Form: 10-Q

Quarterly report pursuant to Section 13 or 15(d)

May 6, 2011

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2011

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

incorporation or organization)

  

(I.R.S. Employer

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.

Yesx            No¨

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).

Yesx            No¨

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 ¨

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

  

Smaller reporting company ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).

Yes¨            Nox

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:

87,316,504 shares of common stock, par value $0.01 per share, were outstanding as of April 29, 2011

 

 

 

 


AVALONBAY COMMUNITIES, INC.

FORM 10-Q

INDEX

 

  PART I - FINANCIAL INFORMATION   
         Page  

Item 1. Condensed Consolidated Financial Statements

  
 

Condensed Consolidated Balance Sheets as of March 31, 2011 (unaudited) and December 31, 2010

     1   
 

Condensed Consolidated Statements of Operations and Other Comprehensive Income (unaudited) for the three months ended March 31, 2011 and 2010

     2   
 

Condensed Consolidated Statements of Cash Flows (unaudited) for the three months ended March 31, 2011 and 2010

     3-4   
 

Notes to Condensed Consolidated Financial Statements (unaudited)

     5-17   

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operation

     18-39   

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     40   

Item 4. Controls and Procedures

     40   
  PART II - OTHER INFORMATION   

Item 1. Legal Proceedings

     40   

Item 1a. Risk Factors

     40   

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

     40-41   

Item 3. Defaults Upon Senior Securities

     41   

Item 4. (Removed and Reserved)

     41   

Item 5. Other Information

     41   

Item 6. Exhibits

     41-43   

Signatures

     44   


AVALONBAY COMMUNITIES, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except per share data)

 

     3-31-11     12-31-10  
     (unaudited)        

ASSETS

    

Real estate:

    

Land

   $ 1,344,871      $ 1,344,946   

Buildings and improvements

     6,688,251        6,618,559   

Furniture, fixtures and equipment

     213,599        203,852   
                
     8,246,721        8,167,357   

Less accumulated depreciation

     (1,767,133     (1,705,566
                

Net operating real estate

     6,479,588        6,461,791   

Construction in progress, including land

     330,243        309,704   

Land held for development

     193,593        184,150   
                

Total real estate, net

     7,003,424        6,955,645   

Cash and cash equivalents

     291,800        306,426   

Cash in escrow

     185,132        173,343   

Resident security deposits

     23,109        22,289   

Investments in unconsolidated real estate entities

     120,255        121,537   

Deferred financing costs, net

     31,566        33,284   

Deferred development costs

     85,382        77,253   

Prepaid expenses and other assets

     141,094        131,711   
                

Total assets

   $ 7,881,762      $ 7,821,488   
                

LIABILITIES AND STOCKHOLDERS’ EQUITY

    

Unsecured notes, net

   $ 1,819,786      $ 1,820,141   

Variable rate unsecured credit facility

     --        --   

Mortgage notes payable

     2,217,397        2,247,516   

Dividends payable

     77,941        76,676   

Payables for construction

     32,697        34,433   

Accrued expenses and other liabilities

     245,311        246,591   

Accrued interest payable

     25,732        32,248   

Resident security deposits

     35,384        34,030   
                

Total liabilities

     4,454,248        4,491,635   
                

Redeemable noncontrolling interests

     6,691        14,262   

Stockholders’ equity:

    

Preferred stock, $0.01 par value; $25 liquidation preference; 50,000,000 shares authorized at both March 31, 2011 and December 31, 2010; zero shares issued and outstanding at March 31, 2011 and December 31, 2010

     --        --   

Common stock, $0.01 par value; 140,000,000 shares authorized at both March 31, 2011 and December 31, 2010; 87,315,258 and 85,899,080 shares issued and outstanding at March 31, 2011 and December 31, 2010, respectively

     873        859   

Additional paid-in capital

     3,749,371        3,593,677   

Accumulated earnings less dividends

     (332,401     (282,743

Accumulated other comprehensive loss

     (1,259     (1,175
                

Total stockholders’ equity

     3,416,584        3,310,618   
                

Noncontrolling interests

     4,239        4,973   
                

Total equity

     3,420,823        3,315,591   
                

Total liabilities and equity

   $ 7,881,762      $ 7,821,488   
                

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  
     3-31-11     3-31-10  

Revenue:

    

Rental and other income

   $     233,488      $     213,600   

Management, development and other fees

     2,320        1,849   
                

Total revenue

     235,808        215,449   
                

Expenses:

    

Operating expenses, excluding property taxes

     68,062        64,922   

Property taxes

     24,850        23,146   

Interest expense, net

     44,271        42,541   

Depreciation expense

     61,299        55,972   

General and administrative expense

     7,292        8,895   
                

Total expenses

     205,774        195,476   
                

Equity in income (loss) of unconsolidated entities

     503        227   
                

Income from continuing operations

     30,537        20,200   
                

Discontinued operations:

    

Income (loss) from discontinued operations

     --          1,875   

Gain on sale of communities

     --          50,291   
                

Total discontinued operations

     --          52,166   
                

Net income

     30,537        72,366   

Net (income) loss attributable to noncontrolling interests

     (196     157   
                

Net income attributable to common stockholders

   $ 30,341      $ 72,523   
                

Other comprehensive income:

    

Unrealized (loss) gain on cash flow hedges

     (84     542   
                

Comprehensive income

   $ 30,257      $ 73,065   
                

Earnings per common share - basic:

    

Income from continuing operations attributable to common
stockholders

   $ 0.35      $ 0.25   

Discontinued operations attributable to common stockholders

     --          0.64   
                

Net income attributable to common stockholders

   $ 0.35      $ 0.89   
                

Earnings per common share - diluted:

    

Income from continuing operations attributable to common
stockholders

   $ 0.35      $ 0.25   

Discontinued operations attributable to common stockholders

     --          0.63   
                

Net income attributable to common stockholders

   $ 0.35      $ 0.88   
                

Dividends per common share:

   $ 0.8925      $ 0.8925   
                

See accompanying notes to Condensed Consolidated Financial Statements.

 

2


AVALONBAY COMMUNITIES, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

(Dollars in thousands)

 

     For the three months ended  
         3-31-11             3-31-10      

Cash flows from operating activities:

    

Net income

   $ 30,537      $ 72,366   

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

    

Depreciation expense

     61,299        55,972   

Depreciation expense from discontinued operations

     --          123   

Amortization of deferred financing costs and debt premium/discount

     1,818        2,246   

Amortization of stock-based compensation

     1,733        2,226   

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

     (228     226   

Gain on sale of real estate assets

     --          (50,291

(Increase) decrease in cash in operating escrows

     (4,217     269   

Increase in resident security deposits, prepaid expenses and other assets

     (9,407     (4,813

Decrease in accrued expenses, other liabilities and accrued interest payable

     (8,320     (9,441
                

Net cash provided by operating activities

     73,215        68,883   
                

Cash flows from investing activities:

    

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

     (110,644     (118,604

Capital expenditures - existing real estate assets

     (2,974     (1,475

Capital expenditures - non-real estate assets

     (2,982     (359

Proceeds from sale of real estate, net of selling costs

     --          81,335   

Decrease in payables for construction

     (1,736     (1,255

(Increase) decrease in cash in construction escrows

     (7,572     3,071   

Decrease (increase) in investments in unconsolidated real estate entities

     1,225        1,244   
                

Net cash used in investing activities

     (124,683     (36,043
                

Cash flows from financing activities:

    

Issuance of common stock

     150,157        83,896   

Dividends paid

     (76,557     (72,603

Repayments of mortgage notes payable

     (30,119     (26,465

Acquisition of joint venture partner equity interest

     (6,570     --     

Distributions to DownREIT partnership unitholders

     (7     (14

Distributions to joint venture and profit-sharing partners

     (62     (48
                

Net cash provided by financing activities

     36,842        (15,234
                

Net (decrease) increase in cash and cash equivalents

     (14,626     17,606   

Cash and cash equivalents, beginning of period

     306,426        105,691   
                

Cash and cash equivalents, end of period

   $ 291,800      $ 123,297   
                

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

   $ 47,462      $ 49,552   
                

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 three months ended March 31, 2011:

 

  •  

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

 

  •  

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

 

  •  

The Company recorded a decrease to prepaid expenses and other assets and a corresponding decrease to other comprehensive income of $84 and recorded a decrease to prepaid expenses and other assets of $456, 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 $77,941.

 

  •  

The Company recorded an increase of $981 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”.

During the three months ended March 31, 2010:

 

  •  

96,394 shares of common stock valued at $7,152 were issued in connection with stock grants, 1,998 shares valued at $159 were issued through the Company’s dividend reinvestment plan, 38,960 shares valued at $3,167 were withheld to satisfy employees’ tax withholding and other liabilities, 1,300 shares valued at $38 were forfeited, and 3,283 shares valued at $161 were issued to members of the board of directors in fulfillment of deferred stock awards, for a net value of $4,267. In addition, the Company granted 126,484 options for common stock at a value of $2,460.

 

  •  

The Company recorded a decrease to other liabilities and a corresponding increase to other comprehensive income of $542 and recorded an increase to prepaid expenses and other assets of $1,410, with a corresponding offset to the basis of unsecured notes, net to record the impact of the Company’s hedge accounting.

 

  •  

Common dividends declared but not paid totaled $73,804.

 

  •  

The Company recorded an increase of $1,145 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.

 

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 March 31, 2011, the Company owned or held a direct or indirect ownership interest in 176 operating apartment communities containing 52,581 apartment homes in ten states and the District of Columbia, of which nine communities containing 3,348 apartment homes were under reconstruction. In addition, the Company owned or held a direct or indirect ownership interest in 11 communities under construction that are expected to contain an aggregate of 2,446 apartment homes when completed. The Company also owned or held a direct or indirect ownership interest in land or rights to land in which the Company expects to develop an additional 34 communities that, if developed as expected, will contain an estimated 9,424 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 2010 Annual Report on Form 10-K. The results of operations for the three months ended March 31, 2011 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  
     3-31-11     3-31-10  

Basic and diluted shares outstanding

    
    

Weighted average common shares - basic

     86,168,732        81,637,686   

Weighted average DownREIT units outstanding

     10,291        15,351   

Effect of dilutive securities

     818,507        657,633   
                

Weighted average common shares - diluted

     86,997,530        82,310,670   
                

Calculation of Earnings per Share - basic

    
    

Net income attributable to common stockholders

   $ 30,341      $ 72,523   

Net income allocated to unvested restricted shares

     (83     (230
                

Net income attributable to common stockholders, adjusted

   $ 30,258      $ 72,293   
                

Weighted average common shares - basic

     86,168,732        81,637,686   
                

Earnings per common share - basic

   $ 0.35      $ 0.89   
                

Calculation of Earnings per Share - diluted

    
    

Net income attributable to common stockholders

   $ 30,341      $ 72,523   

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

     7        14   
                

Adjusted net income attributable to common stockholders

   $ 30,348      $ 72,537   
                

Weighted average common shares - diluted

     86,997,530        82,310,670   
                

Earnings per common share - diluted

   $ 0.35      $ 0.88   
                

Certain options to purchase shares of common stock in the amounts of 469,647 and 1,641,986 were outstanding at March 31, 2011 and 2010, respectively, but were not included in the computation of diluted earnings per share because such options were anti-dilutive.

The Company is required to estimate the forfeiture of stock options and recognize compensation cost net of the estimated forfeitures. The estimated forfeitures included in compensation cost are adjusted to reflect actual forfeitures at the end of the vesting period. The forfeiture rate at March 31, 2011 is based on the average forfeiture activity over a period equal to the estimated life of the stock options, and was 0.9%. The application of estimated forfeitures did not materially impact compensation expense for the three months ended March 31, 2011 or 2010.

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 $651 and $505 for the three months ended March 31, 2011 and 2010, 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.

The Company evaluates its real estate and other long-lived assets for impairment when potential indicators of impairment exist. Such assets are stated at cost, less accumulated depreciation and amortization, unless the carrying amount of the asset is not recoverable. If events or circumstances indicate that the carrying amount of a long-lived asset may not be recoverable, the Company assesses its recoverability by comparing the carrying amount of the long-lived asset to its estimated undiscounted future cash flows. If the carrying amount exceeds the aggregate undiscounted future cash flows, the Company recognizes an impairment loss to the extent the carrying amount exceeds the estimated fair value of the long-lived asset. Based on periodic tests of recoverability of long-lived assets, the Company did not record any impairment losses for the three months ended March 31, 2011 and 2010.

 

6


Commitments and Contingencies

During the three months ended March 31, 2011, the Company exercised a termination provision under a ground lease associated with an abandoned development pursuit. The lease required cash payments of $5,400 in 2011 and between $8,000 and $12,000 per year through the expiration date of the lease in 2105. The required cash payments under the ground lease were being offset in their entirety by cash receipts from subleases through termination of the agreement. By exercising its termination option, the Company eliminated all future obligations under the land lease, reducing both future cash payments due under the land lease and offsetting cash receipts under the associated subleases.

Legal and Other Contingencies

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

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

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 $6,343 and $9,836 for the three months ended March 31, 2011 and 2010, respectively.

3. Notes Payable, Unsecured Notes and Credit Facility

The Company’s mortgage notes payable, unsecured notes and Credit Facility, as defined below, as of March 31, 2011 and December 31, 2010, 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 March 31, 2011 and December 31, 2010, as shown in the Condensed Consolidated Balance Sheets (see Note 7, “Real Estate Disposition Activities”).

 

     3-31-11      12-31-10  

Fixed rate unsecured notes (1)

   $         1,595,901       $         1,595,901   

Variable rate unsecured notes (1)

     225,000         225,000   

Fixed rate mortgage notes payable - conventional and tax-exempt

     1,650,201         1,651,135   

Variable rate mortgage notes payable -conventional and tax-exempt

     567,196         596,381   
                 

Total notes payable and unsecured notes

     4,038,298         4,068,417   

Credit Facility

     --         --   
                 

Total mortgage notes payable, unsecured notes and Credit Facility

   $ 4,038,298       $ 4,068,417   
                 

 

(1) 

Balances at March 31, 2011 and December 31, 2010 exclude $2,168 and $2,269, respectively, of debt discount, and $1,053 and $1,509, respectively, for basis adjustments, as reflected in unsecured notes on the Company’s Condensed Consolidated Balance Sheets.

 

7


The following debt activity occurred during the three months ended March 31, 2011:

 

  •  

In March 2011, the Company repaid a variable rate secured mortgage note in the amount of $28,785 in accordance with its scheduled maturity date.

In the aggregate, secured notes payable mature at various dates from October 2011 through July 2066, and are secured by certain apartment communities and improved land parcels (with a net carrying value of approximately $1,686,000 as of March 31, 2011).

As of March 31, 2011, the Company has guaranteed approximately $274,698 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 both March 31, 2011 and December 31, 2010. 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 both March 31, 2011 and December 31, 2010.

Scheduled payments and maturities of mortgage notes payable and unsecured notes outstanding at March 31, 2011 are as follows:

 

Year

   Secured
notes
payments
(1)
     Secured
notes
maturities
     Unsecured
notes
maturities
     Stated
interest
rate of
unsecured
notes
 

2011

   $ 8,163       $ 7,277       $ 39,900         6.625
           150,000         5.714 % (2) 

2012

     14,068         108,101         104,400         5.500
           201,601         6.125
           75,000         4.377 % (2) 

2013

     14,910         264,697         100,000         4.950

2014

     15,803         33,100         150,000         5.375

2015

     14,759         365,244         —           —     

2016

     15,634         —           250,000         5.750

2017

     16,567         18,300         250,000         5.700

2018

     17,556         —           —           —     

2019

     2,588         701,133         —           —     

2020

     2,761         —           250,000         6.100

Thereafter

     358,101         238,635         250,000         3.950
                             
   $ 480,910       $ 1,736,487       $ 1,820,901      
                             

 

(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 March 31, 2011.

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. At March 31, 2011, there were no amounts outstanding under the Credit Facility and $53,123 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 (0.64% at March 31, 2011).

The Company expects to refinance the Credit Facility prior to maturity in November 2011. The Company expects the cost of the new facility will increase as compared to its current Credit Facility. While market conditions likely support an ability to retain the Company’s current capacity, a reduction in capacity may be appropriate to avoid increased costs to maintain that capacity.

The Company was in compliance at March 31, 2011 with certain customary financial and other covenants under the Credit Facility and the Company’s unsecured notes.

 

8


4. Stockholders’ Equity

The following summarizes the changes in stockholders’ equity for the three months ended March 31, 2011:

 

    Common
stock
    Additional
paid-in
capital
    Accumulated
earnings less
dividends
    Accumulated
other
comprehensive
loss
    Total
AvalonBay
stockholders’
equity
    Noncontrolling
interests
    Total
equity
 

Balance at December 31, 2010

  $ 859      $ 3,593,677      $ (282,743   $ (1,175   $ 3,310,618      $ 4,973      $ 3,315,591   

Net income attributable to common stockholders

    —          —          30,341        —          30,341        —          30,341   

Unrealized loss on cash flow hedges

    —          —          —          (84     (84     —          (84

Change in redemption value of redeemable noncontrolling interest

    —          —          (981     —          (981     —          (981

Noncontrolling interests

    —          —          —          —          —          (734     (734

Dividends declared to common stockholders

    —          —          (77,929     —          (77,929     —          (77,929

Issuance of common stock, net of withholdings

    14        147,703        (1,089     —          146,628        —          146,628   

Amortization of deferred compensation

    —          7,991        —          —          7,991        —          7,991   
                                                       

Balance at March 31, 2011

  $ 873      $ 3,749,371      $ (332,401   $ (1,259   $ 3,416,584      $ 4,239      $ 3,420,823   
                                                       

During the three months ended March 31, 2011, the Company:

  (i)

issued 1,247,910 shares of common stock through public offerings;

  (ii)

issued 110,557 shares of common stock in connection with stock options exercised;

  (iii)

issued 941 common shares through the Company’s dividend reinvestment plan;

  (iv)

issued 88,124 common shares in connection with stock grants;

  (v)

issued 7,500 common shares in exchange for an equal number of DownREIT limited partnership units;

  (vi)

withheld 38,349 common shares to satisfy employees’ tax withholding and other liabilities; and

  (vii)

redeemed 505 shares of restricted common stock upon forfeiture.

In addition, the Company granted 144,827 options for common stock to employees. Any deferred compensation related to the Company’s stock option and restricted stock grants during the three months ended March 31, 2011 is not reflected on the Company’s Condensed Consolidated Balance Sheet as of March 31, 2011, and will not be reflected until earned as compensation cost.

In November 2010, the Company commenced CEP II, under which the Company may sell up to $500,000 of its common stock from time to time during a 36-month period. During the three months ended March 31, 2011, the Company sold 1,247,910 shares at an average sales price of $115.99 per share, for net proceeds of $142,569. From program inception in November 2010 through the end of the first quarter of 2011, the Company sold 1,680,742 shares at an average price of $115.07 for net proceeds of $190,504.

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 March 31, 2011, excluding derivatives executed to hedge debt on communities classified as held for sale (dollars in thousands):

 

      Non-designated
Hedges
    Cash Flow
Hedges
    Fair Value
Hedges
 
     Interest
Rate
Caps
    Interest
Rate

Caps
    Interest
Rate
Swaps
 

Notional balance

   $ 75,847      $ 196,097      $ 225,000   

Weighted average interest rate (1)

     1.2     2.5     5.3

Weighted average capped interest rate

     7.1     5.3     N/A   

Earliest maturity date

     Aug-12        Jun-12        Sep-11   

Latest maturity date

     Mar-14        Jun-15        Jan-12   

Estimated fair value, asset/(liability)

   $ 24      $ 541      $ 1,053   

 

(1) 

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

 

9


Excluding derivatives executed to hedge debt on communities classified as held for sale, the Company had five derivatives designated as cash flow hedges, three derivatives designated as fair value hedges and four derivatives not designated as hedges at March 31, 2011. 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 three months ended March 31, 2011, 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 $84 during the three months ended March 31, 2011 and an increase of $542 during the three months ended March 31, 2010. The amount reclassified into earnings for the three months ended March 31, 2011, as well as the estimated amount included in accumulated other comprehensive income as of March 31, 2011, 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 three months ended March 31, 2011, the Company has recorded a decrease in the fair value of $456 with the derivatives fair value reported as a component of prepaid expenses and other assets, with the associated loss as an adjustment to the carrying amount of the corresponding debt being hedged on the accompanying Condensed Consolidated Balance Sheets as of March 31, 2011.

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.

6. Investments in Real Estate Entities

As of March 31, 2011, the Company had investments in six unconsolidated real estate entities with ownership interest percentages ranging from 15.2% to 50%. The Company accounts for its investments in unconsolidated real estate entities under the equity method of accounting, except as otherwise noted below. The significant accounting policies of the Company’s unconsolidated real estate entities are consistent with those of the Company in all material respects.

 

10


During the three months ended March 31, 2011, AvalonBay Value Added Fund II, LP (“Fund II”) acquired the following apartment community:

 

  •  

Waterstone Carlsbad, a garden-style community consisting of 448 apartment homes located in Carlsbad (San Diego County), CA, was acquired for a purchase price of $78,100;

There were no other changes in the Company’s ownership interest in, or presentation of, its investments in unconsolidated real estate entities during the three months ended March 31, 2011.

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

 

Unconsolidated Real Estate Investments

   Company
Ownership
Percentage
    # of
Apartment
Homes
     Total
Capitalized
Cost (1)
     Debt  
           Amount (2)      Type      Interest
Rate (3)
    Maturity
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         18,405         12,056         Fixed         5.74%        Mar 2012   

3. Avalon Columbia - Baltimore, MD

       170         29,410         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         28,097         16,500         Fixed         4.83%        Oct 2012   

6. Avalon at Civic Center - Norwalk, CA

       192         42,756         27,001         Fixed         5.39%        Aug 2013   

7. Avalon Paseo Place - Fremont, CA

       134         24,984         11,800         Fixed         5.74%        Nov 2013   

8. Avalon at Yerba Buena - San Francisco, CA

       160         66,811         41,500         Fixed         5.88%        Mar 2014   

9. Avalon at Aberdeen Station - Aberdeen, NJ

       290         58,587         39,842         Fixed         5.64%        Sep 2013   

10. The Springs - Corona, CA (4)

       320         29,897         23,839         Fixed         6.06%        Oct 2014   

11. Avalon Lombard - Lombard, IL

       256         35,323         17,243         Fixed         5.43%        Jan 2014   

12. Avalon Cedar Place - Columbia, MD

       156         24,505         12,000         Fixed         5.68%        Feb 2014   

13. Avalon Centerpoint - Baltimore, MD (5)

       392         80,148         45,000         Fixed         5.74%        Dec 2013   

14. Middlesex Crossing - Billerica, MA

       252         38,305         24,100         Fixed         5.49%        Dec 2013   

15. Avalon Crystal Hill - Ponoma, NY

       168         38,645         24,500         Fixed         5.43%        Dec 2013   

16. Avalon Skyway - San Jose, CA

       348         78,219         37,500         Fixed         6.11%        Mar 2014   

17. Avalon Rutherford Station - East Rutherford, NJ

       108         36,821         19,707         Fixed         6.13%        Sep 2016   

18. South Hills Apartments - West Covina, CA

       85         24,756         11,762         Fixed         5.92%        Oct 2014   

19. Weymouth Place - Weymouth, MA

       211         25,298         13,455         Fixed         5.12%        Mar 2013   
                                                

Total Fund I

     15.2%        3,829         $726,492         $433,863            5.6%     
                                                

Fund II

                  

1. Avalon Bellevue Park - Bellevue, WA

       220         33,992         21,515         Fixed         5.52%        Jun 2019   

2. Avalon Fair Oaks - Fairfax, VA

       491         71,893         42,600         Fixed         5.26%        May 2017   

3. Avalon Rothbury - Gaithersburg, MD

       203         31,481         18,750         Variable         2.83%        Jun 2017   

4. Briarwood, an Avalon Community - Owings Mills, MD

       348         45,056         26,850         Fixed         3.64%        Nov 2017   

5. Grove Park Apts, an AvalonBay Community - Gaithersburg, MD

       684         101,371         63,200         Fixed         5.42%        Jan 2017   

6. Creekside Meadows - Tustin, CA

       628         99,195         59,100         Fixed         3.81%        Oct 2017   

7. Canyonwoods - Lake Forest, CA

       140         24,741         -         N/A         N/A        N/A   

8. Fox Run Apts - Plainsboro, NJ (6)

       776         86,486         54,726         Fixed         4.56%        Nov 2014   

9. Waterstone Carlsbad - Carlsbad, CA

       448         78,200         46,141         Fixed         4.68%        Feb 2018   

Fund II corporate debt

       N/A         N/A         11,000         Variable         2.74%        Dec 2011   
                                                

Total Fund II

     31.3%        3,938         $572,415         $343,882            4.5%     
                                                

Other Operating Joint Ventures

                  

1.    Avalon Chrystie Place I - New York, NY (7)

     20.0%        361         135,735         117,000         Variable         0.94%        Nov 2036   

2.    Avalon at Mission Bay North II - San Francisco, CA (8)

     25.0%        313         124,014         105,000         Fixed         6.02%        Dec 2015   

3.    Avalon Del Rey - Los Angeles, CA

     30.0%        309         70,037         44,838         Variable         3.60%        Apr 2016   

Other Development Joint Ventures

                  

1.    Aria at Hathorne - Danvers, MA (8) (9)

     50.0%        64         N/A         1,860         Variable         7.98%        Jun 2010 (10)   
                                          

Total Other Joint Ventures

       1,047       $ 329,786       $ 268,698            3.4  
                                          

Total Unconsolidated Investments

       8,814       $ 1,628,693       $ 1,046,443            4.7  
                                          

 

  (1)

Represents total capitalized cost as of March 31, 2011.

 

  (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 as of March 31, 2011.

 

  (4)

Beginning in the third quarter of 2010, the Company consolidated the net assets and results of operations of The Springs.

 

  (5)

Borrowing on this community is comprised of three mortgage loans.

 

  (6)

Borrowing on this community is comprised of two mortgage loans.

 

  (7)

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

 

  (8)

The Company has contributed land, receiving capital credit for the fair value upon contribution, as its only capital contribution to this development.

 

  (9)

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

 

 

11


(10)

The loan for this venture matured in June 2010. As of March 31, 2011, the amounts under this borrowing have not been repaid, and the venture is negotiating an extension or refinancing of the amounts outstanding. As of March 31, 2011, the lender has declared an event of default with respect to the note and required the venture to pay a default rate of interest, the impact of which is not material to the Company. Although the Company has not guaranteed the debt of Aria at Hathorne nor does it have any obligation to fund the debt should the venture be unable to do so, the Company has the right to cure any event of default by the venture.

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

 

     3-31-11      12-31-10  
     (unaudited)      (unaudited)  

Assets:

     

Real estate, net

   $ 1,461,589       $ 1,393,274   

Other assets

     52,910         67,278   
                 

Total assets

   $ 1,514,499       $ 1,460,552   
                 

Liabilities and partners’ capital:

     

Mortgage notes payable and credit facility

   $ 1,022,603       $ 965,931   

Other liabilities

     29,008         24,835   

Partners’ capital

     462,888         469,786   
                 

Total liabilities and partners’ capital

   $ 1,514,499       $ 1,460,552   
                 

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

 

     For the three months
ended (unaudited)
 
     3-31-11     3-31-10  

Rental and other income

   $ 37,823      $ 27,033   

Operating and other expenses

     (17,554     (13,428

Interest expense, net

     (12,301     (9,489

Depreciation expense

     (11,603     (8,981
                

Net loss

   $ (3,635   $ (4,865
                

In conjunction with the formation of Fund I and Fund II, as well as the acquisition and development of certain other investments in unconsolidated entities, the Company incurred costs in excess of its equity in the underlying net assets of the respective investments. These costs represent $10,543 at March 31, 2011 and $10,644 at December 31, 2010 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 for Fund I and approximately $5,843 for Fund II as of March 31, 2011). As of March 31, 2011, the expected realizable values of the real estate assets owned by Fund I and Fund II are considered adequate to cover such potential payments under a liquidation scenario. The estimated fair value of, and the Company’s obligation under these guarantees, both at inception and as of March 31, 2011, was not significant and therefore the Company has not recorded any obligation for either of these guarantees as of March 31, 2011.

7. Real Estate Disposition Activities

The Company did not sell any communities during the three months ended March 31, 2011, and had no real estate assets that qualified as held for sale as of March 31, 2011.

 

12


The following is a summary of income from discontinued operations for the periods presented:

 

     For the three months ended  
        3-31-11            3-31-10     

Rental income

   $ —         $ 3,340   

Operating and other expenses

     —           (1,342

Interest expense, net

     —           —     

Depreciation expense

     —           (123
                 

Income from discontinued operations

   $ —         $ 1,875   
                 

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 maintains that classification, unless disposition plans regarding a community change, throughout the year for the purpose of reporting segment operations.

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

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

A reconciliation of NOI to net income for the three months ended March 31, 2011 and 2010 is as follows:

 

     For the three months ended  
     3-31-11     3-31-10  

Net income

   $ 30,537      $ 72,366   

Indirect operating expenses, net of corporate income

     7,027        7,232   

Investments and investment management expense

     1,191        1,039   

Expensed development and other pursuit costs

     651        505   

Interest expense, net

     44,271        42,541   

General and administrative expense

     7,292        8,895   

Equity in income of unconsolidated entities

     (503     (227

Depreciation expense

     61,299        55,972   

Gain on sale of real estate assets

     —          (50,291

(Income) loss from discontinued operations

     —          (1,875
                

Net operating income

   $ 151,765      $ 136,157   
                

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. The segments are classified based on the individual community’s status as of the beginning of the given calendar year. Therefore, each year the composition of communities within each business segment is adjusted. Accordingly, the amounts between years are not directly comparable. Segment information for the three months ended March 31, 2011 and 2010 have been adjusted for the communities that were sold from January 1, 2010 through March 31, 2011, or otherwise qualify as discontinued operations as of March 31, 2011, as described in Note 7, “Real Estate Disposition Activities”.

 

13


     For the three months ended  
     Total
revenue
     NOI      % NOI change
from prior year
    Gross real
estate (1)
 
          

For the period ended March 31, 2011

          

Established

          

New England

   $ 41,027       $ 25,482         6.7   $ 1,293,907   

Metro NY/NJ

     47,691         31,559         5.5     1,527,764   

Mid-Atlantic/Midwest

     30,207         21,643         8.3     725,124   

Pacific Northwest

     9,129         6,140         0.8     361,623   

Northern California

     24,707         17,386         6.5     928,925   

Southern California

     18,394         11,955         1.9     695,067   
                                  

Total Established

     171,155         114,165         5.8     5,532,410   
                                  

Other Stabilized

     33,612         18,711         N/A        1,640,776   

Development / Redevelopment

     28,721         18,889         N/A        1,324,743   

Land Held for Future Development

     N/A         N/A         N/A        193,593   

Non-allocated (2)

     2,320         N/A         N/A        79,035   
                                  

Total

   $ 235,808       $ 151,765         11.5   $ 8,770,557   
                                  

For the period ended March 31, 2010

          

Established

          

New England

   $ 35,193       $ 21,643         (4.6 %)    $ 1,086,197   

Metro NY/NJ

     44,390         29,507         (3.5 %)      1,385,405   

Mid-Atlantic/Midwest

     29,391         17,546         (5.6 %)      750,566   

Pacific Northwest

     6,617         4,426         (15.0 %)      239,683   

Northern California

     29,416         20,158         (14.5 %)      1,108,224   

Southern California

     14,773         9,707         (9.9 %)      467,275   
                                  

Total Established

     159,780         102,987         (7.6 %)      5,037,350   
                                  

Other Stabilized

     28,779         16,866         N/A        1,546,664   

Development / Redevelopment

     25,041         16,304         N/A        1,429,601   

Land Held for Future Development

     N/A         N/A         N/A        206,713   

Non-allocated (2)

     1,849         N/A         N/A        96,659   
                                  

Total

   $ 215,449       $ 136,157         (0.4 %)    $ 8,316,987   
                                  

 

(1)

Does not include gross real estate assets held for sale of $127,699 as of March 31, 2010.

(2)

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

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 under the AvalonBay Communities, Inc. 2009 Stock Option and Incentive Plan (the “2009 Plan”) are as follows:

 

     2009 Plan
shares
    Weighted
average
exercise  price
per share
     1994 Plan
shares
    Weighted
average
exercise price
per share
 

Options Outstanding, December 31, 2010

     126,484      $ 74.20         2,072,217      $ 88.50   

Exercised

     (7,604     74.20         (102,953     73.77   

Granted

     144,827        115.83         —          —     

Forfeited

     —          —           (8     44.58   
                                 

Options Outstanding, March 31, 2011

     263,707      $ 97.06         1,969,256      $ 89.27   
                                 

Options Exercisable March 31, 2011

     37,021      $ 74.20         1,862,293      $ 91.61   
                                 

 

14


The weighted average fair value of the options granted under the 2009 Plan during the three months ended March 31, 2011 is estimated at $29.40 per share on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions: dividend yield of 4.0% over the expected life of the option, volatility of 35.00%, risk-free interest rate of 3.0% and an expected life of approximately seven years.

At March 31, 2011, the Company had 216,326 outstanding unvested shares granted under restricted stock awards. The Company issued 88,124 shares of restricted stock valued at $10,207 as part of its stock-based compensation plan during the three months ended March 31, 2011. Restricted stock vesting during the three months ended March 31, 2011 totaled 100,414 shares and had fair values at the grant date ranging from $48.60 to $147.75 per share. The total grant date fair value of shares vested was $8,647 and $8,913 for the three months ended March 31, 2011 and 2010, respectively.

Total employee stock-based compensation cost recognized in income was $2,834 and $3,485 for the three months ended March 31, 2011 and 2010, respectively, and total capitalized stock-based compensation cost was $1,341 and $1,329 for the three months ended March 31, 2011 and 2010, respectively. At March 31, 2011, there was a total of $4,473 and $8,559 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 2.56 years and 2.90 years, respectively.

Deferred Stock Performance Plan

The total cost recognized in earnings in connection with the multi-year performance plan implemented by the Company in 2008 was $403 and $427 for the three months ended March 31, 2011 and 2010, respectively, and total capitalized stock-based compensation cost was $233 for both the three months ended March 31, 2011 and 2010.

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 received fees of $2,320 and $1,849 in the three months ended March 31, 2011 and 2010, respectively. These fees are included in management, development and other fees on the accompanying Condensed Consolidated Statements of Operations and Other Comprehensive Income. In addition, the Company has outstanding receivables associated with its management role of $4,857 and $3,803 as of March 31, 2011 and 2010, respectively.

Director Compensation

The Company recorded non-employee director compensation expense relating to the restricted stock grants and deferred stock awards in the amount of $187 and $219 for the three months ended March 31, 2011 as a component of general and administrative expense. Deferred compensation relating to these restricted stock grants and deferred stock awards was $125 and $146 on March 31, 2011 and December 31, 2010, respectively.

11. Fair Value

Financial Instruments Carried at Fair Value

Derivative Financial Instruments

Currently, the Company uses interest rate swap and interest rate cap agreements to manage its interest rate risk. These instruments are carried at fair value in the Company’s financial statements. See Note 5, “Derivative Instruments and Hedging Activities,” for derivative values at March 31, 2011 and a description of where these amounts are recorded in the 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. 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

 

15


inputs, such as estimates of current credit spreads, to evaluate the likelihood of default by itself and its counterparties. As of March 31, 2011, 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.

Redeemable Noncontrolling Interests

 

  •  

Puts – The Company provided redemption options (the “Puts”) that allow two of the Company’s joint venture partners to require the Company to purchase their interests in the investments at the future fair market value. In March 2011, the Company acquired the noncontrolling interest associated with a consolidated community for $6,570 satisfying its obligation under one of the Puts. The remaining Put is payable in cash or, at the Company’s option, common stock of the Company. The Company determines the fair value of the Put based on unobservable inputs considering the assumptions that market participants would make in pricing the obligations. The Company applies discount factors to the estimated future cash flows of the asset underlying the associated joint venture, which in the case of the Put is the NOI from an apartment community, as well as potential disposition proceeds utilizing market capitalization rates, to derive the fair value of the position. Given the significance of the unobservable inputs, the valuation is classified in Level 3 of the fair value hierarchy. At December 31, 2010, the Puts’ aggregate fair value was $12,106. At March 31, 2011, the aggregate fair value of the remaining outstanding Put was $5,331.

 

  •  

DownREIT units – The Company issued units of limited partnership interest in DownREITs which provide the DownREIT limited partners the ability to present all or some of their units for redemption for a cash amount as determined by the applicable partnership agreement. Under the DownREIT agreements, for each limited partnership unit, the limited partner is entitled to receive cash in the amount equal to the fair value of the Company’s common stock on or about the date of redemption. In lieu of cash redemption, the Company may elect to exchange such units for an equal number of shares in the Company’s common stock. The limited partnership units in DownREITs are valued using the market price of the Company’s common stock, a Level 1 price under the fair value hierarchy. At December 31, 2010, the fair value of the DownREIT units was $1,721. At March 31, 2011, the fair value of the DownREIT units was $925.

Financial Instruments Not Carried at Fair Value

Cash and Cash Equivalents

Cash and cash equivalent balances are held with various financial institutions within principal protected accounts. The Company monitors credit ratings of these financial institutions and the concentration of cash and cash equivalent balances with any one financial institution and believes the likelihood of realizing material losses related to cash and cash equivalent balances is remote. Cash and cash equivalents are carried at their face amounts, which reasonably approximate their fair values.

Other Financial Instruments

Rents receivable, accounts and construction payable and accrued expenses and other liabilities are carried at their face amounts, which reasonably approximate their fair values.

The Company values its bond indebtedness, notes payable and outstanding amounts under the Credit Facility using a discounted cash flow analysis on the expected cash flows of each instrument. 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 considers credit valuation adjustments to appropriately reflect the Company’s nonperformance risk. The Company has concluded that the value of its bond indebtedness and 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. Bond indebtedness, notes payable and outstanding amounts under the Credit Facility (as applicable) with an aggregate outstanding par amount of approximately $4,038,298 and $4,068,417 had an estimated aggregate fair value of $4,198,020 and $4,236,216 at March 31, 2011 and December 31, 2010, respectively.

 

16


12. Subsequent Events

The Company has evaluated subsequent events through the date on which this Form 10-Q was filed, the date on which these financial statements were issued, and identified the following for disclosure:

In April 2011, the Company purchased Fairfax Towers, located in Falls Church, Virginia. The community contains 415 apartment homes and was acquired for a purchase price of $89,200. In conjunction with this acquisition, the Company assumed the existing 4.75% fixed-rate mortgage loan of $44,044 which matures in August 2015.

In April 2011, the Company completed an exchange of assets with UDR, Inc. (“UDR”). The transaction includes exchanging a portfolio of three existing apartment communities for a portfolio of six UDR apartment communities and $26,000 in cash. The Company’s portfolio includes two properties containing 833 apartment homes and a small land parcel located in metropolitan Boston and one property containing 227 apartment homes located in San Francisco, with net real estate assets at March 31, 2011 of approximately $164,000. The UDR portfolio consists of 1,418 apartment homes and is located in Southern California (Los Angeles, Orange County and San Diego). As part of the transaction, the Company assumed a $55,400 fixed-rate mortgage with a 5.24% interest rate and a maturity date of June 2013. In exchange, the Company relinquished a $55,800 mortgage loan with a fixed rate of 5.86% and a maturity date of May 2019.

Also in April 2011, the Company entered into $430,000 of forward starting interest rate swaps where the Company has agreed to pay a fixed rate of interest in exchange for a floating rate of interest at a future date. These swaps were transacted to reduce the Company’s exposure to rising interest rates on future debt issuances.

 

17


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help provide an understanding of our business and results of operations. This MD&A should be read in conjunction with our Condensed Consolidated Financial Statements and the accompanying Notes to Condensed Consolidated Financial Statements included elsewhere in this report. This report, including the following MD&A, contains forward-looking statements regarding future events or trends as described more fully under “Forward-Looking Statements” included in this report. Actual results or developments could differ materially from those projected in such statements as a result of the factors described under “Forward-Looking Statements” below and the risk factors described in Item 1a, “Risk Factors,” of our Form 10-K for the year ended December 31, 2010 (our “Form 10-K”).

All capitalized terms have the meaning as provided elsewhere in this Form 10-Q.

Executive Overview

Business Description

We are primarily engaged in developing, acquiring, owning and operating apartment communities in high barrier to entry markets of the United States. We believe that apartment communities are an attractive long-term investment opportunity compared to other real estate investments because a broad potential resident base should help reduce demand volatility over a real estate cycle. We seek to create long-term shareholder value by accessing capital at cost effective terms; deploying that capital to develop, redevelop and acquire apartment communities in high barrier to entry markets; operating apartment communities; and selling communities when they no longer meet our long-term investment strategy or when pricing is attractive. Barriers to entry in our markets generally include a difficult and lengthy entitlement process with local jurisdictions and dense urban or suburban areas where zoned and entitled land is in limited supply.

We regularly evaluate the allocation of our investments by the amount of invested capital and by product type within our individual markets, which are located in New England, the New York/New Jersey metro area, the Mid-Atlantic, the Midwest, the Pacific Northwest, and the Northern and Southern California regions of the United States. Our strategy is to be leaders in market research and capital allocation, delivering a range of multifamily offerings tailored to serve the needs of the most attractive customer segments in the best-performing submarkets of the United States. Our communities are predominately upscale, which generally command among the highest rents in their markets. However, we also pursue the ownership and operation of apartment communities that target a variety of customer segments and price points, consistent with our goal of offering a broad range of products and services.

First Quarter 2011 Highlights

 

  •  

Net income attributable to common stockholders for the quarter ended March 31, 2011 was $30,341,000, a decrease of $42,182,000 or 58.2% from the prior year period. The decrease is attributable primarily to sales of communities and the associated gains in the quarter ended March 31, 2010, which were not present in 2011, offset partially by an increase in NOI from operating communities.

 

  •  

For the quarter ended March 31, 2011, Established Communities NOI increased by 5.8% or $6,230,000 over the prior year period. This year-over-year increase was driven primarily by an increase in rental revenue of 3.7%, along with a decrease in operating expenses of 0.1%.

Financial Outlook

The economic recovery has continued in 2011 with the positive trend improving at a faster pace than we anticipated when we provided our 2011 outlook in February 2011. We now expect that the midpoint of our full year 2011 FFO per share will meet or exceed the high end of the range provided in our February outlook, and expect to provide revised ranges for our full year expected performance in early June 2011. Our results for the quarter ended March 31, 2011 reflect this ongoing improvement in apartment fundamentals. We experienced an increase in our Established Community revenues in each of our regions, driving the growth in our NOI. Our overall NOI growth was also favorably

 

18


impacted by our portfolio growth through new development. The improvement in multifamily fundamentals is due largely to job growth that accelerated during the quarter. This growth was concentrated in the younger age groups, which have a higher propensity to rent. These factors are driving the increase in the rate of new household formation. In addition, apartment fundamentals also continue to benefit from a combination of the continued decline in the homeownership rate and limited supply of new multifamily rental product. We expect further improvement in revenue growth and operating fundamentals will be driven by home ownership trends, demographic trends, as well as the timing and magnitude of employment growth. We believe that the continued improvement in apartment fundamentals, as well as favorable capital markets activity, supports our investment activity as further discussed below.

Throughout the recent recession we maintained a focus on ensuring that our development capabilities were positioned to take advantage of the expected economic recovery. We believe that our investment in development now allows us to deliver new assets in a supply constrained environment. We completed the development of three communities during the quarter ended March 31, 2011 containing an aggregate of 888 apartment homes for a total capitalized cost of $234,400,000. At March 31, 2011, we had 11 communities under construction with a total projected capitalized cost of approximately $643,400,000. As of March 31, 2011, approximately $256,800,000 of the capital for this development activity was invested, with $386,600,000 remaining to invest. At March 31, 2011 our combined development under way and in planning is $3,335,400,000.

At March 31, 2011, there were nine communities under redevelopment, with an expected investment of approximately $112,400,000, excluding costs incurred prior to the start of redevelopment, and $59,144,000 remaining to be invested. There were no redevelopment completions or starts during the first quarter of 2011. However, we expect to maintain our current level of redevelopment activity through 2011, reinvesting and repositioning our assets to meet the needs of our residents and position our assets to outperform in an improving economic environment.

At present, we believe that cash on hand and available capital from our current credit facility and expected capacity under our refinanced credit facility will be sufficient to provide the capital necessary to fund our development and redevelopment activities for the balance of 2011. We believe that the strength of our balance sheet, as measured by our current level of indebtedness, our current ability to service interest and other fixed charges and our current limited use of financial encumbrances (such as secured financing), provides us with adequate access to liquidity from the capital markets through the issuance of corporate securities (which could include unsecured debt and/or common and preferred equity) and secured debt, as well as other sources of liquidity such as from joint ventures or from our retained cash, to meet any reasonably foreseeable liquidity needs as they arise. See the discussion under Liquidity and Capital Resources.

While we continue to grow principally through our demonstrated core competency of developing wholly-owned assets, we are also actively managing the investments in our wholly-owned portfolio. In April 2011, we completed an asset exchange. Through this transaction we exchanged three existing communities and a small land parcel for six operating communities and $26,000,000 in cash. The communities we exchanged consisted of two properties and a small land parcel located in metropolitan Boston and one property located in San Francisco. In exchange we received six operating communities in Southern California (Los Angeles, Orange County and San Diego). This transaction is consistent with our strategy of increasing our presence in a region that we were under-allocated, providing us with a larger portfolio of assets at multiple price points that we believe will perform better than other US markets over the current operating cycle. As part of the transaction, we assumed a $55,400,000 fixed-rate mortgage loan with a 5.24% interest rate and a maturity date of June 2013. In exchange, we relinquished a $55,800,000 mortgage loan with a fixed rate of 5.86% and a maturity date of May 2019.

Also in April 2011, we acquired Fairfax Towers for our wholly-owned portfolio. Fairfax Towers is a high-rise community consisting of 415 apartment homes, located in Falls Church, VA, and was acquired for a purchase price of $89,200,000. In conjunction with this acquisition, we assumed the existing 4.75% fixed rate mortgage loan for $44,044,000, which matures in August 2015.

In addition to this activity for our wholly-owned portfolio, we also expect to acquire interests in additional assets, primarily through our investment in two private discretionary investment funds.

 

19


We established Fund I and Fund II (collectively “the Funds”) to engage in acquisition programs through discretionary investment funds. We believe this investment format provides the following attributes: (i) third-party joint venture equity as an additional source of financing to expand and diversify our portfolio; (ii) additional sources of income in the form of property management and asset management fees and, potentially, incentive distributions if the performance of the Funds exceeds certain thresholds; and (iii) visibility into the transactions occurring in multi-family assets that helps us with other investment decisions related to our wholly-owned portfolio.

Fund I has nine institutional investors, including us. One of our wholly-owned subsidiaries is the general partner of Fund I and we have made an equity investment of approximately $44,000,000 in Fund I (net of distributions and excluding the purchase of a mortgage note secured by a Fund I community), representing a 15.2% combined general partner and limited partner equity interest. Fund I was our principal vehicle for acquiring apartment communities through the close of its investment period in March 2008. Fund I has a term that expires in March 2013, plus two one-year extension options. Subsidiaries of Fund I have 21 loans secured by individual assets with amounts outstanding in the aggregate of $433,863,000, with varying maturity dates (or dates after which the loans can be prepaid without penalty), ranging from October 2011 to September 2016. The outstanding loans include $23,839,000 for the mortgage note we purchased during 2010. These mortgage loans are secured by the underlying real estate.

Fund II has six institutional investors, including us. One of our wholly-owned subsidiaries is the general partner of Fund II and we have total equity commitments of $125,000,000, representing a 31.3% combined general partner and limited partner equity interest. Fund II has invested $572,415,000 as of March 31, 2011. Fund II has a term that expires in August 2018, plus two one-year extension options. Fund II serves as the exclusive vehicle through which we will acquire investment interests in apartment communities until August 2011 or, if earlier, until 90% of the committed capital of Fund II is invested, subject to certain exceptions. Fund II will not include or involve our development activities. We will receive, in addition to any returns on our invested equity, asset management fees, property management fees and redevelopment fees. We will also receive a promoted interest if certain return thresholds are met. During the three months ended March 31, 2011 a subsidiary of Fund II acquired one community. Waterstone Carlsbad, a garden-style community consisting of 448 apartment homes located in Carlsbad, CA was acquired for a purchase price of $78,100,000.

Subsidiaries of Fund II have nine loans secured by individual assets with amounts outstanding in the aggregate of $332,882,000, with varying maturity dates (or dates after which the loans can be prepaid without penalty), ranging from to November 2014 to June 2019. The mortgage loans are secured by the underlying real estate. In addition, Fund II has $11,000,000 outstanding under a credit facility that matures in December 2011.

Communities Overview

Our real estate investments consist primarily of current operating apartment communities, communities in various stages of development (“Development Communities”) and Development Rights as defined below. Our current operating communities are further distinguished as Established Communities, Other Stabilized Communities, Lease-Up Communities and Redevelopment Communities. The following is a description of each category:

Current Communities are categorized as Established, Other Stabilized, Lease-Up, or Redevelopment according to the following attributes:

 

  •  

Established Communities (also known as Same Store Communities) are consolidated communities where a comparison of operating results from the prior year to the current year is meaningful, as these communities were owned and had stabilized occupancy and operating expenses as of the beginning of the prior year. For the period ended March 31, 2011, the Established Communities are communities that are consolidated for financial reporting purposes, had stabilized occupancy and operating expenses as of January 1, 2010, are not conducting or planning to conduct substantial redevelopment activities and are not held for sale or planned for disposition within the current year. A community is considered to have stabilized occupancy at the earlier of (i) attainment of 95% physical occupancy or (ii) the one-year anniversary of completion of development or redevelopment.

 

20


  •  

Other Stabilized Communities are all other completed communities that we own or have a direct or indirect ownership interest in, and that have stabilized occupancy, as defined above. Other Stabilized Communities do not include communities that are conducting or planning to conduct substantial redevelopment activities within the current year.

 

  •  

Lease-Up Communities are communities where construction has been complete for less than one year and where physical occupancy has not reached 95%.

 

  •  

Redevelopment Communities are communities where substantial redevelopment is in progress or is planned to begin during the current year. Redevelopment is considered substantial when capital invested during the reconstruction effort is expected to exceed either $5,000,000 or 10% of the community’s pre-redevelopment basis and is expected to have a material impact on the operations of the community, including occupancy levels and future rental rates.

Development Communities are communities that are under construction and for which a certificate of occupancy has not been received. These communities may be partially or fully complete and operating.

Development Rights are development opportunities in the early phase of the development process for which we either have an option to acquire land or enter into a leasehold interest, for which we are the buyer under a long-term conditional contract to purchase land or where we control the land through a ground lease or own land to develop a new community. We capitalize related pre-development costs incurred in pursuit of new developments for which we currently believe future development is probable.

We currently lease both our corporate headquarters located in Arlington, Virginia as well as all other regional and administrative offices under operating leases.

As of March 31, 2011, communities that we owned or held a direct or indirect interest in were classified as follows:

 

     Number of
communities
     Number of
apartment homes
 

Current Communities

     

Established Communities:

     

New England

     30         7,315   

Metro NY/NJ

     22         6,981   

Mid-Atlantic/Midwest

     16         5,950   

Pacific Northwest

     10         2,533   

Northern California

     15         4,829   

Southern California

     15         4,003   
                 

Total Established

     108         31,611   
                 

Other Stabilized Communities:

     

New England

     6         1,791   

Metro NY/NJ

     8         2,941   

Mid-Atlantic/Midwest

     12         3,830   

Pacific Northwest

     2         431   

Northern California

     14         3,378   

Southern California

     13         3,945   
                 

Total Other Stabilized

     55         16,316   
                 

Lease-Up Communities

     4         1,306   

Redevelopment Communities

     9         3,348   
                 

Total Current Communities

     176         52,581   
                 

Development Communities

     11         2,446   
                 

Development Rights

     34         9,424   
                 

 

21


Results of Operations

Our year-over-year operating performance is primarily affected by both overall and individual geographic market conditions and apartment fundamentals and is reflected in changes in NOI of our Established Communities; NOI derived from acquisitions and development completions; the loss of NOI related to disposed communities; and capital market and financing activity. A comparison of our operating results for the three months ended March 31, 2011 and 2010 follows (dollars in thousands):

 

     For the three months ended  
     3-31-11      3-31-10      $ Change      % Change  

Revenue:

           

Rental and other income

     $233,488        $ 213,600         $19,888          9.3%     

Management, development and other fees

     2,320          1,849         471          25.5%     
                                   

Total revenue

     235,808          215,449         20,359          9.4%     
                                   

Expenses:

           

Direct property operating expenses, excluding property taxes

     56,870          54,324         2,546          4.7%     

Property taxes

     24,850          23,146         1,704          7.4%     
                                   

Total community operating expenses

     81,720          77,470         4,250          5.5%     
                                   

Corporate-level property management and other indirect operating expenses

     9,350          9,054         296          3.3%     

Investments and investment management expense

     1,191          1,039         152          14.6%     

Expensed development and other pursuit costs

     651          505         146          28.9%     

Interest expense, net

     44,271          42,541         1,730          4.1%     

Depreciation expense

     61,299          55,972         5,327          9.5%     

General and administrative expense

     7,292          8,895         (1,603)         (18.0%)   
                                   

Total other expenses

     124,054          118,006         6,048          5.1%     
                                   

Equity in income of unconsolidated entities

     503          227         276          121.6%     
                                   

Income from continuing operations

     30,537          20,200         10,337          51.2%     

Discontinued operations:

           

Income from discontinued operations

     —          1,875         (1,875)         (100.0%)   

Gain on sale of communities

     —          50,291         (50,291)         (100.0%)   
                                   

Total discontinued operations

     —          52,166         (52,166)         (100.0%)   
                                   

Net income

     30,537          72,366         (41,829)         (57.8%)   

Net income (loss) attributable to noncontrolling interests

     (196)         157         (353)         (224.8%)   
                                   

Net income attributable to common stockholders

     $30,341        $ 72,523         $(42,182)         (58.2%)   
                                   

Net income attributable to common stockholders decreased $42,182,000 or 58.2%, to $30,341,000 for the three months ended March 31, 2011. The decrease for the three months ended March 31, 2011 from the prior year period is due primarily to gains on asset sales during the three months ended March 31, 2010 that were not present in the three months ended March 31, 2011, offset partially by an increase in NOI from existing and newly developed communities.

NOI is considered by management to be an important and appropriate supplemental performance measure to net income because it helps both investors and management to understand the core operations of a community or communities prior to the allocation of any corporate-level or financing-related costs. NOI reflects the operating performance of a community and allows for an easy comparison of the operating performance of individual assets or groups of assets. In addition, because prospective buyers of real estate have different financing and overhead structures, with varying marginal impacts to overhead by acquiring real estate, NOI is considered by many in the real estate industry to be a useful measure for determining the value of a real estate asset or group of assets. We define NOI as total property revenue less direct property operating expenses, including property taxes, and excluding corporate-level income (including management, development and other fees), corporate-level property management and other indirect operating expenses, investments and investment management expenses, expensed development and other pursuit costs, net interest expense, gain (loss) on extinguishment of debt, general and administrative expense, joint venture income (loss), depreciation expense, impairment loss on land holdings, gain on sale of real estate assets and income from discontinued operations.

 

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NOI does not represent cash generated from operating activities in accordance with GAAP. Therefore, NOI should not be considered an alternative to net income as an indication of our performance. NOI should also not be considered an alternative to net cash flow from operating activities, as determined by GAAP, as a measure of liquidity, nor is NOI indicative of cash available to fund cash needs. Reconciliations of NOI for the three months ended March 31, 2011 and 2010 to net income for each period are as follows (dollars in thousands):

 

     For the three months ended  
     3-31-11     3-31-10  

Net income

   $ 30,537      $ 72,366   

Indirect operating expenses, net of corporate income

     7,027        7,232   

Investments and investment management expense

     1,191        1,039   

Expensed development and other pursuit costs

     651        505   

Interest expense, net

     44,271        42,541   

General and administrative expense

     7,292        8,895   

Equity in income of unconsolidated entities

     (503     (227

Depreciation expense

     61,299        55,972   

Gain on sale of real estate assets

     —          (50,291

Income from discontinued operations

     —          (1,875
                

Net operating income

   $ 151,765      $ 136,157   
                

The NOI changes for the three months ended March 31, 2011, as compared to the prior year period, consist of changes in the following categories (dollars in thousands):

 

     For the three months
ended 3-31-11
 

Established Communities

   $ 6,230   

Other Stabilized Communities

     5,808   

Development and Redevelopment Communities

     3,570   
        

Total

   $ 15,608   
        

The increase in our Established Communities’ NOI for the three months ended March 31, 2011 is due to a combination of increased rental revenues and a small decrease in operating expenses. For the balance of 2011, we expect rental revenue growth will continue to accelerate and further improve over the prior year period due to continued improvement in rental rates while maintaining occupancy near current occupancy levels at our Established Communities.

Rental and other income increased in the three months ended March 31, 2011 as compared to the prior year period due to additional rental income generated from newly developed communities and increases in rental rates at our Established Communities.

Overall Portfolio – The weighted average number of occupied apartment homes increased to 41,742 apartment homes for the three months ended March 31, 2011 as compared to 39,777 homes for the prior year period. This increase is primarily due to new homes from increased development activity. The weighted average monthly revenue per occupied apartment home increased to $1,863 for the three months ended March 31, 2011 as compared to $1,790 in the prior year period.

Established Communities – Rental revenue increased $6,180,000, or 3.7%, for the three months ended March 31, 2011 from the prior year period. The increase for the three months ended March 31, 2011 is due to an increase in rental rates, with no change in economic occupancy at 96.0%. Economic occupancy takes into account the fact that apartment homes of different sizes and locations within a community have different economic impacts on a community’s gross revenue. Economic occupancy is defined as gross potential revenue less vacancy loss, as a percentage of gross potential revenue. Gross potential revenue is determined by valuing occupied homes at leased rates and vacant homes at market rents.

 

23


We experienced improved operating results in all markets for our Established Communities during the three months ended March 31, 2011. While East Coast markets continue to show strong improvement, operating performance is accelerating on the West Coast. The shift in momentum is due to improving job growth in several of our West Coast markets. Our first quarter 2011 Established Community results reflect both sequential and year-over-year increases in rental revenue in each of our six regions. Information regarding rental revenue for each of our six regions is discussed in more detail below.

The Metro New York/New Jersey region, which accounted for 27.8% of Established Community rental revenue for the three months ended March 31, 2011, experienced an increase in rental revenue of 4.0% as compared to the prior year period. Average rental rates increased 4.2% to $2,368, offset partially by a decrease in economic occupancy of 0.2% to 96.0% for the three months ended March 31, 2011. On a sequential basis, Metro New York/New Jersey reported rental revenue growth of 0.3% during the first quarter of 2011. We believe rental revenue growth will continue this positive trend during 2011 at a moderate pace, supported by the ongoing recovery in New York’s financial services driven economy.

The New England region accounted for 24.0% of the Established Community rental revenue for the three months ended March 31, 2011 and experienced a rental revenue increase of 4.1% over the prior year period. Average rental rates increased 4.1% to $1,948, with economic occupancy remaining consistent at 96.0% for the three months ended March 31, 2011, as compared to the prior year period. Sequential revenue growth over the prior quarter was 0.2% during the three months ended March 31, 2011. Growth in this region is supported by an improving high-tech sector and a relatively large share of stable industry sectors in the region’s employment base, with Fairfield-New Haven benefiting from improvements in the Metro New York economy.

The Mid-Atlantic/Midwest region, which represented 17.7% of Established Community rental revenue for the three months ended March 31, 2011, experienced an increase in rental revenue of 4.4% over the prior year period, the strongest year-over-year growth for the first quarter of 2011 in our markets. Average rental rates increased by 5.1% to $1,771, while economic occupancy decreased 0.7% to 95.5% for the three months ended March 31, 2011 as compared to the prior year period. The Mid-Atlantic/Midwest region also experienced sequential quarterly rental revenue growth of 0.5%. Given stronger fundamentals and operating performance in recent years compared to other regions, the level of permits and construction starts is increasing in the DC Metro area. While we expect continued strong operating performance near-term, the impact of reduced federal spending combined with an increase in new rental deliveries may slow growth in rental revenue relative to performance in other regions.

Northern California accounted for 14.4% of the Established Community rental revenue for the three months ended March 31, 2011 and experienced a rental revenue increase of 4.1% over the prior year period. Average rental rates increased 3.9% to $1,768 and economic occupancy increased 0.2% to 96.4% for the three months ended March 31, 2011 as compared to the prior year period. The Northern California region is seeing some of the strongest sequential revenue growth in our markets, with rental revenue increasing 1.5% over the fourth quarter of 2010, driven by increased hiring in the technology sector. We expect continued improvement in the technology sector to support renter demand in the near-term at a faster pace than our other markets, but the impact is expected to be uneven among the Company’s markets in this region.

Southern California accounted for 10.8% of the Established Community rental revenue for the three months ended March 31, 2011 and experienced a rental revenue increase of 1.6% over the prior year period. Average rental rates increased 0.5% to $1,584, and economic occupancy increased 1.1% to 96.7% for the three months ended March 31, 2011. We expect this region’s economy will recover in-line with growth in the national economy but at a somewhat slower pace than our other regions, improving at an increasing rate for the balance of 2011. Consistent with our other West Coast markets, the Southern California region showed strong sequential rental revenue growth, increasing 1.4% over the fourth quarter of 2010.

The Pacific Northwest region accounted for 5.3% of the Established Community rental revenue for the three months ended March 31, 2011 and experienced a rental revenue increase of 2.1% over the prior year period. Average rental rates increased 2.6% to $1,259, offset somewhat by a decrease in economic occupancy of 0.5% to 95.3% for the three months ended March 31, 2011. The Pacific Northwest showed the strongest sequential quarterly growth of 2.5%, led by an improving employment situation, however the region’s improvement in apartment fundamentals remains challenged by the slow absorption of new supply in certain submarkets.

 

24


In accordance with GAAP, cash concessions are amortized as an offset to rental revenue over the approximate lease term, which is generally one year. As a supplemental measure, we also present rental revenue with concessions stated on a cash basis to help investors evaluate the impact of both current and historical concessions on GAAP based rental revenue and to more readily enable comparisons to revenue as reported by other companies. Rental revenue with concessions stated on a cash basis also allows investors to understand historical trends in cash concessions, as well as current rental market conditions.

The following table reconciles total rental revenue in conformity with GAAP to total rental revenue adjusted to state concessions on a cash basis for our Established Communities for the three months ended March 31, 2011 and 2010 (dollars in thousands):

 

     For the three months ended  
     3-31-11     3-31-10  

Rental revenue (GAAP basis)

   $ 171,018      $ 164,838   

Concessions amortized

     573        2,130   

Concessions granted

     (129     (906
                

Rental revenue adjusted to state concessions on a cash basis

   $ 171,462      $ 166,062   
                

Year-over-year % change – GAAP revenue

       3.7

Year-over-year % change – cash concession based revenue

       3.3

Direct property operating expenses, excluding property taxes increased $2,546,000, or 4.7% for the three months ended March 31, 2011 as compared to the prior year periods, primarily due to the addition of recently developed apartment homes.

For Established Communities, direct property operating expenses, excluding property taxes, were consistent with the prior year period at $39,133,000 for the three months ended March 31, 2011. The portfolio experienced a continued reduction in bad debt expense due to the economic improvement and savings in snow removal charges over the prior year period due to the winter storms that occurred in the three months ended March 31, 2010. These decreases were offset somewhat by increased payroll and performance bonuses.

Property taxes increased $1,704,000, or 7.4% for the three months ended March 31, 2011, due to the addition of newly developed and redeveloped apartment homes. Property tax increases are often impacted by the size and timing of successful tax appeals.

For Established Communities, property taxes decreased by $60,000, or 0.3% for the three months ended March 31, 2011 from the prior year period. The decrease is due primarily to the impact of a refund from a successful appeal for a community in the New York/New Jersey metro area, partially offset by normal assessment and rate increases. We expect property taxes to increase for the balance of 2011 over 2010. For communities in California, property tax changes are determined by the change in the California Consumer Price Index, with increases limited by law (Proposition 13). We evaluate property tax increases internally and also engage third-party consultants to assist in our evaluations. We appeal property tax increases when appropriate.

Corporate-level property management and other indirect operating expenses increased by $296,000, or 3.3% for the three months ended March 31, 2011 over the prior year period. The increase is due primarily to increases in compensation costs.

Expensed development and other pursuit costs primarily reflect the costs incurred for abandoned pursuit costs, which include costs incurred for development pursuits not yet considered probable for development, as well as the abandonment of Development Rights and disposition pursuits. These costs can be volatile, particularly in periods of economic downturn or when there is limited access to capital, and the costs may vary significantly from period to period.

 

25


Interest expense, net increased $1,730,000, or 4.1% for the three months ended March 31, 2011 over the prior year period. This category includes interest costs offset by interest capitalized and interest income. The increase for the three months ended March 31, 2011 is due primarily to a decrease in the amount of interest cost allocated to capitalized interest in 2011, as well as interest expense from additional debt outstanding, as compared to the prior year period. The year-over-year increase was offset somewhat by an increase in interest income associated with escrow accounts for certain tax exempt secured borrowings.

Depreciation expense increased $5,327,000 or 9.5% in the three months ended March 31, 2011 primarily due to the net increase in assets from the completion of development and redevelopment activities.

General and administrative expense (“G&A”) decreased $1,603,000, or 18.0%, for the three months ended March 31, 2011 as compared to the prior year period. The decrease is due primarily to a decrease in legal and professional fees and lower equity compensation expense for retirement eligible executive officers.

Equity in income of unconsolidated entities for the three months ended March 31, 2011 increased $276,000, or 121.6% from the prior year period due primarily to additional income from Fund II.

Income from discontinued operations represents the net income generated by communities sold or qualifying as discontinued operations during the period from January 1, 2010 through March 31, 2011. This income decreased for the three months ended March 31, 2011 as we did not have any communities classified as held for sale as of March 31, 2011.

Gain on sale of communities decreased for the three months ended March 31, 2011 due to the community sales during the prior year period, with no comparable activity in the three months ended March 31, 2011. The amount of gain realized upon disposition of a community depends on many factors, including the number of communities sold, the size and carrying value of those communities and the market conditions in the local area.

Net income (loss) attributable to noncontrolling interests for the three months ended March 31, 2011 resulted in an allocation of income of $196,000 compared to an allocation of a loss of $157,000 for the three months ended March 31, 2010. The change for the quarter ended March 31, 2011 is due to allocating the proportionate share of the results of operations from a consolidated subsidiary of Fund I to our joint venture partners.

Funds from Operations Attributable to Common Stockholders (“FFO”)

FFO is considered by management to be an appropriate supplemental measure of our operating and financial performance. In calculating FFO, we exclude gains or losses related to dispositions of previously depreciated property and exclude real estate depreciation, which can vary among owners of identical assets in similar condition based on historical cost accounting and useful life estimates. FFO can help one compare the operating performance of a real estate company between periods or as compared to different companies. We believe that in order to understand our operating results, FFO should be examined with net income as presented in our Condensed Consolidated Financial Statements included elsewhere in this report.

Consistent with the definition adopted by the Board of Governors of the National Association of Real Estate Investment Trusts® (“NAREIT”), we calculate FFO as net income or loss computed in accordance with GAAP, adjusted for:

 

  •  

gains or losses on sales of previously depreciated operating communities;

 

  •  

extraordinary gains or losses (as defined by GAAP);

 

  •  

depreciation of real estate assets; and

 

  •  

adjustments for unconsolidated partnerships and joint ventures.

FFO does not represent net income attributable to common stockholders of the Company in accordance with GAAP, and therefore it should not be considered an alternative to net income, which remains the primary measure of performance. In addition, FFO as calculated by other REITs may not be comparable to our calculation of FFO.

 

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The following is a reconciliation of net income attributable to the Company to FFO (dollars in thousands, except per share data):

 

     For the three months ended  
     3-31-11      3-31-10  

Net income attributable to common stockholders

   $ 30,341       $ 72,523   

Depreciation—real estate assets, including discontinued operations and joint venture adjustments

     63,194         57,011   

Distributions to noncontrolling interests, including discontinued operations

     7         14   

Gain on sale of operating communities

     —           (50,291
                 

FFO attributable to common stockholders

   $ 93,542       $ 79,257   
                 

Weighted average common shares outstanding—diluted

     86,997,530         82,310,670   

EPS per common share — diluted

   $ 0.35       $ 0.88   
                 

FFO per common share — diluted

   $ 1.08       $ 0.96   
                 

FFO also does not represent cash generated from operating activities in accordance with GAAP, and therefore should not be considered an alternative to net cash flows from operating activities, as determined by GAAP, as a measure of liquidity. Additionally, it is not necessarily indicative of cash available to fund cash needs.

A presentation of GAAP based cash flow metrics is as follows (dollars in thousands) and a discussion of “Liquidity and Capital Resources” can be found later in this report:

 

     For the three months ended  
     3-31-11     3-31-10  

Net cash provided by operating activities

   $ 73,215      $ 68,883   
                

Net cash used in investing activities

   $ (124,683   $ (36,043
                

Net cash provided (used in) by financing activities

   $ 36,842      $ (15,234
                

Liquidity and Capital Resources

We believe our principal short-term liquidity needs are to fund:

 

  •  

development and redevelopment activity in which we are currently engaged;

 

  •  

the minimum dividend payments on our common stock required to maintain our REIT qualification under the Code;

 

  •  

debt service and principal payments either at maturity or opportunistic pre-payments;

 

  •  

normal recurring operating expenses; and

 

  •  

capital calls for Fund II, as required.

Factors affecting our liquidity and capital resources are our cash flows from operations, financing activities and investing activities (including dispositions) as well as general economic and market conditions. Operating cash flow has historically been determined by: (i) the number of apartment homes currently owned, (ii) rental rates, (iii) occupancy levels and (iv) operating expenses with respect to apartment homes. The timing and type of capital markets activity in which we engage, as well as our plans for development, redevelopment, acquisition and disposition activity, are affected by changes in the capital markets environment, such as changes in interest rates or the availability of cost-effective capital. We regularly review our liquidity needs, the adequacy of cash flows from operations and other expected liquidity sources to meet these needs.

For the balance of 2011, we expect to meet our liquidity needs from a variety of internal and external sources, which may include cash balances on hand, borrowing capacity under our Credit Facility (as defined elsewhere in this Form 10-Q), secured and unsecured debt financings, and other public or private sources of liquidity including common and preferred equity, amounts issued under the CEP II discussed below, as well as from our operating activities. Our ability to obtain additional financing will depend on a variety of factors such as market conditions, the general

 

27


availability of credit, the overall availability of credit to the real estate industry, our credit ratings and credit capacity, as well as the perception of lenders regarding our long or short-term financial prospects.

At March 31, 2011, we have unrestricted cash, cash equivalents and cash in escrow of $476,932,000 available for both current liquidity needs as well as development activities, of which $93,440,000 relates to a Development Right for which we have not begun construction.

Unrestricted cash and cash equivalents totaled $291,800,000 at March 31, 2011, a decrease of $14,626,000 from $306,426,000 at December 31, 2010. The following discussion relates to changes in cash due to operating, investing and financing activities, which are presented in our Condensed Consolidated Statements of Cash Flows included elsewhere in this report.

Operating Activities – Net cash provided by operating activities increased to $73,215,000 for the three months ended March 31, 2011 from $68,883,000 for the three months ended March 31, 2010. The change was driven primarily by increased NOI from our communities.

Investing Activities – Net cash used in investing activities of $124,683,000 for the three months ended March 31, 2011 related to investments in assets primarily through development and redevelopment. During the three months ended March 31, 2011, we invested $116,600,000 in the development of the following real estate and capital expenditures:

 

  •  

We invested approximately $110,644,000 in the development of communities.

  •  

We had capital expenditures of $5,956,000 for real estate and non-real estate assets.

Financing Activities – Net cash provided by financing activities totaled $36,842,000 for the three months ended March 31, 2011. The net cash provided is due to $150,157,000 received from the issuance of common stock, primarily through the CEP II we initiated in November 2010, partially offset by the payment of cash dividends in the amount of $76,557,000 and $30,119,000 for the repayment of secured notes.

Variable Rate Unsecured Credit Facility

We currently have a $1,000,000,000 revolving variable rate Credit Facility with a syndicate of commercial banks that matures in November 2011. We pay an annual facility fee of approximately $1,250,000. The Credit Facility bears interest at varying levels based on LIBOR, our credit rating and on a maturity schedule selected by us. The current stated pricing is LIBOR plus 0.40% per annum (0.61% on April 30, 2011). At April 30, 2011, there were no amounts outstanding on the Credit Facility, $53,823,000 was used to provide letters of credit, and $946,177,000 was available for borrowing under the Credit Facility.

We expect to refinance the Credit Facility prior to maturity in November 2011. We expect the cost of the new facility will increase as compared to our current Credit Facility. While market conditions likely support an ability to retain our current capacity, a reduction in capacity may be appropriate to avoid increased costs to maintain that capacity.

Financial Covenants

We are subject to financial and other covenants contained in the Credit Facility and the indenture under which our unsecured notes were issued. The financial covenants include the following:

 

  •  

limitations on the amount of total and secured debt in relation to our overall capital structure;

  •  

limitations on the amount of our unsecured debt relative to the undepreciated basis of real estate assets that are not encumbered by property-specific financing; and

  •  

minimum levels of debt service coverage.

We were in compliance with these covenants at March 31, 2011.

 

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In addition, our secured borrowings may include yield maintenance, defeasance, or prepayment penalty provisions, which would result in us incurring an additional charge in the event of a full or partial prepayment of outstanding principal before the scheduled maturity. These provisions in our secured borrowings are generally consistent with other similar types of debt instruments issued during the same time period in which our borrowings were secured.

Continuous Equity Program (CEP)

In November 2010, we commenced our second continuous equity program (“CEP II”), under which we may sell up to $500,000,000 of our common stock from time to time during a 36-month period. Actual sales will depend on a variety of factors to be determined by us, including market conditions, the trading price of our common stock and determinations of the appropriate sources of funding. In conjunction with CEP II, we engaged sales agents who receive compensation of approximately 1.5% of the gross sales price for shares sold. During the three months ended March 31, 2011 we sold 1,247,910 shares under CEP II at an average sales price of $115.99 per share, for net proceeds of $142,569,000. From program inception in November 2010 through the end of the first quarter 2011, we sold 1,680,742 shares at an average price of $115.07 for net proceeds of $190,504,000. No shares have been sold under CEP II subsequent to March 31, 2011.

Future Financing and Capital Needs – Debt Maturities

One of our principal long-term liquidity needs is the repayment of long-term debt at the time that such debt matures. For both our unsecured and secured notes, a portion of the principal of these notes may be repaid prior to maturity. Early retirement of our unsecured notes could result in gains or losses on extinguishment. If we do not have funds on hand sufficient to repay our indebtedness as it becomes due, it will be necessary for us to refinance the debt. This refinancing may be accomplished by uncollateralized private or public debt offerings, additional debt financing that is secured by mortgages on individual communities or groups of communities or draws on our Credit Facility. Although we believe we will have the capacity to meet our currently anticipated liquidity needs, we cannot assure you that additional debt financing or debt or equity offerings will be available or, if available, that they will be on terms we consider satisfactory.

During the three months ended March 31, 2011, we repaid a variable rate secured mortgage note in the amount of $28,785,000 in accordance with its scheduled maturity date.

In April 2011, we entered into $430,000,000 of forward starting interest rate swaps agreeing to pay a fixed rate of interest in exchange for a floating rate of interest at a future date. These swaps were transacted to reduce our exposure to fluctuations in interest rates on future debt issuances.

The following table details our consolidated debt maturities for the next five years, excluding our Credit Facility and amounts outstanding related to communities classified as held for sale, for debt outstanding at March 31, 2011 (dollars in thousands). The Company is not directly or indirectly (as borrower or guarantor) obligated in any material respect to pay principal or interest on the indebtedness of any unconsolidated entities in which the Company has an equity or other interest.

 

29


Community

  All-In
interest
rate (1)
    Principal
maturity
date
    Balance outstanding     Scheduled maturities  
      12-31-10     3-31-11     2011     2012     2013     2014     2015     Thereafter  

Tax-exempt bonds

                   

Fixed rate

                   

Avalon Fields

    7.80     May-2027        9,419        9,342        213        339        364        390        419        7,617   

Avalon Oaks

    7.49     Feb-2041        16,637        16,596        114        180        193        207        222        15,680   

Avalon Oaks West

    7.54     Apr-2043        16,519        16,482        102        162        173        185        198        15,662   

Avalon at Chestnut Hill

    6.15     Oct-2047        41,150        41,060        248        388        409        432        455        39,128   

Morningside Park

    4.11     May-2046        100,000        100,000  (5)(8)      —          —          —          —          —          100,000   
                                                                   
        183,725        183,480        677        1,069        1,139        1,214        1,294        178,087   

Variable rate (3) 

                   

Waterford

    1.12     Jul-2014        33,100        33,100 (4)      —          —          —          33,100        —          —     

Avalon at Mountain View

    1.17     Feb-2017        18,300        18,300 (4)      —          —          —          —          —          18,300   

Avalon at Mission Viejo

    1.40     Jun-2025        7,635        7,635 (4)      —          —          —          —          —          7,635   

Avalon at Nob Hill

    1.34     Jun-2025        20,800        20,800 (4)      —          —          —          —          —          20,800   

Avalon Campbell

    1.67     Jun-2025        38,800        38,800        —          —          —          —          —          38,800   

Avalon Pacifica

    1.69     Jun-2025        17,600        17,600        —          —          —          —          —          17,600   

Bowery Place I

    3.31     Nov-2037        93,800        93,800 (4)      —          —          —          —          —          93,800   

Bowery Place II

    4.46     Nov-2039        48,500        48,500 (5)      —          —          —          —          —          48,500   

Avalon Acton

    1.79     Jul-2040        45,000        45,000 (4)      —          —          —          —          —          45,000   

West Chelsea

    0.22     May-2012        93,440        93,440 (5)      —          93,440        —          —          —          —     

Avalon Walnut Creek

    2.99     Mar-2046        116,000        116,000  (5)      —          —          —          —          —          116,000   

Avalon Walnut Creek

    2.97     Mar-2046        10,000        10,000 (5)      —          —          —          —          —          10,000   
                                                                   
        542,975        542,975        —          93,440        —          33,100        —          416,435   

Conventional loans (6) 

                   

Fixed rate

                   

$300 Million unsecured notes

    6.79     Sep-2011        39,900        39,900        39,900        —          —          —          —          —     

$250 Million unsecured notes

    5.74     Jan-2012        104,400        104,400        —          104,400        —          —          —          —     

$250 Million unsecured notes

    6.26     Nov-2012        201,601        201,601        —          201,601        —          —          —          —     

$100 Million unsecured notes

    5.11     Mar-2013        100,000        100,000        —          —          100,000        —          —          —     

$150 Million unsecured notes

    5.52     Apr-2014        150,000        150,000        —          —          —          150,000        —          —     

$250 Million unsecured notes

    5.89     Sep-2016        250,000        250,000        —          —          —          —          —          250,000   

$250 Million unsecured notes

    5.82     Mar-2017        250,000        250,000        —          —          —          —          —          250,000   

$250 Million unsecured notes

    6.19     Mar-2020        250,000        250,000        —          —          —          —          —          250,000   

$250 Million unsecured notes

    4.04     Jan-2021        250,000        250,000        —          —          —          —          —          250,000   

Avalon at Twinbrook

    7.25     Oct-2011        7,339        7,277        7,277        —          —          —          —          —     

Avalon at Tysons West

    5.55     Jul-2028        5,862        5,813        130        238        250        263        276        4,656   

Avalon Orchards

    7.78     Jul-2033        18,678        18,591        240        382        409        438        470        16,652   

Avalon at Arlington Square

    4.81     Apr-2013        170,125        170,125        —          —          170,125        —          —          —     

Avalon at Cameron Court

    5.07     Apr-2013        94,572        94,572        —          —          94,572        —          —          —     

Avalon Crescent

    5.59     May-2015        110,600        110,600        —          —          —          —          110,600        —     

Avalon at Silicon Valley

    5.74     Jul-2015        150,000        150,000        —          —          —          —          150,000        —     

Avalon Darien

    6.22     Nov-2015        50,559        50,389        527        746        793        843        47,480        —     

Avalon Greyrock Place

    6.12     Nov-2015        60,935        60,726        646        914        971        1,031        57,164        —     

Avalon Commons

    6.10     Jan-2019        55,100        54,988        580        734        779        826        875        51,194   

Avalon Walnut Creek

    4.00     Jul-2066        2,500        2,500        —          —          —          —          —          2,500   

Avalon Shrewsbury

    5.92     May-2019        21,130        21,130        137        285        301        319        338        19,750   

Avalon Gates

    5.92     May-2019        41,321        41,321        268        557        589        624        660        38,623   

Avalon at Stamford Harbor

    5.92     May-2019        65,695        65,695        426        885        937        992        1,050        61,405   

Avalon Freehold

    5.94     May-2019        36,630        36,630        237        493        522        553        585        34,240   

Avalon Run East II

    5.94     May-2019        39,250        39,250        254        529        560        592        627        36,688   

Avalon Gardens

    6.05     May-2019        66,237        66,237        429        892        945        1,000        1,058        61,913   

Avalon Edgewater

    5.94     May-2019        78,565        78,565        509        1,058        1,120        1,186        1,255        73,437   

Avalon Foxhall

    6.05     May-2019        59,010        59,010        382        795        841        891        943        55,158   

Avalon Gallery Place I

    6.05     May-2019        45,850        45,850        297        618        654        692        733        42,856   

Avalon Traville

    5.91     May-2019        77,700        77,700        504        1,047        1,108        1,173        1,242        72,626   

Avalon Bellevue

    5.91     May-2019        26,698        26,698        173        360        381        403        427        24,954   

Avalon on the Alameda

    5.90     May-2019        53,980        53,980        350        727        770        815        863        50,455   

Avalon Mission Bay North

    5.90     May-2019        73,269        73,269        475        987        1,045        1,106        1,171        68,485   

Avalon Woburn

    5.90     May-2019        55,805        55,805        362        752        796        842        892        52,161   
                                                                   
        3,063,311        3,062,622        54,103        319,000        378,468        164,589        378,709        1,767,753   

Variable rate (3)(6) 

                   

Avalon at Crane Brook

    0.00     Mar-2011        29,185        —   (2)      —          —          —          —          —          —     

Avalon at Bedford Center

    1.74     May-2012        15,221        15,221 (4)      560        14,661        —          —          —          —     

Avalon Walnut Creek

    3.01     Mar-2046        9,000        9,000 (5)      —          —          —          —          —          9,000   

$300 Million unsecured notes

    5.71     Sep-2011        100,000        100,000  (7)      100,000        —          —          —          —          —     

$50 Million unsecured notes

    5.71     Sep-2011        50,000        50,000 (7)      50,000        —          —          —          —          —     

$250 Million unsecured notes

    4.38     Jan-2012        75,000        75,000 (7)      —          75,000        —          —          —          —     
                   
                                                                   
        278,406        249,221        150,560        89,661        —          —          —          9,000   
                   

Total indebtedness—excluding unsecured credit facility

   

  $ 4,068,417      $ 4,038,298      $ 205,340      $ 503,170      $ 379,607      $ 198,903      $ 380,003      $ 2,371,275   
                                                                   

 

(1)

Includes credit enhancement fees, facility fees, trustees’ fees and other fees.

(2)

Borrowing was repaid in accordance with its scheduled maturity in March 2011.

(3)

Variable rates are given as of March 31, 2011.

(4)

Financed by variable rate debt, but interest rate is capped through an interest rate protection agreement.

(5)

Represents full amount of the debt as of March 31, 2011. Actual amounts drawn on the debt as of March 31, 2011 are $48,015 for Bowery Place II, $90,000 for Morningside Park, $109,834 for Walnut Creek, and $0 for West Chelsea.

(6)

Balances outstanding represent total amounts due at maturity, and are net of $1,115 and $760 of debt discount and basis adjustments associated with the hedged unsecured notes as of March 31, 2011 and December 31, 2010, respectively, as reflected in unsecured notes on our Condensed Consolidated Balance Sheets included elsewhere in this report.

 

30


(7)

In October 2009, we executed interest rate swaps allowing us to effectively convert principal of our fixed rate unsecured notes to floating rate debt.

(8)

In October 2010, we elected to fix the borrowing rate until June 2011, at which point we will select the updated term and mode for the bonds.

Future Financing and Capital Needs – Portfolio and Other Activity

As of March 31, 2011, we had 11 wholly-owned communities under construction, for which a total estimated cost of $386,600,000 remained to be invested. We also had nine wholly-owned communities under reconstruction, for which a total estimated cost of $59,144,000 remained to be invested. In addition, we may be required to contribute our proportionate share of capital to Fund II, if or to the extent that Fund II makes capital calls in conjunction with additional community acquisitions during 2011. Substantially all of the capital expenditures necessary to complete the communities currently under construction and reconstruction, fund development costs related to pursuing Development Rights, and make equity contributions to Fund II, will be funded from:

 

  •  

cash currently on hand, including cash in construction escrows, invested in highly liquid overnight money market funds and repurchase agreements, and short-term investment vehicles;

 

  •  

the remaining capacity under our $1,000,000,000 Credit Facility;

 

  •  

retained operating cash;

 

  •  

the net proceeds from sales of existing communities;

 

  •  

the issuance of debt or equity securities; and/or

 

  •  

private equity funding, including joint venture activity.

Before planned reconstruction activity, including reconstruction activity related to communities acquired by the Funds, or the construction of a Development Right begins, we intend to arrange adequate financing to complete these undertakings, although we cannot assure you that we will be able to obtain such financing. In the event that financing cannot be obtained, we may have to abandon Development Rights, write off associated pre-development costs that were capitalized and/or forego reconstruction activity. In such instances, we will not realize the increased revenues and earnings that we expected from such Development Rights or reconstruction activity and significant losses could be incurred.

From time to time we use joint ventures to hold or develop individual real estate assets. We generally employ joint ventures primarily to mitigate asset concentration or market risk and secondarily as a source of liquidity. We may also use joint ventures related to mixed-use land development opportunities where our partners bring development and operational expertise to the venture. Each joint venture or partnership agreement has been individually negotiated, and our ability to operate and/or dispose of a community in our sole discretion may be limited to varying degrees depending on the terms of the joint venture or partnership agreement. We cannot assure you that we will achieve our objectives through joint ventures.

In evaluating our allocation of capital within our markets, we sell assets that do not meet our long-term investment criteria or when capital and real estate markets allow us to realize a portion of the value created over the past business cycle and redeploy the proceeds from those sales to develop and redevelop communities. Because the proceeds from the sale of communities may not be immediately redeployed into revenue generating assets, the immediate effect of a sale of a community for a gain is to increase net income, but reduce future total revenues, total expenses and NOI. However, we believe that the absence of future cash flows from communities sold will have a minimal impact on our ability to fund future liquidity and capital resource needs.

Off-Balance Sheet Arrangements

In addition to our investment interests in consolidated and unconsolidated real estate entities, we have certain off-balance sheet arrangements with the entities in which we invest. Additional discussion of these entities can be found in Note 6, “Investments in Real Estate Entities,” of our Condensed Consolidated Financial Statements located elsewhere in this report.

 

  •  

CVP I, LLC has outstanding tax-exempt, variable rate bonds maturing in November 2036 in the amount of $117,000,000, which have permanent credit enhancement. We have agreed to guarantee, under limited

 

31


 

circumstances, the repayment to the credit enhancer of any advances it may make in fulfillment of CVP I, LLC’s repayment obligations under the bonds. We have also guaranteed to the credit enhancer that CVP I, LLC will obtain a final certificate of occupancy for the project (Chrystie Place in New York City), which is expected in 2011. Our 80% partner in this venture has agreed that it will reimburse us its pro rata share of any amounts paid relative to these guaranteed obligations. The estimated fair value of and our obligation under these guarantees, both at inception and as of March 31, 2011, were not significant. As a result we have not recorded any obligation associated with these guarantees at March 31, 2011.

 

  •  

Subsidiaries of Fund I have 21 loans secured by individual assets with amounts outstanding in the aggregate of $433,863,000, including $23,839,000 for the mortgage note of a Fund I subsidiary that we purchased during 2010. Fund I subsidiary loans have varying maturity dates (or dates after which the loans can be prepaid), ranging from October 2011 to September 2016. These mortgage loans are secured by the underlying real estate. The mortgage loans are payable by the subsidiaries of Fund I with operating cash flow or disposition proceeds from the underlying real estate. We have not guaranteed the debt of Fund I, nor do we have any obligation to fund this debt should Fund I be unable to do so.

In addition, as part of the formation of Fund I, we have provided to one of the limited partners a guarantee. The guarantee provides that if, upon final liquidation of Fund I, the total amount of all distributions to that partner during the life of Fund I (whether from operating cash flow or property sales) does not equal a minimum of the total capital contributions made by that partner, then we will pay the partner an amount equal to the shortfall, but in no event more than 10% of the total capital contributions made by the partner (maximum of approximately $7,500,000 as of March 31, 2011). As of March 31, 2011, the expected realizable value of the real estate assets owned by Fund I is considered adequate to cover such potential payment to that partner under the expected Fund I liquidation scenario. The estimated fair value of, and our obligation under this guarantee, both at inception and as of March 31, 2011 was not significant and therefore we have not recorded any obligation for this guarantee as of March 31, 2011.

 

  •  

As of March 31, 2011, subsidiaries of Fund II have nine loans secured by individual assets with amounts outstanding in the aggregate of $332,882,000 with varying maturity dates (or dates after which the loans can be prepaid), ranging from November 2014 to June 2019. During the three months ended March 31, 2011, one subsidiary of Fund II obtained a fixed rate secured note for $46,141,000 with a 4.68% interest rate with a maturity of February 2018. As of March 31, 2011, Fund II also has $11,000,000 outstanding under a credit facility that matures in December 2011. The mortgage loans are payable by the subsidiaries of Fund II with operating cash flow or disposition proceeds from the underlying real estate, and the credit facility is payable by Fund II and is secured by capital commitments. We have not guaranteed, beyond our proportionate share of capital commitments supporting the credit facility of Fund II, the debt of Fund II, nor do we have any obligation to fund this debt should Fund II be unable to do so.

In addition, as part of the formation of Fund II, we have provided to one of the limited partners a guarantee. The guarantee provides that if, upon final liquidation of Fund II, the total amount of all distributions to that partner during the life of Fund II (whether from operating cash flow or property sales) does not equal a minimum of the total capital contributions made by that partner, then we will pay the partner an amount equal to the shortfall, but in no event more than 10% of the total capital contributions made by the partner (maximum of approximately $5,843,000 as of March 31, 2011). As of March 31, 2011, the expected realizable value of the real estate assets owned by Fund II is considered adequate to cover such potential payment to that partner under the expected Fund II liquidation scenario. The estimated fair value of, and our obligation under this guarantee, both at inception and as of March 31, 2011 was not significant and therefore we have not recorded any obligation for this guarantee as of March 31, 2011.

 

  •  

Each individual mortgage loan of Fund I or Fund II was made to a special purpose, single asset subsidiary of the Funds. Each mortgage loan provides that it is the obligation of the respective subsidiary only, except under exceptional circumstances (such as fraud or misapplication of funds) in which case the respective Fund could also have obligations with respect to the mortgage loan. In no event do the mortgage loans provide for recourse against investors in the Funds, including against us or our wholly-owned subsidiaries that invest in the Funds. Similarly, in no event are investors in Fund II obligated with respect to the credit facility for Fund II except with respect to their capital commitment to Fund II. A default by a Fund or a

 

32


 

Fund subsidiary on any loan to it would not constitute a default under any of our loans or any loans of our other non-Fund subsidiaries or affiliates. If either the Funds or a subsidiary of one of the Funds were unable to meet its obligations under a loan, the value of our investment in that Fund would likely decline and we might also be more likely to be obligated under the guarantee we provided to one of the Fund partners in each Fund as described above. If either of the Funds or a subsidiary of one of the Funds were unable to meet its obligations under a loan, we and/or the other investors might evaluate whether it was in our respective interests to voluntarily support the Fund through additional equity contributions and/or take other actions to avoid a default under a loan or the consequences of a default (such as foreclosure of a Fund asset).

In the future, in the event either of the Funds were unable to meet their obligations under a loan, we cannot predict at this time whether we would provide any voluntary support, or take any other action, as any such action would depend on a variety of factors, including the amount of support required and the possibility that such support could enhance the return of either of the Funds and/or our returns by providing time for performance to improve.

 

  •  

MVP I, LLC, the entity that owns Avalon at Mission Bay North II, has a loan secured by the underlying real estate assets of the community for $105,000,000. The loan is a fixed rate, interest-only note bearing interest at 6.02%, maturing in December 2015. We have not guaranteed the debt of MVP I, LLC, nor do we have any obligation to fund this debt should MVP I, LLC be unable to do so.

 

  •  

Avalon Del Rey Apartments, LLC has a loan secured by the underlying real estate assets of the community for $44,838,000 maturing in April 2016. The variable rate loan had an interest rate of 3.60% at March 31, 2011. We have not guaranteed the debt of Avalon Del Rey Apartments, LLC, nor do we have any obligation to fund this debt should Avalon Del Rey Apartments, LLC be unable to do so.

 

  •  

Aria at Hathorne Hill, LLC is a joint venture in which we have a non-managing member interest. The LLC is developing for-sale town homes in Danvers, Massachusetts. The LLC has a variable rate loan for $1,860,000 that matured in June 2010. As of March 31, 2011, the amounts under this borrowing have not been repaid, and the venture is negotiating an extension or refinancing of the amounts outstanding. The lender has declared an event of default with respect to the note and required the venture to pay a default rate of interest, the impact of which is immaterial to us. Although we bear no responsibility to repay the amounts outstanding, we have the right to cure any event of default by the venture.

 

  •  

In 2007 we entered into a non-cancelable commitment (the “Commitment”) to acquire parcels of land in Brooklyn, New York for an aggregate purchase price of approximately $111,000,000. Under the terms of the Commitment, we are closing on the various parcels over a period determined by the seller’s ability to execute unrelated purchase transactions and achieve deferral of gains for the land sold under this Commitment. During the three months ended March 31, 2011, we negotiated an extension for the purchase period with the seller extending the period during which the land closings can occur, until December 2012. At December 2012, either we or the seller can compel execution of the remaining transactions. At March 31, 2011, we have an outstanding commitment to purchase the remaining land for approximately $50,527,000.

There are no other lines of credit, side agreements, financial guarantees or any other derivative financial instruments related to or between our unconsolidated real estate entities and us. In evaluating our capital structure and overall leverage, management takes into consideration our proportionate share of this unconsolidated debt.

Contractual Obligations

We currently have contractual obligations consisting primarily of long-term debt obligations and lease obligations for certain land parcels and regional and administrative office space. During the three months ended March 31, 2011, we exercised a termination provision under a ground lease associated with an abandoned development pursuit. The lease required cash payments of $5,400 in 2011 and between $8,000 and $12,000 per year through the expiration date of the lease in 2105. The required cash payments under the ground lease were being offset in their entirety by cash receipts from subleases through termination of the agreement. By exercising its termination option,

 

33


we eliminated all future obligations under the land lease, reducing both future cash payments due under the land lease and offsetting cash receipts under the associated subleases. There have been no other changes in our scheduled contractual obligations required for the next five years and thereafter for the quarter ended March 31, 2011.

Development Communities

As of March 31, 2011, we had 11 Development Communities under construction. We expect these Development Communities, when completed, to add a total of 2,446 apartment homes to our portfolio for a total capitalized cost, including land acquisition costs, of approximately $643,400,000. You should carefully review Item 1a., “Risk Factors,” of our Form 10-K for a discussion of the risks associated with development activity.

The following table presents a summary of the Development Communities. We hold a direct or indirect fee simple ownership interest in these communities.

 

     Number of
apartment
homes
     Total
capitalized
cost (1)

($ millions)
     Construction
start
     Initial
occupancy (2)
     Estimated
completion
     Estimated
stabilization (3)
 

1 Avalon Rockville Centre

     349       $ 109.7         Q1 2010         Q2 2011         Q3 2012         Q1 2013   

Rockville Centre, NY

                 

2 Avalon Queen Anne

     203         56.7         Q3 2010         Q4 2011         Q2 2012         Q4 2012   

Seattle, WA

                 

3 Avalon at the Pinehills II

     91         18.4         Q3 2010         Q2 2011         Q3 2011         Q1 2012   

Plymouth, MA

                 

4 Avalon Springs II

     100         31.3         Q3 2010         Q2 2011         Q3 2011         Q1 2012   

Wilton, CT

                 

5 Avalon Green II

     444         110.6         Q3 2010         Q4 2011         Q1 2013         Q3 2013   

Greenburgh, NY

                 

6 Avalon Brandemoor II

     82         15.5         Q3 2010         Q3 2011         Q4 2011         Q2 2012   

Lynnwood, WA

                 

7 Avalon Cohasset

     220         53.1         Q4 2010         Q4 2011         Q2 2012         Q4 2012   

Cohasset, MA

                 

8 Avalon Ocean Avenue

     173         61.1         Q4 2010         Q2 2012         Q4 2012         Q2 2013   

San Francisco, CA

                 

9 Avalon North Bergen

     164         45.2         Q4 2010         Q3 2012         Q3 2012         Q1 2013   

North Bergen, NJ

                 

10 Avalon at Wesmont Station I

     266         64.2         Q4 2010         Q2 2012         Q1 2013         Q3 2013   

Wood-Ridge, NJ

                 

11 Avalon Park Crest

     354         77.6         Q4 2010         Q2 2012         Q2 2013         Q4 2013   

Tysons Corner, VA

                 
                             

Total

     2,446       $ 643.4               
                             

 

(1)

Total capitalized cost includes all capitalized costs projected to be or actually incurred to develop the respective Development Community, determined in accordance with GAAP, including land acquisition costs, construction costs, real estate taxes, capitalized interest and loan fees, permits, professional fees, allocated development overhead and other regulatory fees. Total capitalized cost for communities identified as having joint venture ownership, either during construction or upon construction completion, represents the total projected joint venture contribution amount.

(2)

Future initial occupancy dates are estimates. There can be no assurance that we will pursue to completion any or all of these proposed developments.

(3)

Stabilized operations is defined as the earlier of (i) attainment of 95% or greater physical occupancy or (ii) the one-year anniversary of completion of development.

 

34


Redevelopment Communities

As of March 31, 2011, there were nine communities under redevelopment. We expect the total capitalized cost to redevelop these communities to be $112,400,000 excluding costs prior to redevelopment. We have found that the cost to redevelop an existing apartment community is more difficult to budget and estimate than the cost to develop a new community. Accordingly, we expect that actual costs may vary from our budget by a wider range than for a new development community. We cannot assure you that we will meet our schedule for reconstruction completion or increasing operations, or that we will meet our budgeted costs, either individually or in the aggregate. We anticipate maintaining our current level of redevelopment activity related to communities in our current operating portfolio for the remainder of 2011. You should carefully review Item 1a., “Risk Factors,” of our Form 10-K for a discussion of the risks associated with redevelopment activity.

The following presents a summary of these Redevelopment Communities:

 

     Number of
apartment
homes
     Total cost
($ millions)
     Reconstruction
start
     Estimated
reconstruction
completion
     Estimated
restabilized
operations (2)
 
      Pre-redevelopment
cost
     Total capitalized
cost (1)
          
                 
                 

1. Avalon Pleasanton

     456       $ 63.0       $ 80.6         Q2 2009         Q4 2011         Q2 2012   

Pleasanton, CA

                 

2. Avalon Princeton Junction

     512         30.2         49.7         Q2 2009         Q1 2012         Q3 2012   

West Windsor, NJ

                 

3. Avalon Summit

     245         17.7         26.2         Q2 2010         Q2 2011         Q4 2011   

Quincy, MA

                 

4. Avalon at Decoverly (3)

     564         63.5         71.1         Q3 2010         Q2 2011         Q4 2011   

Rockville, MD

                 

5. Avalon Commons

     312         34.1         38.4         Q4 2010         Q3 2011         Q1 2012   

Smithtown, NY

                 

6. Avalon at South Coast

     258         26.0         33.8         Q4 2010         Q1 2012         Q3 2012   

Costa Mesa, CA

                 

7. Crowne Ridge

     254         33.1         46.8         Q4 2010         Q2 2012         Q4 2012   

San Rafael, CA

                 

8. Avalon Cove

     504         93.7         114.0         Q4 2010         Q3 2012         Q1 2013   

Jersey City, NJ

                 

9. Avalon Sunset Towers

     243         28.9         42.0         Q4 2010         Q3 2013         Q1 2014   

San Francisco, CA

                 
                                   

Total (4)

     3,348       $ 390.2       $ 502.6            
                                   

 

(1)

Total capitalized cost includes all capitalized costs projected to be or actually incurred to redevelop the respective Redevelopment Community, including land acquisition costs, construction costs, real estate taxes, capitalized interest and loan fees, permits, professional fees, allocated development overhead and other regulatory fees, all as determined in accordance with GAAP.

(2)

Restabilized operations is defined as the earlier of (i) attainment of 95% or greater physical occupancy or (ii) the one-year anniversary of completion of redevelopment.

(3)

Redevelopment efforts will be focused on the 368 units associated with the initial phase of this community which was acquired by one of our predecessors in Q3 1995.

(4)

We commenced the redevelopment of Avalon at Prudential Center in Boston, MA during the second quarter of 2010 for an estimated total capitalized cost of $28.4 million, excluding costs incurred prior to the redevelopment. The redevelopment is primarily focused on the exterior and/or common area and is not expected to have a material impact on community operations, including occupancy, or the expected future level of rental revenue. This community is therefore included in the Established Community portfolio and not classified as a Redevelopment Community.

Development Rights

At March 31, 2011, we had $193,593,000 in acquisition and related capitalized costs for land parcels we own, and $85,382,000 in capitalized costs (including legal fees, design fees and related overhead costs) related to Development Rights for which we control the land parcel, typically through an option to purchase or lease the land. Collectively, the land held for development and associated costs for deferred development rights relate to 34 Development Rights for which we expect to develop new apartment communities in the future. The cumulative capitalized costs for land held for development as of March 31, 2011, includes $154,375,000 in original land

 

35


acquisition costs. We also have $50,527,000 in future land acquisition costs under our Commitment, related to a Development Right in Brooklyn, NY, as discussed under “Off-Balance Sheet Arrangements” elsewhere within this Form 10-Q. The original land acquisition cost per home, including our obligation under the Commitment, ranged from $9,000 per home in Connecticut to $150,000 per home in New York City. In addition, the land for a Development Right that we control under a 99-year land lease agreement is subject to future minimum rental amounts of $6,600,000 per year. The Development Rights range from those beginning design and architectural planning to those that have completed site plans and drawings and can begin construction almost immediately. We estimate that the successful completion of all of these communities would ultimately add approximately 9,424 apartment homes to our portfolio. Substantially all of these apartment homes will offer features like those offered by the communities we currently own.

For 24 Development Rights, we control the land through an option to purchase or lease the parcel. While we generally prefer to hold Development Rights through options to acquire land, for the remaining 10 Development Rights we either currently own the land or have executed a long term land lease for the parcel of land on which a community would be built if we proceeded with development.

The properties comprising the Development Rights are in different stages of the due diligence and regulatory approval process. The decisions as to which of the Development Rights to invest in, if any, or to continue to pursue once an investment in a Development Right is made, are business judgments that we make after we perform financial, demographic and other analyses. In the event that we do not proceed with a Development Right, we generally would not recover capitalized costs incurred in the pursuit of those communities, unless we were to recover amounts in connection with the sale of land; however, we cannot guarantee a recovery. Pre-development costs incurred in the pursuit of Development Rights 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 no longer probable, any capitalized pre-development costs are charged to expense.

You should carefully review Section 1a., “Risk Factors,” of our Form 10-K for a discussion of the risks associated with Development Rights.

 

Market

   Number
of rights
     Estimated
number
of homes
     Total
capitalized
cost
($ millions) (1)
 

Boston, MA

     5         1,289       $ 423   

Fairfield-New Haven, CT

     4         781         154   

New York, NY

     3         1,720         754   

New Jersey

     10         2,444         489   

Long Island, NY

     2         507         143   

Washington, DC Metro

     4