholders in consolidated partnerships, including discontinued operations

 

8

 

7

 

16

 

13

 

 

 

 

 

 

 

 

 

 

 

Adjusted net income attributable to common stockholders

 

$

36,226

 

$

156,916

 

$

111,664

 

$

214,680

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares - diluted

 

129,595,399

 

95,992,825

 

124,879,663

 

95,820,203

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share - diluted

 

$

0.28

 

$

1.63

 

$

0.89

 

$

2.24

 

 

Certain options to purchase shares of common stock in the amounts of 606,318 and 424,357 were outstanding at June 30, 2013 and 2012, 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 June 30, 2013 is based on the average forfeiture activity over a period equal to the estimated life of the stock options, and was 1.2%. The application of estimated forfeitures did not materially impact compensation expense for the three and six months ended June 30, 2013 or 2012.

 

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 interest expense, net.  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 effective portion of 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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Table of Contents

 

Legal and Other Contingencies

 

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.

 

Acquisitions of Investments in Real Estate

 

The Company accounts for acquisitions of investments in real estate in accordance with the authoritative guidance for the initial measurement, which require the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree to be recognized at fair value.  Typical assets and liabilities acquired include land, building, furniture, fixtures, and equipment, and identified intangible assets and liabilities, consisting of the value of above-below market leases and in-place leases.  In making estimates of fair values for purposes of allocating purchase price, we utilize various sources, including our own analysis of recently acquired and existing comparable properties in our portfolio and other market data.

 

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.

 

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 $16,824,000 and $12,625,000 for the three months ended June 30, 2013 and 2012, respectively, and $29,963,000 and $24,945,000 for the six months ended June 30, 2013 and 2012, 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 June 30, 2013 and December 31, 2012, 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 June 30, 2013 and December 31, 2012, as shown in the Condensed Consolidated Balance Sheets (see Note 7, “Real Estate Disposition Activities”).

 

 

 

6-30-13

 

12-31-12

 

 

 

 

 

 

 

Fixed rate unsecured notes (1)

 

$

1,850,000

 

$

1,950,000

 

Fixed rate mortgage notes payable - conventional and tax-exempt (2)

 

2,714,321

 

1,427,133

 

Variable rate mortgage notes payable - conventional and tax-exempt(2)

 

1,011,709

 

476,935

 

 

 

 

 

 

 

Total notes payable and unsecured notes

 

5,576,030

 

3,854,068

 

 

 

 

 

 

 

Credit Facility

 

142,000

 

—

 

 

 

 

 

 

 

Total mortgage notes payable, unsecured notes and Credit Facility

 

$

5,718,030

 

$

3,854,068

 

 

7



Table of Contents

 


(1)         Balances at June 30, 2013 and December 31, 2012 exclude $3,887 and $4,202, respectively, of debt discount as reflected in unsecured notes on the Company’s Condensed Consolidated Balance Sheets.

(2)         Balances at June 30, 2013 and December 31, 2012 exclude $139,175 and $1,167, respectively of debt premium as reflected in mortgage notes payable on the Company’s Condensed Consolidated Balance Sheets.

 

The following debt activity occurred during the six months ended June 30, 2013:

 

·                  In February 2013, as a portion of the consideration for the Archstone Acquisition, the Company assumed $3,512,202,000 consolidated principal amount of Archstone’s existing secured indebtedness, repaying $1,477,720,000 principal amount of the indebtedness assumed concurrent with the closing of the Archstone Acquisition.

·                  In March 2013, the Company repaid $100,000,000 of its 4.95% medium term notes in accordance with the scheduled maturity.

·                  In April 2013, the Company obtained a 3.06% fixed rate, secured mortgage note in the amount of $15,000,000 that matures in April 2018.

·                  In April 2013, the Company repaid a 4.69% fixed rate, secured mortgage note in the amount of $170,125,000 pursuant to its scheduled maturity date.

·                  In May 2013, the Company repaid a $5,393,000 fixed rate secured mortgage note with an interest rate of 5.55% at par and without penalty in advance of its July 2028 scheduled maturity date.

·                  In May 2013, the Company obtained a 3.08% fixed rate secured mortgage note that matures in May 2020 in the amount of $56,210,000, in association with the refinancing of an existing $47,000,000 variable rate secured mortgage note.

·                  In May 2013, the Company repaid a $52,806,000 fixed rate secured mortgage note with an interest rate of 5.24% pursuant to its scheduled maturity date.

 

The Company has a $1,300,000,000 revolving variable rate unsecured credit facility with a syndicate of banks (the “Credit Facility”) which matures in April 2017. The Company has the option to extend the maturity by up to one year for a fee of $1,950,000. The Credit Facility bears interest at varying levels based on the London Interbank Offered Rate (“LIBOR”), rating levels achieved on our unsecured notes and on a maturity schedule selected by us. The current stated pricing is LIBOR plus 1.05% (1.24% at June 30, 2013).  The annual facility fee is approximately $1,950,000 annually based on the $1,300,000,000 facility size and based on our current credit rating.

 

The Company had $142,000,000 and $0 of borrowings outstanding under the Credit Facility and had $54,485,000 and $44,883,000 outstanding in letters of credit that reduced the borrowing capacity as of June 30, 2013 and December 31, 2012, respectively.

 

In the aggregate, secured notes payable mature at various dates from April 2014 through July 2066, and are secured by certain apartment communities and improved land parcels (with a net carrying value of $4,761,224,000, excluding communities classified as held for sale, as of June 30, 2013).

 

As of June 30, 2013, the Company has guaranteed approximately $400,290,000 of mortgage notes payable 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 4.7% and 5.8% at June 30, 2013 and December 31, 2012, respectively.  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 2.4% and 2.7% at June 30, 2013 and December 31, 2012, respectively.

 

Scheduled payments and maturities of mortgage notes payable and unsecured notes outstanding at June 30, 2013 are as follows (dollars in thousands):

 

8



Table of Contents

 

 

 

 

 

 

 

 

 

Stated

 

 

 

Secured

 

Secured

 

Unsecured

 

interest rate

 

 

 

notes

 

notes

 

notes

 

of unsecured

 

Year

 

payments (1)

 

maturities

 

maturities

 

notes

 

 

 

 

 

 

 

 

 

 

 

2013

 

$

9,723

 

$

—

 

$

—

 

—

 

 

 

 

 

 

 

 

 

 

 

2014

 

19,608

 

—

 

150,000

 

5.375

%

 

 

 

 

 

 

 

 

 

 

2015

 

18,358

 

904,014

 

—

 

—

 

 

 

 

 

 

 

 

 

 

 

2016

 

19,708

 

16,255

 

250,000

 

5.750

%

 

 

 

 

 

 

 

 

 

 

2017

 

20,865

 

710,491

 

250,000

 

5.700

%

 

 

 

 

 

 

 

 

 

 

2018

 

20,200

 

76,759

 

—

 

—

 

 

 

 

 

 

 

 

 

 

 

2019

 

8,761

 

610,813

 

—

 

—

 

 

 

 

 

 

 

 

 

 

 

2020

 

7,934

 

50,825

 

250,000

 

6.100

%

 

 

 

 

 

 

 

 

 

 

2021

 

7,779

 

27,844

 

250,000

 

3.950

%

 

 

 

 

 

 

 

 

 

 

2022

 

8,242

 

—

 

450,000

 

2.950

%

 

 

 

 

 

 

 

 

 

 

Thereafter

 

89,800

 

1,098,051

 

250,000

 

2.850

%

 

 

 

 

 

 

 

 

 

 

 

 

$

230,978

 

$

3,495,052

 

$

1,850,000

 

 

 

 


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

 

The Company was in compliance at June 30, 2013 with certain customary financial and other covenants under the Credit Facility and the Company’s unsecured notes.

 

9



Table of Contents

 

4.  Equity

 

The following summarizes the changes in stockholders’ equity for the six months ended June 30, 2013 (dollars in thousands):

 

 

 

 

 

 

 

Accumulated

 

Accumulated

 

Total

 

 

 

 

 

 

 

 

 

Additional

 

earnings

 

other

 

AvalonBay

 

 

 

 

 

 

 

Common

 

paid-in

 

less

 

comprehensive

 

stockholders’

 

Noncontrolling

 

Total

 

 

 

stock

 

capital

 

dividends

 

loss

 

equity

 

interests

 

equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2012

 

$

1,144

 

$

7,086,407

 

$

(142,329

)

$

(108,007

)

$

6,837,215

 

$

3,578

 

$

6,840,793

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income attributable to common stockholders

 

—

 

—

 

111,648

 

—

 

111,648

 

—

 

111,648

 

Cash flow hedge loss reclassified to earnings

 

—

 

—

 

—

 

2,965

 

2,965

 

—

 

2,965

 

Change in redemption value of redeemable noncontrolling interest

 

—

 

—

 

(329

)

—

 

(329

)

—

 

(329

)

Noncontrolling interests income allocation

 

—

 

—

 

—

 

—

 

—

 

19

 

19

 

Dividends declared to common stockholders

 

—

 

—

 

(276,894

)

—

 

(276,894

)

—

 

(276,894

)

Issuance of common stock, net of withholdings

 

150

 

1,872,418

 

(1,034

)

—

 

1,871,534

 

—

 

1,871,534

 

Amortization of deferred compensation

 

—

 

14,027

 

—

 

—

 

14,027

 

—

 

14,027

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at June 30, 2013

 

$

1,294

 

$

8,972,852

 

$

(308,938

)

$

(105,042

)

$

8,560,166

 

$

3,597

 

$

8,563,763

 

 

During the six months ended June 30, 2013, the Company:

 

(i)                                     issued 30,118 shares of common stock in connection with stock options exercised;

(ii)                                  issued 1,030 common shares through the Company’s dividend reinvestment plan;

(iii)                               issued 123,977 common shares in connection with stock grants;

(iv)                              withheld 44,222 common shares to satisfy employees’ tax withholding and other liabilities;

(v)                                 cancelled 5,214 shares of restricted common stock upon forfeiture; and

(vi)                              issued 14,889,706 common shares in connection with the closing of the Archstone Acquisition.

 

With respect to the 14,889,706 common shares issued in conjunction with the Archstone Acquisition to Lehman (as defined below), the Company and Lehman entered into a shareholders agreement (the “Shareholders Agreement”). Under the Shareholders Agreement, until February 27, 2014 Lehman will vote all of its shares of the Company’s common stock in accordance with the recommendation of the Company’s board of directors on any matter other than an extraordinary transaction.  After February 14, 2014, and for so long as Lehman holds more than 5% of the Company’s common stock, Lehman will vote all of its shares of the Company’s common stock (i) in accordance with the recommendations of the Company’s board of directors with respect to any election of directors, compensation and equity plan matters, and any amendment to our charter to increase our authorized capital stock; (ii) on all matters proposed by other shareholders, either proportionately in accordance with the votes of the other shareholders or, at its election, in accordance with the recommendation of the Company’s board of directors; and (iii) on all other matters, in its sole and absolute discretion.  In May 2013, Lehman sold 7,870,000 of the Company’s common shares it received as consideration for the Archstone Acquisition. Lehman received all of the net proceeds from the offering, and the sale did not impact the total number of the Company’s common shares outstanding.

 

In addition, during the six months ended June 30, 2013 the Company granted 215,230 options for common stock to employees.  Any deferred compensation related to the Company’s stock option and restricted stock grants during the six months ended June 30, 2013 is not reflected on the Company’s Condensed Consolidated Balance Sheet as of June 30, 2013, and will not be reflected until earned as compensation cost.

 

In August 2012, the Company commenced a third continuous equity program (“CEP III”), under which the Company is authorized to sell up to $750,000,000 of shares of its common stock from time to time during a 36-month period. The Company had no sales under CEP III during the six months ended June 30, 2013, and has $646,274,000 of shares that remain authorized for issuance under this program as of June 30, 2013.

 

10



Table of Contents

 

5.  Archstone Acquisition

 

On February 27, 2013, pursuant to an asset purchase agreement (the “Purchase Agreement”) dated November 26, 2012, by and among the Company, Equity Residential and its operating partnership, ERP Operating Limited Partnership (together, “Equity Residential”), Lehman Brothers Holdings, Inc. (“Lehman”, which term is sometimes used in this report to refer to Lehman Brothers Holdings, Inc., and/or its relevant subsidiary or subsidiaries), and Archstone Enterprise LP (“Archstone,” which has since changed its name to Jupiter Enterprise LP), the Company, together with Equity Residential, acquired, directly or indirectly, all of Archstone’s assets, including all of the ownership interests in joint ventures and other entities owned by Archstone, and assumed Archstone’s liabilities, both known and unknown, with certain limited exceptions.

 

Under the terms of the Purchase Agreement, the Company acquired approximately 40% of Archstone’s assets and liabilities and Equity Residential acquired approximately 60% of Archstone’s assets and liabilities (the “Archstone Acquisition”). The Company accounted for the acquisition as a business combination and recorded the purchase price to acquired tangible assets consisting primarily of direct and indirect interests in land and related improvements, buildings and improvements, construction in progress and identified intangible assets and liabilities, consisting primarily of the value of above and below market leases, and the value of in-places leases, at their fair values. The following table summarizes the Company’s preliminary purchase price allocation:

 

 

 

Acquisition Date
Preliminary Fair Value
(dollars in thousands)

 

Land and land improvements

 

$

1,760,100

 

Buildings and improvements

 

3,729,422

 

FF&E

 

52,290

 

Construction-in-progress, including land and land held for development

 

404,765

 

In-place lease intangibles

 

182,467

 

Other assets

 

85,829

 

Total consolidated assets

 

$

6,214,873

 

Interest in unconsolidated real estate entities

 

256,454

 

Total assets

 

$

6,471,327

 

Fair value of assumed mortgage notes payable

 

3,732,980

 

Liability for preferred obligations

 

66,500

 

Other liabilities

 

34,100

 

Noncontrolling interest

 

13,262

 

Net Assets Acquired

 

2,624,485

 

Common shares issued

 

1,875,210

 

Cash consideration

 

$

749,275

 

 

The allocation of the fair values to the assets acquired and liabilities assumed is subject to further adjustment due primarily to information not readily available at the acquisition date, additional market information and final purchase price settlement with the sellers and Equity Residential in accordance with the terms of the Purchase Agreement.  The Company’s assessment of the fair values and the allocation of the purchase price to the identified tangible and intangible assets and assumed liabilities is its current best estimate of fair value.

 

The Company engaged a third party valuation specialist to assist in the determination of the fair value of each of the component parts of the operating communities, consisting of land and land improvements, buildings and improvements, furniture, fixtures and equipment, above and below market leases and in-place lease-related intangibles.

 

11



Table of Contents

 

Land valuation was based on a market approach, whereby recent sales of similar properties were used, adjusted for differences due to location, the state of entitlement as well as the shape and size of the parcel.  Improvements to the land were valued using a replacement cost approach and considered the structures and amenities included for the communities.  The approach applied industry standard replacement costs adjusted for geographic specific considerations, and reduced by estimated depreciation.  The value for furniture, fixtures and equipment was also determined based on a replacement cost approach, adjusted for estimated depreciation.  The FF&E value estimate considered both costs for items in the apartment homes, such as appliances and furnishings, and those for common areas such as exercise facilities and on site offices.  The estimate of depreciation was made considering industry standard information and depreciation curves for the identified asset classes.  The fair value of buildings acquired was estimated using the replacement cost approach, assuming the buildings were vacant at acquisition.  The replacement cost approach considered the composition of structures in the acquired portfolio, adjusted for an estimate of depreciation.  If the operating community is held in an unconsolidated joint venture, the Company valued its interest in the operating community based on its ownership interest.

 

The value of the acquired lease-related intangibles considered the estimated cost of leasing the apartment homes as if the acquired buildings were vacant, as well as the value of the current leases relative to market-rate leases.  The in-place lease value was determined using an average total lease-up time, the number of apartment homes and net revenues generated during the lease-up time.  The lease-up period for an apartment community was assumed to be 12 months to achieve stabilized occupancy.  Net revenues were developed using market rent considering actual leasing and industry rental rate data.  The value of current leases relative to a market-rate lease was based on market rents obtained for market comparables, and considered a market derived discount rate.

 

The Company is applying a weighted average depreciation period for the in-place lease intangibles of six months.  During the three and six months ended June 30, 2013, the Company recognized $93,726,000 and $124,601,000, respectively, of depreciation expense for in-place lease intangibles, recorded as a component of Depreciation expense on the accompanying Condensed Consolidated Statements of Comprehensive Income.

 

The Company used an internal model to determine the fair value for the development land parcels acquired.  The internal model applied a discounted cash flow analysis on the expected cash flows for each land parcel as if the expected multifamily rental community is constructed. The cash flow analysis incorporated assumptions that market participants would make, including the application of (i) discount factors to the estimated future cash flows of the underlying asset, (ii) a compound annual growth rate for the revenue from the operating community, and (iii) an exit capitalization rate.

 

The Company valued the Development Communities under construction and/or in lease-up using either the invested capital basis, or an internal model, depending on the stage of construction completion.  For Development Communities earlier in the construction process and not yet in lease-up, invested capital was the relevant metric and was considered reflective of the fair value of the community.  For Development Communities that either had completed construction or that were substantially complete with construction and in lease-up, the Company used a capitalization rate model.  The capitalization rate model considered the pro-forma NOI for the Development Community, relative to NOI for comparable operating communities, with adjustments for the location and/or quality of the community. A capitalization rate was applied to each Development Community’s NOI which was based on a relevant capitalization rate observed in comparable acquisition or disposition transactions, if available, as adjusted by the Company for differences in fundamentals between the Development Community and the referenced comparable transactions.

 

Given the significance of unobservable inputs, the Company has classified the valuations of the real estate assets acquired as Level 3 prices under the fair value hierarchy.

 

Other assets acquired consisted primarily of working capital determined by the Company to be reflective of the fair value.

 

12



Table of Contents

 

During the six months ended June 30, 2013, the Company recognized $77,939,000 in acquisition related expenses associated with the Archstone Acquisition, with $34,552,000 reported as a component of Equity in income (loss) of unconsolidated entities, and the balance in Expensed acquisition, development, and other pursuit costs on the accompanying Condensed Consolidated Statements of Comprehensive Income.

 

Consideration

 

Pursuant to the Purchase Agreement and separate arrangements between the Company and Equity Residential governing the allocation of liabilities assumed under the Purchase Agreement, the Company’s portion of consideration under the Purchase Agreement, consisted of the following:

 

·                  the issuance of 14,889,706 shares of the Company’s common stock, valued at $1,875,210,000 as of the market’s close on February 27, 2013;

·                  a cash payment of approximately $749,000,000;

·                  the assumption of consolidated indebtedness with a fair value of approximately $3,732,979,000, consisting of $3,512,202,000 principal amount of consolidated indebtedness and $220,777,000 representing the amount by which fair value of the aforementioned debt exceeds the principal face value, $70,479,000 of which related to debt the Company repaid concurrent with the Archstone Acquisition;

·                  the acquisition with Equity Residential of interests in entities that have preferred units outstanding some of which may be presented for redemption from time to time. The Company’s 40% share of the fair value of the collective obligation, including accrued dividends on these outstanding Archstone preferred units as of the closing date of the Archstone Acquisition, is approximately $66,500,000; and

·                  the assumption with Equity Residential of all other liabilities, known or unknown, of Archstone, other than certain excluded liabilities. The Company shares approximately 40% of the responsibility for these liabilities.

 

The Company valued the assumed mortgage notes payable using a discounted cash flow analysis that incorporated assumptions that market participants would use.  This analysis reflects the contractual terms of the instrument, including the period to maturity, and uses observable market-based inputs, including interest rate curves. The process also considered credit valuation adjustments to appropriately reflect the Company’s nonperformance risk. The Company has concluded that the value of the assumed mortgage notes payable are Level 2 prices as the majority of the inputs used to value its positions fall within Level 2 of the fair value hierarchy.

 

The Company valued its obligation under the preferred units outstanding based on the current liquidation price of the respective preferred unit series, including accrued but unpaid dividends as appropriate. During the three months ended June 30, 2013, the Company paid approximately $32,100,000 to redeem its proportionate share of a portion of the preferred interest obligations assumed in conjunction with the Archstone Acquisition. The Company used the pricing for the settlement as the fair value at February 27, 2013.

 

The following table presents information for Archstone that is included in our Condensed Consolidated Statement of Comprehensive Income from the acquisition date, February 27, 2013, through June 30, 2013 (in thousands).

 

13



Table of Contents

 

 

 

For the period including
February 28, 2013 through
June 30, 2013

 

Revenues

 

$

140,196

 

Loss attributable to common shareholders (1)

 

$

(91,137

)

 


(1) Amounts exclude acquisition costs for the Archstone Acquisition.

 

The following table presents the Company’s supplemental consolidated pro forma information as if the acquisition had occurred on January 1, 2012 (in thousands, except per share amounts):

 

 

 

For the six months ended
June 30, 2013

 

For the six months
ended June 30, 2012

 

Revenues

 

$

771,547

 

$

695,464

 

Income (loss) from continuing operations

 

198,262

 

(24,486

)

Earnings (loss) per common share - diluted (from continuing operations)

 

$

1.53

 

$

(0.19

)

 

The unaudited proforma consolidated results are prepared for informational purposes only, and are based on assumptions and estimates considered appropriate by the Company’s management.  However, they are not necessarily indicative of what the Company’s consolidated financial condition or results of operations actually would have been assuming the Archstone Acquisition had occurred on January 1, 2012, nor do they purport to represent the consolidated financial position or results of operations for future periods.

 

Investments in Archstone Consolidated Entities

 

In connection with the Archstone Acquisition, the Company entered into a limited liability company agreement with Equity Residential to acquire and own directly and indirectly certain Archstone entities (the “Archstone Legacy Entities”) which hold indirect interests in real estate assets, including 16 of the 60 of the consolidated communities acquired by the Company.  As of June 30, 2013, the Archstone Legacy Entities have outstanding preferred interests held by unrelated third parties with an aggregate liquidation preference of approximately $90,000,000 (including accrued but unpaid distributions), which are generally subject to redemption at the election of the holders of such interests.  One of the Archstone Legacy Entities previously entered into tax protection arrangements with the holders of certain of the preferred interests, which arrangements may limit for varying periods of time the Company’s and Equity Residential’s ability to dispose of the properties held indirectly by the Archstone Legacy Entities or to refinance certain related indebtedness, without making payments to the holders of such preferred interests.  Pursuant to this LLC agreement, the Company has agreed to bear 40% of the economic cost of these preferred redemption obligations, and the tax protection payments that may arise from our disposition or refinancing of properties of the Archstone Legacy Entities that were contributed to a subsidiary that will be consolidated by the Company.  The fair value of the Company’s proportionate share of preferred redemption obligations of approximately $36,000,000 is recorded as a component of Accrued expenses and other liabilities on the accompanying Condensed Consolidated Balance Sheets. As part of the Archstone Acquisition, the Company and Equity Residential have agreed with Lehman and Archstone to require the acquired Archstone Legacy Entities to have sufficient funds available to honor their redemption obligations and to make any payments under its tax protection arrangements, when they may become due. The principal assets indirectly held by the limited liability company that acquired the Archstone Legacy Entities are interests in a subsidiary of the Company’s (the “AvalonBay Legacy Subsidiary”) and a subsidiary of Equity Residential, each of which subsidiaries acquired certain properties formerly owned by the Archstone Legacy Entities.  The Company consolidates the assets, liabilities and results of operations of the AvalonBay Legacy Subsidiary.

 

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Table of Contents

 

Investments in Archstone Unconsolidated Entities

 

In conjunction with the Archstone Acquisition, the Company acquired interests in the following entities:

 

·                  Archstone Multifamily Partners AC LP (the “Archstone U.S. Fund”) — The Archstone U.S. Fund was formed in July 2011 and is fully invested. As of June 30, 2013, the Archstone U.S. Fund owns nine communities containing 1,728 apartment communities, one of which includes a marina containing 229 boat slips.  Through subsidiaries the Company owns the general partner of the fund and holds a 28.6% interest in the fund.

 

Subsidiaries of the Archstone U.S. Fund have eight loans secured by individual assets with amounts outstanding in the aggregate of $330,516,000 with varying maturity dates, ranging from 2019 to 2022. The mortgage loans are payable by the subsidiaries of the Archstone U.S. Fund with operating cash flow or disposition proceeds from the underlying real estate. The Company has not guaranteed the debt of the Archstone U.S. Fund, nor does it have any obligation to fund this debt should the Archstone U.S. Fund be unable to do so.

 

·                  Archstone Multifamily Partners AC JV LPthe AC JV”) — The AC JV is a joint venture in which the Company assumed Archstone’s 20% ownership interest. The AC JV was formed in 2011 and as of June 30, 2013 owned two apartment communities containing 818 apartment homes in Cambridge, MA and Herndon, VA.  The AC JV partnership agreement contains provisions that require the Company to provide a right of first offer (“ROFO”) to the AC JV in connection with additional opportunities to acquire or develop additional interests in multifamily real estate assets within a specified geographic radius of the two existing assets, generally one mile or less. The Company owns two land parcels for the development of 444 apartment homes, classified as Development Rights in Cambridge, MA, acquired as part of the Archstone Acquisition that are subject to ROFO restrictions. The ROFO restrictions expire in 2019.

 

As of June 30, 2013, subsidiaries of the AC JV have eight unsecured loans outstanding in the aggregate of $162,300,000 which mature in July 2021, and which were made by the investors in the venture, including us, in proportion to the investors’ respective equity ownership interest.  The unsecured loans are payable by the subsidiaries of the AC JV with operating cash flow from the venture.  The Company has not guaranteed the debt of the AC JV, nor does it have any obligation to fund this debt should the AC JV be unable to do so.

 

·                  Brandywine Apartments of Maryland, LLC (“Brandywine”) — Brandywine owns a 305 apartment home community located in Washington, DC. The community is managed by a third party. Brandywine is comprised of five members who hold various interests in the joint venture.  In conjunction with the Archstone Acquisition, the Company assumed a 26.1% equity interest in the venture, and subsequently purchased an additional 2.6% interest such that as of June 30, 2013, the Company now holds a 28.7% equity interest in the venture.

 

Brandywine has an outstanding $25,000,000 fixed rate mortgage loan that is payable by the venture.  The Company has not guaranteed the debt of Brandywine, nor does the Company have any obligation to fund this debt should Brandywine be unable to do so.

 

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·                  Additionally, through subsidiaries the Company and Equity Residential entered into three limited liability company agreements (collectively, the “Residual JV”) through which the Company and Equity Residential acquired (i) certain assets of Archstone that the Company and Equity Residential plan to divest (to third parties or to the Company or Equity Residential) over time (the “Residual Assets”), and (ii) various liabilities of Archstone that the Company and Equity Residential agreed to assume in conjunction with the Archstone Acquisition (the “Residual Liabilities”). The Residual Assets include interests in apartment communities in Germany (including through a fund which Archstone managed), a 20.0% interest in a joint venture which owns and manages six apartment communities with 1,902 apartment homes in the United States, two land parcels, and various licenses, insurance policies, contracts, office leases and other miscellaneous assets.  The Residual Liabilities generally include most existing or future litigation and claims related to Archstone’s operations for periods before the close of the Archstone Acquisition, except for (i) claims that principally relate to the physical condition of the assets acquired directly by the Company or Equity Residential, which generally remain the sole responsibility of the Company or Equity Residential, as applicable, and (ii) certain tax and other litigation between Archstone and various equity holders in Archstone related to periods before the close of the Archstone Acquisition, and claims which may arise due to changes in the capital structure of Archstone that occurred prior to closing, for which Lehman has agreed to indemnify the Company and Equity Residential. The Company and Equity Residential jointly control the Residual JV and the Company holds a 40% economic interest in the assets and liabilities of the Residual JV.

 

6.  Investments in Real Estate Entities

 

Investment in unconsolidated entities

 

As of June 30, 2013, including the interests in joint ventures acquired in the Archstone Acquisition, and excluding interest in the Residual JV, the Company had investments in seven 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 June 30, 2013, AvalonBay Value Added Fund, LP (“Fund I”) sold Avalon at Civic Center, located in Norwalk, CA.  Avalon at Civic Center, containing 192 homes, was sold for $45,844,000.  The Company’s share of the gain in accordance with GAAP for the disposition was $1,472,000.

 

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

 

 

 

6-30-13

 

12-31-12

 

 

 

(unaudited)

 

(unaudited)

 

Assets:

 

 

 

 

 

Real estate, net

 

$

2,067,969

 

$

1,337,084

 

Other assets

 

168,822

 

73,252

 

 

 

 

 

 

 

Total assets

 

$

2,236,791

 

$

1,410,336

 

 

 

 

 

 

 

Liabilities and partners’ capital:

 

 

 

 

 

Mortgage notes payable and credit facility

 

$

1,372,106

 

$

943,259

 

Other liabilities

 

40,860

 

20,405

 

Partners’ capital

 

823,825

 

446,672

 

 

 

 

 

 

 

Total liabilities and partners’ capital

 

$

2,236,791

 

$

1,410,336

 

 

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

 

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For the three months ended

 

For the six months ended

 

 

 

(unaudited)

 

(unaudited)

 

 

 

6-30-13

 

6-30-12

 

6-30-13

 

6-30-12

 

 

 

 

 

 

 

 

 

 

 

Rental and other income

 

$

57,452

 

$

44,505

 

$

101,216

 

$

87,132

 

Operating and other expenses

 

(22,986

)

(19,131

)

(40,680

)

(37,800

)

Gain on sale of communities

 

11,216

 

3,825

 

65,267

 

12,735

 

Interest expense, net

 

(15,829

)

(12,659

)

(31,098

)

(25,726

)

Depreciation expense

 

(17,783

)

(12,597

)

(30,933

)

(25,297

)

Net income (loss)

 

$

12,070

 

$

3,943

 

$

63,772

 

$

11,044

 

 

In conjunction with the formation of Fund I and AvalonBay Value Added Fund II, L.P. (“Fund II”), the Company incurred costs in excess of its equity in the underlying net assets of the respective investments. These costs represent $6,430,000 at June 30, 2013 and $7,342,000 at December 31, 2012 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 June 30, 2013).  As of June 30, 2013, 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 June 30, 2013, was not significant and therefore the Company has not recorded any obligation for either of these guarantees as of June 30, 2013.

 

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 acquisition or disposition of assets for which such transactional activity did not occur, in the amounts of $195,000 and $820,000 for the three months ended June 30, 2013 and 2012, respectively, and $440,000 and $968,000 for the six months ended June 30, 2013 and 2012, respectively. These costs are included in Expensed acquisition, development, and other pursuit costs 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 and six months ended June 30, 2013 and 2012.

 

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The Company assesses its portfolio of land held for both development and 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 and six months ended June 30, 2013 and 2012.

 

The Company also evaluates its unconsolidated investments for impairment, considering both the 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 and six months ended June 30, 2013 and 2012.

 

7.  Real Estate Disposition Activities

 

During the three months ended June 30, 2013, the Company sold Avalon at Dublin Station I, located in Dublin, CA containing a total of 305 apartment homes, for $105,400,000. The disposition resulted in a gain in accordance with GAAP of $33,682,000.

 

As of June 30, 2013, the Company did not have any real estate assets that qualified as held for sale.

 

The operations for any real estate assets sold from January 1, 2012 through June 30, 2013 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 from discontinued operations for the periods presented (dollars in thousands):

 

 

 

For the three months ended

 

For the six months ended

 

 

 

(unaudited)

 

(unaudited)

 

 

 

6-30-13

 

6-30-12

 

6-30-13

 

6-30-12

 

 

 

 

 

 

 

 

 

 

 

Rental income

 

$

897

 

$

9,425

 

$

5,890

 

$

19,537

 

Operating and other expenses

 

(314

)

(3,088

)

(1,621

)

(6,314

)

Interest expense, net

 

—

 

(55

)

—

 

(138

)

Loss on extinguishment of debt

 

—

 

(602

)

—

 

(602

)

Depreciation expense

 

(220

)

(1,795

)

(875

)

(4,194

)

Income from discontinued operations

 

$

363

 

$

3,885

 

$

3,394

 

$

8,289

 

 

8.  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 unless disposition or redevelopment plans regarding a community change, maintains that classification 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.

 

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Table of Contents

 

A reconciliation of NOI to net income for the three and six months ended June 30, 2013 and 2012 is as follows (dollars in thousands):

 

 

 

For the three months ended

 

For the six months ended

 

 

 

6-30-13

 

6-30-12

 

6-30-13

 

6-30-12

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

36,097

 

$

156,821

 

$

111,570

 

$

214,430

 

Indirect operating expenses, net of corporate income

 

10,890

 

8,617

 

19,932

 

16,653

 

Investments and investment management expense

 

1,096

 

1,499

 

2,110

 

2,945

 

Expensed acquisition, development and other pursuit costs

 

3,768

 

901

 

43,827

 

1,141

 

Interest expense, net

 

43,169

 

33,191

 

81,342

 

66,814

 

Loss on extinguishment of debt, net

 

—

 

—

 

—

 

1,179

 

General and administrative expense

 

11,345

 

8,316

 

21,384

 

18,026

 

Equity in (income) loss of unconsolidated entities

 

940

 

(2,073

)

19,503

 

(4,248

)

Depreciation expense

 

196,106

 

63,224

 

305,280

 

124,137

 

Gain on sale of real estate assets

 

(33,922

)

(95,329

)

(118,413

)

(95,329

)

Income from discontinued operations

 

(363

)

(3,885

)

(3,394

)

(8,289

)

Net operating income

 

$

269,126

 

$

171,282

 

$

483,141

 

$

337,459

 

 

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 and six months ended June 30, 2013 and 2012 have been adjusted for the real estate assets that were sold from January 1, 2012 through June 30, 2013, or otherwise qualify as discontinued operations as of June 30, 2013, as described in Note 7, “Real Estate Disposition Activities.”

 

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Table of Contents

 

 

 

For the three months ended

 

For the six months ended

 

 

 

Total

 

 

 

% NOI change

 

Total

 

 

 

% NOI change

 

Gross

 

 

 

revenue

 

NOI

 

from prior year

 

revenue

 

NOI

 

from prior year

 

real estate (1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the period ended June 30, 2013

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Established

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

New England

 

$

45,555

 

$

30,320

 

4.9

%

$

90,209

 

$

58,897

 

3.3

%

$

1,391,807

 

Metro NY/NJ

 

62,549

 

43,449

 

5.1

%

123,794

 

85,888

 

5.3

%

1,917,740

 

Mid-Atlantic

 

25,312

 

18,330

 

2.8

%

50,346

 

36,518

 

2.2

%

631,578

 

Pacific Northwest

 

11,603

 

7,937

 

10.5

%

22,979

 

15,787

 

10.5

%

443,641

 

Northern California

 

37,476

 

28,218

 

12.4

%

74,078

 

55,722

 

12.0

%

1,313,242

 

Southern California

 

29,542

 

20,375

 

6.9

%

58,872

 

40,475

 

6.2

%

1,055,368

 

Total Established

 

212,037

 

148,629

 

6.6

%

420,278

 

293,287

 

6.1

%

6,753,376

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other Stabilized

 

147,704

 

102,161

 

N/A

 

226,802

 

157,166

 

N/A

 

7,045,024

 

Development / Redevelopment

 

26,580

 

18,336

 

N/A

 

47,335

 

32,688

 

N/A

 

2,183,928

 

Land Held for Future Development

 

N/A

 

N/A

 

N/A

 

N/A

 

N/A

 

N/A

 

409,930

 

Non-allocated (2)

 

2,913

 

N/A

 

N/A

 

5,185

 

N/A

 

N/A

 

50,120

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

389,234

 

$

269,126

 

57.1

%

$

699,600

 

$

483,141

 

43.2

%

$

16,442,378

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the period ended June 30, 2012

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Established

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

New England

 

$

41,736

 

$

27,263

 

5.7

%

$

82,812

 

$

53,894

 

7.2

%

$

1,285,318

 

Metro NY/NJ

 

58,169

 

40,637

 

6.3

%

115,388

 

80,229

 

8.0

%

1,962,950

 

Mid-Atlantic

 

25,829

 

18,722

 

2.4

%

51,525

 

37,538

 

4.4

%

591,284

 

Pacific Northwest

 

8,119

 

5,651

 

9.5

%

16,024

 

11,223

 

10.7

%

303,343

 

Northern California

 

30,191

 

22,051

 

13.0

%

59,645

 

43,715

 

14.2

%

1,095,715

 

Southern California

 

24,508

 

17,023

 

8.5

%

48,869

 

34,002

 

10.2

%

946,376

 

Total Established

 

188,552

 

131,347

 

7.1

%

374,263

 

260,601

 

8.7

%

6,184,986

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other Stabilized

 

31,561

 

20,042

 

N/A

 

61,813

 

39,538

 

N/A

 

1,140,536

 

Development / Redevelopment

 

29,562

 

19,893

 

N/A

 

55,425

 

37,320

 

N/A

 

1,656,545

 

Land Held for Future Development

 

N/A

 

N/A

 

N/A

 

N/A

 

N/A

 

N/A

 

294,116

 

Non-allocated (2)

 

2,770

 

N/A

 

N/A

 

5,319

 

N/A

 

N/A

 

59,043

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

$

252,445

 

$

171,282

 

10.8

%

$

496,820

 

$

337,459

 

13.0

%

$

9,335,226

 

 


(1)         Does not include gross real estate assets held for sale of $0 and $218,377 as of June 30, 2013 and 2012, respectively.

 

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

 

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Table of Contents

 

9.  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 its 2009 Stock Option and Incentive Plan (the “2009 Plan”) are as follows (dollars in thousands, other than per share amounts):

 

 

 

 

 

Weighted

 

 

 

Weighted

 

 

 

 

 

average

 

 

 

average

 

 

 

2009 Plan

 

exercise price

 

1994 Plan

 

exercise price

 

 

 

shares

 

per share

 

shares

 

per share

 

 

 

 

 

 

 

 

 

 

 

Options Outstanding, December 31, 2012

 

307,554

 

$

112.67

 

719,830

 

$

105.40

 

Exercised

 

(6,951

)

96.72

 

(23,167

)

80.91

 

Granted

 

215,230

 

129.03

 

—

 

—

 

Forfeited

 

(1,061

)

131.29

 

(4,012

)

127.56

 

Options Outstanding, June 30, 2013

 

514,772

 

$

119.69

 

692,651

 

$

106.09

 

Options Exercisable June 30, 2012

 

195,034

 

$

104.99

 

692,651

 

$

106.09

 

 

The weighted average fair value of the options granted under the 2009 Plan during the six months ended June 30, 2013 is estimated at $26.78 per share on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions: dividend yield of 3.7% over the expected life of the option, volatility of 34.0%, risk-free interest rate of 0.9% and an expected life of approximately 5 years.

 

During 2013, the Company adopted a revised compensation framework under which share-based compensation will be granted, composed of annual awards and multiyear long term incentive performance awards.  Annual awards will include restricted stock awards for which one third of the award will vest annually over a three year period following the measurement period.  Under the multiyear long term incentive component of the revised framework, the Company will grant a target number of restricted stock units, with the ultimate award determined by the total shareholder return of the Company’s common stock over a three-year measurement period.  The share-based compensation earned will be in the form of restricted stock, or upon election of the recipient up to 25% in the form of stock options, for which one third of the award will vest annually over a three year period following the measurement period.

 

During the six months ended June 30, 2013, the Company issued 123,977 shares of restricted stock as well as awards for restricted stock units, with an estimated aggregate compensation cost of $36,996,000.  The grant of restricted stock units includes an award which matures at the end of 2015 as well as two transitional awards that mature at the end of 2013 and 2014.  The restricted stock units were valued using a Monte Carlo model with the following weighted average assumptions:  baseline share value of $130.23, a dividend yield of 2.8%, estimated volatility figures over the life of the plan using 50% historical volatility and 50% implied volatility and risk free rates over the life of the plan ranging from 0.08% to 0.37%, resulting in an average estimated fair value per restricted stock unit of $110.00.

 

At June 30, 2013, the Company had 192,212 outstanding unvested shares granted under restricted stock awards. Restricted stock vesting during the six months ended June 30, 2013 totaled 132,790 shares and had fair values at the grant date ranging from $48.60 to $149.05 per share.  The total grant date fair value of shares vested was $13,685,000 and $36,162,000 for the six months ended June 30, 2013 and 2012, respectively.

 

Total employee stock-based compensation cost recognized in income was $11,793,000 and $6,106,000 for the six months ended June 30, 2013 and 2012, respectively, and total capitalized stock-based compensation cost was $3,922,000 and $2,603,000 for the six months ended June 30, 2013 and 2012, respectively.  At June 30, 2013, there was a total of $4,729,000 and $11,664,000 in unrecognized compensation cost for unvested stock options and unvested restricted stock, respectively, which does not include estimated forfeitures. The unrecognized compensation cost for unvested stock options and restricted stock is expected to be recognized over a weighted average period of 2.24 years and 2.85 years, respectively.

 

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10.  Related Party Arrangements

 

Unconsolidated Entities

 

The Company manages unconsolidated real estate entities for which it receives asset management, property management, development and redevelopment fee revenue.  From these entities, the Company earned fees of $2,913,000 and $2,770,000 in the three months ended June 30, 2013 and 2012, respectively, and $5,185,000 and $5,319,000 for the six months ended June 30, 2013 and 2012, respectively.  These fees are included in management, development and other fees on the accompanying Condensed Consolidated Statements of Comprehensive Income. In addition, the Company has outstanding receivables associated with its management role of $10,983,000 and $3,484,000 as of June 30, 2013 and December 31, 2012, respectively.

 

Director Compensation

 

The Company recorded non-employee director compensation expense relating to restricted stock grants and deferred stock awards in the amount of $493,000 and $429,000 for the six months ended June 30, 2013 and 2012, respectively,  as a component of general and administrative expense.  Deferred compensation relating to restricted stock grants and deferred stock awards to non-employee directors was $916,000 and $364,000 on June 30, 2013 and December 31, 2012, respectively.

 

11.  Fair Value

 

Financial Instruments Carried at Fair Value

 

Derivative Financial Instruments

 

Currently, the Company uses interest rate cap agreements to manage its interest rate risk.   These instruments are carried at fair value in the Company’s financial statements.  In adjusting the fair value of its derivative contracts for the effect of counterparty nonperformance risk, the Company has considered the impact of its net position with a given counterparty, as well as any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees. The Company minimizes its credit risk on these transactions by dealing with major, creditworthy financial institutions which have an A or better credit rating by the Standard & Poor’s Ratings Group. As part of its on-going control procedures, the Company monitors the credit ratings of counterparties and the exposure of the Company to any single entity, thus minimizing credit risk concentration. The Company believes the likelihood of realizing losses from counterparty non-performance is remote. Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives use Level 3 inputs, such as estimates of current credit spreads, to evaluate the likelihood of default by itself and its counterparties. As of June 30, 2013, the Company assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined it is not significant.  As a result, the Company has determined that its derivative valuations are classified in Level 2 of the fair value hierarchy.

 

Hedge ineffectiveness did not have a material impact on earnings of the Company for any prior period, and the Company does not anticipate that it will have a material effect in the future.

 

The following table summarizes the consolidated Hedging Derivatives at June 30, 2013, excluding derivatives executed to hedge debt on communities classified as held for sale (dollars in thousands):

 

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Table of Contents

 

 

 

Non-

 

 

 

 

 

designated

 

Cash Flow

 

 

 

Hedges

 

Hedges

 

 

 

Interest

 

Interest

 

 

 

Rate Caps

 

Rate Caps

 

 

 

 

 

 

 

Notional balance

 

$

612,851

 

$

179,497

 

Weighted average interest rate (1)

 

1.7

%

2.4

%

Weighted average capped interest rate

 

5.9

%

5.3

%

Earliest maturity date

 

Aug-13

 

Jul-13

 

Latest maturity date

 

Sep-17

 

Jun-15

 

 


(1) For interest rate caps, this represents the weighted average interest rate on the debt.

 

Excluding derivatives executed to hedge secured debt on communities classified as held for sale, the Company had four derivatives designated as cash flow hedges and 14 derivatives not designated as hedges at June 30, 2013. Fair value changes for derivatives not in qualifying hedge relationships for the three and six months ended June 30, 2013, resulted in unrealized gains of $1,069,000 and $2,484,000, respectively, included in interest expense, net in the Condensed Consolidated Statement of Comprehensive Income. Fair value changes for derivatives not in qualifying hedge relationships for the three and six months ended June 30, 2012 were not material. To adjust the Hedging Derivatives in qualifying cash flow hedges to their fair value and recognize the impact of hedge accounting, the Company recorded a decrease in other comprehensive income of $16,789,000 during the six months ended June 30, 2012. The Company reclassified $1,574,000 and $2,965,000 of deferred losses from accumulated other comprehensive income into earnings as a component of the interest expense, net for the three and six months ended June 30, 2013. The Company anticipates reclassifying approximately $5,493,000 of hedging losses from accumulated other comprehensive income into earnings within the next 12 months to offset the variability of cash flows of the hedged item during this period. The Company did not have any derivatives designated as fair value hedges as of June 30, 2013 or 2012.

 

The Company was also party to a $215,000,000 forward interest rate protection agreement, which was entered into in 2011 to reduce the impact of variability in interest rates on a portion of our expected debt issuance activity in 2013. Based on changes in the Company’s capital markets outlook for the year, and current liquidity position, it is now uncertain as to whether the Company will issue the anticipated debt for which this interest rate protection agreement was transacted. The Company settled this position at its maturity in May 2013 with a payment to the counterparty of $51,000,000, the fair value at the time of settlement. As of June 30, 2013, the Company has recorded deferred loss in accumulated other comprehensive income of $53,484,000 for the forward interest swap agreement with the timing for recognition in earnings dependent on the Company’s capital markets activity for the balance of 2013.  If the Company does issue the debt as anticipated, then the amounts recorded within accumulated other comprehensive income will be recognized as interest expense over the term of the debt.

 

Redeemable Noncontrolling Interests

 

The Company provided redemption options (the “Puts”) that allow joint venture partners of the Company to require the Company to purchase their interests in the investment at a guaranteed minimum amount related to three ventures, two of which were acquired as p