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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 March 31, 1998
Commission file number 1-12452
AVALON PROPERTIES, INC.
(Exact name of registrant as specified in its charter)
----------
<TABLE>
<S> <C>
Maryland 06-1379111
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
</TABLE>
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 ISSUERS:
-------------------------------------
Indicate the number of shares outstanding of each issuer's classes of common
stock as of the latest practicable date:
43,144,853 shares outstanding as of May 11, 1998.
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AVALON PROPERTIES, INC.
INDEX
<TABLE>
<CAPTION>
PART I FINANCIAL INFORMATION
Item 1 Financial Statements Page
<S> <C> <C>
Condensed Consolidated Balance Sheets as of March 31, 1998
and December 31, 1997................................................................1
Condensed Consolidated Statements of Operations for the three months
ended March 31, 1998 and 1997........................................................2
Condensed Consolidated Statements of Cash Flows for the three months
ended March 31, 1998 and 1997........................................................3
Notes to Condensed Consolidated Financial Statements.................................4
Item 2 Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................................9
PART II OTHER INFORMATION
Item 1 Legal Proceedings...................................................................25
Item 2 Changes in Securities...............................................................25
Item 3 Defaults upon Senior Securities.....................................................25
Item 4 Submission of Matters to a Vote of Stockholders.....................................25
Item 5 Other Information...................................................................25
Item 6 Exhibits and Reports on Form 8-K....................................................25
Signatures..........................................................................26
</TABLE>
<PAGE> 3
Part I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
AVALON PROPERTIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Dollars in thousands, except per share data
<TABLE>
<CAPTION>
ASSETS 03/31/98 12/31/97
------------ ------------
<S> <S> <S>
Real estate
Land $ 261,150 $ 247,613
Buildings and improvements 1,190,347 1,120,505
Furniture, fixtures and equipment 43,090 39,830
--------- ---------
1,494,587 1,407,948
Less: accumulated depreciation (78,994) (69,932)
--------- ---------
Net operating real estate 1,415,593 1,338,016
Construction in progress (including land) 127,927 127,038
--------- ---------
TOTAL REAL ESTATE, NET 1,543,520 1,465,054
Cash and cash equivalents $ 3,497 $ 6,722
Cash in escrow 3,083 4,109
Resident security deposits 8,448 7,812
Investments in unconsolidated joint ventures 18,052 18,315
Deferred financing costs, net 9,891 10,022
Deferred development costs 8,218 7,207
Prepaid expenses and other assets 16,404 10,462
--------- ---------
TOTAL ASSETS $ 1,611,113 $ 1,529,703
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Unsecured Facilities $ 24,000 $ 71,500
Unsecured senior notes, net of unamortized discount 309,683 209,695
Notes payable 224,653 224,934
Payables for construction 13,624 16,311
Accrued expenses and other liabilities 18,561 15,466
Accrued interest payable 4,974 3,041
Resident security deposits 10,235 9,589
-------- --------
TOTAL LIABILITIES 605,730 550,536
-------- --------
Minority interest of unitholders in consolidated operating partnerships 16,167 18,157
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 (aggregate liquidation preference of $111,375) 45 45
4,300,000 shares of 8.96% Series B Cumulative Redeemable Preferred Stock
issued and outstanding (aggregate liquidation preference of $107,500) 43 43
Common Stock, $.01 par value; 80,000,000 shares authorized;
43,140,225 and 41, 975,240 shares issued and outstanding
at March 31, 1998 and December 31, 1997, respectively 431 420
Additional paid-in capital 1,021,302 987,540
Deferred compensation (5,967) (3,265)
Dividends in excess of accumulated earnings (26,638) (23,773)
--------- ---------
STOCKHOLDERS' EQUITY 989,216 961,010
--------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,611,113 $ 1,529,703
========= =========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
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AVALON PROPERTIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Dollars in thousands, except per share data)
<TABLE>
<CAPTION>
Three months ended
--------------------
3-31-98 3-31-97
------- -------
<S> <C> <C>
Revenue:
Rental income $ 55,941 $ 37,152
Management fees 375 255
Other income 136 120
------- -------
Total revenue 56,452 37,527
------- -------
Expenses:
Operating expenses 20,894 13,532
Interest expense 6,540 3,717
Depreciation and amortization 9,285 6,481
General and administrative expenses 1,400 912
------- -------
Total expenses 38,119 24,642
------- -------
Equity in income of unconsolidated joint ventures 651 1,042
Interest income 296 275
Minority interest (411) 94
------- -------
Income before extraordinary item 18,869 14,296
Extraordinary item -- (1,183)
------- -------
Net income 18,869 13,113
Dividends attributable to preferred stock (4,914) (4,914)
------- -------
Net income available to common stockholders $ 13,955 $ 8,199
======= =======
Per common share:
Income before extraordinary item - basic $ 0.33 $ 0.28
======= =======
Income before extraordinary item - diluted $ 0.33 $ 0.28
======= =======
Net income - basic $ 0.33 $ 0.24
======= =======
Net income - diluted $ 0.33 $ 0.24
======= =======
</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>
Three months ended
----------------------------
3-31-98 3-31-97
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<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 18,869 $ 13,113
Adjustments to reconcile net income to
cash provided by operating activities:
Depreciation and amortization 9,285 6,481
Equity in income of unconsolidated joint ventures 695 (17)
Amortization of deferred compensation 371 248
Income allocated to Minority Interest 417 --
Extraordinary item -- 1,183
Decrease in cash in escrow, net 1,036 386
Increase in prepaid expenses
and other assets (6,953) (1,763)
Increase in accrued expenses, other liabilities
and accrued interest payable 5,731 2,882
------- -------
Total adjustments 10,582 9,400
------- -------
Net cash provided by operating activities 29,451 22,513
------- -------
CASH FLOWS USED IN INVESTING ACTIVITIES:
Investments in unconsolidated joint ventures (432) (167)
Decrease in construction payables (2,687) (1,491)
Purchase and development of real estate (87,238) (90,775)
------- -------
Net cash used in investing activities (90,357) (92,433)
------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock, net 29,764 269
Dividends paid (21,734) (17,652)
Borrowings under notes payable 99,976 --
Repayments of notes payable (281) (321)
Borrowings under Unsecured Facilities 59,000 83,000
Repayments of Unsecured Facilities (106,500) (6,500)
Redemption of OP Units (1,990) --
Distributions to minority partners (417) --
Payments of deferred financing costs (137) (81)
------- -------
Net cash provided by financing activities 57,681 58,715
------- -------
Net decrease in cash (3,225) (11,205)
Cash and cash equivalents, beginning of period 6,722 14,241
------- -------
Cash and cash equivalents, end of period $ 3,497 $ 3,036
======= =======
Cash paid during period for interest, net of amount capitalized $ 4,189 $ 4,858
======= =======
</TABLE>
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 Acquisitions
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 high
barrier-to-entry markets of the United States. Additionally, the Company
provides management services for communities owned by unrelated parties.
During the three months ended March 31, 1998, the Company purchased
two apartment communities containing a total of 406 apartment homes for an
aggregate contract purchase price of approximately $27,625.
During the three months ended March 31, 1998, the Company purchased
three tracts of land containing a total of 71.6 acres from unrelated third
parties for an aggregate purchase price of approximately $6,871.
On January 9, 1998, the Company purchased a 5-story office building
located in Alexandria, Virginia for approximately $6,600. The Company has
relocated its Mid-Atlantic regional office to this location and it
occupies half of the 60,000 net rentable square feet of this office
building. The remaining 30,000 square feet is rented to unrelated third
party tenants at market rents.
On January 15, 1998, the Company entered into a letter of intent
with Prudential to purchase the residential component of the Prudential
Center in Boston Massachusetts. This property contains approximately 779
apartment homes and related underground parking. Negotiations are ongoing
and there can be no assurance that these negotiations will be successful.
On March 9, 1998, the Company entered into a definitive merger
agreement with Bay Apartment Communities, Inc. ("Bay"), pursuant to which
the Company will be merged into Bay, with Bay as the surviving entity (the
"Merger"). Under the terms of the agreement, each outstanding common share
of the Company will be exchanged for 0.7683 shares of common stock of Bay.
The holders of the Company's preferred stock will receive one share of
comparable Bay preferred stock for each share of comparable stock they
own. The Merger will be accounted for as a purchase of the Company by Bay.
The Merger is expected to close in June 1998 and is subject to the
approval of both companies' shareholders and other customary regulatory
conditions and there can be no assurance that the Merger will be
consummated and that the required conditions to closing will be met. The
surviving company, to be renamed Avalon Bay Communities, Inc., will (on a
pro forma basis as of April 20, 1998) own 141 apartment communities
containing 40,700 apartment homes (including those under construction) in
29 markets in 15 states and the District of Columbia.
On March 9, 1998, the Company announced that it has entered into a
definitive agreement to acquire selected assets on a presale basis from
Trammell Crow Residential - Pacific Northwest ("TCR-NW"). The presale
acquisitions are expected to be completed during the next 24 to 36 months.
The acquisitions include seven communities in the Seattle, Washington
market and one community in the
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<PAGE> 7
Portland, Oregon market for a total investment by the Company of up to
$279,000. Together, these eight communities are expected to contain 2,411
apartment homes. The Company will manage these communities after
acquiring ownership.
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 and the operating partnerships structured as DownREITs. 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 years and 7 years, respectively. If there is an event or change in
circumstance that indicates an impairment in the value of a community has
occurred, the Company's policy is to 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 the community. If such
carrying amounts are in excess of the estimated projected operating cash
flows of the community, the Company would recognize an impairment loss
equivalent to an amount required to adjust the carrying amount to its
estimated fair market value.
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 which extend the economic useful life of the
assets are capitalized.
The Company does not actively market any of its communities for
sale. In the event the Company decides to sell a community, it will be
reclassified as "held for sale" when the Company's Board of Directors
approves the decision to sell.
Deferred Financing and Development Costs
Deferred financing costs include fees and costs incurred to obtain
debt 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. Unamortized financing costs are written-off when
debt is retired before the maturity date. 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.
Recently Issued Accounting Pronouncement
On March 19, 1998, the Emerging Issues Task Force of the Financial
Accounting Standards Board reached a consensus opinion on issue #97-11,
"Accounting for Internal Costs Relating to Real Estate Property
Acquisitions" which requires that the internal costs of identifying and
acquiring an operating property should be expensed as incurred. The
adoption of this issue will have no impact on the Company's financial
condition or results of operations since the Company fully expenses these
costs.
Per Common Share Disclosures
Per common share disclosures for the three months ended March 31,
1998 and 1997 are based upon the following basic and diluted weighted
average number of shares of common stock outstanding:
5
<PAGE> 8
<TABLE>
<CAPTION>
Three months ended
--------------------------
03/31/98 03/31/97
------------ ------------
<S> <C> <C>
Weighted average common shares outstanding- basic 42,618,030 33,478,709
Shares issuable from assumed conversion of:
Common stock options 286,316 264,215
Operating partnership units 1,133 36
------------ ------------
Weighted average common shares outstanding- diluted 42,905,479 33,742,960
============ ============
</TABLE>
Operating partnerships units that were issued based on a common
stock price that was higher than the average price during the quarter are
excluded from the weighted average calculation, as inclusion of these
units would be anti-dilutive.
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 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 the 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,
1997.
Reclassifications
Certain reclassifications have been made to amounts in prior years'
financial statements to conform with current year presentations.
Specifically, overhead expenses related to acquisitions and
telecommunication costs previously classified as general and
administrative is now included in operating expenses.
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. The excess of the interest income at
the pay rate on the mortgage loan over the cash flow from operations
generated by the community is reflected in minority interest. This excess
is funded from payments drawn from an escrow account established from
contributions by the minority partners. At March 31, 1998, the
partnership had $2,934 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 March 31,
1998. 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 credit facility (the "Unsecured Facility")
is provided by a consortium of banks that provides for $175,000 in
short-term credit and is subject to an annual fee of $263. The Unsecured
Facility expires on March 31, 2000. As of March 31, 1998, approximately
$12,873 of available capacity was used to provide letters of credit and
$1,000 was borrowed under the facility.
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<PAGE> 9
Accordingly, the balance that remains available at March 31, 1998 to be
drawn under the Unsecured Facility is $161,127. The Unsecured Facility
bears interest based upon a LIBOR, Prime or CD rate election at the
Company's option. The current pricing is LIBOR plus .80%, provided,
however, that up to $75,000 can be competitively bid at lower pricing if
market conditions allow. Pricing may be adjusted higher or lower
depending on the Company's senior unsecured debt ratings.
The Company's supplemental unsecured credit facility (the
"Supplemental Unsecured Facility" and together with the Unsecured
Facility, the "Unsecured Facilities") is provided by First Union National
Bank in the amount of $50,000 and is subject to an annual facility fee of
$75. The Supplemental Unsecured Facility expires in March 2000 and bears
a current interest rate of LIBOR plus .80%. At March 31, 1998, $2,560 of
available capacity was used to provide letters of credit and $23,000 was
borrowed under the Supplemental Unsecured Facility. Accordingly, the
balance that remains available at March 31, 1998 to be drawn under the
Supplemental Unsecured Facility is $24,440.
The weighted average effective interest rates (excluding the cost
of facility fees) on borrowings under the Unsecured Facilities for the
three months ended March 31, 1998 and 1997 were 6.4% and 6.5%,
respectively. Including the cost of facility fees, the weighted average
effective interest rates on borrowings under the Unsecured Facilities for
the three months ended March 31, 1998 and 1997 were 7.6% and 7.0%,
respectively.
The Company, among other things, is subject to certain customary
covenants under the credit agreements for the Unsecured Facilities
including maintaining certain maximum leverage ratios, minimum fixed
charge coverage ratio, minimum unencumbered asset and equity levels and
is restricted from paying dividends in amounts that exceed 95% of the
Company's Funds from Operations, as defined.
5. Stockholders' Equity
The following summarizes the changes in stockholders' equity for
the three months ended March 31, 1998:
<TABLE>
<CAPTION>
Dividends
Additional in excess of
Preferred Common paid-in Deferred accumulated
Stock Stock capital compensation earnings Total
--------- ------- ---------- ------------ ------------ ---------
<S> <C> <C> <C> <C> <C> <C>
Stockholders' equity, 12-31-97 $ 88 $ 420 $ 987,540 $ (3,265) $ (23,773) $ 961,010
Net income - - - - 18,869 18,869
Dividends declared - - - - (21,734) (21,734)
Issuance of Restricted Common
Stock - 1 4,008 - - 4,009
Deferred compensation,
net of amortization - - - (2,702) - (2,702)
Issuance of Common Stock - 10 29,754 - - 29,764
--------- ------- ---------- ------------ ------------ ---------
Stockholders' equity, 3-31-98 $ 88 $ 431 $ 1,021,302 $ (5,967) $ (26,638) $ 989,216
========= ======= ========== ============ ============ =========
</TABLE>
6. Investments in Unconsolidated Joint Ventures
At March 31, 1998, investments in unconsolidated joint ventures
consist of a 50% general partnership interest in Falkland Partners, a 49%
equity interest in Avalon Run, an 86.5% effective equity interest in Town
Close Associates (the New Canaan Development Right) and a 50% general
partnership interest in Avalon Grove. The following is a combined summary
of the financial position of these joint ventures for the periods
presented:
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<PAGE> 10
<TABLE>
<CAPTION>
3-31-98 12-31-97
------- --------
<S> <C> <C>
Assets:
Real estate, net $ 97,500 $ 97,964
Other assets 4,533 10,790
------- --------
Total assets $ 102,033 $ 108,754
======= ========
Liabilities and partners' equity:
Mortgage notes payable $ 26,000 $ 26,000
Other liabilities 4,197 4,164
Partners' equity 71,836 78,590
------- --------
Total liabilities and partners' equity $ 102,033 $ 108,754
======= ========
</TABLE>
The following is a combined summary of the operating results of
these joint ventures for the periods presented:
<TABLE>
<CAPTION>
Three months ended
----------------------
3-31-98 3-31-97
------- --------
<S> <C> <C>
Rental income $ 4,764 $ 3,373
Other income 7 12
Operating expenses (1,289) (1,128)
Mortgage interest expense (197) (196)
Depreciation and amortization (753) (571)
------- --------
Net income $ 2,532 $ 1,490
======= ========
</TABLE>
7. Subsequent Events
On April 30, 1998, the Company purchased a 480 apartment home
community located in the St. Louis metropolitan area for $29,760.
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PART I FINANCIAL INFORMATION (CONTINUED)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
Certain statements in this Form 10-Q constitute "forward-looking
statements" as that term is defined under the Private Securities Litigation
Reform Act of 1995 (the "Reform Act"). The words "believe," "expect,"
"anticipate," "intend," "estimate," "assume" and other similar expressions
which are predictions of or indicate future events and trends and which do not
relate to historical matters identify forward-looking statements. In addition,
information concerning construction, occupancy and completion of Development
Communities and Development Rights (as hereinafter defined) and related cost
and EBITDA estimates, are forward-looking statements. Reliance should not be
placed on forward-looking statements because they involve known and unknown
risks, uncertainties and other factors, which are in some cases beyond the
control of the Company and may cause the actual results, performance or
achievements of the Company to differ materially from anticipated future
results, performance or achievements expressed or implied by such
forward-looking statements.
Certain factors that might cause such differences include, but are not
limited to, the following: the Company may not be successful in managing its
current growth in the number of apartment communities and the related growth of
its business operations; the Company's expansion into new geographic market
areas may not produce financial results that are consistent with its historical
performance; acquisitions of portfolios of apartment communities may result in
the Company acquiring communities that are more expensive to manage and
portfolio acquisitions may not be successfully completed, resulting in charges
to earnings; the Company may fail to secure or may abandon development
opportunities; construction costs of a community may exceed original estimates;
construction and lease-up may not be completed on schedule, resulting in
increased debt service expense and construction costs and reduced rental
revenues; occupancy rates and market rents may be adversely affected by local
economic and market conditions which are beyond management's control; financing
may not be available on favorable terms; the Company's cash flow may be
insufficient to meet required payments of principal and interest; and existing
indebtedness may not be able to be refinanced or the terms of such refinancing
may not be as favorable as the terms of existing indebtedness.
The following discussion should be read in conjunction with the condensed
consolidated financial statements and notes included in this report.
RECENT DEVELOPMENTS
Merger and Geographic Expansion. On March 9, 1998, the Company announced
that it has entered into a definitive merger agreement with Bay Apartment
Communities, Inc. ("Bay"), pursuant to which the Company will be merged into
Bay, with Bay as the surviving entity (the "Merger"). Under the terms of the
agreement, each outstanding common share of the Company will be exchanged for
0.7683 shares of common stock of Bay. The holders of the Company's preferred
stock will receive one share of comparable Bay preferred stock for each share
of comparable stock they own. The Merger will be accounted for as a purchase of
the Company by Bay. The Merger is expected to close in June 1998 and is subject
to the approval of both companies' shareholders and other customary regulatory
conditions and there can be no assurance that the Merger will be consummated
and that the required conditions to closing will be met. The surviving company,
to be renamed Avalon Bay Communities, Inc., will (on a pro forma basis as of
April 20, 1998) own 141 apartment communities containing 40,700 apartment homes
in 29 markets in 15 states and the District of Columbia.
On March 9, 1998, the Company announced that it has entered into a
definitive agreement to acquire selected assets on a presale basis from
Trammell Crow Residential - Pacific Northwest ("TCR-NW"). The presale
acquisitions are expected to be completed during the next 24 to 36 months. The
acquisitions include seven communities in the Seattle, Washington market and
one community in the Portland, Oregon market for a total investment by the
Company of up to $279,000,000. Together, these eight communities are expected
to contain 2,411 apartment homes. The Company will manage these communities
after acquiring ownership.
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<PAGE> 12
Possible Sale of Existing Communities. In connection with an agreement
executed by the Company in March 1998 which provided for the buyout of certain
limited partners in DownREIT V Limited Partnership, the Company granted such
partners, or their respective affiliates, the option to purchase two
communities owned by the Company and located in Michigan for an aggregate
purchase price of approximately $43,000,000. The purchase option expires on
July 20, 1998.
Acquisitions of Existing Communities. On January 7, 1998, the Company
purchased two apartment communities located in the Minneapolis metropolitan
area. Carriage Green, a 246 apartment home community located in Eagan,
Minnesota, and Summer Place, a 160 apartment home community located in
Plymouth, Minnesota, were acquired for $27,625,000.
On April 30, 1998, the Company purchased a 480 apartment home community
located in the St. Louis metropolitan area for $29,760,000.
Land Acquisitions for New Development. On February 26, 1998, the Company
purchased a 17.1 acre tract of land in Danbury, Connecticut for $2,100,000.
Construction of a new 268 apartment community, Avalon Valley, commenced in the
second quarter of 1998.
On February 27, 1998, the Company purchased a 32 acre tract of land in
Danbury, Connecticut for $3,271,000. Construction of a new 135 apartment home
community, Avalon Lake, commenced in the first quarter of 1998.
On March 25, 1998, the Company purchased a 22.5 acre tract of land in
Wilmington, Massachusetts for $1,500,000. Construction of a new 204 apartment
home community, Avalon Oaks, commenced in the second quarter of 1998.
GENERAL
The Company's operations consist of the development, construction,
acquisition and operation of apartment communities in the Mid-Atlantic,
Northeast and the Midwest regions of the United States. The Company also
recently announced plans to expand to certain high barrier-to-entry markets of
the Pacific Northwest. As of March 31, 1998, the Company held a fee simple
ownership interest in 55 operating communities (one of which, Avalon at Center
Place, is on land subject to a 149 year land lease), a general partnership
interest in three other operating communities (a 50% interest in Falkland
Chase, a 49% interest in Avalon Run, and a 50% interest in Avalon Grove), a 99%
general partner interest in two partnerships structured as DownREITs (Avalon at
Ballston Quincy and Avalon a Ballston Vermont, which are operated as a single
community, six communities acquired from Trammell Crow Residential - Midwest
and a single community located in Westmont, Illinois) and a 100% interest in a
senior participating mortgage note secured by another operating community
(Avalon Arbor) which is accounted for as an investment in real estate. The
Company also holds a fee simple ownership interest in twelve Development
Communities. The existing DownREITs have been structured so that substantially
all of the economic interests of these partnerships accrue to the benefit of
the Company. The Company believes that it is unlikely that the limited partners
in these partnerships will receive any financial return on their limited
partnership interests other than the stated distributions on their Units of the
Operating Partnerships ("Units") or as a result of the possible future
conversion of their Units into shares of common stock. The DownREIT
partnerships are consolidated for financial reporting purposes.
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
10
<PAGE> 13
attained a physical occupancy level of 94% 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 the current and 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 months ended March 31, 1998 and 1997.
Net income increased $5,756,000 (43.9%) to $18,869,000 for the three
months ended March 31, 1998 compared to $13,113,000 for the comparable period
of the preceding year. The primary reasons for this increase are additional
operating income from communities developed or acquired during 1998 and 1997,
as well as growth in operating income from existing communities.
Rental income increased $18,789,000 (50.6%) to $55,941,000 for the three
months ended March 31, 1998 compared to $37,152,000 for the comparable period
of the preceding year. Of the increase for the three month period, $1,536,000
relates to rental revenue increases from Established Communities and
$17,253,000 is attributable to the addition of newly completed or acquired
apartment homes.
Overall Portfolio - The $18,789,000 increase in rental income for the
three 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 12,252 apartment
homes for the three months ended March 31, 1997 to 18,082 apartment homes
for the three months ended March 31, 1998 as a result of the development
and acquisition of new communities. For the three months ended March 31,
1998, the weighted average monthly revenue per occupied apartment home
increased $114 (12.4%) to $1,030 compared to $916 for the comparable
period of the preceding year.
Established Communities - Rental revenue increased $1,536,000 due to
strengthening market conditions and the resulting impact on rents and
occupancy. Weighted average monthly revenue per occupied apartment home
increased $44 (4.9%) to $942 compared to $898 for the comparable period of
the preceding year. The average economic occupancy increased .2% from
95.5% to 95.7%.
11
<PAGE> 14
Management fees increased $120,000 (47.1%) to $375,000 for the three
months ended March 31, 1998 compared to $255,000 for the comparable period of
the preceding year. The increase for the three month period is due to certain
third-party management contracts acquired in connection with the purchase of a
portion of the Trammell Crow Residential - Midwest ("TCR/MW) portfolio in
December 1997.
Operating expenses increased $7,362,000 (54.4%) to $20,894,000 for
the three months ended March 31, 1998 compared to $13,532,000 for the comparable
period of the preceding year.
Overall Portfolio - This increase 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 stabilized operating phase.
Established Communities - Operating expenses increased $288,000 (2.9%) to
$10,123,000 for the three months ended March 31, 1998 compared to
$9,835,000 for the comparable period of the preceding year. The increase
was concentrated in the maintenance and property taxes categories.
Interest expense increased $2,823,000 (75.9%) to $6,540,000 for the three
months ended March 31, 1998 compared to $3,717,000 for the comparable period of
the preceding year. This increase is primarily attributable to the issuance of
$110,000,000 and $100,000,000 unsecured senior notes in December 1997 and
January 1998, respectively, as well as the assumption of approximately
$27,305,000 of variable tax-exempt debt in connection with the purchase of the
TCR/MW portfolio.
Depreciation and amortization increased $2,804,000 (43.3%) to $9,285,000
for the three months ended March 31, 1998 compared to $6,481,000 for the
comparable period of the preceding year. This increase reflects additional
depreciation expense for the increased number of acquired and developed
communities in 1998 and 1997.
General and administrative expenses increased $488,000 (53.5%) to
$1,400,000 for the three months ended March 31, 1998 compared to $912,000 for
the comparable period of the preceding year. This increase is primarily due to
staff additions related to the growth of the Company's portfolio and higher
compensation expense under the restricted stock grant program.
Equity in income of unconsolidated joint ventures decreased $391,000 to
$651,000 for the three months ended March 31, 1998 compared to $1,042,000 for
the comparable period of the preceding year. This decrease is principally the
result of the non-recurring income from the Avalon Grove joint venture in which
the Company was allocated 100% of the lease-up period income prior to the
formation of the partnership in December 1997.
Extraordinary items totaled $1,183,000 for the three months ended March
31, 1997 and reflects the write-off of unamortized deferred financing costs
associated with the early retirement of the Company's previous $165,000,000
unsecured credit facility.
12
<PAGE> 15
FUNDS FROM OPERATIONS
The Company's management ("Management") generally considers FFO to be an
appropriate measure of the operating performance of the Company because it
provides investors an understanding of the ability of the Company to incur and
service debt and to make capital expenditures. The Company believes that in
order to facilitate a clear understanding of the operating results of the
Company, FFO should be examined in conjunction with the net income as presented
in the condensed consolidated financial statements included elsewhere in this
report. FFO is determined in accordance with a resolution adopted by the Board
of Governors of NAREIT, and is defined as net income (loss) (computed in
accordance with generally accepted accounting principles ("GAAP"), excluding
gains (or losses) from debt restructuring and sales of property, plus
depreciation of real estate assets and after adjustments for unconsolidated
partnerships and joint ventures. FFO does not represent cash generated from
operating activities in accordance with GAAP and therefore should not be
considered an alternative to net income as an indication of the Company's
performance or to net cash flows from operating activities as determined by
GAAP as a measure of liquidity and is not necessarily indicative of cash
available to fund cash needs. Further, FFO as disclosed by other REITs may not
be comparable to the Company's calculation of FFO.
The following table presents an analysis of Funds from Operations for the
periods presented (dollars in thousands):
13
<PAGE> 16
ANALYSIS OF FUNDS FROM OPERATIONS
<TABLE>
<CAPTION>
Three months ended
----------------------------------------
3-31-98 3-31-97
------------------- ------------------
<S> <C> <C>
NET INCOME $ 18,869 $ 13,113
Depreciation (real estate related) 8,790 6,138
Joint venture adjustment 177 81
Extraordinary item -- 1,183
Preferred stock dividends (4,914) (4,914)
------------------- ------------------
FUNDS FROM OPERATIONS $ 22,922 $ 15,601
=================== ==================
WEIGHTED AVERAGE SHARES OUTSTANDING - BASIC 42,618,030 33,478,709
=================== ==================
WEIGHTED AVERAGE SHARES OUTSTANDING - DILUTED 42,905,479 33,742,960
=================== ==================
OTHER CAPITALIZED EXPENDITURES AND OTHER INFORMATION
Capital expenditures:
Community level (1) $ 522 $ 439
Corporate level (2) $ 1,732 $ 263
Loan principal amortization payments $ 281 $ 321
Capitalized deferred financing costs (3) $ 137 $ 81
</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) Primarily represents the cost of new offices in Alexandria, Chicago and
Minnepolis as well as new computer equipment to absorb additional
communities and to support the merged company.
(3) Substantially all of the deferred financing costs incurred for the three
months ended March 31, 1998 relate to the costs incurred on the closing of
the $100 million unsecured senior notes.
14
<PAGE> 17
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.
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 (such as computers and 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 three months ended March 31,
1998 resulted in non-revenue generating capitalized expenditures for Stabilized
Communities of approximately $522,000 or $29 per apartment home. For the three
months ended March 31, 1998, the Company charged to maintenance expense,
including carpet and appliance replacements, a total of approximately
$3,859,000 for Stabilized Communities or $213 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 three months ended March 31, 1998.
15
<PAGE> 18
EXPENDITURES FOR COMMUNITY AND CORPORATE UPGRADES (CAPITALIZED)
AND COMMUNITY MAINTENANCE (EXPENSED)
(Dollars in thousands, except per home data)
<TABLE>
<CAPTION>
Q1 1998 Capitalized Costs
------------------------------------
Acquisitions,
Construction Non-Revenue Q1 1998
and Revenue Generating Capx Maintenance Expensed
Number Balance at Balance at Generating ------------------- --------------------
Community of Homes 12-31-97 (1) 03/31/98(1) Costs Total Per Home Total Per Home
- ------------------------------- -------- ------------- ----------- ------------ ----- -------- ----- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
STABILIZED
Avalon Watch 512 $ 28,423 $ 28,464 $ -- $ 41 $ 80 $ 79 $ 154
Avalon Pavilions 932 56,693 56,717 -- 24 26 156 167
Avalon Glen 238 30,244 30,285 13 28 118 90 378
Avalon Walk I 430 34,587 34,618 -- 31 72 71 165
Avalon Walk II 334 23,740 23,764 -- 24 72 65 195
Avalon View 288 17,812 17,832 -- 20 69 87 302
Avalon Park 372 19,948 19,956 -- 8 22 79 212
Avalon at Ballston -
Washington Towers 344 36,893 36,908 -- 15 44 74 215
Avalon at Gayton 328 9,945 10,034 43 46 140 68 207
Avalon at Hampton I 186 3,764 3,824 60 -- -- 44 237
Avalon at Hampton II 231 8,229 8,298 69 -- -- 39 169
Avalon at Dulles 236 11,706 11,719 -- 13 55 84 356
Avalon Knoll 300 8,067 8,111 4 40 133 73 243
Avalon Lea 296 16,130 16,135 -- 5 17 61 206
Avalon at Fairway Hills I 192 9,454 9,456 2 -- -- 37 193
Avalon Ridge 432 25,269 25,278 9 -- -- 88 204
Avalon at Symphony Glen 174 8,166 8,174 1 7 40 47 270
Avalon at Park Center 492 37,658 37,658 -- -- -- 95 193
4100 Mass. Avenue 308 34,931 34,931 -- -- -- 112 364
Avalon Woods 268 8,319 8,324 -- 5 19 40 149
Avalon at Carter Lake 259 11,560 11,560 -- -- -- 60 232
Avalon Pointe 140 7,841 7,851 -- 10 71 29 207
Avalon Landing 158 9,303 9,303 -- -- -- 48 304
Avalon Birches 312 13,461 13,567 101 5 16 56 179
Avalon at Lake Arbor 209 11,950 11,959 -- 9 43 58 278
Avalon at Decoverly 368 31,151 31,154 -- 3 8 58 158
Avalon Summit 245 16,289 16,386 97 -- -- 50 204
Avalon Towers 109 15,943 15,943 -- -- -- 76 697
Longwood Towers 307 21,501 21,501 -- -- -- 80 261
Avalon Fields 192 14,298 14,305 -- 7 36 30 156
Avalon West 120 10,810 10,810 -- -- -- 33 275
Avalon Chase 360 23,661 23,661 -- -- -- 77 214
Avalon Pines 174 8,659 8,664 5 -- -- 28 161
Avalon at Fairway Hills II 527 33,924 33,985 61 -- -- 102 194
Avalon at Boulders 284 16,087 16,126 35 4 14 48 169
AutumnWoods 420 30,631 30,640 1 8 19 73 174
Avalon Run East 206 16,233 16,233 -- -- -- 23 112
Avalon Station 223 12,001 12,014 -- 13 58 55 247
Avalon Cove 504 90,291 90,347 56 -- -- 84 167
Avalon Crossing 132 13,778 13,867 89 -- -- 24 182
Avalon Springs 102 15,775 15,824 49 -- -- 35 343
Avalon at Ballston -
Vermont/Quincy 454 46,722 46,722 -- -- -- 114 251
Avalon at Center Place 225 26,424 27,063 523 116 516 59 262
Avalon at Providence Park 140 11,066 11,069 3 -- -- 36 257
Avalon Gates 340 35,369 35,426 57 -- -- 76 224
Avalon at Lexington 198 14,784 14,816 -- 32 -- 53 268
Avalon Green 105 12,439 12,447 -- 8 -- 51 486
Avalon Commons 312 31,732 32,442 710 -- -- 66 212
Avalon Crescent 558 56,625 56,752 127 -- -- 58 104
Avalon Court 154 17,231 17,605 374 -- -- 33 214
Summerplace (2) 160 -- 10,740 10,740 -- -- 33 206
Carriage Green (2) 246 -- 17,775 17,775 -- -- 45 183
Village Park of Westmont 400 25,743 25,747 4 -- -- 104 260
Village Park of Troy 544 31,290 31,290 -- -- -- 117 215
Avalon Heights 225 15,308 15,308 -- -- -- 45 200
Avalon at Willow Lake 230 14,944 15,231 287 -- -- 41 178
Avalon at Geist 146 12,080 12,178 98 -- -- 26 178
Avalon at Montgomery 264 15,153 15,624 471 -- -- 40 152
Avalon Devonshire 498 36,143 36,679 536 -- -- 113 227
Avalon at Danada Farms 295 37,571 37,766 195 -- -- 60 203
Avalon at Stratford Green 192 21,572 21,687 115 -- -- 39 203
Aspen Meadows 214 12,435 12,435 -- -- -- 34 159
-------- ---------- ---------- ------- ----- ------ ----- --------
18,144 1,329,756 1,362,988 32,710 522 29 3,859 213
-------- ---------- ---------- ------- ----- ------ ----- --------
</TABLE>
16
<PAGE> 19
EXPENDITURES FOR COMMUNITY AND CORPORATE UPGRADES
(CAPITALIZED) AND COMMUNITY MAINTENANCE (EXPENSED) - CONTINUED
(Dollars in thousands, except per home data)
<TABLE>
<CAPTION>
Number Balance at Balance at
Community of Homes 12-31-97 (1) 3-31-98 (1)
- --------------------------------------- ---------- ------------- -------------
<S> <C> <C> <C>
NEW DEVELOPMENTS 3,029 154,762 205,079
- ---------------- ---------- ------------- -------------
OTHER
Longwood Towers - Renovation -- 15,876 17,987
Avalon Arbor (4) 302 28,461 28,597
Corporate Level Expenditures -- 6,131 7,863
========== ============= =============
Grand Total 21,475 (5) 1,534,986 1,622,514
========== ============= =============
<CAPTION>
Q1 1998 Capitalized Costs
---------------------------------------------
Acquisitions, Non-Revenue Q1 1998
Construction Generating Capx Maintenance Expensed
and Revenue ------------------------- --------------------------
Community Generating Costs Total Per Home Total Per Home
- --------------------------------------- ----------------- ------------ ---------- ------------- -----------
<S> <C> <C> <C> <C> <C>
NEW DEVELOPMENTS 50,317 -- -- 83 N/A
- ---------------- ----------------- ------------ ---------- ------------- -----------
OTHER
Longwood Towers - Renovation 2,111 (3) -- -- -- --
Avalon Arbor (4) 136 -- N/A 85 281
Corporate Level Expenditures 1,732 -- N/A -- --
================= ============ ========== ============= ===========
Grand Total 87,006 522 N/A 4,027 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 1998.
(3) Represents renovation costs incurred.
(4) Ownership through ownership of the Avalon Arbor mortgage note. See Note 3
to the unaudited condensed consolidated financial statements. Increases in
capitalized value relate primarily to accrued interest and do not reflect
capitalized community upgrades.
(5) Excludes Falkland Chase, Avalon Run and Avalon Grove, a total of 1,278
apartment homes owned by joint ventures in which the Company holds a 50%
interest, 49% interest and 50% interest, respectively.
17
<PAGE> 20
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, occupancy levels and the Company's
expenses with respect to such apartment homes. The 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 $3,036,000 at March 31, 1997 to
$3,497,000 at March 31, 1998 due to the excess of cash provided by financing
and operating activities over cash flow used in investing activities.
Net cash provided by operating activities increased by $6,938,000 from
$22,513,000 to $29,451,000 primarily due to an increase in operating
income from newly developed and acquired communities and Established
Communities.
Cash used in investing activities decreased by $2,076,000 from
$92,433,000 to $90,357,000 primarily due to the acquisition of two
communities for $45,698,000 in 1997 compared to the acquisition of two
communities for $27,625,000 in 1998, offset by an increase in construction
costs.
Net cash provided by financing activities decreased by $1,034,000 from
$58,715,000 to $57,681,000 primarily due to an increase in dividends paid
and a decrease in borrowings under the Unsecured Facilities, offset by the
net proceeds received from the sale of 923,856 shares of the Company's
common stock and the issuance of $100,000,000 unsecured senior notes in
January 1998.
The Company regularly reviews its short-term liquidity needs and the
adequacy of Funds from Operations and other expected liquidity sources to meet
these needs. The Company believes that its principal 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. Any
short-term liquidity needs not provided by current operating cash flows would
be funded from the Company's Unsecured Facilities. 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 (such as computers and 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
three month period ended March 31, 1998 resulted in capitalized expenditures
for Stabilized Communities of $29 per apartment home.
The Company's 7-3/8%, 6-7/8% and 6-5/8% unsecured senior notes will
mature in 2002, 2007 and 2005, respectively. Additionally, mortgage
indebtedness on the Avalon Pines and Avalon Walk II apartment communities will
mature in 2003 and 2004, respectively. Since Management anticipates that no
significant portion of the principal of such indebtedness will be repaid prior
to maturity and if Company does not have funds on hand sufficient to repay such
indebtedness, it will be necessary for the Company to refinance this debt. Such
refinancing could 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. There can be no assurance that such additional
debt financing or debt offerings will be available on terms satisfactory to the
Company. Currently, no other permanent indebtedness will require balloon
payments prior to the year 2005.
18
<PAGE> 21
Capital Resources. To sustain the Company's active development and
acquisitions program, continuous access to the capital markets is required.
Management intends 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 $1.1 billion and over $345 million in the last 5 months.
Management follows a focused strategy to help facilitate uninterrupted access
to capital. This strategy includes:
1. Hire, train and retain associates with a strong resident service focus, which
should lead to higher rents, lower turnover and reduced operating costs;
2. Manage, acquire and develop institutional quality communities with in-fill
locations that should 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, which the Company believes 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. Maintain a conservative capital structure largely comprised of equity and
with modest, cost-effective leverage. Secured debt will generally be avoided
and used primarily to obtain low cost, tax-exempt debt. Such a structure
should promote an environment for ratings upgrades that can lead to a lower
cost of capital and increased financial flexibility;
5. Accounting practices that provide a high level of quality to reported
earnings; and
6. Timely, accurate and detailed disclosures to the investment community;
Management believes that these strategies provide a disciplined
approach to capital access that is expected to 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 unsecured credit facility (the "Unsecured Facility") is
provided by a consortium of banks that provides for $175,000,000 in short-term
credit and is subject to an annual facility fee of $262,500. The Unsecured
Facility expires in March 2000. Borrowings under the Unsecured Facility bear an
interest rate of .80% over LIBOR. A competitive bid option is available for up
to $75,000,000 which may result in lower pricing if market conditions allow. At
March 31, 1998, $1,000,000 was borrowed, $12,873,000 was used to provide
letters of credit and $161,127,000 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.
The Company's supplemental unsecured credit facility (the
"Supplemental Unsecured Facility" and together with the Unsecured Facility, the
"Unsecured Facilities") is provided by First Union National Bank in the amount
of $50,000,000 and is subject to an annual fee of $75,000. The Supplemental
Unsecured Facility expires in March 2000 and bears an interest rate of LIBOR
plus .80%. At March 31, 1998, $2,560,000 of available capacity was used to
provide letters of credit, and $23,000,000 was borrowed under the Supplemental
Unsecured Facility. Accordingly, the balance that remains available at March
31, 1998 to be drawn under the Supplemental Unsecured Facility is $24,440,000.
19
<PAGE> 22
Interest Rate Protection Agreements
In connection with the refinancing of the tax-exempt bonds related to
the Avalon Lea and Avalon Ridge communities in October 1997, the Company
purchased an interest rate cap agreement for $101,000. This agreement
terminates October 31, 2002 and serves to place a ceiling on the interest rate
on the bonds at 6.9%.
The Company is not a party to any long-term interest rate agreements,
other than the interest rate protection agreement described above. The Company
intends, however, to evaluate the need for 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 Commitments/Transactions Completed
On January 22, 1998, the Company completed a $100,000,000 offering of
unsecured senior notes. The notes bear an interest rate at 6.625% payable
semi-annually on January 15 and July 15 and will mature on January 15, 2005.
The notes were sold at a price of 99.976% par value to yield 6.629% to maturity
or a 111 basis point spread over the then-prevailing 7-year U.S. Treasury Note
rate. The Company used the net proceeds of approximately $99,400,000 to repay
amounts outstanding under the Unsecured Facilities.
On January 27, 1998, the Company completed the sale of 923,856 shares
of Common Stock to The Prudential Insurance Company of America under its
existing shelf registration statement at a net purchase price of $29.09 per
share. The net proceeds of approximately $26,872,000 were used to retire
indebtedness under the Unsecured Facilities.
Future Financing Needs
Substantially all of the capital expenditures to complete the
communities currently under construction will be funded from the Unsecured
Facilities and/or issuance of debt or equity securities. 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 expected
to be completed by the end of June 1998 and is being funded by advances under
the Unsecured Facilities, operating cash flow or other financing sources.
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.
Management anticipates that available borrowing capacity under the
Unsecured Facilities and Funds from Operations will be adequate to meet future
expenditures required to commence construction of each of the Development
Rights. In addition, the Company currently anticipates funding construction of
some (but not all) of the Development Rights under the expected remaining
capacity of the Unsecured Facilities. However, before the construction of a
Development Right commences, the Company intends, if necessary, to issue
additional equity or debt securities, arrange additional capacity under the
Unsecured Facilities or future credit facilities or obtain additional
construction loan commitments not currently in place to ensure that adequate
liquidity sources are in place to fund the construction of a Development Right,
although no assurance can be given in this regard.
The table on the following page summarizes debt maturities for the
next five years (excluding the Unsecured Facilities):
20
<PAGE> 23
AVALON PROPERTIES, INC.
DEBT MATURITY SCHEDULE
(Dollars in thousands)
<TABLE>
<CAPTION>
Balance Outstanding at
--------------------------------
All-in Maturity
Community Interest Rate Date 12-31-97 3-31-98
- ----------------------------- -------------- ----------- -------------- ----------------
<S> <C> <C> <C> <C>
Tax-Exempt Bonds:
Fixed Rate
* Avalon Lea 8.02% Jun-2026 $ 16,835 $ 16,835
* Avalon Ridge 8.00% Jun-2026 26,815 26,815
* Avalon at Dulles 7.04% Jul-2024 12,360 12,360
* Avalon Hampton II 7.04% Jul-2024 11,550 11,550
* Avalon at Symphony Glen 7.06% Jul-2024 9,780 9,780
* Avalon View 7.55% Aug-2024 19,315 19,265
* Avalon at Lexington 6.56% Feb-2025 15,071 15,015
* Avalon Knoll 6.95% Jun-2026 13,917 13,878
* Avalon Landing 6.85% Jun-2026 6,892 6,872
* Avalon West 7.73% Dec-2036 8,731 8,716
* Avalon Fields 7.57% May-2027 12,019 11,988
-------------- ----------------
153,285 153,074
Variable Rate
* Avalon at Fairway Hills I Jun-2026 11,500 11,500
* Avalon at Hampton I Jun-2026 8,060 8,060
* Avalon Pointe Jun-2026 6,387 6,387
* Avalon Devonshire Dec-2025 27,305 27,305
-------------- ----------------
53,252 53,252
Conventional Loans:
Fixed Rate
Unsecured Senior Notes 7.375% Sep-2002 99,892 99,898
Unsecured Senior Notes 7.035% Dec-2007 109,803 109,808
Unsecured Senior Notes 6.625% Jan-2005 -- 99,977
* Avalon Pines 8.00% Dec-2003 5,433 5,416
* Avalon Walk II 8.93% Nov-2004 12,964 12,911
-------------- ----------------
228,092 328,010
Variable Rate-None -- --
-------------- ----------------
Total indebtedness - excluding
Unsecured Facilities $ 434,629 $ 534,336
============== ================
<CAPTION>
Total Maturities
----------------------------------------------------------------------------------
Community 1998 1999 2000 2001 2002 THEREAFTER
- ----------------------------- -------- ------------- ----------- -------------- --------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Tax-Exempt Bonds:
Fixed Rate
* Avalon Lea $ -- $ -- $ -- $ -- $ -- $ 16,835
* Avalon Ridge -- -- -- -- -- 26,815
* Avalon at Dulles -- -- -- -- -- 12,360
* Avalon Hampton II -- -- -- -- -- 11,550
* Avalon at Symphony Glen -- -- -- -- -- 9,780
* Avalon View 180 290 330 350 373 17,742
* Avalon at Lexington 170 240 255 271 288 13,791
* Avalon Knoll 124 175 187 200 214 12,978
* Avalon Landing 63 89 95 101 108 6,416
* Avalon West 31 50 53 57 61 8,464
* Avalon Fields 96 137 147 157 169 11,282
-------- ------------- ----------- -------------- --------------- --------------
664 981 1,067 1,136 1,213 148,013
Variable Rate
* Avalon at Fairway Hills I -- -- -- -- -- 11,500
* Avalon at Hampton I -- -- -- -- -- 8,060
* Avalon Pointe -- -- -- -- -- 6,387
* Avalon Devonshire -- -- -- -- -- 27,305
-------- ------------- ----------- -------------- --------------- --------------
-- -- -- -- -- 53,252
Conventional Loans:
Fixed Rate
Unsecured Senior Notes -- -- -- -- 99,898 --
Unsecured Senior Notes -- -- -- -- -- 109,808
Unsecured Senior Notes -- -- -- -- -- 99,977
* Avalon Pines 86 112 121 131 142 4,824
* Avalon Walk II 149 221 241 264 288 11,748
-------- ------------- ----------- -------------- --------------- --------------
235 333 362 395 100,328 226,357
Variable Rate-None -- -- -- -- -- --
-------- ------------- ----------- -------------- --------------- --------------
Total indebtedness - excluding
Unsecured Facilities $ 899 $ 1,314 $ 1,429 $ 1,531 $ 101,541 $ 427,622
======== ============= =========== ============== =============== ==============
</TABLE>
* Indicates loan is collateralized.
21
<PAGE> 24
BUSINESS STRATEGY; INFLATION
Management believes that apartment communities present an attractive
investment opportunity compared to other real estate investments because a
broad potential resident base results in relatively stable demand of all phases
of a real estate cycle. The Company intends to pursue appropriate new
investments (both acquisitions of new communities and new developments) where
constraints to new supply exist and where new household formations have
out-paced multifamily permit activity in recent years. The Company has targeted
certain high barrier-to-entry markets in the Northeast, Mid-Atlantic and
Midwest regions of the United States for investment opportunities. Recently,
the Company has begun expanding into selected Pacific Northwest markets and
entered into a merger agreement with Bay that will create a combined company
with assets in the supply constrained markets of the Mid-Atlantic, Northeast,
Midwest and selected West Coast markets. The combined company will have 75% of
its assets located in the top 10 apartment markets of the United States, as
rated by the January/February 1998 issue of Multi-Housing News.
At March 31, 1998, Management had positioned the Company's portfolio
of Stabilized Communities, excluding communities owned by joint ventures, to a
physical occupancy level of 97.0% and achieved an average economic occupancy of
95.9% for the three months ended March 31, 1998. Average economic occupancy for
the portfolio for the three months ended March 31, 1997 was 95.1%. 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 Established 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 Established
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 May 5, 1998, 12 Development Communities were under construction.
The total capitalized cost of these Development Communities, when completed, is
currently expected to be approximately $389.2 million. 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.
In accordance with GAAP, the Company capitalizes interest expense
during construction until each building obtains a certificate of occupancy,
thereafter, interest for each completed building is expensed. Capitalized
interest for the three months ended March 31, 1998 and 1997 totaled $2,171,000
and $2,511,000, respectively.
The following page presents a summary of Development Communities:
22
<PAGE> 25
<TABLE>
<CAPTION>
DEVELOPMENT COMMUNITIES SUMMARY
NUMBER OF BUDGETED ESTIMATED ESTIMATED EBITDA AS %
APARTMENT COST CONSTRUCTION INITIAL COMPLETION STABILIZATION OF TOTAL
HOMES ($ MILLIONS) START OCCUPANCY DATE DATE (1) BUDGETED COST (2)
---------- ----------- ------------- ---------- ------------ -------------- ----------------
<S> <C> <C> <C> <C> <C> <C> <C>
Avalon at Fair Lakes
Fairfax, VA 234 $ 23.3 Q1 1997 Q4 1997 Q2 1998 Q4 1998 10.4%
Avalon at Faxon Park
Quincy, MA 171 15.8 Q1 1997 Q4 1997 Q2 1998 Q4 1998 12.1%
Avalon Gardens
Nanuel, NY 504 53.8 Q3 1996 Q2 1997 Q3 1998 Q1 1999 10.8%
Avalon at Cameron Court
Alexandria, VA 460 44.7 Q2 1997 Q1 1998 Q4 1998 Q1 1999 11.0%
Avalon Fields II
Gaithersburg, MD 96 9.2 Q3 1997 Q2 1998 Q4 1998 Q1 1999 10.2%
Avalon Willow
Mamaroneck, NY 227 41.8 Q2 1997 Q3 1998 Q1 1999 Q2 1999 9.2%
Avalon Crest
Fort Lee, NJ 351 57.4 Q4 1997 Q2 1999 Q4 1999 Q1 2000 10.1%
Avalon Cove South
Jersey City, NJ 269 51.8 Q1 1998 Q2 1999 Q3 1999 Q4 1999 10.0%
Avalon House
Bronxville, Ny 110 26.4 Q1 1998 Q2 1999 Q3 1999 Q4 1999 9.7%
Avalon Valley
Danbury, CT 268 26.1 Q1 1998 Q1 1999 Q3 1999 Q1 2000 10.1%
Avalon Lake
Danbury, CT 135 17.0 Q2 1998 Q2 1999 Q3 1999 Q1 2000 10.1%
Avalon Oaks
Wilmington, MA (3) 204 21.9 Q2 1998 Q1 1999 Q3 1999 Q1 2000 10.3%
---------- ----------- ----------------
Total/Average 3,029 $ 389.2 10.3%
========== =========== ================
</TABLE>
(1) Stabilized occupancy is defined as the first full quarter of 94% 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) Financed with tax-exempt bonds.
23
<PAGE> 26
DEVELOPMENT RIGHTS
The Company is considering the development of 18 new apartment
communities. The status of these Development Rights range from land owned or
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 4,922 institutional-quality apartment homes to the
Company's portfolio. At March 31, 1998, the cumulative capitalized costs
incurred in pursuit of the 18 Development Rights were approximately $14.4
million, including the capitalized cost of $7.5 million related to the purchase
of land in New Canaan, Connecticut. Many of these apartment homes will offer
features like those offered by the communities currently owned by the Company.
The 18 Development Rights that the Company is currently pursuing are summarized
below.
DEVELOPMENT RIGHTS SUMMARY
<TABLE>
<CAPTION>
TOTAL
ESTIMATED BUDGETED
NUMBER OF COST
LOCATION HOMES ($ MILLIONS)
------------------ ---------------- --------------
<S> <C> <C>
1. Peabody, MA 434 $ 35.9
2. Hull, MA 162 17.0
3. New Rochelle, NY 408 62.7
4. Stamford, CT 195 30.5
5. Freehold, NJ 452 38.4
6. Herndon, VA 165 19.5
7. Melville - II, NY 340 40.3
8. Orange, CT 172 15.5
9. New Canaan, CT (1) 104 24.1
10. Darien, CT 172 26.1
11. Yonkers, NY 256 33.7
12. Greenburgh - II, NY 500 74.0
13. Greenburgh - III, NY 266 39.3
14. Florham Park, NJ 270 37.5
15. Ridgefield, CT 240 30.2
16. Naperville, IL 200 22.0
17. Westbury, NY 361 47.6
18. Providence, RI 225 26.4
----------- -----------
Total 4,922 $620.7
=========== ===========
</TABLE>
(1) Currently anticipated that the land seller will retain a minority limited
partnership interest.
24
<PAGE> 27
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Neither the Company nor any of the communities is presently subject to
any material litigation nor, to the Company's knowledge, is any litigation
threatened against the Company or any of the communities, other than routine
actions for negligence or other claims and administrative proceedings arising
in the ordinary course of business, some of which are expected to be covered by
liability insurance and all of which collectively are not expected to have a
material adverse effect on the business or financial condition 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
None.
ITEM 5. OTHER INFORMATION
On January 22, 1998, the Company completed a $100,000,000 offering of
unsecured senior notes. The notes bear an interest rate at 6.625% payable
semi-annually on January 15 and July 15 and will mature on January 15, 2005.
The notes were sold at a price of 99.976% par value to yield 6.629% to maturity
or a 111 basis point spread over the 7-year U.S. Treasury Note rate. The
Company used the net proceeds of approximately $99,400,000 to repay amounts
outstanding under the Unsecured Facilities.
On January 27, 1998, the Company completed the sale of 923,856 shares
of Common Stock to The Prudential Insurance Company of America under its
existing shelf registration statement at a net purchase price of $29.09 per
share. The net proceeds of approximately $26,872,000 were used to retire
indebtedness under the Unsecured Facilities.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibit No. Description
27.1 Financial Data Schedule - Q1 1998
27.2 Financial Data Schedule - Q1 1997
b) On January 15, 1998, the Company filed a Current Report on Form 8-K,
reporting under item (5) the pursuit of certain investment
opportunities in Boston, Massachusetts and the Pacific Northwest.
On January 26, 1998, the Company filed a Current Report on Form 8-K
relating to the offering and sale of $100,000,000 aggregate principal
amount of the Company's 6 5/8% Senior Notes due 2005.
On March 10, 1998, the Company filed a Current Report on Form 8-K, as
amended and restated by Form 8-K/A on March 12, 1998, reporting under
item (5) the merger agreement between the Company and Bay Apartment
Communities, Inc.
25
<PAGE> 28
SIGNATURES
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: May 12, 1998 By /s/ RICHARD L. MICHAUX
------------------------------------------
Richard L. Michaux, Chairman of the Board,
Chief Executive Officer and
Director (Principal Executive Officer)
Date: May 12, 1998 By /s/ THOMAS J. SARGEANT
------------------------------------------
Thomas J. Sargeant, Chief Financial Officer,
Treasurer and Secretary
(Principal Financial and Accounting Officer)
26
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> MAR-31-1998
<CASH> 3,497
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 16,404
<PP&E> 1,622,514
<DEPRECIATION> 78,994
<TOTAL-ASSETS> 1,611,113
<CURRENT-LIABILITIES> 47,394
<BONDS> 558,336
0
88
<COMMON> 431
<OTHER-SE> 988,697
<TOTAL-LIABILITY-AND-EQUITY> 989,216
<SALES> 0
<TOTAL-REVENUES> 56,452
<CGS> 0
<TOTAL-COSTS> 30,179
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 6,540
<INCOME-PRETAX> 18,869
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 18,869
<EPS-PRIMARY> .33
<EPS-DILUTED> .33
</TABLE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> MAR-31-1997
<CASH> 3,036
<SECURITIES> 0
<RECEIVABLES> 0
<ALLOWANCES> 0
<INVENTORY> 0
<CURRENT-ASSETS> 12,719
<PP&E> 1,173,435
<DEPRECIATION> 50,784
<TOTAL-ASSETS> 1,158,269
<CURRENT-LIABILITIES> 35,982
<BONDS> 310,334
0
88
<COMMON> 335
<OTHER-SE> 734,330
<TOTAL-LIABILITY-AND-EQUITY> 1,158,269
<SALES> 0
<TOTAL-REVENUES> 37,527
<CGS> 0
<TOTAL-COSTS> 20,013
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 3,717
<INCOME-PRETAX> 14,296
<INCOME-TAX> 0
<INCOME-CONTINUING> 0
<DISCONTINUED> 0
<EXTRAORDINARY> 1,183
<CHANGES> 0
<NET-INCOME> 13,113
<EPS-PRIMARY> .24
<EPS-DILUTED> .24
</TABLE>
