================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 1999 Commission file number 1-12672 AVALONBAY COMMUNITIES, INC. (Exact name of registrant as specified in its charter) -------------------- Maryland 77-0404318 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 2900 Eisenhower Avenue, Suite 300 Alexandria, Virginia 22314 (Address of principal executive offices, including zip code) (703) 329-6300 (Registrant's telephone number, including area code) (Former name, if changed since last report) -------------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve (12) months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past ninety (90) days. Yes [ X ] No 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: 65,737,629 shares outstanding as of November 1, 1999 ================================================================================ AVALONBAY COMMUNITIES, INC. FORM 10-Q INDEX PAGE ---- PART I - FINANCIAL INFORMATION Item 1. Condensed Consolidated Financial Statements Condensed Consolidated Balance Sheets as of September 30, 1999 (unaudited) and December 31,1998 (audited).......................................................... 2 Condensed Consolidated Statements of Operations (unaudited) for the three and nine months ended September 30, 1999 and 1998....................................... 3 Condensed Consolidated Statements of Cash Flows (unaudited) for the nine months ended September 30, 1999 and 1998................................................... 4-5 Notes to Condensed Consolidated Financial Statements (unaudited).................... 6-16 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.......................................................................... 17-43 Item 3. Quantitative and Qualitative Disclosures About Market Risk.......................... 44 PART II - OTHER INFORMATION Item 1. Legal Proceedings................................................................... 44 Item 2. Changes in Securities............................................................... 44 Item 3. Defaults Upon Senior Securities..................................................... 44 Item 4. Submission of Matters to a Vote of Security Holders................................. 44 Item 5. Other Information................................................................... 44 Item 6. Exhibits and Reports on Form 8-K.................................................... 44-45 Signatures................................................................................... 46 1 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS AVALONBAY COMMUNITIES, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (Dollars in thousands, except share data) 9-30-99 (unaudited) 12-31-98 ------------- ------------ ASSETS Real estate: Land $ 748,282 $ 705,989 Buildings and improvements 2,908,695 2,585,247 Furniture, fixtures and equipment 115,004 103,396 ------------- ------------ 3,771,981 3,394,632 Less accumulated depreciation (221,860) (143,135) ------------- ------------ Net operating real estate 3,550,121 3,251,497 Construction in progress (including land) 376,049 407,870 Communities held for sale 120,299 231,492 ------------- ------------ Total real estate, net 4,046,469 3,890,859 Cash and cash equivalents 9,043 8,890 Cash in escrow 29,374 8,238 Resident security deposits 13,364 10,383 Investments in unconsolidated joint ventures 17,132 17,211 Deferred financing costs, net 13,901 12,376 Deferred development costs 15,767 11,983 Participating mortgage notes 45,483 45,483 Prepaid expenses and other assets 25,430 24,781 ------------- ------------ TOTAL ASSETS $ 4,215,963 $ 4,030,204 ============= ============ LIABILITIES AND STOCKHOLDERS' EQUITY Variable rate unsecured credit facility $ 247,000 $ 329,000 Unsecured senior notes 985,000 710,000 Notes payable 441,797 445,371 Dividends payable 43,829 42,805 Payables for construction 28,382 49,100 Accrued expenses and other liabilities 49,062 42,097 Accrued interest payable 15,086 20,664 Resident security deposits 23,474 19,501 ------------- ------------ TOTAL LIABILITIES 1,833,630 1,658,538 ------------- ------------ Minority interest of unitholders in consolidated partnerships 36,350 32,213 Stockholders' equity: Preferred stock, $.01 par value; $25 liquidation value; 50,000,000 shares authorized at September 30, 1999 and December 31, 1998; 18,322,700 shares outstanding at both September 30, 1999 and December 31, 1998 183 183 Common stock, $.01 par value; 140,000,000 shares authorized at both September 30, 1999 and December 31, 1998; 65,161,756 and 63,887,126 shares outstanding at September 30, 1999 and December 31, 1998, respectively 652 639 Additional paid-in capital 2,367,118 2,328,466 Deferred compensation (5,006) (4,356) Dividends in excess of accumulated earnings (16,964) 14,521 ------------- ------------ TOTAL STOCKHOLDERS' EQUITY 2,345,983 2,339,453 ------------- ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 4,215,963 $ 4,030,204 ============= ============ The accompanying notes are an integral part of these condensed consolidated financial statements. 2 AVALONBAY COMMUNITIES, INC. CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) (Dollars in thousands, except share data) For the three months ended For the nine months ended ------------------------------- ------------------------------ 9-30-99 9-30-98 9-30-99 9-30-98 -------------- -------------- ------------- ------------- Revenue: Rental income $ 130,373 $ 117,757 $ 371,073 $ 233,228 Management fees 277 342 930 457 Other income 97 29 198 44 -------------- -------------- ------------- ------------- Total revenue 130,747 118,128 372,201 233,729 -------------- -------------- ------------- ------------- Expenses: Operating expenses, excluding property taxes 35,649 33,412 101,274 64,122 Property taxes 10,718 10,034 32,058 19,193 Interest expense 19,643 18,387 54,592 35,748 Depreciation and amortization 27,930 23,578 81,371 48,082 General and administrative 2,349 2,578 7,092 5,525 Non-recurring charges 54 -- 16,644 -- -------------- -------------- ------------- ------------- Total expenses 96,343 87,989 293,031 172,670 -------------- -------------- ------------- ------------- Equity in income of unconsolidated joint ventures 860 608 2,266 846 Interest income 2,301 1,223 5,723 1,690 Gain on sale of communities 7,032 40 12,336 40 Minority interest in consolidated partnerships (524) (470) (1,452) (874) -------------- -------------- ------------- ------------- Net income 44,073 31,540 98,043 62,761 Dividends attributable to preferred stock (9,944) (7,769) (29,834) (16,292) -------------- -------------- ------------- ------------- Net income available to common stockholders $ 34,129 $ 23,771 $ 68,209 $ 46,469 ============== ============== ============= ============= Per common share: Net income - basic $ 0.52 $ 0.37 $ 1.04 $ 1.05 ============== ============== ============= ============= Net income - diluted $ 0.52 $ 0.37 $ 1.04 $ 1.03 ============== ============== ============= ============= The accompanying notes are an integral part of these condensed consolidated financial statements. 3 AVALONBAY COMMUNITIES, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (Dollars in thousands) For the nine months ended --------------------------- 9-30-99 9-30-98 ------------ ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 98,043 $ 62,761 Adjustments to reconcile net income to cash provided by operating activities: Depreciation and amortization 81,371 48,082 Amortization of deferred compensation 2,517 574 Decrease in investments in unconsolidated joint ventures 79 120 Income allocated to minority interest in consolidated partnerships 1,452 874 Gain on sale of communities (12,336) (40) Increase in cash in escrow (21,136) (1,902) Decrease (increase) in participating mortgage notes, prepaid expenses and other assets (3,630) 1,377 Increase in accrued expenses, other liabilities and accrued interest payable 4,368 10,004 ------------ ------------ Net cash provided by operating activities 150,728 121,850 ------------ ------------ CASH FLOWS USED IN INVESTING ACTIVITIES: Increase (decrease) in construction payables (20,718) 10,119 Proceeds from sale of communities, net of selling costs 165,055 56,665 Acquisition of participating mortgage note -- (24,000) Purchase and development of real estate (386,148) (532,449) ------------ ------------ Net cash used in investing activities (241,811) (489,665) ------------ ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Issuance of common stock, net 35,498 59,294 Dividends paid (128,504) (71,176) Proceeds from sale of unsecured senior notes 275,000 400,000 Payment of deferred financing costs (3,255) (5,590) Repayments of notes payable (3,574) (1,836) Borrowings under unsecured facilities 342,800 545,926 Repayments of unsecured facilities (424,800) (551,526) Distributions to minority partners (1,929) (1,007) ------------ ------------ Net cash provided by financing activities 91,236 374,085 ------------ ------------ Net increase in cash 153 6,270 Cash and cash equivalents, beginning of period 8,890 3,188 ------------ ------------ Cash and cash equivalents, end of period $ 9,043 $ 9,458 ============ ============ Cash paid during period for interest, net of amount capitalized $ 55,536 $ 23,818 ============ ============ The accompanying notes are an integral part of these condensed consolidated financial statements. 4 Supplemental disclosures of non-cash investing and financing activities (dollars in thousands): In connection with the merger of Avalon Properties, Inc. with and into Bay Apartment Communities, Inc. in June 1998 (the "Merger"), AvalonBay Communities, Inc. (the "Company") issued shares of Common and Preferred Stock valued at $1,439,513 in exchange for all of the outstanding capital stock of Avalon Properties, Inc. As a result of the Merger, the Company acquired all of the assets of Avalon Properties, Inc. and also assumed or acquired $643,410 in debt, $6,221 in deferred compensation expense, $67,073 in net other assets, $1,013 in cash and cash equivalents and minority interest of $19,409. During the nine months ended September 30, 1998, the Company assumed $10,400 of debt in connection with acquisitions, issued $3,851 in operating partnership units for acquisitions, and converted 2,308,800 shares of Series A Preferred Stock and 405,022 shares of Series B Preferred Stock into an aggregate of 2,713,822 shares of Common Stock. During the nine months ended September 30, 1999, 117,178 units of limited partnership in DownREIT partnerships, valued at $4,614, were issued in connection with an acquisition for cash and units pursuant to a forward purchase agreement signed in 1997 with an unaffiliated party. Also during the nine months ended September 30, 1999, 22,623 units of limited partnership were presented for redemption to the DownREIT partnership that issued such units and were acquired by the Company for an equal number of shares of the Company's Common Stock. Common and preferred dividends declared but not paid as of September 30, 1999 and 1998 totaled $43,829 and $40,522 respectively. 5 AVALONBAY COMMUNITIES, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) (DOLLARS IN THOUSANDS, EXCEPT PER SHARE DATA) 1. Organization and Significant Accounting Policies Organization and Recent Developments AvalonBay Communities, Inc. (the "Company," which term is often used to refer to AvalonBay Communities, Inc. together with its subsidiaries) is a Maryland corporation that has elected to be taxed as a real estate investment trust ("REIT") under the Internal Revenue Code of 1986, as amended. The Company focuses on the ownership and operation of institutional-quality apartment communities in high barrier-to-entry markets of the United States. These markets include Northern and Southern California and selected states in the Mid-Atlantic, Northeast, Midwest and Pacific Northwest regions of the country. The Company is the surviving corporation from the merger (the "Merger") of Avalon Properties, Inc. ("Avalon") with and into the Company (sometimes hereinafter referred to as "Bay" before the Merger) on June 4, 1998. The Merger was accounted for as a purchase of Avalon by Bay. In connection with the Merger, the Company changed its name from Bay Apartment Communities, Inc. to AvalonBay Communities, Inc. At September 30, 1999, the Company owned or held an ownership interest in 127 operating apartment communities containing 37,435 apartment homes in fifteen states and the District of Columbia of which 10 communities containing 3,193 apartment homes were under reconstruction. The Company also owned 10 communities with 2,464 apartment homes under construction and rights to develop an additional 30 communities that, if developed as expected, will contain an estimated 8,940 apartment homes. During the third quarter of 1999, four new development communities, Avalon Valley and Avalon Lake (both located in the Fairfield County, Connecticut area), The Tower at Avalon Cove (located in the Northern New Jersey area) and The Avalon (located in the Westchester, New York area), were completed. In the aggregate, these communities contain 782 apartment homes for a total investment of approximately $120,400. The redevelopment of five communities, Arbor Heights, Westside Terrace and Viewpointe (all located in the Los Angeles, California area), Amberway (located in the Orange County, California area) and Gallery Place (located in the Seattle, Washington area) were completed during the third quarter of 1999. In the aggregate, these communities contain 1,871 apartment homes for a total investment in redevelopment (i.e., excluding acquisition costs) of approximately $30,500. The development of two new communities, Avalon River Mews (located in the Northern New Jersey area) and Avalon Haven (located in the Fairfield County, Connecticut area) commenced during the third quarter of 1999. These two communities are expected to contain a total of 536 apartment homes upon completion with a projected total investment of $90,000. The redevelopment of two existing communities, Crossbrook and Laguna Brisas, (located in the San Francisco and Orange County, California areas) commenced during the third quarter of 1999. The total projected investment in redevelopment for these communities, which contain 402 apartment homes, is $7,900. During the third quarter of 1999, the Company purchased Avalon at Woodbury, a 224 apartment home community located in the Minneapolis, Minnesota area for approximately $26,000 pursuant to a forward purchase agreement signed in 1997 with an unaffiliated party. 6 During the third quarter of 1999, the Company sold three communities. The Pointe, located in the Napa/Solono, California area, and Avalon at Willow Lake and Avalon at Geist, located in the Indianapolis, Indiana area, contained a total of 672 apartment homes. The net proceeds from the sale of these communities were approximately $47,900 resulting in a net gain of approximately $7,032. The proceeds from the sale of these communities will be redeployed to development and redevelopment communities. Pending such redeployment, the proceeds from The Pointe were deposited into an escrow account to facilitate a like-kind exchange transaction, and the proceeds from the sale of Avalon at Willow Lake and Avalon at Geist were primarily used to repay amounts outstanding under the Company's variable rate unsecured credit facility (the "Unsecured Facility"). The interim unaudited financial statements have been prepared in accordance with generally accepted accounting principles ("GAAP") for interim financial information and in conjunction with the rules and regulations of the Securities and Exchange Commission. 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 Annual Report on Form 10-K for the year ended December 31, 1998. The results of operations for the three and nine months ended September 30, 1999 are not necessarily indicative of the operating results for the full year. Management believes the disclosures are adequate to make the information presented 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. Principles of Consolidation The accompanying condensed consolidated financial statements include the accounts of the Company and its wholly-owned partnerships as well as four subsidiary partnerships structured as DownREITs. All significant intercompany balances and transactions have been eliminated in consolidation. In each of the four partnerships structured as DownREITs, the Company (or one of its wholly-owned subsidiaries) is the general partner and there are one or more limited partners whose interest in the partnership is denominated in units of limited partnership interest ("Units"). For each DownREIT partnership, limited partners who hold Units are entitled to receive certain distributions (a "Stated Distribution") prior to any distribution that such DownREIT partnership makes to the general partner. Although the partnership agreements for each of the DownREITs are different, currently the Stated Distributions that are paid in respect of the DownREIT Units in general approximate the dividend rate applicable to shares of Common Stock of the Company. Each DownREIT partnership has been structured in a manner that makes it unlikely that the limited partners will be entitled to any greater distribution than the Stated Distribution. Each holder of Units has the right to require the DownREIT partnership that issued a Unit to redeem that Unit at a cash price equal to the then fair market value of a share of Common Stock of the Company. In lieu of a cash redemption of a Unit, the Company may acquire any Unit presented for redemption for one share of Common Stock. Real Estate Significant expenditures which improve or extend the life of the asset are capitalized. The operating real estate assets are stated at cost and consist of land, buildings and improvements, furniture, fixtures and equipment, and other costs incurred during their development, redevelopment and acquisition. Expenditures for maintenance and repairs are charged to operations as incurred. The capitalization of costs during the development of assets (including interest and related loan fees, property taxes and other direct and indirect costs) begins when active development commences and ends when the asset is delivered and a final certificate of occupancy is issued. Cost capitalization during redevelopment of assets (including interest and related loan fees, property taxes and other direct and 7 indirect costs) begins when an apartment home is taken out-of-service for redevelopment and ends when the apartment home redevelopment is completed and the apartment home is placed in-service. The Company increased the West Coast portfolio's threshold for capitalization of community improvements from $5 per occurrence to $15 per occurrence effective January 1, 1999, in order to conform to the Company-wide threshold for capitalization of community improvements. The accompanying condensed consolidated financial statements include a charge to expense for unrecoverable deferred development costs related to pre-development communities that are unlikely to be developed. Depreciation is calculated on buildings and improvements using the straight-line method over their estimated useful lives, which range from seven to thirty years. Furniture, fixtures and equipment are generally depreciated using the straight-line method over their estimated useful lives, which range from three years, for computers, to seven years. Lease terms for apartment homes are generally one year or less. Rental income and operating costs incurred during the initial lease-up or post-redevelopment lease-up period are fully recognized as they accrue. Earnings per Common Share The Company has adopted Statement of Financial Accounting Standards ("SFAS") No. 128, "Earnings per Share." In accordance with the provisions of SFAS No. 128, basic earnings per share for the three and nine months ended September 30, 1999 and 1998 is computed by dividing earnings available to common shares (net income less preferred stock dividends) by the weighted average number of shares and Units outstanding during the period. Additionally, other potentially dilutive common shares are considered when calculating earnings per share on a diluted basis. The Company's basic and diluted weighted average shares outstanding for the three and nine months ended September 30, 1999 and 1998 are as follows: Three Months Ended Nine Months Ended --------------------------- ----------------------- 9-30-99 9-30-98 9-30-99 9-30-98 --------- -------- -------- ------- Weighted average common shares outstanding - basic 64,832,386 63,416,472 64,412,322 43,875,766 Weighted average units outstanding 984,398 900,549 915,606 556,506 ---------- ---------- ---------- ---------- Weighted average common shares and units outstanding - basic 65,816,784 64,317,021 65,327,928 44,432,272 Shares issuable from assumed conversion of: Common stock options 259,561 374,780 285,375 447,268 Unvested restricted stock grants 146,551 240,765 146,551 240,765 ---------- ---------- ---------- ---------- Weighted average common shares and units outstanding - diluted 66,222,896 64,932,566 65,759,854 45,120,305 ========== ========== ========== ========== 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. 8 Reclassifications Certain reclassifications have been made to amounts in prior years' financial statements to conform with current year presentations. Newly Issued Accounting Standards In June 1998, the Financial Accounting Standards Board issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This pronouncement establishes accounting and reporting standards requiring that every derivative instrument be recorded on the balance sheet as either an asset or liability measured at its fair value. SFAS No. 133 requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. In June 1999, the Financial Accounting Standards Board issued SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities - Deferral of the Effective date of SFAS No. 133." SFAS No. 137 delays the effective date of SFAS No. 133 for one year, to fiscal years beginning after June 15, 2000. The Company currently plans to adopt this pronouncement effective January 1, 2001, and will determine both the method and impact of adoption prior to that date. 2. Merger between Bay and Avalon In June 1998, the Company completed the Merger with Avalon. The Merger and related transactions were accounted for using the purchase method of accounting in accordance with GAAP. Accordingly, the assets and liabilities of Avalon were adjusted to fair value for financial accounting purposes and the results of operations of Avalon prior to June 4, 1998 are not included in the results of operations of the Company. As part of the fair value adjustment discussed above, management made certain estimates related to individual community real estate asset values. Subsequent to the Merger, the Company sold several assets previously owned by Avalon, which would have resulted in the recognition of material gains prior to the Merger, but resulted in no gain due to each asset's fair value allocation. 3. Interest Capitalized Capitalized interest associated with communities under development or redevelopment totaled $5,208 and $4,847 for the three months ended September 30, 1999 and 1998, respectively, and $18,357 and $11,372 for the nine months ended September 30, 1999 and 1998, respectively. 4. Notes Payable, Unsecured Senior Notes and Credit Facility The Company's notes payable, unsecured senior notes and credit facility are summarized as follows: 9-30-99 12-31-98 ------------ ------------- Fixed rate mortgage notes payable (conventional and tax-exempt) $ 384,532 $ 388,106 Variable rate mortgage notes payable (tax-exempt) 57,265 57,265 Fixed rate unsecured senior notes 985,000 710,000 ------------ ------------- Total notes payable and unsecured senior notes 1,426,797 1,155,371 Variable rate unsecured credit facility 247,000 329,000 ------------- ------------- Total notes payable, unsecured senior notes and credit facility $ 1,673,797 $ 1,484,371 ============= ============= 9 Mortgage notes payable are collateralized by certain apartment communities and mature at various dates from May 2001 through December 2036. The weighted average interest rate of the Company's variable rate notes and credit facility was 6.3% at September 30, 1999. The weighted average interest rate of the Company's fixed rate notes (conventional and tax-exempt) was 6.9% at September 30, 1999. The maturity schedule for the Company's unsecured senior notes consists of the following: Year of Maturity Principal Interest Rate ----------------------------------------------------- 2002 $ 100,000 7.375% 2003 $ 50,000 6.25% $ 100,000 6.5% 2004 $ 125,000 6.58% 2005 $ 100,000 6.625% $ 50,000 6.5% 2006 $ 150,000 6.8% 2007 $ 110,000 6.875% 2008 $ 50,000 6.625% 2009 $ 150,000 7.50% The Company's unsecured senior notes contain a number of financial and other covenants with which the Company must comply, including, but not limited to, limits on the aggregate amount of total and secured indebtedness the Company may have on a consolidated basis and limits on the Company's required debt service payments. The Company's $600,000 Unsecured Facility is with Morgan Guaranty Trust Company of New York, Union Bank of Switzerland and Fleet National Bank, serving as co-agents for a syndicate of commercial banks. The Unsecured Facility bears interest at a spread over the London Interbank Offered Rate ("LIBOR") based on rating levels achieved on the Company's senior unsecured notes and on a maturity selected by the Company. The current stated pricing is LIBOR plus 0.6% per annum. In addition, the Unsecured Facility includes a competitive bid option (which allows banks that are part of the lender consortium to bid to make loans to the Company at a rate that is lower than the stated rate provided by the Unsecured Facility) for up to $400,000. The Company is subject to certain customary covenants under the Unsecured Facility, including, but not limited to, maintaining certain maximum leverage ratios, a minimum fixed charges coverage ratio, minimum unencumbered assets and equity levels and restrictions on paying dividends in amounts that exceed 95% of the Company's Funds from Operations, as defined therein. The Unsecured Facility matures in July 2001 and has two, one-year extension options. 10 5. Stockholders' Equity The following summarizes the changes in stockholders' equity for the nine months ended September 30, 1999: Dividends Additional in excess of Preferred Common paid-in Deferred accumulated stock stock capital compensation earnings Total ----------- ----------- ------------- ------------- ------------ -------------- Stockholders' equity, December 31, 1998 $ 183 $ 639 $ 2,328,466 $ (4,356) $ 14,521 $ 2,339,453 Dividends declared to common and preferred stockholders -- -- -- -- (129,528) (129,528) Issuance of common stock -- 13 38,652 (3,167) -- 35,498 Amortization of deferred compensation -- -- -- 2,517 -- 2,517 Net income -- -- -- -- 98,043 98,043 ----------- ----------- ------------- ----------- ------------ -------------- Stockholders' equity, September 30, 1999 $ 183 $ 652 $ 2,367,118 $ (5,006) $ (16,964) $ 2,345,983 =========== =========== ============= =========== ============ ============== During the nine months ended September 30, 1999, the Company issued 450,142 Common Stock shares in connection with stock options exercised (the majority of which related to the organization changes announced in February 1999), 663,284 shares through the Company's Dividend Reinvestment Plan, 22,623 shares that were issued to acquire operating partnership units from third parties, 41,102 shares in connection with the Company's Employee Stock Purchase Plan and 97,479 shares in connection with restricted stock grants to employees. 6. Investments in Unconsolidated Joint Ventures In connection with the Merger, the Company succeeded to certain investments in unconsolidated joint ventures. At September 30, 1999, these investments consisted of a 50% general partnership interest in Falkland Partners, a 49% general partnership interest in Avalon Run and a 50% limited liability company membership interest in Avalon Grove. The following is a combined summary of the financial position of these joint ventures as of the dates presented (which includes the period prior to the Merger): 9-30-99 12-31-98 ----------- ------------ Assets: Real estate, net $ 94,810 $ 96,419 Other assets 5,203 4,532 ----------- ------------ Total assets $ 100,013 $ 100,951 =========== ============ Liabilities and partners' equity: Mortgage notes payable $ 26,000 $ 26,000 Other liabilities 5,559 4,933 Partners' equity 68,454 70,018 ----------- ------------ Total liabilities and partners' equity $ 100,013 $ 100,951 =========== ============ The following is a combined summary of the operating results of these joint ventures for the periods presented (which includes the periods prior to the Merger): 11 Three months ended Nine months ended ---------------------------- ---------------------------- 9-30-99 9-30-98 9-30-99 9-30-98 ------------ ------------ ------------ ------------ Rental income $ 5,323 $ 5,019 $ 15,489 $ 14,719 Other income 8 8 18 20 Operating expenses (1,455) (1,500) (4,196) (4,156) Mortgage interest expense (196) (205) (564) (628) Depreciation and amortization (773) (764) (2,314) (2,279) ------------ ------------ ------------ ------------ $ 2,907 $ 2,558 $ 8,433 $ 7,676 ============ ============ ============ ============ 7. Communities Held for Sale During 1998, the Company completed a strategic planning effort resulting in a decision to pursue a disposition strategy for certain assets. The Company solicits competing bids from unrelated parties for these individual assets, and considers the sales price and tax ramifications of each proposal. Management sold seven communities in connection with this disposition strategy in 1998, and nine communities during the first nine months of 1999. Management intends to have additional selected assets actively marketed for sale during the fourth quarter of 1999. However, there can be no assurance that such assets can be sold, or that such sales will prove to be beneficial to the Company. The communities sold during the first nine months of 1999 and the respective sales price and net proceeds are summarized below: Period Apartment Gross sales Net Communities Location of sale homes price proceeds ------------------------ ---------------------- ---------- ------------ ------------ -------------- Blairmore Rancho Cordova, CA 1Q99 252 $ 13,250 $ 12,991 Avalon at Park Center Alexandria, VA 2Q99 492 44,250 43,820 Avalon at Lake Arbor Mitchellville, MD 2Q99 209 14,160 13,800 Avalon Station Fredricksburg, VA 2Q99 223 12,734 12,500 Avalon Gayton Richmond, VA 2Q99 328 18,418 18,210 Avalon at Boulders Richmond, VA 2Q99 284 16,075 15,840 The Pointe Fairfield, CA 3Q99 296 24,350 23,833 Avalon at Willow Lake Indianapolis, IN 3Q99 230 14,350 14,055 Avalon at Geist Lawrence, IN 3Q99 146 10,300 10,006 ----- ------- ------- 2,460 $ 167,887 $ 165,055 ===== ======= ======= The assets targeted for sale include land, buildings and improvements and furniture, fixtures and equipment, and are recorded at the lower of cost or fair value less estimated selling costs. The Company has not recognized a write-down in its real estate to arrive at net realizable value. At September 30, 1999, total real estate, net of accumulated depreciation, subject to sale totaled $120,299. Certain individual assets are secured by mortgage indebtedness which may be assumed by the purchaser or repaid by the Company from the net sales proceeds. The Company's condensed consolidated statements of operations include net income of the communities held for sale at September 30, 1999 of $1,953 and $828 for the three months ended September 30, 1999 and 1998, respectively, and $5,237 and $1,123 for the nine months ended September 30, 1999 and 1998, respectively. Depreciation expense on these assets, which was not recognized subsequent to the date of 12 held-for-sale classification, totaled $1,075 and $3,229 for the three and nine months ended September 30, 1999, respectively. 8. Segment Reporting The Company adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," during 1998. SFAS No. 131 established standards for reporting financial and descriptive information about operating segments in annual financial statements. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker, or decision making group, in deciding how to allocate resources and in assessing performance. The Company's chief operating decision making group consists primarily of the Company's senior officers. The Company's reportable operating segments include Stable Communities, Developed Communities and Redeveloped Communities: - - Stable Communities are communities that 1) have attained stabilized occupancy levels (at least 95% occupancy) and operating costs since the beginning of the prior calendar year (these communities are also known as Established Communities); or 2) were acquired subsequent to the beginning of the previous calendar year but were stabilized in terms of occupancy levels and operating costs at the time of acquisition, and remained stabilized throughout the end of the current calendar year. Stable Communities do not include communities where planned redevelopment or development activities have not yet commenced. The primary financial measure for this business segment is Net Operating Income ("NOI"), which represents total revenue less operating expenses and property taxes. With respect to Established Communities, an additional financial measure of performance is NOI for the current year as compared against the prior year and against current year budgeted NOI. With respect to other Stable Communities, performance is primarily based on reviewing growth in NOI for the current period as compared against prior periods within the calendar year and against current year budgeted NOI. - - Developed Communities are communities which completed development and attained stabilized occupancy and expense levels during the prior calendar year of presentation. The primary financial measure for this business segment is Operating Yield (defined as NOI divided by total capitalized costs). Performance of Developed Communities is based on comparing Operating Yields against projected yields as determined by Management prior to undertaking the development activity. - - Redeveloped Communities are communities that completed redevelopment and attained stabilized occupancy and expense levels during the prior calendar year of presentation. The primary financial measure for this business segment is Operating Yield. Performance for Redeveloped Communities is based on comparing Operating Yields against projected yields as estimated by Management prior to undertaking the redevelopment activity. Other communities owned by the Company which are not included in the above segments are communities that were under development or redevelopment or lease-up at any point in time during the applicable calendar year. The primary performance measure for these assets depends on the stage of development or redevelopment of the community. While under development or redevelopment, Management monitors actual construction costs against budgeted costs as well as economic occupancy. While under lease-up, the primary performance measures for these assets are projected Operating Yield as defined above, lease-up pace compared to budget and rent levels compared to budget. Net Operating Income for each community is generally equal to that community's contribution to Funds from Operations ("FFO"), except that interest expense related to indebtedness secured by an individual 13 community and depreciation and amortization on non-real estate assets are not included in the community's NOI although such expenses decrease the Company's consolidated net income and FFO. 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. In addition to reporting segments based on the above property types, the Company previously reported results within these segments based on the West and East Coast geographic areas. This disclosure was provided as the West and East Coast geographic areas substantially reflected the operating communities of Bay and Avalon, respectively, prior to the Merger. Management currently reviews its operating segments by geographic regions, including Northern and Southern California, Pacific Northwest, Northeast, Mid-Atlantic and Midwest regions. The various locales within each individual region have similar economic and other characteristics such that management finds it useful to review the performance of the Company's communities in those locales on a regional, aggregated basis. The accounting policies applicable to the operating segments described above are the same as those described in the summary of significant accounting policies in the Company's Form 10-K. For the three months ended -------------------------- Stable Developed Redeveloped Communities Communities Communities Other Total ----------- ----------- ----------- ----- ----- For the three and nine months ended September 30, 1999 - ----------------------------- Segment Results Total revenue $ 86,636 $ 8,473 $ 8,131 $ 26,964 $ 130,204 Net Operating Income $ 60,029 $ 6,249 $ 5,747 $ 17,800 $ 89,825 Gross real estate $ 2,512,342 $ 224,795 $ 251,770 $ 1,034,495 $ 4,023,402 Non-allocated operations Total revenue $ -- $ -- $ -- $ 543 $ 543 Net Operating Income $ -- $ -- $ -- $ 584 $ 584 Gross real estate $ -- $ -- $ -- $ 249,785 $ 249,785 Total, AvalonBay Total revenue $ 86,636 $ 8,473 $ 8,131 $ 27,507 $ 130,747 Net Operating Income $ 60,029 $ 6,249 $ 5,747 $ 18,384 $ 90,409 Gross real estate $ 2,512,342 $ 224,795 $ 251,770 $ 1,284,280 $ 4,273,187 For the three and nine months ended September 30, 1998 - ----------------------------- Segment Results Total revenue $ 77,870 $ 1,405 $ 6,203 $ 32,062 $ 117,540 Net Operating Income $ 53,289 $ 1,053 $ 4,282 $ 20,933 $ 79,557 Gross real estate $ 2,066,571 $ 29,507 $ 179,951 $ 1,254,663 $ 3,530,692 Non-allocated operations Total revenue $ -- $ -- $ -- $ 588 $ 588 Net Operating Income $ -- $ -- $ -- $ 503 $ 503 Gross real estate $ -- $ -- $ -- $ 416,247 $ 416,247 Total, AvalonBay Total revenue $ 77,870 $ 1,405 $ 6,203 $ 32,650 $ 118,128 Net Operating Income $ 53,289 $ 1,053 $ 4,282 $ 21,436 $ 80,060 Gross real estate $ 2,066,571 $ 29,507 $ 179,951 $ 1,670,910 $ 3,946,939 For the nine months ended ------------------------- Stable Developed Redeveloped Communities Communities Communities Other Total ----------- ----------- ----------- ----- ----- For the three and nine months ended September 30, 1999 - ----------------------------- Segment Results Total revenue $ 261,124 $ 24,224 $ 24,119 $ 61,148 $ 370,615 Net Operating Income $ 181,819 $ 18,234 $ 16,794 $ 38,698 $ 255,545 Gross real estate $ 2,512,342 $ 224,795 $ 251,770 $ 1,034,495 $ 4,023,402 Non-allocated operations Total revenue $ -- $ -- $ -- $ 1,586 $ 1,586 Net Operating Income $ -- $ -- $ -- $ 1,390 $ 1,390 Gross real estate $ -- $ -- $ -- $ 249,785 $ 249,785 Total, AvalonBay Total revenue $ 261,124 $ 24,224 $ 24,119 $ 62,734 $ 372,201 Net Operating Income $ 181,819 $ 18,234 $ 16,794 $ 40,088 $ 256,935 Gross real estate $ 2,512,342 $ 224,795 $ 251,770 $ 1,284,280 $ 4,273,187 For the three and nine months ended September 30, 1998 - ----------------------------- Segment Results Total revenue $ 134,881 $ 4,091 $ 17,983 $ 75,874 $ 232,829 Net Operating Income $ 94,313 $ 3,136 $ 12,592 $ 48,967 $ 159,008 Gross real estate $ 2,066,571 $ 29,507 $ 179,951 $ 1,254,663 $ 3,530,692 Non-allocated operations Total revenue $ -- $ -- $ -- $ 900 $ 900 Net Operating Income $ -- $ -- $ -- $ 794 $ 794 Gross real estate $ -- $ -- $ -- $ 416,247 $ 416,247 Total, AvalonBay Total revenue $ 134,881 $ 4,091 $ 17,983 $ 76,774 $ 233,729 Net Operating Income $ 94,313 $ 3,136 $ 12,592 $ 49,761 $ 159,802 Gross real estate $ 2,066,571 $ 29,507 $ 179,951 $ 1,670,910 $ 3,946,939 Operating expenses as reflected on the Condensed Consolidated Statements of Operations include $6,029 and $5,378 for the three months ended September 30, 1999 and 1998, respectively, and $18,066 and $9,388 for the nine months ended September 30, 1999 and 1998 of property management overhead costs 14 that are not allocated to individual communities. These costs are not reflected in Net Operating Income as shown in the above tables. Communities held for sale as reflected on the Condensed Consolidated Balance Sheets is net of $4,858 and $6,169 of accumulated depreciation as of September 30, 1999 and 1998, respectively. In June 1998, the Company completed the Merger with Avalon. The Merger and related transactions were accounted for using the purchase method of accounting in accordance with GAAP. Accordingly, the results of operations of the Avalon communities prior to June 4, 1998 are not included in the results of operations of the Company. Avalon communities are included in Established Communities for Management's decision making purposes although the results of operations prior to the Merger are not included in the Company's historical operating results determined in accordance with GAAP. For comparative purposes, the 1998 operating information for the Company is presented below on a pro forma basis (unaudited) assuming the Merger had occurred as of January 1, 1998. For the nine months ended ------------------------------------------------------------------ Stable Developed Redeveloped Communities Communities Communities Other Total ----------- ----------- ----------- ---------- -------- For the nine months ended September 30, 1998 - ------------------------ Segment Results Total revenue $ 184,546 $ 34,838 $ 17,984 $ 88,739 $ 326,107 Net Operating Income $ 126,053 $ 26,749 $ 12,592 $ 57,314 $ 222,708 Gross real estate $ 1,749,485 $ 308,799 $ 179,951 $ 1,292,457 $ 3,530,692 Non-allocated operations Total revenue $ -- $ -- $ -- $ 1,780 $ 1,780 Net Operating Income $ -- $ -- $ -- $ 1,565 $ 1,565 Gross real estate $ -- $ -- $ -- $ 416,247 $ 416,247 Total, AvalonBay Total revenue $ 184,546 $ 34,838 $ 17,984 $ 90,519 $ 327,887 Net Operating Income $ 126,053 $ 26,749 $ 12,592 $ 58,879 $ 224,273 Gross real estate $ 1,749,485 $ 308,799 $ 179,951 $ 1,708,704 $ 3,946,939 9. Subsequent Events During October 1999, the Company sold four communities containing 1,214 apartment homes. The net proceeds of approximately $62,140 from the sale of these communities will be redeployed to development and redevelopment communities. Pending such redeployment, the proceeds from the sale of these communities were primarily used to repay amounts outstanding under the Company's Unsecured Facility. During October 1999, the Company sold a participating mortgage note secured by a 288 apartment home community located in the Detroit, Michigan area. The net proceeds from the sale of the participating mortgage note of $25,300 were used to repay amounts outstanding under the Company's Unsecured Facility. During October 1999, the Company completed a refinancing of approximately $18,755 of tax exempt bonds related to the Avalon Ridge community. These bonds bear a variable interest rate, will mature on May 1, 2026 and are credit enhanced by the Company's credit enhancement facility with the Federal National Mortgage Association. 15 During October 1999, the Company exercised its options to acquire a 19-acre site in San Diego, California for approximately $11,800 and a 9.58-acre site in Orange, Connecticut for approximately $1,200. The Company plans to develop apartment home communities on each of these sites with up to 546 combined apartment homes. 16 PART I. FINANCIAL INFORMATION (CONTINUED) Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Forward-Looking Statements This Form 10-Q, including the footnotes to the Company's condensed consolidated financial statements, contains "forward-looking statements" as that term is defined under the Private Securities Litigation Reform Act of 1995. You can identify forward-looking statements by our use of the words "believe," "expect," "anticipate," "intend," "estimate," "assume," and other similar expressions in this Form 10-Q, that predict or indicate future events and trends or that do not relate to historical matters. We cannot assure the future results or outcome of the matter described in these statements; rather, these statements merely reflect our current expectations of the approximate outcome of the matter discussed. In addition, information concerning the following are forward-looking statements: - the timing and cost of completion of apartment communities under construction, reconstruction, development or redevelopment; - the timing of lease-up and occupancy of apartment communities; - the pursuit of communities which we are considering for future development; - cost, yield and earnings estimates; - the development, implementation and use of management information systems; and - the timing and effectiveness of Year 2000 compliance. You should not rely on forward-looking statements since they involve known and unknown risks, uncertainties and other factors, some of which are beyond our control. These risks, uncertainties and other factors may cause our actual results, performance or achievements to differ materially from the anticipated future results, performance or achievements expressed or implied by forward-looking statements. Some of the factors that could cause our actual results, performance or achievements to differ materially from those expressed or implied by forward-looking statements include, but are not limited to, the following: - we may be unsuccessful in managing our current growth in the number of apartment communities and the related growth of our business operations; - our previous or possible future expansion into new geographic market areas may not produce financial results that are consistent with our historical performance; - we may abandon development opportunities for a number of reasons, including changes in local market conditions which make development less desirable, increases in costs of development and increases in the cost of capital; - we may fail to secure development opportunities due to an inability to reach agreements with third parties or to obtain desired zoning and other local approvals; - construction costs of a community may exceed our original estimates; - construction and lease-up of communities under development or redevelopment may not be completed on schedule, resulting in increased interest expense, construction costs and reduced rental revenues; - occupancy rates and market rents may be adversely affected by local economic and market conditions which are beyond our control; - financing may not be available on favorable terms and our cash flow from operations and access to cost effective capital may be insufficient for the development of our pipeline and could limit our pursuit of opportunities; - our cash flow may be insufficient to meet required payments of principal and interest, and we may be unable to refinance existing indebtedness or the terms of such refinancing may not be as favorable as the terms of existing indebtedness; - the development, implementation and use of new management information systems may cost more than anticipated or may be delayed for a number of reasons, including unforeseen technological or integration issues; - we may, with our suppliers and service providers, experience unanticipated delays or expenses in achieving Year 2000 compliance. 17 You should read our unaudited condensed consolidated financial statements and notes included in this report and the audited financial statements for the year ended December 31, 1998 and the notes included in our annual report on Form 10-K in conjunction with the following discussion. These forward-looking statements represent our estimates and assumptions only as of the date of this report, and we do not undertake to update these forward-looking statements. Business Description and Community Information AvalonBay is a Maryland corporation that elected to be treated as a real estate investment trust, or REIT, for federal income tax purposes. We focus on the ownership and operation of institutional quality apartment communities in high barrier-to-entry markets of the United States. This is because we believe that the limited new supply of apartment homes in these markets helps assure more predictable cash flows. These barriers-to-entry include a difficult and lengthy entitlement process with local jurisdictions and dense in-fill locations where zoned and entitled land is not available. These markets are located in Northern and Southern California and selected states in the Mid-Atlantic, Northeast, Midwest and Pacific Northwest regions of the country. AvalonBay is the surviving corporation from the merger of Avalon Properties, Inc. with and into Bay Apartment Communities, Inc. on June 4, 1998. The merger was accounted for as a purchase of Avalon Properties by Bay Apartment Communities. In connection with the merger, the Company changed its name from Bay Apartment Communities, Inc. to AvalonBay Communities, Inc. We are a fully-integrated real estate organization with in-house expertise in the following areas: - acquisition; - development and redevelopment; - construction and reconstruction; - financing; - marketing; - leasing and management; and - information technologies. With our experience and in-house capabilities, we believe we are well-positioned to continue to pursue opportunities to develop and acquire upscale apartment homes in our target markets. Our ability to pursue attractive opportunities may be constrained by capital market conditions that limit the availability of cost effective capital to finance these activities. We have acquired fewer communities in 1999 than in prior years due to these capital constraints, and expect to direct most of our invested capital to new developments for the foreseeable future. We believe apartment communities present an attractive investment opportunity compared to other real estate investments because a broad potential resident base results in relatively stable demand during all phases of a real estate cycle. We intend to pursue appropriate new investments, including both new developments and acquisitions of communities, in markets where constraints to new supply exist and where new household formations have out-paced multifamily permit activity in recent years. Our real estate investments as of November 1, 1999 consist primarily of stabilized operating apartment communities and communities in various stages of the development cycle and land or land options held for development. We classify these investments into the following categories: 18 Number of Number of communities apartment homes ----------- --------------- Current Communities 123 (**) 36,221 (**) ------------------- Established Communities: 65 18,438 Northern California 25 6,461 Southern California 3 600 Mid-Atlantic 19 5,631 Northeast 17 5,248 Midwest 1 498 Other Stabilized Communities: 48 14,706 Northern California 8 2,460 Southern California 11 3,945 Mid-Atlantic 6 1,658 Northeast 14 4,650 Midwest 6 1,317 Pacific Northwest 3 676 Lease-Up Communities 1 110 Redevelopment Communities 10 3,193 Development Communities 10 2,464 ----------------------- Development Rights 30 8,940 (*) ------------------ (*) Represents an estimate (**) Includes one community that is currently undergoing redevelopment of its exterior. No homes will be taken out of service. Therefore, the community is both an Established Community and a Redevelopment Community. The community has only been included once in the Current Communities total. Current Communities are apartment communities that have been completed and have reached occupancy of at least 95%, have been complete for one year, are in the initial lease-up process or are under redevelopment. Current Communities consist of the following: Stabilized Communities. Represents all Current Communities that have completed initial lease-up by attaining physical occupancy levels of at least 95% or have been completed for one year, whichever occurs earlier. Stabilized Communities are categorized as either Established Communities or Other Stabilized Communities. - Established Communities. Represents all Stabilized Communities owned by Bay, or on a pro forma basis, those owned by Avalon as of January 1, 1998, with stabilized operating costs as of January 1, 1998 such that a comparison of 1998 operating results to 1999 operating results is meaningful. Each of the Established Communities falls into one of six geographic areas including Northern California, Southern California, Mid-Atlantic, Northeast, Midwest and Pacific Northwest regions. At September 30, 1999, there were no Established Communities in the Pacific Northwest. - Other Stabilized Communities. Represents Stabilized Communities as defined above, but which became stabilized or were acquired after January 1, 1998. 19 Lease-Up Communities. Represents all communities where construction has been complete for less than one year and where occupancy of at least 95% has not been reached. Redevelopment Communities. Represents all communities where substantial redevelopment has begun. Redevelopment is considered substantial when capital invested during the reconstruction effort exceeds the lesser of $5 million or 10% of the community's acquisition cost. Development Communities are communities that are under construction and for which a final certificate of occupancy has not been received. These communities may be partially complete and operating. Development Rights are development opportunities in the early phase of the development process for which we have an option to acquire land or where we own land to develop a new community. We capitalize all related pre-development costs incurred in pursuit of these new developments. Of the Current Communities as of November 1, 1999, we own: - a fee simple, or absolute, ownership interest in 104 operating communities, one of which is on land subject to a 149 year land lease; - a general partnership interest in five partnerships that hold a fee simple interest in five other operating communities; - a general partnership interest in four partnerships structured as "DownREITs," as described more fully below, that own 13 communities; and - a 100% interest in a senior participating mortgage note secured by one community, which allows us to share in part of the rental income or resale proceeds of the community. We also hold a fee simple ownership interest in each of the ten Development Communities. In each of the four partnerships structured as DownREITs, either AvalonBay or one of our wholly-owned subsidiaries is the general partner, and there are one or more limited partners whose interest in the partnership is represented by units of limited partnership interest. For each DownREIT partnership, limited partners are entitled to receive distributions before any distribution is made to the general partner. Although the partnership agreements for each of the DownREITs are different, generally the distributions paid to the holders of units of limited partnership interests approximate the current AvalonBay common stock dividend rate. Each DownREIT partnership has been structured so that it is unlikely the limited partners will be entitled to a distribution greater than that stated in the partnership agreement. The holders of units of limited partnership interest have the right to present each unit of limited partnership interest for redemption for cash equal to the fair market value of a share of AvalonBay common stock on the date of redemption. In lieu of a cash redemption of a unit, we may acquire any unit presented for redemption for one share of common stock. As of November 1, 1999, there were 996,319 units outstanding. The DownREIT partnerships are consolidated for financial reporting purposes. At September 30, 1999, we had positioned our portfolio of Stabilized Communities, excluding communities owned by unconsolidated joint ventures, to an average physical occupancy level of 97.1%. The Established Communities, on a pro forma basis, assuming the merger had occurred on January 1, 1998, had achieved an average economic occupancy of 97.0% for the three months ended September 30, 1999 and 96.4% for the nine months ended September 30, 1999. Average economic occupancy for the Established Communities, on a pro forma basis, assuming the merger had occurred on January 1, 1998, for the three months ended September 30, 1998 was 97.4% and for the nine months ended September 30, 1998 was 97.0%. Aggressive marketing efforts combined with limited and targeted pricing adjustments are 20 responsible for this continued high occupancy. This positioning has resulted in overall growth in rental revenue from Established Communities of 3.2% for the three months ended September 30, 1999 from the comparable period of the preceding year and 3.9% for the nine months ended September 30, 1999 from the comparable period of the preceding year. Our strategy is to maximize total rental revenue through management of rental rates and occupancy levels. Our strategy of maximizing total rental revenue could lead to lower occupancy levels. Given the current high occupancy level of our portfolio, we believe that any rental revenue and net income gains from our Established Communities would be achieved primarily through higher rental rates and the lower average operating costs per apartment home that result from economies of scale due to national and regional growth of our portfolio. We elected to be taxed as a REIT for federal income tax purposes for the year ended December 31, 1994 and we have not revoked that election. We were incorporated under the laws of the State of California in 1978, and we were reincorporated in the State of Maryland in July 1995. Our principal executive offices are located at 2900 Eisenhower Avenue, Suite 300, Alexandria, Virginia, 22314, and our telephone number at that location is (703) 329-6300. We also maintain regional offices and administrative or specialty offices in or near the following metropolitan areas: - San Jose, California; - Wilton, Connecticut; - Boston, Massachusetts; - Chicago, Illinois; - Los Angeles, California; - Minneapolis, Minnesota; - Newport Beach, California; - New York, New York; - Princeton, New Jersey; and - Seattle, Washington. Recent Developments Sales of Existing Communities. During 1998, we completed a strategic planning effort that resulted in our decision to increase our concentration in selected high barrier-to-entry markets where we believe we can: - bring sufficient market and management presence to enhance revenue growth; - reduce operating expenses; and - leverage management talent. To effect this concentration, we are selling assets in markets where our current presence is limited. Accordingly, we sold three communities totaling 672 apartment homes during the third quarter of 1999. Net proceeds from these sales totaled $47,900,000 resulting in a net gain of $7,032,000. We sold four additional communities containing 1,214 apartment homes in October 1999 in connection with our disposition strategy. The net proceeds from the sale of these communities were approximately $62,140,000. In addition, we sold a participating mortgage note secured by an apartment home community for net proceeds of $25,300,000. We intend to dispose of additional assets as described more fully under "Future Financing and Capital Needs." We intend to redeploy the proceeds from sales to develop and redevelop communities currently under construction or reconstruction. Pending such redeployment, the proceeds from the sale of these communities will be used to repay amounts outstanding under our variable rate unsecured credit facility. Community Acquisition. We acquired one community, Avalon at Woodbury, during July 1999 for approximately $26,000,000 in connection with a forward purchase agreement signed in 1997 with an unaffiliated party. The community contains 224 apartment homes and is located in the Minneapolis, Minnesota area. Construction and Completion of Development Communities. During the third quarter of 1999, we began development of two new communities, Avalon River Mews and Avalon Haven, that are expected to contain 536 apartment homes. These communities are located in the Northern New Jersey and Fairfield, 21 Connecticut areas. The land parcels were acquired for a total purchase price of $15,285,000 and the total projected investment in the two communities, including the land acquisition costs, is projected to be approximately $90,000,000. During the third quarter of 1999, four new development communities, Avalon Valley, Avalon Lake, The Tower at Avalon Cove and The Avalon were completed for a total investment of $120,400,000. Two of these communities are located in the Fairfield County, Connecticut area, and the remaining two are located in the Northern New Jersey and the Westchester, New York areas. In the aggregate, these four communities contain a total of 782 apartment homes. Construction and Completion of Redevelopment Communities. The redevelopment of two existing communities, Crossbrook and Laguna Brisas, began during the third quarter of 1999. These communities are located in the San Francisco and Orange County, California areas. The total projected investment in redevelopment for these communities (i.e., excluding acquisition costs), which contain 402 apartment homes, is $7,900,000. Five redevelopment communities were completed during the third quarter of 1999 for a total investment in redevelopment, excluding acquisition costs, of $30,500,000. These communities, Arbor Heights, Westside Terrace, Viewpointe, Amberway and Gallery Place, contain 1,871 apartment homes and are located in the Los Angeles, California, Orange County, California and Seattle, Washington areas. The development and redevelopment of communities involves risks that the investment will fail to perform in accordance with expectations. See "Risks of Development and Redevelopment" for our discussion of these and other risks inherent in developing or redeveloping communities. Results of Operations Historically, the changes in our operating results from period-to-period have been primarily the result of increases in the number of apartment homes owned. Where appropriate, period-to-period comparisons of the number of occupied apartment homes are made on a weighted average basis to adjust for changes in the number of apartment homes during the period. For Stabilized Communities, excluding communities owned by unconsolidated joint ventures, all occupied apartment homes are included in the calculation of weighted average occupied apartment homes for each reporting period. For communities in the initial lease-up phase, only apartment homes of communities that are completed and occupied are included in the weighted average number of occupied apartment homes calculation for each reporting period. The analysis that follows compares our operating results for the three and nine months ended September 30, 1999 and September 30, 1998. Net income available to common stockholders increased $10,358,000 (43.6%) to $34,129,000 for the three months ended September 30, 1999 compared to $23,771,000 for the comparable period of the preceding year. Net income available to common stockholders increased $21,740,000 (46.8%) to $68,209,000 for the nine months ended September 30, 1999 compared to $46,469,000 for the comparable period of the preceding year. Excluding non-recurring charges and gain on sale of communities, net income available to common stockholders, as adjusted, increased by $3,420,000 for the three months ended September 30, 1999 and $26,088,000 for the nine months ended September 30, 1999 from the comparable periods of 1998. The increase in net income, as adjusted, for the three months ended September 30, 1999 is primarily attributable to additional operating income from newly developed or redeveloped communities as well as growth in operating income from Established Communities. The increase in net income, as adjusted, for the nine months ended September 30, 1999 is primarily attributable to additional operating income from the former Avalon communities and secondarily, to additional operating income from newly developed or redeveloped communities and growth in operating income from Established Communities. 22 Rental income increased $12,616,000 (10.7%) to $130,373,000 for the three months ended September 30, 1999 compared to $117,757,000 for the comparable period of the preceding year. Rental income increased $137,845,000 (59.1%) to $371,073,000 for the nine months ended September 30, 1999 compared to $233,228,000 for the comparable period of the preceding year. Of the nine month increase, $1,315,000 relates to rental revenue increases from Established Communities and $136,530,000 relates to rental revenue attributable to newly developed, redeveloped or acquired apartment homes, of which $94,135,000 relates to rental revenue attributable to currently stabilized communities acquired in connection with the merger. Overall Portfolio - The $137,845,000 increase in rental income is primarily due to increases in the weighted average number of occupied apartment homes as well as an increase in the weighted average monthly rental income per occupied apartment home. The weighted average number of occupied apartment homes increased from 23,745 apartment homes for the nine months ended September 30, 1998 to 36,628 apartment homes for the nine months ended September 30, 1999 primarily as a result of additional apartment homes from the former Avalon communities, as well as the development, redevelopment and acquisition of new communities. For the nine months ended September 30, 1999, the weighted average monthly revenue per occupied apartment home increased $53 (5.1%) to $1,101 compared to $1,048 for the comparable period of the preceding year. Established Communities, on a pro forma basis, assuming the merger had occurred on January 1, 1998 - Rental revenue increased $2,020,000 (3.2%) for the three months ended September 30, 1999 compared to the comparable period of the preceding year. Rental revenue increased $7,221,000 (3.9%) for the nine months ended September 30, 1999 compared to the comparable period of the preceding year. The increases are due to market conditions that allowed for higher average rents, but lower economic occupancy levels. For the three months ended September 30, 1999, weighted average monthly revenue per occupied apartment home increased $43 (3.6%) to $1,223 compared to $1,180 for the comparable period of the preceding year. The average economic occupancy decreased from 97.4% for the three months ended September 30, 1998 to 97.0% for the three months ended September 30, 1999. For the nine months ended September 30, 1999, weighted average monthly revenue per occupied apartment home increased $52 (4.5%) to $1,210 compared to $1,158 for the comparable period of the preceding year. The average economic occupancy decreased from 97.0% for the nine months ended September 30, 1998 to 96.4% for the nine months ended September 30, 1999. Beginning in October 1998, the Northern California sub-markets that are primarily dependent on Silicon Valley employment softened. These sub-markets have experienced reduced rental rate growth and occupancy declines as compared to other Northern California sub-markets and our other markets as a whole. Established Communities on a pro forma basis include the Established Communities as well as the communities owned by Avalon at January 1, 1998 with stabilized occupancy levels and operating costs as of that date, so that a comparison of 1998 operating results to 1999 operating results is meaningful. Established Communities on a pro forma basis include communities located in the Northeast, Mid-Atlantic and Midwest in addition to those communities located in Northern California and Southern California. Management fees decreased $65,000 to $277,000 for the three months ended September 30, 1999 compared to $342,000 for the comparable period of the preceding year. Management fees increased $473,000 to $930,000 for the nine months ended September 30, 1999 compared to $457,000 for the comparable period of the preceding year. Management fees represent revenue from third-party contracts to which we succeeded in the merger. The decrease in management fees for the three months ended September 30, 1999 is the result of terminated third-party contracts. We anticipate that management fees will increase over the next several years with the receipt of development and construction management fees for joint venture development arrangements. Operating expenses increased $2,237,000 (6.7%) to $35,649,000 for the three months ended September 30, 1999 compared to $33,412,000 for the comparable period of the preceding year. These expenses increased 23 $37,152,000 (57.9%) to $101,274,000 for the nine months ended September 30, 1999 compared to $64,122,000 for the comparable period of the preceding year. Overall Portfolio - The increase for the three months ended September 30, 1999 is primarily due to the addition of newly developed and redeveloped apartment homes. The increase for the nine months ended September 30, 1999 is primarily due to additional operating expenses from the former Avalon communities, and secondarily, due to the addition of newly developed, redeveloped and acquired apartment homes. Maintenance, insurance and other costs associated with Development and Redevelopment Communities are expensed as communities move from the initial construction and lease-up phase to the stabilized operating phase. Established Communities, on a pro forma basis, assuming the merger had occurred on January 1, 1998 - Operating expenses increased $357,000 (2.7%) to $13,730,000 for the three months ended September 30, 1999 compared to $13,373,000 for the comparable period of the preceding year. These expenses increased $1,565,000 (4.2%) to $39,006,000 for the nine months ended September 30, 1999 compared to $37,441,000 for the comparable period of the preceding year. The net changes are the result of higher administrative, payroll and maintenance costs, offset by lower utility and insurance costs. Property taxes increased $684,000 (6.8%) to $10,718,000 for the three months ended September 30, 1999 compared to $10,034,000 for the comparable period of the preceding year. Property taxes increased $12,865,000 (67.0%) to $32,058,000 for the nine months ended September 30, 1999 compared to $19,193,000 for the comparable period of the preceding year. Overall Portfolio - The increase for the three months ended September 30, 1999 is primarily due to the addition of newly developed and redeveloped apartment homes. The increase for the nine months ended September 30, 1999 is primarily due to additional expense from the former Avalon communities and secondarily, due to the addition of newly developed, redeveloped or acquired apartment homes. Property taxes on Development and Redevelopment Communities are expensed as communities move from the initial construction and lease-up phase to the stabilized operating phase. Established Communities, on a pro forma basis, assuming the merger had occurred on January 1, 1998 - Property taxes decreased $126,000 (2.3%) to $5,332,000 for the three months ended September 30, 1999 compared to $5,458,000 for the comparable period of the preceding year. Property taxes increased $222,000 (1.4%) to $16,124,000 for the nine months ended September 30, 1999 compared to $15,902,000 for the comparable period of the preceding year. The quarter to quarter decrease is a result of base year tax assessments indicating lower supplemental taxes for previously renovated communities than originally projected. The year-to-date increase is primarily the result of a net increase in property value assessments and increased property tax rates in the Northeast and Mid-Atlantic regions. Interest expense increased $1,256,000 (6.8%) to $19,643,000 for the three months ended September 30, 1999 compared to $18,387,000 for the comparable period of the preceding year. Interest expense increased $18,844,000 (52.7%) to $54,592,000 for the nine months ended September 30, 1999 compared to $35,748,000 for the comparable period of the preceding year. The increase in interest expense for the three months ended September 30, 1999 is primarily attributable to higher debt balances offset by an increase in capitalized interest. The increase for the nine months ended September 30, 1999 is primarily attributable to debt assumed in connection with the merger and the issuance of unsecured notes in 1998 and 1999, offset by an increase in capitalized interest. Depreciation and amortization increased $4,352,000 (18.5%) to $27,930,000 for the three months ended September 30, 1999 compared to $23,578,000 for the comparable period of the preceding year. 24 Depreciation and amortization increased $33,289,000 (69.2%) to $81,371,000 for the nine months ended September 30, 1999 compared to $48,082,000 for the comparable period of the preceding year. The increase for the three months ended September 30, 1999 is primarily attributable to newly developed and redeveloped communities. The increase for the nine months ended September 30, 1999 is primarily attributable to additional expense from the former Avalon communities and secondarily to newly developed and redeveloped communities in 1998 and 1999. General and administrative decreased $229,000 (8.9%) to $2,349,000 for the three months ended September 30, 1999 compared to $2,578,000 for the comparable period of the preceding year. General and administrative increased $1,567,000 (28.4%) to $7,092,000 for the nine months ended September 30, 1999 compared to $5,525,000 for the comparable period of the preceding year. The quarter-to-quarter decrease reflects cost reductions associated with our management realignment and related organizational adjustments announced in the first quarter of 1999. The increase for the nine months ended September 30, 1999 is primarily due to costs incurred to support the increase in the size of our portfolio that resulted from the merger. Equity in income of unconsolidated joint ventures increased $252,000 to $860,000 for the three months ended September 30, 1999 compared to $608,000 for the comparable period of the preceding year and increased $1,420,000 to $2,266,000 for the nine months ended September 30, 1999 compared to $846,000 for the comparable period of the preceding year. Equity in income of unconsolidated joint ventures represents our share of income of joint ventures that we succeeded to in connection with the merger. Interest income increased $1,078,000 to $2,301,000 for the three months ended September 30, 1999 compared to $1,223,000 for the comparable period of the preceding year. Interest income increased $4,033,000 to $5,723,000 for the nine months ended September 30, 1999 compared to $1,690,000 for the comparable period of the preceding year. These increases are primarily from an increase in interest from participating mortgage notes including the Avalon Arbor promissory note that we succeeded to in connection with the merger and the Fairlane Woods promissory note acquired in August 1998. The Fairlane Woods promissory note was sold in October 1999. Capitalization of Fixed Assets and Community Improvements Our policy with respect to capital expenditures generally provides that only non-recurring expenditures are capitalized. Improvements and upgrades are capitalized only if the item: - exceeds $15,000; - extends the useful life of the asset; and - is not related to making an apartment home ready for the next resident. Effective January 1, 1999, we increased the West Coast portfolio's threshold for capitalization of community improvements from $5,000 per occurrence to $15,000 per occurrence. This increase was necessary in order to conform our West Coast portfolio to our company-wide threshold for capitalization of community improvements. Under this policy, virtually all capitalized costs are non-recurring, and recurring make-ready costs are expensed as incurred. Recurring make-ready costs include the following: - carpet and appliance replacements; - floor coverings; - interior painting; and - other redecorating costs. We capitalize purchases of personal property, such as computers and furniture, only if the item is a new addition and the item exceeds $2,500. Purchases of personal property made for replacement purposes are usually expensed. The application of these policies for the nine months ended September 30, 1999 resulted in non-revenue generating capitalized expenditures for Stabilized Communities of approximately $126 per apartment home. For the nine months ended September 30, 1999, we charged to maintenance expense, 25 including carpet and appliance replacements, a total of approximately $27,219,000 for Stabilized Communities or $1,003 per apartment home. We anticipate that capitalized costs per apartment home will gradually rise as the average age of our communities increases. Liquidity and Capital Resources Liquidity. A primary source of liquidity is our cash flows from operations. Operating cash flows have historically been determined by: - the number of apartment homes; - rental rates; - occupancy levels; and - our expenses with respect to these apartment homes. The timing, source and amount of cash flows provided by financing activities and used in investing activities are sensitive to the capital markets environment. Thus, changes in the capital markets environment will affect our plans for the undertaking of construction and development as well as acquisition activity. Cash and cash equivalents decreased from $9,458,000 at September 30, 1998 to $9,043,000 at September 30, 1999 due to a decrease in cash provided by financing activities, offset by an increase in cash provided by operating activities and a decrease in cash used in investing activities. Net cash provided by operating activities increased by $28,878,000 from $121,850,000 for the nine months ended September 30, 1998 to $150,728,000 for the nine months ended September 30, 1999. The increase is primarily due to the addition of the former Avalon communities as well as an increase in operating income from newly developed, redeveloped and existing Bay communities. Net cash used in investing activities decreased by $247,854,000 from $489,665,000 for the nine months ended September 30, 1998 to $241,811,000 for the nine months ended September 30, 1999. This decrease in expenditures reflects decreased acquisition activity and proceeds from the sale of nine communities in the nine months ended September 30, 1999, offset by increased construction and reconstruction activity. The decrease in acquisition activity is attributable to a shift in our investment focus away from acquisitions and towards higher yielding development opportunities, primarily in response to the lack of available properties that meet our yield requirements combined with a decrease in the availability of cost-effective capital. Net cash provided by financing activities decreased by $282,849,000 from $374,085,000 for the nine months ended September 30, 1998 to $91,236,000 for the nine months ended September 30, 1999. The decrease is primarily due to decreased borrowings under our unsecured facility, an increase in dividends paid as a result of additional common and preferred shares issued in connection with the merger, as well as reduced capital markets activity in response to market conditions. We regularly review our short and long-term liquidity needs and the adequacy of Funds from Operations, as defined below, and other expected liquidity sources to meet these needs. We believe our principal short-term liquidity needs are to fund: - normal recurring operating expenses; - development and redevelopment activity in which we are currently engaged; - debt service payments; - the distributions required with respect to our series of preferred stock; and 26 - the minimum dividend payments required to maintain our REIT qualification under the Internal Revenue Code of 1986. We anticipate that these needs will be fully funded from cash flows provided by operating activities. Any short-term liquidity needs not provided by current operating cash flows will be funded from our unsecured facility. We believe our principal long-term liquidity needs are the repayment of medium and long-term debt, as well as the procurement of long-term debt to refinance construction and other development related short-term debt. We anticipate that no significant portion of the principal of any indebtedness will be repaid prior to maturity. If we do not have funds on hand sufficient to repay our indebtedness, it will be necessary for us to refinance this debt. This refinancing may be accomplished through additional debt financing, which may be collateralized by mortgages on individual communities or groups of communities, by uncollateralized private or public debt offerings or by additional equity offerings. We also anticipate having significant retained cash flow in each year so that when a debt obligation matures, some or all of each maturity can be satisfied from this retained cash. Although we believe we are well positioned and that we will have the capacity to meet our long-term liquidity needs, we cannot assure that additional debt financing or debt or equity offerings will be available or, if available, that they will be on terms we consider satisfactory. Capital Resources. We intend to match the long-term nature of our real estate assets with long-term cost effective capital. We follow a focused strategy to help facilitate uninterrupted access to capital. This strategy includes: 1. Hiring, training and retaining associates with a strong resident service focus, which should lead to higher rents, lower turnover and reduced operating costs; 2. Managing, acquiring and developing institutional quality communities with in-fill locations that should provide consistent, sustained earnings growth; 3. Operating in markets with growing demand, as measured by household formation and job growth, and high barriers-to-entry. We believe these characteristics generally combine to provide a favorable demand-supply balance, which we believe will create a favorable environment for future rental rate growth while protecting existing and new communities from new supply. This strategy is expected to result in a high level of quality to the revenue stream; 4. Maintaining a conservative capital structure largely comprised of equity and with modest, cost-effective leverage. We generally avoid secured debt except in order to obtain low cost, tax-exempt debt. We believe that such a structure should promote an environment whereby current ratings levels can be maintained; 5. Following accounting practices that provide a high level of quality to reported earnings; and 6. Providing timely, accurate and detailed disclosures to the investment community. We believe these strategies provide a disciplined approach to capital access to help position AvalonBay to fund portfolio growth. Capital markets conditions have decreased our access to cost effective capital. See "Future Financing and Capital Needs" for a discussion of our response to the current capital markets environment. The following is a discussion of specific capital transactions, arrangements and agreements. 27 Unsecured Facility Our unsecured facility is furnished by a consortium of banks and provides $600,000,000 in short-term credit. We pay these banks an annual facility fee of $900,000 in equal quarterly installments. The unsecured facility bears interest at varying levels tied to the London Interbank Offered Rate based on ratings levels achieved on our senior unsecured notes and on a maturity selected by us. The current stated pricing is LIBOR plus 0.6% per annum. The unsecured facility matures in July 2001, however we have two options to extend the credit facility for one-year periods. Therefore, subject to certain conditions, we may extend the maturity to July 2003. A competitive bid option is available for up to $400,000,000. This option allows banks that are part of the lender consortium to bid to give us loans at a rate that is lower than the stated pricing provided by the unsecured facility. The competitive bid option may result in lower pricing if market conditions allow. Pricing under the competitive bid option resulted in average pricing of LIBOR plus .54% for balances most recently placed under the competitive bid option. At November 1, 1999, $170,500,000 was outstanding, $74,068,000 was used to provide letters of credit and $355,432,000 was available for borrowing under the unsecured facility. We intend to use borrowings under the unsecured facility for: - capital expenditures; - construction, development and redevelopment costs; - acquisitions of developed or undeveloped communities; - credit enhancement for tax-exempt bonds; and - working capital purposes. Interest Rate Protection Agreements We are not a party to any long-term interest rate agreements, other than interest rate protection and swap agreements on some of our tax-exempt indebtedness. We intend, however, to evaluate the need for long-term interest rate protection agreements as interest rate market conditions dictate, and we have engaged a consultant to assist in managing our interest rate risks and exposure. Financing Commitments/Transactions Completed We issued $150,000,000 of unsecured notes in July 1999 that bear interest at 7.50% per annum and will mature August 1, 2009. The net proceeds of approximately $148,400,000 were used to repay amounts outstanding under our unsecured facility. We completed a refinancing of approximately $18,755,000 of tax exempt bonds related to the Avalon Ridge community. These bonds bear a variable interest rate, will mature on May 1, 2026 and are credit enhanced by our credit enhancement facility with the Federal National Mortgage Association. Future Financing and Capital Needs As of September 30, 1999, we had 19 new communities under construction either by us or by unaffiliated third parties with whom we have entered into forward purchase commitments. As of September 30, 1999, a total estimated cost of $269,890,000 remained to be invested in these communities. In addition, we had a total of 10 communities that were under reconstruction, for which an estimated $52,008,000 remained to be invested as of September 30, 1999. Substantially all of the capital expenditures necessary to complete the communities currently under construction and reconstruction will be funded from: - the remaining capacity under our $600,000,000 unsecured credit facility; - the net proceeds from the sale of existing communities; 28 - retained operating cash; or - the issuance of debt or equity securities. We expect to continue to fund deferred development costs related to future developments from retained operating cash and borrowings under the unsecured facility. We believe that these sources of capital will be adequate to take the proposed communities to the point in the development cycle where construction can begin. We have observed and been impacted by a reduction in the availability of cost effective capital over the last twelve months. We cannot assure you that cost effective capital will be available to meet future expenditures required to begin planned reconstruction activity or the construction of the Development Rights. Before planned reconstruction activity or the construction of a Development Right begins, we intend to arrange adequate capital sources to complete these undertakings, although we cannot assure 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 pursuit costs and forego reconstruction activity which we believe would have increased revenues. We estimate that a significant portion of our liquidity needs will be met from retained operating cash and borrowings under our unsecured facility. To meet the balance of our liquidity needs, we will need to arrange additional capacity under our existing unsecured facility, sell additional existing communities and/or issue additional debt or equity securities. While we believe we have the financial position to expand our short term credit capacity and support our capital markets activity, we cannot assure that we will be successful in completing these arrangements, offerings or sales. The failure to complete these transactions on a cost-effective basis could have a material adverse impact on our operating results and financial condition, including the abandonment of deferred development costs and a resultant charge to earnings. During 1998, we launched an aggressive disposition program, to sell assets in markets where we have limited market presence. Under this program, we solicit competing bids from unrelated parties for these individual assets, and consider the sales price and tax ramifications of each proposal. In connection with this disposition strategy, we have disposed of thirteen communities and a participating mortgage note since January 1, 1999. The net proceeds from the sale of these assets were approximately $252,495,000. We intend to actively seek buyers for the remaining communities held for sale during the fourth quarter of 1999. However, we cannot assure that these assets can be sold on terms that we consider satisfactory. The remaining assets that have been identified for disposition include land, buildings and improvements and furniture, fixtures and equipment. Total real estate, net of accumulated depreciation, of all communities identified for sale at September 30, 1999 totaled $120,299,000. Certain individual assets are secured by mortgage indebtedness which may be assumed by the purchaser or repaid from our net sales proceeds. Our Condensed Consolidated Statements of Operations include net income from the communities held for sale of $1,953,000 for the three months ended September 30, 1999 and $5,237,000 for the nine months ended September 30, 1999. Our Condensed Consolidated Statements of Operations include net income from the communities held for sale for the three months ended September 30, 1998 of $828,000 and $1,123,000 for the nine months ended September 30, 1998, or $2,810,000 on a pro forma basis assuming the merger had occurred on January 1, 1998. Because the proceeds from the sale of communities are used initially to reduce borrowings under our unsecured facility, the immediate effect of a sale of a community is to reduce Funds from Operations. This is because the yield on a community that is sold, as measured against the net proceeds from the sale of the community, exceeds the interest rate on the borrowings under our unsecured facility. Therefore, changes in the number and timing of dispositions, and the redeployment of the resulting net proceeds, may have a material and adverse effect on our Funds from Operations. 29 Debt Maturities The following table details debt maturities for the next five years, excluding the unsecured facility: (Dollars in thousands) ALL-IN PRINCIPAL BALANCE OUTSTANDING INTEREST MATURITY ----------------------- ------ ------ COMMUNITY RATE DATE 12-31-98 9-30-99 1999 2000 - ---------------------------------------- -------- --------- -------- ------- ------ ------ TAX-EXEMPT BONDS: FIXED RATE Canyon Creek 6.48% Jun-25 $ 38,052 $ 37,667 $ 132 $ 554 Waterford 5.88% Aug-14 33,100 33,100 -- -- City Heights 5.80% Jun-25 20,496 20,323 60 250 CountryBrook 7.87% Mar-12 19,568 19,342 79 330 Villa Mariposa 5.88% Mar-17 18,300 18,300 -- -- Sea Ridge 6.48% Jun-25 17,261 17,086 60 251 Foxchase I 5.88% Nov-07 16,800 16,800 -- -- Barrington Hills 6.48% Jun-25 13,020 12,888 45 190 Rivershore 6.48% Nov-22 10,162 10,035 31 171 Foxchase II 5.88% Nov-07 9,600 9,600 -- -- Fairway Glen 5.88% Nov-07 9,580 9,580 -- -- Crossbrook 6.48% Jun-25 8,382 8,301 28 117 Larkspur Canyon 5.50% Jun-25 7,530 7,467 22 91 Avalon View 7.55% Aug-24 19,085 18,875 80 330 Avalon at Lexington 6.56% Feb-25 14,843 14,664 61 255 Avalon Knoll 6.95% Jun-26 13,755 13,625 45 187 Avalon at Dulles 7.04% Jul-24 12,360 12,360 -- -- Avalon Fields 7.57% May-27 11,881 11,791 47 147 Avalon at Hampton II 7.04% Jul-24 11,550 11,550 -- -- Avalon at Symphony Glen 7.06% Jul-24 9,780 9,780 -- -- Avalon West 7.73% Dec-36 8,681 8,645 14 53 Avalon Landing 6.85% Jun-26 6,809 6,743 23 95 --------------- ------------ --------- ---------- 330,595 328,522 727 3,021 VARIABLE RATE Avalon Devonshire Dec-25 27,305 27,305 -- -- Avalon at Fairway Hills I Jun-26 11,500 11,500 -- -- Laguna Brisas Mar-09 10,400 10,400 -- -- Avalon at Hampton I Jun-26 8,060 8,060 -- -- --------------- ------------ --------- ---------- 57,265 57,265 -- -- CONVENTIONAL LOANS: FIXED RATE $100 Million Senior Unsecured Notes 7.375% Sep-02 100,000 100,000 -- -- $100 Million Senior Unsecured Notes 6.625% Jan-05 100,000 100,000 -- -- $110 Million Senior Unsecured Notes 6.875% Dec-07 110,000 110,000 -- -- $50 Million Senior Unsecured Notes 6.25% Jan-03 50,000 50,000 -- -- $50 Million Senior Unsecured Notes 6.50% Jan-05 50,000 50,000 -- -- $50 Million Senior Unsecured Notes 6.625% Jan-08 50,000 50,000 -- -- $100 Million Senior Unsecured Notes 6.50% Jul-03 100,000 100,000 -- -- $150 Million Senior Unsecured Notes 6.80% Jul-06 150,000 150,000 -- -- $125 Million Medium Term Notes 6.58% Feb-04 -- 125,000 -- -- $150 Million Medium Term Notes 7.50% Jul-09 -- 150,000 -- -- Governor's Square 7.65% Aug-04 14,064 13,959 37 153 The Arbors 7.25% May-04 12,870 12,870 -- -- Gallery Place 7.31% May-01 11,486 11,327 55 230 Cedar Ridge 6.50% Jul-99 1,000 -- -- -- Avalon Walk II 8.93% Nov-04 12,762 12,599 58 241 Avalon Pines 8.00% Dec-03 5,329 5,255 38 121 --------------- ------------ --------- ---------- 767,511 1,041,010 188 745 VARIABLE RATE-NONE -- -- -- -- --------------- ------------ --------- ---------- TOTAL INDEBTEDNESS - EXCLUDING CREDIT FACILITY $ 1,155,371 $ 1,426,797 $ 915 $ 3,766 =============== ============ ========= ========== (Dollars in thousands) -------- ------- ------ ------------ COMMUNITY 2001 2002 2003 THEREAFTER - ---------------------------------------- -------- ------- ------ ------------ TAX-EXEMPT BONDS: FIXED RATE Canyon Creek $ 594 $ 637 $ 684 $ 35,066 Waterford -- -- -- 33,100 City Heights 268 288 308 19,149 CountryBrook 357 386 417 17,773 Villa Mariposa -- -- -- 18,300 Sea Ridge 270 289 310 15,906 Foxchase I -- -- -- 16,800 Barrington Hills 203 218 234 11,998 Rivershore 184 198 213 9,238 Foxchase II -- -- -- 9,600 Fairway Glen -- -- -- 9,580 Crossbrook 126 136 146 7,748 Larkspur Canyon 98 105 112 7,039 Avalon View 350 373 397 17,345 Avalon at Lexington 271 288 307 13,482 Avalon Knoll 200 214 230 12,749 Avalon at Dulles -- -- -- 12,360 Avalon Fields 157 169 180 11,091 Avalon at Hampton II -- -- -- 11,550 Avalon at Symphony Glen -- -- -- 9,780 Avalon West 57 61 65 8,395 Avalon Landing 101 108 116 6,300 -------------- -------------- ----------------- ------------------- 3,236 3,470 3,719 314,349 VARIABLE RATE Avalon Devonshire -- -- -- 27,305 Avalon at Fairway Hills I -- -- -- 11,500 Laguna Brisas -- -- -- 10,400 Avalon at Hampton I -- -- -- 8,060 --------------