Form: 10-Q

Quarterly report pursuant to Section 13 or 15(d)

November 4, 2010



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934


For the quarterly period ended September 30, 2010

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:

85,284,504 shares of common stock, par value $0.01 per share, were outstanding as of October 31, 2010




 
 

 
 
AVALONBAY COMMUNITIES, INC.
FORM 10-Q
INDEX
 
PART I - FINANCIAL INFORMATION
 
Page
     
   
 
     
   
 
     
   
 
     
 
     
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operation 20-43
     
44
     
44
 
 
   
44-45
     
45
     
  45-46
     
46
     
46
     
46
     
46-48
     
49
 
 
 

 
 
AVALONBAY COMMUNITIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)
 
    9-30-10     12-31-09  
   
(unaudited)
         
ASSETS
               
Real estate:
               
Land
  $ 1,330,289     $ 1,249,236  
Buildings and improvements
    6,409,618       5,980,423  
Furniture, fixtures and equipment
    197,586       185,395  
      7,937,493       7,415,054  
Less accumulated depreciation
    (1,650,905 )     (1,474,147 )
Net operating real estate
    6,286,588       5,940,907  
Construction in progress, including land
    402,721       531,299  
Land held for development
    228,496       237,095  
Operating real estate assets held for sale, net
    6,265       124,186  
Total real estate, net
    6,924,070       6,833,487  
                 
Cash and cash equivalents
    229,111       105,691  
Cash in escrow
    178,030       210,676  
Resident security deposits
    22,605       23,646  
Investments in unconsolidated real estate entities
    93,770       74,570  
Deferred financing costs, net
    32,006       34,531  
Deferred development costs
    81,124       87,763  
Prepaid expenses and other assets
    113,686       87,241  
Total assets
  $ 7,674,402     $ 7,457,605  
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
Unsecured notes, net
  $ 1,660,480     $ 1,658,029  
Mortgage notes payable
    2,287,410       2,316,843  
Dividends payable
    76,127       72,773  
Payables for construction
    37,706       49,623  
Accrued expenses and other liabilities
    241,875       232,964  
Accrued interest payable
    22,377       35,069  
Resident security deposits
    33,966       33,646  
Liabilities related to real estate assets held for sale
    --       2,734  
Total liabilities
    4,359,941       4,401,681  
                 
Redeemable noncontrolling interests
    10,630       5,797  
                 
Stockholders' equity:
               
Common stock, $0.01 par value; 140,000,000 shares authorized at both                
September 30, 2010 and December 31, 2009; 85,284,865 and 81,528,957 shares                
issued and outstanding at September 30, 2010 and December 31, 2009, respectively
    853       815  
Noncontrolling interest
    4,812       --  
Additional paid-in capital
    3,532,451       3,200,367  
Accumulated earnings less dividends
    (232,770 )     (149,988 )
Accumulated other comprehensive loss
    (1,515 )     (1,067 )
Total stockholders' equity
    3,303,831       3,050,127  
                 
Total liabilities and stockholders' equity
  $ 7,674,402     $ 7,457,605  
 
See accompanying notes to Condensed Consolidated Financial Statements.
 
 
 
 
1

 
 
AVALONBAY COMMUNITIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND OTHER COMPREHENSIVE INCOME
(unaudited)
(Dollars in thousands, except per share data)
 
   
For the three months ended
   
For the nine months ended
 
    9-30-10     9-30-09     9-30-10     9-30-09  
Revenue:
                               
Rental and other income
  $ 225,783     $ 213,165     $ 658,040     $ 631,392  
Management, development and other fees
    1,800       1,878       5,334       5,423  
Total revenue
    227,583       215,043       663,374       636,815  
                                 
Expenses:
                               
Operating expenses, excluding property taxes
    69,848       66,693       200,575       195,226  
Property taxes
    23,402       21,093       69,695       61,871  
Interest expense, net
    44,262       41,205       128,260       108,215  
Gain on extinguishment of debt, net
    --       --       --       (1,062 )
Depreciation expense
    58,628       52,987       171,956       153,992  
General and administrative expense
    7,039       5,750       19,975       18,388  
Impairment loss - land holdings
    --       --       --       20,302  
Total expenses
    203,179       187,728       590,461       556,932  
                                 
Equity in income (loss) of unconsolidated entities
    (325 )     190       364       4,139  
Gain on sale of land
    --       241       --       241  
                                 
                                 
Income from continuing operations
    24,079       27,746       73,277       84,263  
                                 
Discontinued operations:
                               
Income (loss) from discontinued operations
    (99 )     3,685       1,917       10,991  
Gain on sale of communities
    --       26,670       72,220       26,670  
Total discontinued operations
    (99 )     30,355       74,137       37,661  
                                 
Net income
    23,980       58,101       147,414       121,924  
Net (income) loss attributable to noncontrolling interests
    674       53       890       1,329  
                                 
Net income attributable to common stockholders
  $ 24,654     $ 58,154     $ 148,304     $ 123,253  
                                 
Other comprehensive income:
                               
Unrealized (loss) gain on cash flow hedges
    (314 )     521       (448 )     1,318  
Comprehensive income
  $ 24,340     $ 58,675     $ 147,856     $ 124,571  
                                 
Earnings per common share - basic:
                               
Income from continuing operations attributable to common stockholders
  $ 0.29     $ 0.34     $ 0.88     $ 1.08  
Discontinued operations attributable to common stockholders
    --       0.38       0.89       0.47  
                                 
Net income attributable to common stockholders
  $ 0.29     $ 0.72     $ 1.77     $ 1.55  
                                 
Earnings per common share - diluted:
                               
Income from continuing operations attributable to common stockholders
  $ 0.29     $ 0.34     $ 0.88     $ 1.07  
Discontinued operations attributable to common stockholders
    --       0.38       0.88       0.47  
                                 
Net income attributable to common stockholders
  $ 0.29     $ 0.72     $ 1.76     $ 1.54  
                                 
Dividends per common share:
  $ 0.8925     $ 0.8925     $ 2.6775     $ 2.6775  
 
See accompanying notes to Condensed Consolidated Financial Statements.
 
 
 
 
2

 
 
AVALONBAY COMMUNITIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(Dollars in thousands)
 
   
For the nine months ended
 
    9-30-10     9-30-09  
                 
Cash flows from operating activities:
               
Net income
  $ 147,414     $ 121,924  
Adjustments to reconcile net income to cash provided
               
by operating activities:
               
Depreciation expense
    171,956       153,992  
Depreciation expense from discontinued operations
    371       7,701  
Amortization of deferred financing costs and debt premium/discount
    5,944       5,422  
Amortization of stock-based compensation
    4,536       4,887  
Equity in income of unconsolidated entities and noncontrolling
               
interests, net of eliminations
    852       (3,992 )
Impairment loss - land holdings
    --       20,302  
Gain on sale of real estate assets
    (72,220 )     (26,911 )
Gain on extinguishment of debt, net
    --       (1,062 )
Increase in cash in operating escrows
    (294 )     (2,699 )
Increase in resident security deposits, prepaid expenses and other assets
    (25,221 )     (17,711 )
Increase in accrued expenses, other liabilities and accrued interest payable
    1,041       11,125  
Net cash provided by operating activities
    234,379       272,978  
                 
                 
Cash flows from investing activities:
               
Development/redevelopment of real estate assets including
               
land acquisitions and deferred development costs
    (330,251 )     (444,892 )
Capital expenditures - existing real estate assets
    (9,683 )     (4,112 )
Capital expenditures - non-real estate assets
    (517 )     (699 )
Proceeds from sale of real estate, net of selling costs
    186,058       67,893  
Decrease in payables for construction
    (11,917 )     (14,742 )
Decrease in cash in construction escrows
    32,940       66,492  
Acquisition of mortgage note
    (24,000 )     --  
Decrease (increase) in investments in unconsolidated real estate entities
    (20,977 )     382  
Net cash used in investing activities
    (178,347 )     (329,678 )
                 
                 
Cash flows from financing activities:
               
Issuance of common stock
    322,257       102,442  
Dividends paid
    (222,081 )     (211,269 )
Payments under unsecured credit facility
    --       (124,000 )
Issuance of mortgage notes payable and draws on construction loans
    --       741,140  
Repayments of mortgage notes payable
    (29,433 )     (29,516 )
Issuance of unsecured notes
    --       499,372  
Repayment of unsecured notes
    --       (420,936 )
Payment of deferred financing costs
    (3,149 )     (11,635 )
Redemption of units for cash by minority partners
    --       (202 )
Distributions to DownREIT partnership unitholders
    (42 )     (39 )
Distributions to joint venture and profit-sharing partners
    (164 )     --  
Net cash provided by financing activities
    67,388       545,357  
                 
Net increase in cash and cash equivalents
    123,420       488,657  
                 
Cash and cash equivalents, beginning of period
    105,691       65,678  
                 
Cash and cash equivalents, end of period
  $ 229,111     $ 554,335  
                 
Cash paid during the period for interest, net of amount capitalized
  $ 125,190     $ 101,059  
 
See accompanying notes to Condensed Consolidated Financial Statements.
 
 
 
 
3

 
 
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

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

During the nine months ended September 30, 2010:

As described in Note 4, “Stockholders’ Equity,” 102,984 shares of common stock valued at $7,777 were issued in connection with stock grants; 4,716 shares valued at $419 were issued through the Company’s dividend reinvestment plan; 46,852 shares valued at $3,990 were withheld to satisfy employees’ tax withholding and other liabilities; 1,300 shares valued at $39 were forfeited and 61,055 shares valued at $3,322 were issued to members of the board of directors in fulfillment of deferred stock awards for a net value of $7,489. In addition, the Company granted 126,484 options for common stock at a value of $2,460.

25 units of limited partnership, valued at $3, 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 an increase to other liabilities and a corresponding decrease to other comprehensive income of $448 and recorded an increase to prepaid expenses and other assets of $2,181, with a corresponding offset to the basis of unsecured notes, net to record the impact of the Company’s hedge accounting activity (as described in Note 5, “Derivative Instruments and Hedging Activities”).

Common dividends declared but not paid totaled $76,127.

The Company recorded an increase of $5,305 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. For further discussion of the nature and valuation of these items, see Note 11, “Fair Value”.

The Company recognized $4,812 in noncontrolling interest in conjunction with the consolidation of a Fund I subsidiary. See Note 6, “Investments in Real Estate Entities” for further discussion.

During the nine months ended September 30, 2009:

2,624,641 shares of common stock valued at $139,058 were issued as part of the special dividend declared in the fourth quarter of 2008; 169,851 shares of common stock valued at $8,360 were issued in connection with stock grants; 9,201 shares valued at $505 were issued through the Company’s dividend reinvestment plan; 33,006 shares valued at $1,502 were withheld to satisfy employees’ tax withholding and other liabilities and 1,031 shares valued at $147 were forfeited, for a net value of $146,274.  In addition, the Company granted 344,801 options for common stock at a value of $2,252.

The Company recorded a decrease to other liabilities and a corresponding increase to other comprehensive income of $1,318 to record the impact of the Company’s hedge accounting activity.

Common dividends declared but not paid totaled $72,595.

The Company recorded a decrease of $4,745 in redeemable noncontrolling interests with a corresponding increase to accumulated earnings less dividends to adjust the redemption value associated with the put options held by joint venture partners and DownREIT partnership units.

In May 2009, the Company obtained $93,440 in variable rate tax-exempt bond financing related to a Development Right (as defined elsewhere in this Form 10-Q), the proceeds of which will be held in escrow until requisitioned for construction funding. This loan provides an option for the Company to request an additional construction loan of up to $83,560 subject to the lender’s discretion.
 
 
 
 
4

 
 
AVALONBAY COMMUNITIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
(Dollars in thousands, except per share data)

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 September 30, 2010, the Company owned or held a direct or indirect ownership interest in 167 operating apartment communities containing 49,061 apartment homes in ten states and the District of Columbia, of which seven communities containing 2,361 apartment homes were under reconstruction.  In addition, the Company owned or held a direct or indirect ownership interest in 12 communities under construction that are expected to contain an aggregate of 3,429 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 24 communities that, if developed as expected, will contain an estimated 6,984 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 2009 Annual Report on Form 10-K.  The results of operations for the three and nine months ended September 30, 2010 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.

All capitalized terms 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:
 
 
 
 
5

 
 
   
For the three months ended
   
For the nine months ended
 
    9-30-10     9-30-09     9-30-10     9-30-09  
Basic and diluted shares outstanding
                               
                                 
Weighted average common shares - basic
    84,968,804       80,132,409       83,385,833       79,521,277  
                                 
Weighted average DownREIT units outstanding
    15,346       15,351       15,349       16,874  
                                 
Effect of dilutive securities
    784,546       461,517       728,712       631,942  
                                 
Weighted average common shares - diluted
    85,768,696       80,609,277       84,129,894       80,170,093  
                                 
Calculation of Earnings per Share - basic
                               
                                 
Net income attributable to common stockholders
  $ 24,654     $ 58,154     $ 148,304     $ 123,253  
Net income allocated to unvested restricted shares
    (68 )     (182 )     (429 )     (389 )
Net income attributable to common stockholders, adjusted
  $ 24,586     $ 57,972     $ 147,875     $ 122,864  
                                 
Weighted average common shares - basic
    84,968,804       80,132,409       83,385,833       79,521,277  
                                 
Earnings per common share - basic
  $ 0.29     $ 0.72     $ 1.77     $ 1.55  
                                 
Calculation of Earnings per Share - diluted
                               
                                 
Net income attributable to common stockholders
  $ 24,654     $ 58,154     $ 148,304     $ 123,253  
Add: noncontrolling interests of DownREIT unitholders in
                               
consolidated partnerships, including discontinued operations
    14       14       41       52  
                                 
Adjusted net income attributable to common stockholders
  $ 24,668     $ 58,168     $ 148,345     $ 123,305  
                                 
Weighted average common shares - diluted
    85,768,696       80,609,277       84,129,894       80,170,093  
                                 
Earnings per common share - diluted
  $ 0.29     $ 0.72     $ 1.76     $ 1.54  
 
 
Certain options to purchase shares of common stock in the amounts of 1,039,724 and 2,023,878 were outstanding at September 30, 2010 and 2009, 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 September 30, 2010 is based on the average forfeiture activity over a period equal to the estimated life of the stock options, and was 1.4%. The application of estimated forfeitures did not materially impact compensation expense for the three and nine months ended September 30, 2010 or 2009.

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 $737 and $1,721 for the three months ended September 30, 2010 and 2009, respectively and $1,685 and $5,096 for the nine months ended September 30, 2010 and 2009, respectively. These costs are included in operating expenses, excluding property taxes on the accompanying Condensed Consolidated Statements of Operations and Other Comprehensive Income. Abandoned pursuit costs can vary greatly, and the costs incurred in any given period may be significantly different in future periods.
 
 

 
 
6

 
 
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 nine months ended September 30, 2010. In the second quarter of 2009, the Company concluded that the economic downturn and the related decline in employment levels did not support the development and construction of certain new apartment communities previously in planning.  As a result the Company recognized a charge of $20,302 related to the impairment of two land parcels for which the Company decided not to pursue development. The Company looked to third-party pricing estimates to determine the fair values of the land parcels considered to be impaired. Given the heterogeneous nature of multifamily real estate, the third-party values incorporated significant unobservable inputs, including the use of estimated rates of return, investment time horizons and sales prices for land parcels considered to be market comparables, adjusted for known differences in critical areas including the existing entitlements (such as zoning and state of infrastructure readiness).  Accordingly, the third-party values are classified as Level 3 prices in the fair value hierarchy. In 2009, the Company also recognized a charge for severance related costs associated with this reduction in planned development activity of approximately $2,000, reported as a component of general and administrative expense. However, as a result of improved economic conditions, the Company has increased its investment activity, allowing the Company to retain staff previously expected to depart. Therefore, certain planned terminations are no longer expected to take place, resulting in a decline of $1,550 in accrued severance recorded as a reduction in general and administrative expenses in the nine months ended September 30, 2010.
 
Legal and Other Contingencies

As previously reported, on August 13, 2008 the U.S. Attorney’s Office for the Southern District of New York filed a civil lawsuit against the Company and the joint venture in which it has an interest that owns Avalon Chrystie Place.  The lawsuit alleged that Avalon Chrystie Place was not designed and constructed in accordance with the accessibility requirements of the Fair Housing Act (“FHA”).  Without admitting or denying liability, the Company settled the outstanding claims under this matter in October 2010.  The Company does not expect that the settlement and its fulfillment of settlement terms will have a material impact to its financial position or results of operations.  Refer to Note 12, Subsequent Events.

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.  During the nine months ended September 30, 2010, the Company recognized receipt of settlement proceeds of $3,300 related to environmental contamination matters pursued by the Company.  The Company reported $1,200 of these recoveries as a reduction in the legal and professional fees related to costs incurred in pursuit of the matters during 2010 and years prior as a component of general and administrative expense, with the remainder of the recovery reported as a reduction in the associated capitalized basis of the related communities.

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 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.
 
 

 
 
7

 
 
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 $7,774 and $11,878 for the three months ended September 30, 2010 and 2009, respectively and $27,265 and $37,923 for the nine months ended September 30, 2010 and 2009, 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 September 30, 2010 and December 31, 2009, are summarized below.  The following amounts and discussion do not include the mortgage notes related to the communities classified as held for sale, if any, as of September 30, 2010 and December 31, 2009, as shown in the Condensed Consolidated Balance Sheets (see Note 7, “Real Estate Disposition Activities”).
 
    9-30-10     12-31-09  
                 
Fixed rate unsecured notes(1)
  $ 1,360,477     $ 1,360,477  
Variable rate unsecured notes(1)
    300,000       300,000  
Fixed rate mortgage notes payable - conventional and tax-exempt
    1,661,705       1,632,605  
Variable rate mortgage notes payable - conventional and tax-exempt
    625,705       684,238  
                 
Total notes payable and unsecured notes     3,947,887       3,977,320  
                 
Credit Facility
    --       --  
                 
Total mortgage notes payable, unsecured notes and Credit Facility   $ 3,947,887     $ 3,977,320  
 
(1)
Balances at September 30, 2010 and December 31, 2009 exclude $1,950 and $2,220 respectively of debt discount, and $1,953 and ($228) respectively for basis adjustments, as reflected in unsecured notes on the Company's Condensed Consolidated Balance sheets.
 
 
The following debt activity occurred during the nine months ended September 30, 2010:

In February 2010, the Company repaid a 6.47% fixed rate secured mortgage note in the amount of $13,961 in advance of its March 2012 scheduled maturity date.
In March 2010, the Company repaid a 6.95% fixed rate secured mortgage note in the amount of $11,226 in advance of its February 2025 scheduled maturity date.
 
In the aggregate, secured notes payable mature at various dates from October 2010 through July 2066, and are secured by certain apartment communities and improved land parcels (with a net carrying value of $1,827,153 as of September 30, 2010).  As of September 30, 2010, the Company has guaranteed approximately $278,728 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 September 30, 2010 and 5.9% at December 31, 2009. 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 2.2% at September 30, 2010 and 1.9% at December 31, 2009.
 
 

 
 
8

 
 
Scheduled payments and maturities of mortgage notes payable and unsecured notes outstanding at September 30, 2010 are as follows:
 
Year
 
Secured notes payments (1)
   
Secured notes maturities
   
Unsecured
notes
maturities
   
Stated
interest rate
of unsecured
notes
 
                             
2010
  $ 1,325     $ 28,989     $ 14,576       7.500 %    
                      75,000       7.072 %   (2)
                                     
2011
    10,776       36,425       39,900       6.625 %    
                      150,000       5.701 %   (2)
                                     
2012
    14,034       108,101       201,601       6.125 %    
                      104,400       5.500 %    
                      75,000       4.600 %   (2)
                                     
2013
    14,876       264,697       100,000       4.950 %    
                                     
2014
    15,769       33,100       150,000       5.375 %    
                                     
2015
    14,725       365,130       --       --      
                                     
2016
    15,600       --       250,000       5.750 %    
                                     
2017
    16,533       18,300       250,000       5.700 %    
                                     
2018
    17,522       --       --       --      
                                     
2019
    2,588       699,529       --       --      
                                     
Thereafter
    110,707       498,684       250,000       6.100 %    
                                     
    $ 234,455     $ 2,052,955     $ 1,660,477              
                                     
(1)  Secured note payments are comprised of the principal pay downs for amortizing mortgage notes.
(2)  The weighted average interest rate for the swapped unsecured notes as of September 30, 2010.
 
 
The Company has a variable rate unsecured credit facility (the “Credit Facility”) in the amount of $1,000,000 with a syndicate of commercial banks, to whom the Company pays an annual facility fee of approximately $1,250. The Company did not have any amounts outstanding under the Credit Facility and had $50,933 outstanding in letters of credit as of September 30, 2010. At December 31, 2009, there were no amounts outstanding under the Credit Facility and $44,105 outstanding in letters of credit. The Credit Facility 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 schedule selected by the Company.  The current stated pricing is LIBOR plus 0.40% per annum (0.66% at September 30, 2010).  During the three months ended September 30, 2010, the Company executed its option to extend the maturity of the Credit Facility for one year to November 2011, at a cost of approximately $1,000.

The Company was in compliance at September 30, 2010 with certain customary financial and other covenants under the Credit Facility and the Company’s unsecured notes.
 
 

 
 
9

 
 
4.  Stockholders’ Equity

The following summarizes the changes in stockholders’ equity for the nine months ended September 30, 2010:
 
                                           
               
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, 2009
  $ 815     $ 3,200,367     $ (149,988 )   $ (1,067 )   $ 3,050,127     $ --     $ 3,050,127  
                                                         
Net income attributable to common stockholders
    --       --       148,304       --       148,304       --       148,304  
Unrealized loss on cash flow hedges
    --       --       --       (448 )     (448 )     --       (448 )
Change in redemption value of
                                                       
     redeemable noncontrolling interest
    --       --       (5,305 )     --       (5,305 )     --       (5,305 )
Noncontrolling interests (a)
    --       --       --       --       -       4,812       4,812  
Dividends declared to common stockholders
    --       --       (225,854 )     --       (225,854 )     --       (225,854 )
Issuance of common stock, net of withholdings
    38       321,857       73       --       321,968       --       321,968  
Amortization of deferred compensation
    --       10,227       --       --       10,227       --       10,227  
                                                         
Balance at September 30, 2010
  $ 853     $ 3,532,451     $ (232,770 )   $ (1,515 )   $ 3,299,019     $ 4,812     $ 3,303,831  
                                                         
(a) Represents the impact of consolidating a Fund I subsidiary. See Note 6, "Investments in Real Estate Entities".
                         
 
During the nine months ended September 30, 2010, the Company:
 
(i)
issued 3,080,204 shares of common stock through public offerings;
 
(ii)
issued 555,076 shares of common stock in connection with stock options exercised;
 
(iii)
issued 4,716 common shares through the Company’s dividend reinvestment plan;
 
(iv)
issued 102,984 common shares in connection with stock grants;
 
(v)
issued 61,055 common shares to two members of the Board of Directors in fulfillment of deferred stock awards;
 
(vi)
issued 25 common shares for DownREIT OP units conversion;
 
(vii)
withheld 46,852 common shares to satisfy employees’ tax withholding and other liabilities; and
 
(viii)
redeemed 1,300 shares of restricted common stock upon forfeiture.

In addition, the Company granted 126,484 options for common stock to employees.  Any deferred compensation related to the Company’s stock option and restricted stock grants during the nine months ended September 30, 2010 is not reflected on the Company’s Condensed Consolidated Balance Sheet as of September 30, 2010, and will not be reflected until earned as compensation cost.

In August 2009, the Company commenced a continuous equity program (the “CEP”), under which the Company was authorized to sell up to $400,000 of its common stock until August 2012. During the three and nine months ended September 30, 2010, the Company completed the sale of common stock authorized under the CEP, selling 76,700 and 3,080,204 shares under this program at an average sales price of $100.41 and  $95.88 per share, for net proceeds of $7,586 and $290,884, respectively. From program inception in August 2009 through completion of the currently registered offering, the Company sold 4,585,105 shares at an average price of $87.24 for net proceeds of $393,993.

During the three months ended September 30, 2010, the Company recognized noncontrolling interest of $4,812 in conjunction with the consolidation of an AvalonBay Value Added Fund, LP (“Fund I”) subsidiary.  See Note 6, “Investments in Real Estate Entities” for further discussion.


5.  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 following table summarizes the consolidated Hedging Derivatives at September 30, 2010, excluding derivatives executed to hedge debt on communities classified as held for sale (dollars in thousands):
 

 
 
 
10

 
 
 
   
Non-designated
Hedges
   
Cash Flow
Hedges
   
Fair Value
Hedges
 
   
Interest
   
Interest
   
Interest
 
   
Rate Caps
   
Rate Caps
   
Rate Swaps
 
 
                 
    Notional balance
  $ 109,847     $ 196,678     $ 300,000  
    Weighted average interest rate (1)
    1.5 %     2.5 %     5.8 %
    Weighted average capped interest rate
    6.9 %     5.3 %     N/A  
    Earliest maturity date
 
Apr-11
   
Jun-12
   
Dec-10
 
    Latest maturity date
 
Mar-14
   
Jun-15
   
Jan-12
 
    Estimated fair value, asset/(liability)
  $ 22     $ 370     $ 1,953  
                         
(1) For interest rate caps, this represents the weighted average interest rate on the debt.
 

 
Excluding derivatives executed to hedge debt on communities classified as held for sale, the Company had five derivatives designated as cash flow hedges, five derivatives designated as fair value hedges and five derivatives not designated as hedges at September 30, 2010. Fair value changes for derivatives that are not in qualifying hedge relationships are reported as a component of general and administrative expenses on the accompanying Condensed Consolidated Statements of Operations and Other Comprehensive Income.  Fair value changes for derivatives not in qualifying hedge relationships for the nine months ended September 30, 2010, were not material. 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.  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 $448 and an increase of $1,318 during the nine months ended September 30, 2010 and 2009, respectively. The amount reclassified into earnings for the nine months ended September 30, 2010, as well as the estimated amount included in accumulated other comprehensive income as of September 30, 2010, expected to be reclassified into earnings within the next twelve months to offset the variability of cash flows of the hedged items during this period are not material. For the derivative positions that the Company has determined qualify as effective fair value hedges during the nine months ended September 30, 2010, the Company has recorded an increase in the fair value of $2,181 with the derivatives fair value reported as a component of prepaid expenses and other assets, with the associated gain as an adjustment to the carrying amount of the corresponding debt being hedged on the accompanying Condensed Consolidated Balance Sheets as of September 30, 2010.

The Company assesses, both at inception and on an on-going basis, the effectiveness of qualifying cash flow and fair value hedges.  Hedge ineffectiveness, reported as a component of general and administrative expenses, 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 fair values of the Hedging Derivatives and non-designated derivatives that are in an asset position are recorded in prepaid expenses and other assets. The fair value of derivatives that are in a liability position are included in accrued expenses and other liabilities on the accompanying Condensed Consolidated Balance Sheets.
 
Derivative financial instruments expose the Company to credit risk in the event of nonperformance by the counterparties under the terms of the Hedging Derivatives. 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. The Company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements of its derivative financial instruments.  Refer to Note 11, “Fair Value,” for further discussion.
 
 
 
 
 
11

 

6.  Investments in Real Estate Entities

As of September 30, 2010, the Company had investments in six unconsolidated real estate entities with ownership interest percentages ranging from 15.2% to 50%. In the third quarter of 2010, a lender ran a competitive bid process to sell a $26,000 non-recourse mortgage note secured by a Fund I operating community with an estimated fair value of approximately $30,000. The Company participated in the bidding and purchased the note on an arms length basis for $24,000. The note pays interest-only through the maturity date of October 2014 at a stated interest rate of 6.06%. Subsequent to acquisition, the Company modified certain terms of the mortgage note, including (i) conforming the original principal balance to the Company's purchase price, (ii) modifying the interest payment terms to require remittance of interest based on available cash flow with any deficiency in the monthly payment amount accruing to the principal due on the note, and (iii) modifying certain terms to help eliminate any potential conflicts between the Company and Fund I, such as removing any prepayment penalty.

Upon the acquisition of the note, the Company determined that it had control of the Fund I subsidiary, as a result of its collective equity and debt investments, the relationship between the Company and Fund I, and the nature of the Company’s operations being more similar to those of the Fund I subsidiary than those of Fund I.  Therefore, the Company consolidated the results of operations and net assets of the Fund I subsidiary.  The Fund I subsidiary was consolidated at fair value, determined using a discounted cash flow analysis on the expected cash flows of the underlying community. This analysis reflects the use of estimated rates of return, capitalization rates, estimated holding periods and estimated sales proceeds, all of which are considered significant other unobservable inputs and are therefore classified as Level 3 prices in the fair value hierarchy.

During the three months ended September 30, 2010, AvalonBay Value Added Fund II, LP (“Fund II”) acquired the following three apartment communities:
Creekside Meadows, a garden-style community consisting of 628 apartment homes located in Tustin (Orange County), CA, was acquired for a purchase price of $98,500;
Grove Park Apartments, a garden-style community consisting of 684 apartment homes located in Gaithersburg, MD was acquired for a purchase price of $101,000; and
The Apartments at Briarwood, a garden-style community consisting of 348 apartment homes located in Owings Mills, MD, was acquired for a purchase price of $44,750.

There were no other changes in the Company’s ownership interest in, or presentation of, its investments in unconsolidated real estate entities during the nine months ended September 30, 2010.

Detail of the real estate and associated funding underlying the Company’s unconsolidated investments is presented in the following table (unaudited).
 
 
 
 
 
12

 
 
       
Company
   
# of
   
Total
   
Debt
       
Ownership
   
Apartment
   
Capitalized
           
Interest
 
Maturity
Unconsolidated Real Estate Investments
 
Percentage
   
Homes
   
Cost (1)
   
Amount (2)
 
Type
 
Rate (3)
 
Date
                                       
Fund I
                                 
                                       
  1.  
Avalon at Redondo Beach - Los Angeles, CA
      105     $ 24,622     $ 21,033  
Fixed
    4.87 %
Oct 2011
                                                 
  2.  
Avalon Lakeside - Chicago, IL
          204       18,362       12,056  
Fixed
    5.74 %
Mar 2012
                                                 
  3.  
Avalon Columbia - Baltimore, MD
          170       29,406       22,275  
Fixed
    5.48 %
Apr 2012
                                                 
  4.  
Avalon Sunset - Los Angeles, CA
          82       20,903       12,750  
Fixed
    5.41 %
Mar 2014
                                                 
  5.  
Avalon at Poplar Creek - Chicago, IL
          196       28,093       16,500  
Fixed
    4.83 %
Oct 2012
                                                 
  6.  
Avalon at Civic Center - Norwalk, CA
          192       42,756       27,001  
Fixed
    5.38 %
Aug 2013
                                                 
  7.  
Avalon Paseo Place - Fremont, CA
          134       24,840       11,800  
Fixed
    5.74 %
Nov 2013
                                                 
  8.  
Avalon at Yerba Buena - San Francisco, CA
      160       66,805       41,500  
Fixed
    5.88 %
Mar 2014
                                                 
  9.  
Avalon at Aberdeen Station - Aberdeen, NJ
      290       58,385       39,842  
Fixed
    5.64 %
Sep 2013
                                                 
  10.  
The Springs - Corona, CA (4)
          320       30,832       24,000  
Fixed
    6.06 %
Oct 2014
                                                 
  11.  
Avalon Lombard - Lombard, IL
          256       35,319       17,243  
Fixed
    5.43 %
Jan 2014
                                                 
  12.  
Avalon Cedar Place - Columbia, MD
          156       24,466       12,000  
Fixed
    5.68 %
Feb 2014
                                                 
  13.  
Avalon Centerpoint - Baltimore, MD
          392       80,059       45,000  
Fixed
    5.74 %
Dec 2013
                                  -              
  14.  
Middlesex Crossing - Billerica, MA
          252       38,089       24,100  
Fixed
    5.49 %
Dec 2013
                                                 
  15.  
Avalon Crystal Hill - Ponoma, NY
          168       38,610       24,500  
Fixed
    5.43 %
Dec 2013
                                                 
  16.  
Avalon Skyway - San Jose, CA
          348       78,198       37,500  
Fixed
    6.11 %
Mar 2014
                                                 
  17.  
Avalon Rutherford Station - East Rutherford, NJ
      108       36,795       19,865  
Fixed
    6.13 %
Sep 2016
                                                 
  18.  
South Hills Apartments - West Covina, CA
      85       24,756       11,761  
Fixed
    5.92 %
Oct 2013
                                                 
  19.  
Weymouth Place - Weymouth, MA
          211       25,299       13,455  
Fixed
    5.12 %
Mar 2015
                                                 
     
Total Fund I
    15.2 %     3,829     $ 726,595     $ 434,181         5.6 %  
                                                   
Fund II
                                           
                                                   
  1.  
Avalon Bellevue Park - Bellevue, WA
            220     $ 33,969     $ 21,515  
Fixed
    5.52 %
Jun 2019
                                                   
  2.  
The Hermitage - Fairfax, VA
            491       72,029       42,600  
Fixed
    5.26 %
May 2017
                                                   
  3.  
Avalon Rothbury - Gaithersburg, MD
            203       31,364       18,750  
Variable
    2.85 %
Jun 2017
                                                   
  4.  
The Apartments at Briarwood - Owings Mills, MD
      348       44,750       -   N/A     N/A   N/A
                                                   
  5.  
Grove Park Apartments - Gaithersburg, MD
      684       101,000       63,200  
Fixed
    5.42 %
Jan 2017
                                                   
  6.  
Creekside Meadows - Tustin, CA
      628       98,500       59,100  
Fixed
    3.81 %
Sep 2017
                                                   
     
Fund II corporate debt
            N/A       N/A       46,000  
Variable
    2.76 % 2010 (5)
                                                   
     
Total Fund II
    31.3 %     2,574     $ 381,612     $ 251,165         4.3 %  
                                                   
Other Operating Joint Ventures
                                           
                                                   
                                                   
  1.  
Avalon Chrystie Place I - New York, NY (6)
 
 
20.0
    361     $ 135,393     $ 117,000  
Variable
    0.97 %
Nov 2036
                                                   
  2.   Avalon at Mission Bay North II - San Francisco, CA (7)
 
 
25.0
    313       124,014       105,000  
Fixed
    6.02 %
Dec 2015
                                                   
  3.  
Avalon Del Rey - Los Angeles, CA
    30.0 %     309       70,037       45,292  
Variable
    3.60 %
Apr 2016
                                                   
Other Development Joint Ventures
                                           
                                                   
  1.  
Aria at Hathorne - Danvers, MA (7) (8)
    50.0 %     64       N/A       1,860  
Variable
    4.19 %
Jun 2010 (9)
                                                   
     
Total Other Joint Ventures
            1,047     $ 329,444     $ 269,152         3.4 %  
                                                   
                                                   
     
Total Unconsolidated Investments
            7,450     $ 1,437,651     $ 954,498         4.7 %  
                                                   

 
 
(1)
Represents total capitalized cost as of September 30, 2010.

 
(2)
The Company has not guaranteed the debt of its unconsolidated investees and bears no responsibility for the repayment, other than the construction and completion and related financing guarantee for Avalon Chrystie Place I associated with the construction completion and occupancy certificate.

 
(3)
Represents weighted average rate on outstanding debt.

 
(4)
As discussed elsewhere in this Form 10-Q, beginning in the three months ended September 30, 2010, the Company consolidated the net assets and results of operations of The Springs.

 
(5)
As of September 30, 2010, these borrowings are drawn under an unsecured credit facility maturing in December 2011, assuming exercise of a one-year extension option.

 
(6)
After the venture makes certain threshold distributions to the third-party partner, the Company generally receives 50% of all further distributions.

 
(7)
The Company has contributed land at a stepped up basis as its only capital contribution to this development.

 
(8)
After the venture makes certain threshold distributions to the Company, the Company receives 50% of all further distributions.

 
(9)
The loan for this venture matured in June 2010. As of September 30, 2010, the amounts under this borrowing have not been repaid. The venture is negotiating an extension or refinancing of the amounts outstanding. The lender has not to date declared an event of default with respect to the note or required the venture to pay a default rate of interest. Although the Company bears no responsibility to repay the amounts outstanding, the Company has the right to cure any event of default by the venture.
 
 
 
 
 
13

 
 
The following is a combined summary of the financial position of the entities accounted for using the equity method, as of the dates presented:
 
 
      9-30-10       12-31-09  
   
(unaudited)
   
(unaudited)
 
Assets:
               
Real estate, net
  $ 1,291,271