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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1996
Commission file number 1-12452
AVALON PROPERTIES, INC.
(Exact name of registrant as specified in its charter)
-------------------
Maryland 06-1379111
(State or other jurisdiction of Employer
incorporation or organization) cation No.)
15 River Road
Wilton, Connecticut 06897
(Address of principal executive offices) - (Zip Code)
(203) 761-6500
(Registrant's telephone number, including area code)
-------------------
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 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 90 days.
Yes /X/ No / /
APPLICABLE ONLY TO CORPORATE
-----------------------------
Indicate the number of shares outstanding of each issuer's classes of common
stock as of the latest practicable date:
30,723,589 shares outstanding as of August 9, 1996.
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AVALON PROPERTIES, INC.
INDEX
<TABLE>
<S> <C> <C>
PART I FINANCIAL INFORMATION
Item 1 Financial Statements Page
----
Condensed Consolidated Balance Sheets as of June 30, 1996
and December 31, 1995 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Condensed Consolidated Statements of Operations for the three and six months
ended June 30, 1996 and 1995 . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Condensed Consolidated Statements of Cash Flows for the six months
ended June 30, 1996 and 1995 . . . . . . . . . . . . . . . . . . . . . . . . . . 3
Notes to Condensed Consolidated Financial Statements . . . . . . . . . . . . . . 4
Item 2 Management's Discussion and Analysis of Financial Condition
and Results of Operations . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
PART II OTHER INFORMATION
Item 1 Legal Proceedings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
Item 2 Changes in Securities . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
Item 3 Defaults upon Senior Securities . . . . . . . . . . . . . . . . . . . . . . . 22
Item 4 Submission of Matters to a Vote of Stockholders . . . . . . . . . . . . . . . 22
Item 5 Other Information. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22
Item 6 Exhibits and Reports on Form 8-K . . . . . . . . . . . . . . . . . . . . . . . 22
Signature . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
</TABLE>
<PAGE> 3
PART I FINANCIAL INFORMATION
ITEM 1 FINANCIAL STATEMENTS
AVALON PROPERTIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Dollars in thousands, except share data)
<TABLE>
<CAPTION>
ASSETS 06/30/96 12/31/95
----------- ----------
<S> <C> <C>
Real estate (Notes 1, 2, 3 and 7)
Land $138,098 $128,754
Buildings and improvements 575,575 521,082
Furniture, fixtures and equipment 22,917 19,369
----------- ----------
736,590 669,205
Less: accumulated depreciation (35,753) (27,059)
----------- ----------
700,837 642,146
Construction in progress (including land) 176,182 113,228
----------- ----------
TOTAL REAL ESTATE, NET 877,019 755,374
Cash and cash equivalents 2,113 1,801
Cash in escrow 4,045 3,940
Resident security deposits 5,274 4,193
Investments in joint ventures (Note 6) 2,114 1,735
Deferred financing and other costs, net (Note 2) 9,214 9,959
Deferred development costs, prepaid expenses and other assets (Note 2) 11,466 9,709
----------- ----------
TOTAL ASSETS $911,245 $786,711
=========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Unsecured facilities (Notes 1 and 4) $38,500 $58,000
Construction loans -- 10,477
Unsecured senior notes, 7-3/8% due 2002, net of unamortized discount 99,858 99,846
Mortgage notes payable (Note 7) 114,042 114,900
Unsecured tax-exempt bonds (Note 7) 14,130 14,130
Unsecured tax-exempt custodial receipts, net of unamortized discount 43,420 43,333
Payables for construction 11,717 9,710
Accrued expenses and other liabilities 13,370 11,522
Accrued interest payable 4,594 4,477
Resident security deposits 5,928 4,919
----------- ----------
TOTAL LIABILITIES 345,559 371,314
----------- ----------
Stockholders' equity
Preferred stock, $.01 par value; 20,000,000 shares authorized;
4,455,000 shares of 9% Series A cumulative redeemable
preferred stock issued and outstanding at June 30, 1996 45 --
Common stock, $.01 par value; 80,000,000 shares authorized; 30,716,089
and 28,373,065 shares issued and outstanding at June 30, 1996
and December 31, 1995, respectively 307 284
Additional paid-in capital 580,168 425,946
Distributions in excess of accumulated earnings (14,834) (10,833)
----------- ----------
STOCKHOLDERS' EQUITY 565,686 415,397
----------- ----------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $911,245 $786,711
=========== ==========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
1
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AVALON PROPERTIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Dollars in thousands, except share data)
<TABLE>
<CAPTION>
Three months ended Six months ended
---------------------------- -----------------------------
6-30-96 6-30-95 6-30-96 6-30-95
---------- ---------- ----------- ---------
<S> <C> <C> <C> <C>
Revenue:
Rental income $ 29,329 $ 22,539 $ 56,922 $ 43,954
Management fees 394 505 796 995
Other income 108 120 221 226
---------- ---------- ----------- ---------
Total revenue 29,831 23,164 57,939 45,175
---------- ---------- ----------- ---------
Expenses:
Operating expenses 11,234 8,518 22,168 16,579
Interest expense 1,663 2,292 4,246 4,333
Depreciation and amortization 5,045 4,089 9,699 7,793
General and administrative expenses 887 820 1,850 1,584
---------- ---------- ----------- ---------
Total expenses 18,829 15,719 37,963 30,289
---------- ---------- ----------- ---------
Equity in income of joint ventures (Note 6) 150 68 316 184
Interest income 208 241 446 489
Minority interest income (Note 3) 135 151 299 338
---------- ---------- ----------- ---------
Net income 11,495 7,905 21,037 15,897
Dividends attributable to preferred stock (2,516) -- (3,602) --
---------- ---------- ----------- ---------
Net income available to common stockholders $ 8,979 $ 7,905 $ 17,435 $ 15,897
========== ========== =========== =========
Net income per weighted average
common share outstanding (Note 2) $ 0.29 $ 0.28 $ 0.57 $ 0.56
========== ========== =========== =========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
2
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AVALON PROPERTIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands)
<TABLE>
<CAPTION>
Six months ended
-------------------------------
6-30-96 6-30-95
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<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 21,037 $ 15,897
Adjustments to reconcile net income to
cash provided by operating activities:
Depreciation and amortization 9,699 7,793
Increase (decrease) in resident
security deposits, net of related liability (72) 482
Increase in cash in escrow (105) (188)
Increase in prepaid expenses
and other assets (1,861) (1,202)
Increase in accrued expenses, other liabilities
and accrued interest payable 1,965 1,039
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Total adjustments 9,626 7,924
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Net cash provided by operating activities 30,663 23,821
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CASH FLOWS USED IN INVESTING ACTIVITIES:
Increase in construction payables 2,007 3,195
Purchase and development of real estate (124,711) (64,369)
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Net cash used in investing activities (122,704) (61,174)
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock, net 46,586 323
Issuance of preferred stock, net 107,581 --
Dividends paid (25,038) (20,417)
Borrowings under notes -- 50,237
Repayments of notes (6,340) (1,545)
Borrowings under unsecured facilities 101,000 95,125
Repayments of unsecured facilities (120,500) (83,895)
Borrowings under construction loans 31 3,615
Repayments of construction loans (10,508) (5,172)
Payments of deferred financing costs (459) (2,555)
------------- -------------
Net cash provided by financing activities 92,353 35,716
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Net increase (decrease) in cash 312 (1,637)
Cash and cash equivalents, beginning of period 1,801 2,862
------------- -------------
Cash and cash equivalents, end of period $ 2,113 $ 1,225
============= =============
Cash paid during period for interest, net of amount capitalized $ 3,415 $ 3,501
============= =============
</TABLE>
Non-cash investing and financing activities: $5,581 of debt was assumed
in connection with the Avalon Pines acquisition.
See accompanying notes to condensed consolidated financial statements.
3
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AVALON PROPERTIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except per share data)
1. Organization of the Company and Recent Developments
Avalon Properties, Inc. (the "Company") is a self-administered
and self-managed Real Estate Investment Trust ("REIT"), as defined
under the Internal Revenue Code of 1986, as amended, and was
incorporated under the General Corporation Law of Maryland on August
24, 1993. The Company is engaged principally in the development,
construction, acquisition and operation of residential apartment
communities in the Northeast and Mid-Atlantic regions of the United
States. Additionally, the Company provides management services for
communities owned by unrelated parties.
On April 5, 1996, the Company notified the ten-member bank
group that provides the Company's three-year revolving credit facility
(the "Unsecured Facility") that the Company would reduce the borrowing
capacity under the Unsecured Facility from $225,000 to $165,000.
On May 23, 1996, the Company purchased Avalon Pines (formerly
The Huntington), a 174 apartment home, luxury garden-style community
located in Virginia Beach, Virginia for $8,420. In connection with
this acquisition, the Company assumed a conventional loan with an
outstanding principal amount of approximately $5,600 and bearing an
8.0% annual fixed interest rate with a maturity date of December 2003.
This community was managed by the Company prior to its acquisition.
2. Summary of Significant Accounting Policies
Principles of Consolidation of the Company
The accompanying condensed consolidated financial statements
include the accounts of the Company and its wholly-owned partnerships
and subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation.
Real Estate
Buildings and improvements are recorded at cost and are
depreciated on a straight-line basis over their estimated useful lives
of 40 and 7 years, respectively. The Company's policy is to annually
assess any impairment in value by making a comparison of the current
and projected operating cash flows of each of its communities over its
remaining useful life, on an undiscounted basis, to the carrying
amount of each community. Such carrying amounts would be adjusted, if
necessary, to reflect an impairment in the value of the assets. The
cost of buildings and improvements include capitalized interest,
property taxes and insurance incurred during the construction period.
Furniture and fixtures are stated at cost and depreciated over their
estimated useful lives of seven years. Expenditures for maintenance
and repairs are charged to operations as incurred. Significant
renovations or betterments that exceed $15 and extend the economic
useful life of an asset are capitalized and depreciated over seven
years.
Deferred Financing and Development Costs
Deferred financing costs include fees and costs incurred to
obtain financings and are amortized on a straight-line basis over the
shorter of the term of the loan or the related credit enhancement
facility, if applicable. Fees and other incremental costs incurred in
developing new communities are capitalized as deferred development
costs and are included in the cost of the community when construction
commences. The accompanying condensed consolidated financial
statements include a charge to expense for unrecoverable deferred
development costs related to pre-development communities that may not
proceed to development.
4
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Net Income per Common Share
Net income per common share for the six months ended June 30,
1996 and 1995 is based upon 30,481,694 and 28,358,087 weighted average
number of shares of common stock outstanding, respectively. Net
income per common share for the three months ended June 30, 1996 and
1995 is based upon 30,715,884 and 28,359,284 weighted average number
of shares of common stock outstanding, respectively.
Interim Financial Statements
These condensed consolidated financial statements are
unaudited and were prepared pursuant to the rules and regulations of
the Securities and Exchange Commission. However, in the opinion of
the Company's management, all adjustments (consisting solely
of normal recurring adjustments) necessary for a fair presentation
of the financial statements have been included. The operating
results for these periods are not necessarily indicative of
the operating results that may be attained for a full fiscal year.
The accompanying condensed consolidated financial statements should be
read in conjunction with the consolidated financial statements
included in the Company's Annual Report on Form 10-K for the year
ended December 31, 1995.
3. Senior Participating Mortgage Note
The Company's ownership of the senior participating mortgage
note related to the Town Arbor Partnership ("Avalon Arbor") has been
accounted for as an investment in real estate. Minority interest
represents the excess of the interest income at the pay-rate on the
mortgage note over the cash flow from operations generated by the
community. This excess is committed to be funded by the minority
partners. The minority partners have funded their required capital
contributions of $4,832. At June 30, 1996, the partnership had $3,201
of cash from these contributions available to fund interest payments.
The note bears interest at 10.2%. Upon acquisition, the note was
restructured to provide for a 9% pay rate. The difference between the
stated interest and the pay rate is deferred interest and is added to
the principal. The loan also provides for contingent interest of 50%
of gross revenues, as defined, and is payable prior to any payments to
the partners. No contingent interest has been paid through June 30,
1996. The note entitles the holder to a 50% net residual value of the
property at maturity or upon prior disposition of the property. The
note may be prepaid subject to stipulated penalties.
4. Unsecured Facilities
The Company's Unsecured Facility is provided by a consortium
of ten banks ("Bank Group"), led by JP Morgan and Fleet Bank that
provides for $165,000 in short-term credit. The Unsecured Facility
expires in April 1998. As of June 30, 1996, approximately $64,015 of
available capacity was used to provide credit enhancement of
tax-exempt bonds and other letters of credit, and $8,000 was borrowed
under the facility. Accordingly, the balance that remains available
at June 30, 1996 to be drawn under the Unsecured Facility is $92,985.
See Note 7 for subsequent event information. The Unsecured Facility
bears interest based upon a LIBOR, Prime or CD rate election at the
Company's option. LIBOR pricing ranges from a spread over LIBOR of
150 basis points to 125 basis points, depending on the Company's
senior unsecured debt ratings. Current pricing level is 143.75 basis
points over LIBOR.
In January 1996, the Company arranged the two-year
supplemental unsecured facility provided by First Union National Bank
(the "Supplemental Unsecured Facility" and together with the
three-year revolving credit facility, the "Unsecured Facilities") in
the amount of $35,000. The Supplemental Unsecured Facility expires in
January 1998 and bears an interest rate of LIBOR plus 1.25%. At June
30, 1996, $4,389 of available capacity was used to provide letters of
credit, and $30,500 was borrowed under the Supplemental Unsecured
Facility. Accordingly, the balance that remains available at June 30,
1996 to be drawn under the Supplemental Unsecured Facility is $111.
The weighted average effective interest rates (excluding the cost of
unused fees) on borrowings under the Unsecured Facilities and prior
year's Unsecured Facility for the three and six months ended June 30,
1996 and 1995 were 7.5%, 8.5%, 7.3%
5
<PAGE> 8
and 8.2%, respectively. Including the cost of unused fees, the
weighted average effective interest rates on borrowings under the
Unsecured Facilities and prior year's Unsecured Facility for the three
and six months ended June 30, 1996 and 1995 were 9.7%, 8.6%, 8.8% and
8.4%, respectively.
The Company purchased an interest rate protection agreement
from Fleet Bank (the "Bank") that is separate from the Unsecured
Facility. This agreement, however, helps protect the Company from the
effect of rising interest rates under the Unsecured Facilities. The
agreement (purchased for $23 and maturing October 1, 1996) provides
that the Bank will pay the Company varying amounts if interest rates
rise above a pre-determined level based on a $50,000 principal amount.
This amount is an estimate and, accordingly, the level of interest
rate protection will vary as the actual balance outstanding under the
Unsecured Facility varies from the $50,000 principal amount. No
payments from the Bank were received by the Company during the six
months ended June 30, 1996 and 1995.
On May 30, 1995, the Company entered into an interest rate
protection agreement in the form of an accreting swap agreement (the
"Swap") with a triple A rated counterparty (the "Counterparty"). The
Swap specifies that, commencing October 15, 1995, the Company shall
pay the Counterparty a fixed rate of 5.89% on an initial principal
amount that began at $8,000 and increases in varying amounts to a
maximum of $45,000 in February 1997, at which time the agreement
terminates. The principal amount in effect at June 30, 1996 is
$32,000. In return, the Counterparty will pay to the Company a
variable rate payment equal to 30-day LIBOR on the respective
principal amounts. This Swap serves to fix the variable component of
the Company's total interest rate at 5.89% on the principal amounts
during the term of the agreement. Payments made by the Company under
this agreement totaled $33 and $46 during the three and six month
period ended June 30, 1996, respectively.
5. Stockholders' Equity
The following summarizes the changes in stockholders' equity
for the six months ended June 30, 1996:
<TABLE>
<CAPTION>
Distributions in
Additional excess of
Preferred Common paid-in accumulated
stock stock capital earnings Total
--------- ------ ---------- ---------------- ---------
<S> <C> <C> <C> <C> <C>
Stockholders' equity, 12-31-95 $0 $284 $425,946 $(10,833) $415,397
Net income 0 0 0 21,037 21,037
Dividends declared 0 0 0 (25,038) (25,038)
Issuance of common stock 0 23 46,686 0 46,709
Issuance of preferred stock 45 0 107,536 0 107,581
--------- ------ ---------- ---------------- ----------
Stockholders' equity, 6-30-96 $45 $307 $580,168 $(14,834) $565,686
========= ====== ========== ================ ==========
</TABLE>
6. Investments in Joint Ventures
At June 30, 1996, investments in joint ventures consist of a
50% general partnership interest in Falkland Partners, a 49% equity
interest in Avalon Run and an 86.5% effective equity interest in Town
Close Associates (the New Canaan development right). At December 31,
1995, investments in joint ventures also consisted of a 50% general
partnership interest in Evergreen Hamden Joint Venture. On February
15, 1996, the Company assigned its 50% partnership interest in
Evergreen Hamden Joint Venture to the institutional partner in the
joint venture. The following is a combined summary of the financial
position of these joint ventures for the periods presented:
6
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<TABLE>
<CAPTION>
6-30-96 12-31-95
---------- ---------
<S> <C> <C>
Assets:
Real estate, net $47,646 $60,821
Other assets 3,683 3,964
---------- ---------
Total assets $51,329 $64,785
========== =========
Liabilities and partners' equity:
Mortgage notes payable $26,000 $34,786
Other liabilities 964 3,686
Partners' equity 24,365 26,313
---------- ---------
Total liabilities and partners' equity $51,329 $64,785
========== =========
</TABLE>
The following is a combined summary of the operating results
of these joint ventures for the periods presented. At June 30, 1995,
the investments in joint ventures also includes a 50% general
partnership interest in Evergreen Hamden Joint Venture:
<TABLE>
<CAPTION>
Three months ended Six months ended
------------------------ -----------------------
6-30-96 6-30-95 6-30-96 6-30-95
---------- ---------- -------- ---------
<S> <C> <C> <C> <C>
Rental income $2,329 $2,213 $4,671 $4,386
Other income 14 19 28 34
Operating expenses (908) (837) (1,895) (1,641)
Mortgage interest expense (225) (288) (424) (523)
Depreciation and amortization (413) (427) (820) (851)
---------- ---------- -------- ---------
Net income $797 $680 $1,560 $1,405
========== ========== ======== =========
</TABLE>
7. Subsequent Events
On July 3, 1996, the Company purchased a 47.4 acre tract of
land in Nanuet, New York for $7,000. A new 504 apartment home
community commenced construction in the third quarter of 1996.
On July 23, 1996, the Company purchased Avalon Fairway Hills
II, two luxury, garden-style communities (formerly Greenbriar and
Fairway Pointe) located in Columbia, Maryland for $32,430. These
communities contain a total of 527 apartment homes and, along with
another Company-owned community, Avalon Meadows, will be operated as
two phases of one community.
On August 1, 1996, the Company completed a new tax-exempt
credit enhancement facility with the Federal National Mortgage
Association ("Fannie Mae") that will provide a long-term,
cost-effective credit enhancement source for the Company's current and
future tax-exempt bond portfolio. In connection with this facility,
the Company completed a refunding of $91,000 of its tax-exempt bond
portfolio. The facility will initially involve eleven communities,
seven that are financed with tax-exempt bonds and four unencumbered
communities that are pledged as additional collateral.
7
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PART I FINANCIAL INFORMATION (CONTINUED)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the
condensed consolidated financial statements and notes thereto included
elsewhere herein.
This Form 10-Q contains forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. Although the Company believes that the expectations
reflected in such forward-looking statements are based on reasonable
assumptions, the Company's actual results could differ materially from those
set forth in the forward-looking statements. The Company's ability to achieve
these projections is affected by continued market demand for the Company's new
apartment homes, availability of capital as well as other factors discussed
periodically in the Company's reports filed with the Securities and Exchange
Commission, including the report on Form 10-Q for the quarter ended March 31,
1996 and the Form 10-K for the year ended December 31, 1995. Those factors
that might cause such a difference include those set forth under the "Recent
Developments," "Liquidity and Capital Resources," "Business Conditions;
Inflation" and "Development Communities" sections of this Item 2.
RECENT DEVELOPMENTS
Acquisitions of Existing Communities. On May 23, 1996, the Company
purchased Avalon Pines (formerly The Huntington), a 174 apartment home, luxury
garden-style community located in Virginia Beach, Virginia for $8,420,000. In
connection with this acquisition, the Company assumed a conventional loan with
an outstanding principal amount of approximately $5,600,000 and bearing an 8.0%
annual fixed interest rate with a maturity date of December 2003. This
community was managed by the Company prior to its acquisition.
On July 23, 1996, the Company purchased Avalon Fairway Hills II, two
luxury garden-style communities (formerly Greenbriar and Fairway Pointe)
located in Columbia, Maryland for $32,430,000. These communities contain a
total of 527 apartment homes and, along with Avalon Meadows (a community owned
by the Company), will be operated as two phases of one community.
Land Acquisitions for New Development. On July 3, 1996, the Company
purchased a 47.4 acre tract of land in Nanuet, New York for $7,000,000. A new
504 apartment home community commenced construction in the third quarter of
1996.
Financing Activities. On April 5, 1996, the Company notified the
ten-member bank group that provides the Company's three-year credit facility
(the "Unsecured Facility") that the Company would reduce its capacity under
Unsecured Facility from $225,000,000 to $165,000,000.
On August 1, 1996, the Company completed a new tax-exempt credit
enhancement facility with the Federal National Mortgage Association ("Fannie
Mae") that will provide a long-term cost-effective credit enhancement source
for the Company's current and future tax-exempt bond portfolio. In connection
with this facility, the Company completed a refunding of $91,000,000 of its
tax-exempt bond portfolio. The facility will initially involve eleven
communities, seven that are financed with tax-exempt bonds and four
unencumbered communities that are pledged as additional collateral. The
closing of this tax-exempt bond credit enhancement facility increased the
balance available to be drawn under the Unsecured Facility.
GENERAL
The Company's operations consist of the development, construction,
acquisition and operation of apartment communities in the Mid-Atlantic and
Northeast regions of the United States. At June 30, 1996, the Company owned 39
completed and operating communities, a general partnership interest in two
other communities (a 50% interest in Falkland Chase and a 49% interest in
Avalon Run) and a 100% interest in a senior participating mortgage note secured
by another community (Avalon Arbor) which is accounted for as an investment in
real estate. The Company also has a fee simple ownership interest in eight
Development Communities (as hereinafter defined). One of the eight Development
Communities is or may become subject to an agreement to form a joint venture.
8
<PAGE> 11
The Company's real estate holdings consist exclusively of apartment
communities in various stages of the development cycle and can be divided into
three categories:
"Current Communities" are apartment communities where construction is
complete and the community has either reached stabilized occupancy or
is in the initial lease-up process. A "Stabilized Community" is a
Current Community that has completed its initial lease-up and has
attained a physical occupancy level of 95% or has been completed for
one year, whichever occurs earlier. An "Established Community" is a
Current Community that has been a Stabilized Community with stabilized
operating costs during both the current year and as well as the
beginning of the previous calendar year such that its year-to-date
operating results are comparable between periods.
"Development Communities" are communities that are under construction
and may be partially complete and operating and for which a final
certificate of occupancy has not been received.
"Development Rights" are development opportunities in the very
earliest phase of the development process for which the Company has an
option to acquire land or owns land to develop a new community and
where related pre-development costs have been incurred and capitalized
in pursuit of these new developments.
RESULTS OF OPERATIONS
The changes in operating results from period-to-period are primarily
the result of increases in the number of apartment homes owned due to the
development and acquisition of additional communities. Where appropriate,
comparisons are made on a weighted average basis for the number of occupied
apartment homes in order to adjust for such changes in the number of apartment
homes. For Stabilized Communities (excluding communities owned by 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 the operating results of the
Company for the three and six months ended June 30, 1996 and 1995.
Net income increased $5,140,000 (32.3%) to $21,037,000 from
$15,897,000 for the six months ended June 30, 1996 compared to the comparable
period of the preceding year. Net income increased $3,590,000 (45.4%) to
$11,495,000 from $7,905,000 for the three months ended June 30, 1996 compared
to the comparable period of the preceding year. The notable reasons for these
increases are additional operating income from communities developed or
acquired during 1995 and 1996 as well as growth in operating income from
existing communities.
Rental income increased $12,968,000 (29.5%) to $56,922,000 from
$43,954,000 for the six months ended June 30, 1996 compared to the comparable
period of the preceding year. Rental income increased $6,790,000 (30.1%) to
$29,329,000 from $22,539,000 for the three months ended June 30, 1996 compared
to the comparable period of the preceding year. Of the increase for the six
month period, $10,961,000 was due to newly completed or acquired communities
and $2,007,000 was due to rental rate growth from Established Communities that
were owned or completed throughout both periods.
Overall Portfolio - The $12,968,000 increase in rental income for the
six month period 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
8,744 apartment homes for the six months ended June 30, 1995 to 10,312
apartment homes for the six months ended June 30, 1996 as a result of
the development and acquisition of new communities. For the six
months ended June 30, 1996, the weighted average monthly revenue per
occupied apartment home increased $58 (7.0%) to $884 from $826
compared to the comparable period of the preceding year. For the
three months ended June 30, 1996, the weighted average monthly
9
<PAGE> 12
revenue per occupied apartment home increased $59 (7.1%) to $891 from
$832 compared to the comparable period of the preceding year.
Established Communities - For the six months ended June 30, 1996, the
weighted average monthly revenue per occupied apartment home increased
$42 (5.1%) to $873 from $831 compared to the comparable period of the
preceding year, and the average economic occupancy declined to 96.1%
from 96.5%. For the three months ended June 30, 1996, the weighted
average monthly revenue per occupied apartment home increased $43
(5.1%) to $881 from $838, and the average economic occupancy remained
unchanged at 96.4%. Accordingly, rental revenue from Established
Communities increased $2,007,000 (4.7%) and $1,089,000 (5.1%) for the
six month and three month periods ended June 30, 1996, respectively,
compared to the comparable periods of the preceding year. When
combined with other income from Established Communities, total revenue
from Established Communities increased 4.7% and 5.1% for the six month
and three month periods ended June 30, 1996, respectively, compared to
the comparable periods of the preceding year.
Management fees decreased $199,000 (20.0%) to $796,000 from $995,000
for the six months ended June 30, 1996 compared to the comparable period of the
preceding year. These fees decreased $111,000 (22.0%) to $394,000 from
$505,000 for the three months ended June 30, 1996 compared to the comparable
period of the preceding year. These decreases are primarily due to a decline
in the number of apartment homes managed for third-party owners in 1996. This
decline is due to the sale and cancellation of management contracts of some
third-party communities in 1995 and 1996 as well as the acquisition of two
Current Communities in the third quarter of 1995 and one Current Community in
the second quarter of 1996 that were previously managed by the Company for
third-party owners prior to their acquisition. The Company has decided not to
aggressively pursue new fee management business at this time. New fee
management business will be accepted in cases where it is profitable and where
it presents a possible acquisition opportunity. This creates a very selective
environment under which new fee management business will be added and will
likely result in an overall decline in this revenue source in the future.
Operating expenses, including write-off of deferred development costs,
increased $5,589,000 (33.7%) to $22,168,000 from $16,579,000 for the six months
ended June 30, 1996 compared to the comparable period of the preceding year.
These expenses increased $2,716,000 (31.9%) to $11,234,000 from $8,518,000 for
the three months ended June 30, 1996 compared to the comparable period of the
preceding year.
Overall Portfolio - The $5,589,000 increase for the six month period
is primarily due to the acquisition of new communities, as well as the
completion of Development Communities whereby maintenance, property
taxes, insurance and other costs are expensed as communities move from
the initial construction and lease-up phase to the operating phase.
The increased costs of snow removal and other weather related expenses
as a result of the severe winter weather during the first quarter of
1996 also contributed to the increase.
Established Communities - Operating expenses increased $974,000 (7.0%)
to $14,849,000 from $13,875,000 for the six months ended June 30, 1996
compared to the comparable period of the preceding year. Operating
expenses increased $365,000 (5.2%) to $7,391,000 from $7,026,000 for
the three months ended June 30, 1996 compared to the comparable period
of the preceding year. These increases were concentrated in the
maintenance category partially due to the severe winter weather
throughout the Northeast and Mid-Atlantic regions during the first
quarter of 1996 as well as increases in the property taxes for newly
stabilized development communities and marketing expenses.
Interest expense decreased $87,000 (2.0%) to $4,246,000 from
$4,333,000 for the six months ended June 30, 1996 compared to the comparable
period of the preceding year. Interest expense decreased $629,000 (27.4%) to
$1,663,000 from $2,292,000 for the three months ended June 30, 1996 compared to
the comparable period of the preceding year. These decreases are primarily
attributable to the sale of 2,227,000 shares of the Company's common stock and
the sale of 4,455,000 shares of the Company's preferred stock in the first
quarter of 1996, as the net cash proceeds from the sales were used to retire
indebtedness under the Company's Unsecured Facility, variable rate construction
loans and to repay the mortgage note encumbering the Avalon at Carter Lake
10
<PAGE> 13
community. Lower short-term interest rates under the Unsecured Facilities due
to structural rate reductions achieved as well as lower LIBOR rates also
contributed to the declines. Finally, an increase in capitalized interest due
to an increase in the number of apartment homes under construction is another
reason for the overall declines.
Depreciation and amortization increased $1,906,000 (24.5%) to
$9,699,000 from $7,793,000 for the six months ended June 30, 1996 compared to
the comparable period of the preceding year. Depreciation and amortization
increased $956,000 (23.4%) to $5,045,000 from $4,089,000 for the three months
ended June 30, 1996 compared to the comparable period of the preceding year.
These increases reflect additional depreciation expense for recently acquired
and developed communities and the amortization of the costs related to the
issuance of tax-exempt custodial receipts in May 1995 as well as the costs
related to the closing of the Unsecured Facility and the issuance of
$100,000,000 of unsecured senior notes in September 1995.
General and administrative expenses increased $266,000 (16.8%) to
$1,850,000 from $1,584,000 for the six months ended June 30, 1996 compared to
the comparable period of the preceding year. These expenses increased $67,000
(8.2%) to $887,000 from $820,000 for the three months ended June 30, 1996
compared to the comparable period of the preceding year. These increases are
primarily due to the introduction of the amended and restated 1996 and 1995
Equity Incentive Plan (and related legal and proxy costs) as well as staff
additions related to growth in the Company's portfolio and the implementation
of the Company-wide systems enhancement program.
Equity in income of joint ventures increased $132,000 (71.7%) to
$316,000 from $184,000 for the six months ended June 30, 1996 compared to the
comparable period of the preceding year. This income increased $82,000
(120.6%) to $150,000 from $68,000 for the three months ended June 30, 1996
compared to the comparable period of the preceding year. These increases are
principally the result of increased net income from the Falkland Partners joint
venture due to an increase in rental revenue as well as the income from the
Town Close Associates joint venture that was formed in June 1995.
FUNDS FROM OPERATIONS
The Company's management ("Management") generally considers Funds from
Operations ("FFO") to be an appropriate measure of the operating
performance of the Company. Management believes that in order to facilitate a
clear understanding of the operating results of the Company, Funds from
Operations should be examined in conjunction with the net income as presented
in the condensed consolidated financial statements included elsewhere in this
report. Funds from Operations is determined in accordance with a resolution
adopted by the Board of Governors of the National Association of Real Estate
Investment Trusts, Inc. ("NAREIT"). NAREIT adopted a revised definition of FFO
commencing with reporting periods ending after January 1, 1996 and is defined
as net income (loss) (computed in accordance with generally accepted accounting
principles), excluding gains (or losses) from debt restructuring and sales of
property, plus depreciation of real estate and after adjustments for
unconsolidated partnerships and joint ventures. The Company adopted the
revised definition commencing January 1, 1996.
The following table presents an analysis of Funds from Operations
under the revised and former definition for the periods presented:
11
<PAGE> 14
ANALYSIS OF FUNDS FROM OPERATIONS ($ IN 000'S)
<TABLE>
<CAPTION>
NEW DEFINITION
Three months ended Six months ended
--------------------------- ---------------------------
6-30-96 6-30-95 6-30-96 6-30-95
----------- ----------- ------------ -----------
<S> <C> <C> <C> <C>
NET INCOME AVAILABLE TO COMMON STOCKHOLDERS $ 8,979 $ 7,905 $ 17,435 $ 15,897
Depreciation:
Community level 4,426 3,615 8,464 6,917
Corporate level (FF&E) -- -- -- --
Amortization of deferred financing and other deferred costs -- -- -- --
Allocated share of joint venture depreciation 80 79 159 158
Allocated share of joint venture amortization -- -- -- --
----------- ----------- ------------ -----------
FUNDS FROM OPERATIONS $ 13,485 $ 11,599 $ 26,058 $ 22,972
=========== =========== ============ ===========
WEIGHTED AVERAGE SHARES OUTSTANDING 30,715,884 28,359,284 30,481,694 28,358,087
=========== =========== ============ ===========
OTHER CAPITALIZED EXPENDITURES AND OTHER INFORMATION
Capital expenditures:
Community level (1) $ 481 $ 174 $ 834 $ 474
Corporate level (2) $ 1,081 $ 146 $ 1,591 $ 317
Loan principal amortization payments $ 112 $ 129 $ 236 $ 255
Capitalized deferred financing costs (3) $ 345 $ 2,310 $ 459 $ 2,555
</TABLE>
<TABLE>
<CAPTION>
FORMER DEFINITION
Three months ended Six months ended
--------------------------- ---------------------------
6-30-96 6-30-95 6-30-96 6-30-95
----------- ----------- ------------ -----------
<S> <C> <C> <C> <C>
NET INCOME AVAILABLE TO COMMON STOCKHOLDERS $ 8,979 $ 7,905 $ 17,435 $ 15,897
Depreciation:
Community level 4,426 3,615 8,464 6,917
Corporate level (FF&E) 120 55 230 105
Amortization of deferred financing and other deferred costs 499 419 1,005 771
Allocated share of joint venture depreciation 80 79 159 158
Allocated share of joint venture amortization 2 2 4 4
----------- ----------- ------------ -----------
FUNDS FROM OPERATIONS $ 14,106 $ 12,075 $ 27,297 $ 23,852
=========== =========== ============ ===========
WEIGHTED AVERAGE SHARES OUTSTANDING 30,715,884 28,359,284 30,481,694 28,358,087
=========== =========== ============ ===========
OTHER CAPITALIZED EXPENDITURES AND OTHER INFORMATION
Capital expenditures:
Community level (1) $ 481 $ 174 $ 834 $ 474
Corporate level (2) $ 1,081 $ 146 $ 1,591 $ 317
Loan principal amortization payments $ 112 $ 129 $ 236 $ 255
Capitalized deferred financing costs (3) $ 345 $ 2,310 $ 459 $ 2,555
</TABLE>
- ----------------------
Footnotes to Analysis of Funds from Operations
(1) The Company expenses all recurring non-revenue generating community
expenditures, including carpet and appliance replacements. See
"Capitalization of Fixed Assets and Community Improvements."
(2) Represents the cost of new office leasehold improvements, office equipment
and computer costs related to the implementation of a company-wide systems
enhancement plan.
(3) Substantially all of the deferred financing costs incurred for the six
months ended June 30, 1996 relate to the closing of the Supplemental
Unsecured Facility and costs incurred to date on the credit enhancement
facility with Fannie Mae.
12
<PAGE> 15
CAPITALIZATION OF FIXED ASSETS AND COMMUNITY IMPROVEMENTS
The Company maintains a policy with respect to capital expenditures that
generally provides that only non-recurring expenditures are capitalized.
Community level 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. Under this policy,
virtually all capitalized costs are non-recurring, as recurring make ready
costs are expensed as incurred, including costs of carpet and appliance
replacements, floor coverings, interior painting and other redecorating costs.
Purchases of personal property (computers, furniture) are capitalized only if
the item is a new addition (i.e., not a replacement) and only if the item
exceeds $2,500. The application of these policies for the six months ended
June 30, 1996 resulted in capitalized expenditures for Stabilized Communities
of approximately $83 per apartment home. For the six months ended June 30,
1996, the Company charged to maintenance expense, including carpet and
appliance replacements, a total of approximately $5,016,000 for Stabilized
Communities or $498 per apartment home. Management anticipates that
capitalized costs per apartment home will gradually rise as the Company's
portfolio of communities matures. The table on the following page is a summary
of expenditures for both recurring maintenance costs (expensed) and community
upgrades (capitalized) for the six months ended June 30, 1996.
13
<PAGE> 16
EXPENDITURES FOR COMMUNITY AND CORPORATE UPGRADES (CAPITALIZED) AND COMMUNITY
MAINTENANCE (EXPENSED)
(Dollars in thousands, except per home data)
<TABLE>
<CAPTION> YTD 1996
YTD 1996 Capitalized Upgrades Maintenance Expensed
Number Balance at Balance at ----------------------------- ------------------------
Community of Homes 12/31/95 (1) 06/30/96 (1) Total Per Home Total Per Home
- --------------------------- ---------- ------------- ------------ ---------- --------------- ----------- ----------
<S> <C> <C> <C> <C> <C> <C> <C>
STABILIZED
- ----------
Avalon Park 372 $ 19,635 $ 19,682 $ 47 $126 $ 184 $ 495
Avalon at Ballston 344 36,617 36,682 65 189 149 433
Avalon at Gayton 328 9,715 9,800 85 259 169 515
Avalon at Symphony Glen 174 8,034 8,034 -- -- 117 672
Avalon at Hampton I 186 3,661 3,670 9 48 101 543
Avalon at Hampton II 231 8,093 8,113 20 87 100 433
Avalon at Dulles 236 11,540 11,569 29 123 156 661
Avalon Knoll 300 7,851 7,882 31 103 199 663
Avalon Lea 296 16,057 16,060 3 10 131 443
Avalon Meadows 192 9,281 9,316 35 182 113 589
Avalon Ridge 432 24,874 24,974 100 231 260 602
Longwood Towers 250 16,600 16,616 16 64 197 788
Avalon Farm 306 17,270 17,289 19 62 163 533
Avalon Brooke 280 13,258 13,305 47 168 95 339
Avalon Glen 238 30,066 30,075 9 38 125 525
Avalon Pavilions 932 56,418 56,454 36 39 307 329
Avalon Heights 238 12,217 12,244 27 113 133 559
Avalon View 288 17,725 17,756 31 108 175 608
4100 Massachusetts Ave. 308 34,859 34,865 6 19 176 571
Avalon at Carter Lake 259 11,413 11,482 69 266 165 637
Avalon Pointe 140 7,731 7,731 -- -- 100 714
Avalon Station 127 5,920 5,920 -- -- 62 488
Avalon Woods 268 8,237 8,237 -- -- 112 418
Avalon at Park Center 492 37,244 37,295 51 104 173 352
Avalon at Lexington 198 14,102 14,102 -- -- 113 571
Avalon Watch 512 28,215 28,299 84 164 249 486
Avalon Walk I 430 34,417 34,417 -- -- 121 281
Avalon Walk II 334 23,537 23,537 -- -- 110 329
Avalon Landing 158 9,256 9,256 -- -- 99 627
Avalon Birches 312 13,413 13,416 3 10 116 372
Avalon at Lake Arbor 209 11,895 11,899 4 19 142 679
Avalon at Decoverly 368 30,947 30,952 5 14 152 413
Avalon Summit West 125 6,764 6,764 -- -- 62 496
Avalon Towers 109 15,820 15,823 3 28 93 853
Avalon Green 105 12,017 12,017 -- -- 97 924
--------- ---------- --------- ------- ------ ------- ------
10,077 624,699 625,533 834 83 5,016 498
--------- ---------- --------- ------- ------ ------- ------
NEWLY ACQUIRED/DEVELOPED
- ------------------------
Avalon Fields 192 14,103 14,235 132 688 10 52
Avalon West 120 6,938 10,268 3,330 27,750 13 108
Avalon Station II 96 3,771 5,818 2,047 21,323 18 188
Avalon Summit East 120 6,351 9,039 2,688 22,400 32 267
Avalon Chase (2) 360 -- 23,608 23,608 65,578 230 639
Avalon Pines (2) 174 -- 8,567 8,567 49,236 12 69
--------- ---------- --------- ------- ------ ------- ------
1,062 31,163 71,535 40,372 38,015 315 297
--------- ---------- --------- ------- ------ ------- ------
NEW DEVELOPMENT
- ---------------
Avalon Cove 504 41,877 63,362 21,485 42,629 12 24
Avalon Gates 340 18,459 24,273 5,814 17,100 -- --
Avalon Grove 402 22,952 34,772 11,820 29,403 -- --
Avalon Crossing 132 4,465 9,112 4,647 35,205 1 8
Avalon Springs 102 4,237 7,809 3,572 35,020 -- --
Avalon Crescent 558 -- 22,164 22,164 39,720 -- --
Avalon Commons 312 -- 7,374 7,374 23,635 -- --
Avalon Run East 206 4,421 13,786 9,365 45,461 11 53
--------- ---------- --------- ------- ------ ------- ------
2,556 96,411 182,652 86,241 33,741 24 N/A
--------- ---------- --------- ------- ------ ------- ------
OTHER
Longwood Towers - Renovation -- 1,089 2,106 (5) 1,017 4,068 -- --
Avalon Arbor (3) 302 27,234 27,518 284 940 150 497
Corporate Level Expenditures -- 1,837 3,428 1,591 -- -- --
--------- ---------- --------- ------- ------ ------- ------
Grand Total 13,997(4) $ 782,433 $ 912,772 N/A N/A $ 5,505 N/A
========= ========== ========= ======= ====== ======= ======
</TABLE>
(1) Costs are presented in accordance with generally accepted accounting
principles ("GAAP") and exclude the step-up in basis attributed to
continuing investors.
(2) Acquired in 1996.
(3) Ownership through ownership of the Avalon Arbor mortgage note. See Note 3
to the condensed consolidated financial statements. Increases in
capitalized value relate primarily to accrued interest and do not reflect
capitalized community upgrades.
(4) Excludes Falkland Chase and Avalon Run, 876 apartment homes owned by joint
ventures in which the Company holds a 50% interest and 49% interest,
respectively.
(5) Represents renovation costs incurred.
14
<PAGE> 17
LIQUIDITY AND CAPITAL RESOURCES
Liquidity. A primary source of liquidity to the Company is cash flows
from operations. Operating cash flows have historically been determined by the
number of apartment homes, rental rates and the Company's expenses with respect
to such apartment homes. Cash flows used in investing activities and provided
by financing activities have historically been dependent on the number of
apartment homes under active development and construction or that were acquired
during any given period.
Cash and cash equivalents increased from $1,225,000 at June 30, 1995
to $2,113,000 at June 30, 1996 due to the excess of cash provided by operating
and financing activities over cash used by investing activities, primarily due
to the completion of the preferred stock offering in February 1996 and the
common stock offering in January 1996 as more fully described below:
Net cash provided by operating activities increased by
$6,842,000 from $23,821,000 to $30,663,000, primarily due to an
increase in operating income from newly developed and acquired
communities and Established Communities.
Net cash used in investing activities increased by $61,530,000
from $61,174,000 to $122,704,000, primarily due to an increase in the
number of apartment homes under development from an average of 1,950
in the first six month period of 1995 to 2,724 in 1996.
Net cash provided by financing activities increased by
$56,637,000 from $35,716,000 to $92,353,000, primarily due to the
excess net proceeds received from the completion of the sale of
2,227,000 shares of the Company's common stock and the issuance and
sale of 4,455,000 shares of the Company's Series A cumulative
redeemable preferred stock in 1996, offset by an increase in dividends
paid and repayments under the Unsecured Facility.
The Company regularly reviews short-term liquidity needs and the
adequacy of Funds from Operations and other expected liquidity sources to meet
these needs. The Company's primary short-term liquidity needs are to fund
normal recurring operating expenses, debt service payments and the minimum
dividend payment required to maintain the Company's REIT qualification under
the Internal Revenue Code. Management anticipates that these needs will be
fully funded from cash flows provided by operating activities. Normal
recurring expenditures for maintenance and repairs (including carpet and
appliance replacements) are funded from the operating cash flows of Stabilized
Communities and are expensed as incurred. Major upgrades or community
improvements are capitalized and depreciated over the expected economic useful
life of the item only if the expenditure exceeds $15,000 per occurrence and
only if the expenditure extends the economic useful life of the community.
Purchases of personal property (computers, furniture) are capitalized only if
the item is a new addition (i.e., not a replacement) and only if the item
exceeds $2,500. The application of these policies for the six month period
ended June 30, 1996 resulted in capitalized expenditures for Established
Communities of $83 per apartment home.
Capital Resources. To sustain the Company's active development and
acquisitions program, continuous access to the capital markets is required.
Management understands the need to match the long-term nature of its real
estate assets with long-term cost effective capital. The Company has
demonstrated regular and continuous access to the capital markets since its
initial public offering, raising approximately $445 million in six offerings
over a two-year period and over $300 million in the last fourteen months.
Management follows a focused strategy to help ensure uninterrupted access to
capital. This strategy includes:
1. Hire, train and retain associates with a strong resident service focus,
which leads to higher rents, lower turnover and reduced operation costs;
2. Manage, acquire and develop institutional quality communities with in-fill
locations that can provide consistent, sustained earnings growth;
3. Operate in markets with growing demand (as measured by household formation
and job growth) and high barriers to entry. These characteristics combine
to provide a favorable demand-supply balance, creating a
15
<PAGE> 18
favorable environment for future rental rate growth while protecting
existing and new communities from new supply. This strategy results in a
high level of quality to the revenue stream;
4. Maintain a conservative capital structure largely comprised of equity and
with modest, cost-effective leverage. Collateralized debt will generally
be avoided and used primarily to obtain low cost, tax-exempt debt. Such a
structure will promote an environment for ratings upgrades that can lead to
a lower cost of capital;
5. Timely, accurate and detailed disclosures to the investment community; and
6. Conservative accounting practices that provide a high level of quality to
reported earnings.
Management believes that following these strategies provides a
disciplined approach to capital access and will help ensure that capital
resources are available to fund portfolio growth.
The following is a discussion of specific capital transactions,
arrangements and agreements that are important to the capital resources of the
Company.
Unsecured Facilities
The Company's three-year term Unsecured Facility is provided by a
consortium of ten banks ("Bank Group") led by JP Morgan and Fleet Bank that
provides for $165,000,000 in short-term credit. At June 30, 1996, $8,000,000
was borrowed, $64,015,000 was used to provide credit enhancement of tax-exempt
bonds and other letters of credit and $92,985,000 was available for borrowing
under the Unsecured Facility. The Company will use borrowings under the
Unsecured Facility for capital expenditures, acquisitions of developed or
undeveloped communities, construction, development and renovation costs, credit
enhancement for tax-exempt bonds and for working capital purposes.
In January 1996, the Company arranged the two-year supplemental
unsecured facility provided by First Union National Bank (the "Supplemental
Unsecured Facility" and together with the Unsecured Facility, the "Unsecured
Facilities") in the amount of $35,000,000. The Supplemental Unsecured Facility
expires in January 1998 and bears an interest rate of LIBOR plus 1.25%. At
June 30, 1996, $4,389,000 of available capacity was used to provide letters of
credit, and $30,500,000 was borrowed under the Supplemental Unsecured Facility.
Accordingly, the balance that remains available at June 30, 1996 to be drawn
under the Supplemental Unsecured Facility is $111,000.
Interest Rate Protection Agreements
The Company purchased an interest rate protection agreement from Fleet
Bank that is separate from the Unsecured Facility. This agreement, however,
helps protect the Company from the effect of rising interest rates under the
Unsecured Facilities. The agreement (purchased in November 1993 for $23,500
and ending October 1, 1996) provides that, on the first of each month, if
30-day LIBOR rate exceeds 10%, the Bank will pay to the Company an amount equal
to the difference between the actual 30-day LIBOR rate and 10% on a $50,000,000
principal amount, divided by 12 months. No payments from Fleet Bank were
received by the Company during the six months ended June 30, 1996 and 1995.
The Company entered into another interest rate protection agreement in
the form of an accreting swap transaction ("the Swap") with a triple A rated
counterparty (the "Counterparty") on May 30, 1995. The Swap serves to
fix the floating component of the Company's total interest rate at 5.89% on
notional amounts which increase over time. On the 15th day of each month
during the term of the agreement, the Company will pay to the Counterparty
interest equal to 5.89% on the then principal amount in effect, divided by
twelve months. The Counterparty will pay to the Company interest equal to the
actual 30 day LIBOR rate on the principal amount then in effect, divided by
twelve months. Payments will be based on the following schedule:
16
<PAGE> 19
<TABLE>
<CAPTION>
Periods Covered Principal (Notional) Amount in Effect
--------------- -------------------------------------
<S> <C>
3/15/96 through 4/15/96 $25,000,000
4/15/96 through 5/15/96 $27,000,000
5/15/96 through 6/15/96 $30,000,000
6/15/96 through 7/15/96 $32,000,000
7/15/96 through 8/15/96 $35,000,000
8/15/96 through 9/15/96 $37,000,000
9/15/96 through 10/15/96 $40,000,000
10/15/96 through 11/15/96 $41,000,000
11/15/96 through 12/15/96 $43,000,000
12/15/96 through 1/15/97 $44,000,000
1/15/97 through 2/15/97 $45,000,000
</TABLE>
Payments made by the Company under the Swap totaled $33,000 and
$46,000 during the three and six month period ended June 30, 1996,
respectively.
The Company is not a party to any long-term interest rate agreements,
other than the interest rate protection agreements described above. The
Company intends, however, to evaluate the need for additional long-term
interest rate protection agreements as interest rate market conditions dictate
and has engaged a consultant to assist in managing the Company's interest rate
risks and exposure.
Financing Transactions Completed
On January 18, 1996, the Company completed the sale of 2,227,000
shares of its common stock to certain institutional investors under its
existing shelf registration statement at a purchase price of $21.25 per share,
for an aggregate purchase price of $47,323,750. The net cash proceeds from the
sale (approximately $46,600,000) were used to retire indebtedness under the
Company's Unsecured Facility.
On February 16, 1996, the Company completed an offering of 4,455,000
shares of 9% Series A cumulative redeemable preferred stock. The gross
proceeds of the offering totaled $111,375,000. The net cash proceeds from the
sale (approximately $107,600,000) were used to retire indebtedness under the
Company's Unsecured Facility, variable rate construction loans (see "Financing
Commitments" below) to repay the mortgage note encumbering the Avalon at Carter
Lake community and for general corporate purposes.
On August 1, 1996, the Company completed a new tax-exempt credit
enhancement facility with Fannie Mae that will provide a long-term
cost-effective credit enhancement source for the Company's current and future
tax-exempt bond portfolio. In connection with this facility, the Company
completed a refunding of $91,000,000 of its tax-exempt bond portfolio. The
facility will initially involve eleven communities, seven that are financed
with tax-exempt bonds and four unencumbered communities that are pledged as
additional collateral.
Registration Statements Filed in Connection with Financings
On January 30, 1996, the Company filed a shelf registration statement
with the Securities and Exchange Commission covering up to $327,670,000 of
securities, of which $27,670 was carried forward from the registration
statement filed on August 4, 1995. The registration statement provides for the
issuance of common stock, preferred stock, debt securities and warrants to
purchase common stock, and was used in connection with the February 16, 1996
offering of preferred stock. Accordingly, $216,295,000 remains available for
issuance under this filing.
Financing Commitments
The Company has received commitments for tax-exempt financing on the
Avalon Fields and Avalon West communities. The Community Development
Administration of Maryland has issued $12.7 million of thirty-year
17
<PAGE> 20
fixed-rate bonds, at an all-in rate of 7.55% related to Avalon Fields. The
proceeds will be made available to the Company after the completion of the
Avalon Fields community. The Massachusetts Housing Finance Agency ("MHFA") has
issued $8.8 million of tax-exempt bonds to finance the Avalon West community
upon completion at an all-in cost of 7.72% for 42 years. Management expects to
receive funding under both commitments during the third quarter of 1996.
The Company has arranged construction/permanent financing for two of
the Development Communities, Avalon Grove and Avalon Cove. Under the terms of
the financing, Marine Midland Bank ("MMB") will loan up to $35.5 million under
a twenty-four month construction loan bearing an interest rate at 1.50% over
30, 60, 90, 120 or 180-day LIBOR at the Company's election and will fund
approximately 71% of the total budgeted cost of the Avalon Grove community.
Upon completion of the community, the Company will form a joint venture with
Prudential Insurance Company of America ("Prudential"), whereby Prudential will
make an initial equity contribution in an amount equal to the lesser of $36.3
million or 75% of the actual development costs of the community. United Jersey
Bank ("UJB") will loan up to $45 million that will fund approximately 64% of
the total budgeted cost for the Avalon Cove community. This loan includes an
extension option that, at the election of the Company will extend the maturity
date of the loan until March 2002. Draws under the construction loan will
bear interest at 1.75% over 30-day LIBOR.
On February 22, 1996, outstanding balances of $4,744,258 and
$8,940,987 under the MMB (Avalon Grove) and UJB (Avalon Cove) construction
loans, respectively, were repaid from proceeds of the cumulative redeemable
preferred stock offering. Accordingly, the balances that remained available at
June 30, 1996 to be drawn under the MMB and UJB construction loans are
$30,755,742 and $36,059,013, respectively.
Future Financing Needs
Substantially all of the capital expenditures to complete the
communities currently under construction will be funded from proceeds of
permanent and construction financing commitments already in place or from
proceeds drawn under Unsecured Facilities, and little, if any, additional
capital sources are expected to be needed to complete the communities. Except
for Longwood Towers, the Company has no present plans for any major capital
improvements to any of the Current Communities. The renovation of Longwood
Towers is being funded by advances under the Unsecured Facilities, operating
cash flow or other financing sources over a three-year period. Management
expects to continue to fund deferred development costs related to future
developments from Funds from Operations and advances under the Unsecured
Facilities. The Company believes that these sources of capital are adequate to
take each of the proposed communities to the point in the development cycle
where construction can commence.
To continue to implement its growth strategy, the Company will pursue
additional capital as needed from sources that may include additional public or
private offerings of debt or equity securities, as well as bank or
institutional credit facilities. If all of the Development Rights proceed to
development, Management believes that additional debt or equity financing will
be needed. There can be no assurance that such additional debt financing or
debt offerings will be available on terms satisfactory to the Company.
Additionally, the company's Funds from Operations and the availability of
additional debt or equity financing can be adversely impacted by negative
changes in the economy, particularly as those changes may relate to real estate
assets or interest rates.
BUSINESS CONDITIONS; INFLATION
The Company's principal markets are characterized by high barriers to
entry and restrictive zoning which often takes years to obtain entitlements to
build an apartment community. For this reason, little new rental product has
been added in recent years. For the markets north of Maryland, Management is
not aware of any significant level of planned apartment construction starts.
For the Washington, D.C. metropolitan area, permitting activity has increased,
with 8,800 apartment homes in planning for delivery over the next 36-month
period. Estimated absorption during this period totals 12,000 apartment homes,
which would create a supply-demand balance that would be favorable for owners
of multifamily apartment communities.
18
<PAGE> 21
At June 30, 1996, Management had positioned the Company's portfolio of
Stabilized Communities, excluding communities owned by joint ventures, to a
physical occupancy level of 96.0%, and achieved an average economic occupancy
of 96.1% for the six months ended June 30, 1996. Average economic occupancy
for the portfolio for the six months ended June 30, 1995 was 96.5%. This
continued high occupancy was achieved through aggressive marketing efforts
combined with limited and targeted pricing adjustments. This positioning has
resulted in overall growth in rental revenue from Stabilized Communities
between periods. It is Management's strategy to maximize total rental revenue
through management of rental rates and occupancy levels. If market and
economic conditions change, Management may adopt a strategy of maximizing
rental rates, which could lead to lower occupancy levels, if Management
believes that this strategy will maximize rental revenue. Given the currently
high occupancy level of the portfolio, Management anticipates that, for the
foreseeable future, any rental revenue and net income gains from currently
owned and Stabilized Communities would be achieved primarily through higher
rental rates and enhanced operating cost leverage provided by high occupancy,
rather than through continued occupancy gains.
Substantially all of the leases at the Current Communities are for a
term of one year or less, which may enable the Company to realize increased
rents upon renewal of existing leases or commencement of new leases. Such
short-term leases generally minimize the risk to the Company of the adverse
effects of inflation, although as a general rule these leases permit residents
to leave at the end of the lease term without penalty. The Company's current
policy is to permit residents to terminate leases upon 60-days written notice
and payment of one month's rental as compensation for early termination.
Short-term leases combined with relatively consistent demand allow rents, and
therefore cash flow from the Company's portfolio of apartments, to provide an
attractive inflation hedge.
DEVELOPMENT COMMUNITIES
At June 30, 1996, eight Development Communities were under
construction. The total capitalized cost of these Development
Communities, when completed, is currently expected to be approximately $283.3
million. The Company intends to periodically update the projections in the
table on the following page to the extent Management believes there may be or
has been a material change in these projections on an aggregate basis. There
can be no assurance that the Company will complete the Development Communities,
that the Company's budgeted costs, leasing, start dates, completion dates,
occupancy or estimates of "EBITDA as % of Total Budgeted Cost" will be realized
or that future developments will realize comparable returns.
The Company maintains an active development capacity that Management
anticipates will provide a continuing source of portfolio growth. During the
lease-up period of the development process, the Company anticipates that
Development Communities will experience operating deficits for a three-to-six
month period until such time as the new community approaches stabilized
occupancy. The amount and duration of operating deficits to be incurred are
dependent upon a number of factors, including the size of the community, the
season in which leasing activity occurs and the extent to which delivery of new
apartment homes coincides with leasing and occupancy of these new apartment
homes (which is dependent on local market conditions). Any operating deficits
that occur during the initial lease-up phase of a new development are expensed
in accordance with GAAP. For the six months ended June 30, 1996, initial
lease-up deficits were not material to the financial position and operating
results of the Company.
The following page presents a summary of Development Communities:
19
<PAGE> 22
DEVELOPMENT COMMUNITIES SUMMARY
<TABLE>
<CAPTION>
Number of Budgeted Estimated Estimated EBITDA as %
Apartment Cost Construction Initial Completion Stabilization of Total
Homes ($ millions) Start Occupancy Date Date (1) Budgeted Cost (2)
--------- ------------ ----------- --------- ---------- ------------- -----------------
<S> <C> <C> <C> <C> <C> <C> <C>
Conventionally Financed
Avalon Gates
Trumbull, CT 340 $31.9 Q3 1994 Q2 1996 Q2 1997 Q3 1997 9.8%
Avalon Crossing
Rockville, MD 132 13.4 Q3 1995 Q2 1996 Q3 1996 Q4 1996 11.0%
Avalon Cove
Jersey City, NJ 504 70.5 (3) Q4 1994 Q2 1996 Q1 1997 Q2 1997 11.0%
Avalon Grove(4)
Stamford, CT 402 49.9 Q1 1995 Q3 1996 Q2 1997 Q3 1997 10.7%
Avalon Springs
Wilton, CT 102 15.0 Q3 1995 Q3 1996 Q4 1996 Q1 1997 11.6%
Avalon Run East
Lawrenceville, NJ 206 15.7 Q4 1995 Q2 1996 Q3 1996 Q4 1996
2 13.0%
Avalon Crescent
Tysons Corner, VA 558 56.6 Q1 1996 Q1 1997 Q4 1997 Q1 1998 10.1%
Avalon Commons
Smithtown, NY 312 30.3 Q1 1996 Q1 1997 Q3 1997 Q4 1997 10.0%
--------- ------------ -------------
2,556 $283.3 10.7%
========= ============ =============
</TABLE>
- ------------
The table above includes forward looking information within the meaning of the
Private Securities Litigation Reform Act of 1995 regarding the delivery,
occupancy and total budgeted cost of newly developed apartment homes. This
information is based on a series of projections, estimates and local experience
with construction practices that affect construction costs and completion as
well as market conditions that affect how quickly a community leases and at
what rental rates. The Company's ability to achieve these projections is
affected by continued market demand for the Company's new apartment homes as
well as other factors discussed periodically in the Company's reports filed
with the Securities and Exchange Commission including the report on Form 10-Q
for the quarter ended March 31, 1996 and the Form 10-K for the year ended
December 31, 1995. If the Company's performance differs materially from these
projections, actual results could vary significantly from the performance
projected in the forward looking information.
(1) Stabilized occupancy is defined as the first full quarter of 93% or
greater occupancy.
(2) Projected EBITDA represents gross potential earnings projected to be
achieved based on current rents prevailing in the respective
community's local market (without adjustment for potential growth
factors) and before interest, income taxes, depreciation, amortization
and extraordinary items, minus (a) economic vacancy and (b) projected
stabilized operating expenses. Total budgeted cost includes all
capitalized costs projected to be incurred to develop the respective
Development Community, including land acquisition costs, construction
costs, real estate taxes, capitalized interest and loan fees, permits,
professional fees, allocated development overhead and other regulatory
fees.
(3) In March 1996, the original contractor selected to build Avalon Cove
notified the Company that it was not able to complete the contract
within the guaranteed maximum price and subsequently defaulted on its
contractual obligations. The Company selected Tishman Construction
Company of New Jersey to be the replacement contractor, and the
replacement contractor is currently managing the construction
operations. Management expects that total actual costs to exceed the
current $70.5 million budget presented herein. The Company is
pursuing collection of any excess over the original guaranteed maximum
price contract, but no assurance can be provided that collection
efforts will be successful. Management believes that the excess cost,
even if no recovery from original contractor is made, will not have a
material adverse impact on the financial condition or results of
operations of the Company.
(4) Currently anticipated to be held by a joint venture.
20
<PAGE> 23
DEVELOPMENT RIGHTS
The Company is considering the development of 18 new apartment
communities. The status of these Development Rights range from land under
contract for which design and architectural planning has just commenced to land
under contract or owned by the Company with completed site plans and drawings
where construction can commence almost immediately. There can be no assurance
that the Company will succeed in obtaining zoning and other necessary
governmental approvals or the financing required to develop these communities,
or that the Company will decide to develop any particular community. Further,
there can be no assurance that construction of any particular community will be
undertaken or, if undertaken, will begin at the expected times assumed in the
financial projections or be completed at the total budgeted cost. Although
there is no assurance that all or any of these communities will proceed to
development, the successful completion of all of these communities would
ultimately add approximately 5,973 institutional-quality apartment homes to the
Company's portfolio. At June 30, 1996, the cumulative capitalized costs
incurred in pursuit of the 18 Development Rights were approximately $12.6
million, including the capitalized cost of $5.7 million related to the purchase
of land in New Canaan, Connecticut. Many of these apartment homes will offer
features like those offered by the communities currently owned by the Company.
The 18 Development Rights that the Company is currently pursuing are summarized
below.
DEVELOPMENT RIGHTS SUMMARY
<TABLE>
<CAPTION>
TOTAL
ESTIMATED BUDGETED
NUMBER OF COST
LOCATION HOMES ($ MILLIONS)
----------------- ----------- --------------
<S> <C> <C>
1. Nanuet, NY 504 $ 52.9
2. Fairfax, VA 234 23.0
3. Mamaroneck, NY 227 34.3
4. Melville-I, NY 154 16.6
5. Alexandria, VA 458 43.0
6. Freehold, NJ 456 37.9
7. Quincy, MA 171 15.1
8. New Canaan, CT(1) 104 23.2
9. Greenburgh, NY 794 101.9
10. Darien, CT 172 20.7
11. Fort Lee, NJ 350 43.0
12. Peabody, MA 434 35.5
13. Springfield, NJ 500 44.9
14. Hull, MA 244 20.2
15. Jersey City, NJ 220 39.2
16. New Rochelle, NY 350 50.2
17. Easton, CT 251 26.0
18. Melville-II, NY 350 35.0
---------- -----------
Total 5,973 $ 662.6
---------- -----------
</TABLE>
The table above includes forward looking information within the meaning of the
Private Securities Litigation Reform Act of 1995 regarding the total budgeted
cost of newly developed apartment homes. This information is based on a series
of projections, estimates and local experience with construction practices that
affect construction completion. The Company's ability to achieve these
projections is affected by continued market demand for the company's new
apartment homes, availability of capital as well as other factors discussed
periodically in the company's reports filed with the Securities and Exchange
Commission, including the report on Form 10-Q for the quarter ended March 31,
1996 and the Form 10-K for the year ended December 31, 1995. If the Company's
performance differs materially from these projections, actual results could
vary significantly from the performance projected in the forward looking
information. There can be no assurance that all or any of these communities
will proceed to development.
(1) Currently anticipated that the land seller will retain a minority
limited partner interest.
21
<PAGE> 24
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In March 1996, the original contractor, Procida Construction
Corporation, selected to build Avalon Cove notified the Company that it was not
able to complete the contract within the guaranteed maximum price and
subsequently defaulted on its contractual obligations The Company expects
total actual costs to exceed the current $70.5 million budget. In April 1996,
the Company filed a demand for arbitration with the American Arbitration
Association in New York against Procida Construction Corporation to
recover any excess over the original guaranteed maximum price contract and
instituted suit in the U.S. District Court to comply arbitration. No assurance
can be provided that collection efforts will be successful. Management does
not believe that the excess cost, even if no recovery from the original
contractor is made, will have a material adverse impact on the financial
condition or results of operations of the Company.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS
The Annual Meeting of Stockholders of Avalon Properties, Inc. was
held on May 7, 1996, at which meeting each of the five Directors then serving
and previously nominated for election as a Director was elected to serve until
the next Annual Meeting of Stockholders and until their respective successors
shall be duly elected and qualified. Of 30,715,566 shares outstanding and
eligible to vote at the Annual Meeting of Stockholders, 24,322,191 shares were
present in person or by proxy. Of the votes cast, 24,306,950 were cast in
favor of the reelection of Richard L. Michaux and authority was withheld as to
15,241 shares; 24,312,450 votes were cast in favor of the reelection of Charles
H. Berman and authority was withheld as to 9,741 shares; 24,311,950 votes were
cast in favor of the reelection of Michael A. Futterman and authority was
withheld as to 10,241 shares; 24,311,950 votes were cast in favor of the
reelection of Christopher B. Leinberger and authority was withheld as to 10,241
shares; and 24,310,950 votes were cast in favor of the reelection of Allen D.
Schuster and authority was withheld as to 11,241 shares.
Certain amendments to the Avalon Properties, Inc. 1995 Equity
Incentive Plan were approved by the Company's stockholders at the Annual
Meeting of Stockholders by the affirmative vote of 21,960,926 shares; 2,320,887
shares were voted against and 40,378 shares abstained from voting.
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Not applicable.
b) No reports of Form 8-K have been filed by the Company for
the period covered by this report.
22
<PAGE> 25
SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
AVALON PROPERTIES, INC.
Date: August 12, 1996 By /s/ THOMAS J. SARGEANT
-------------------------------------------
Thomas J. Sargeant, Chief Financial Officer,
Treasurer and Secretary
(Principal Financial and Accounting Officer)
23
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1996
<PERIOD-START> APR-01-1996
<PERIOD-END> JUN-30-1996
<CASH> 2,113
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 11,466
<PP&E> 912,772
<DEPRECIATION> 35,753
<TOTAL-ASSETS> 911,245
<CURRENT-LIABILITIES> 74,109
<BONDS> 271,450
0
45
<COMMON> 307
<OTHER-SE> 565,334
<TOTAL-LIABILITY-AND-EQUITY> 911,245
<SALES> 0
<TOTAL-REVENUES> 29,831
<CGS> 0
<TOTAL-COSTS> 16,279
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 1,663
<INCOME-PRETAX> 8,979
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 8,979
<EPS-PRIMARY> .29
<EPS-DILUTED> 0
</TABLE>
