The Operating Partnership defines its reportable operating segments as the three geographical regions in which its properties are located: Northern California, Southern California and the Pacific Northwest. Excluded from segment revenues are interest and other corporate income. Other non-segment assets include investments, real estate under development, cash, receivables and other assets. The revenues, net operating income, and assets for each of the reportable operating segments are summarized as follows for the periods presented.
Three Months Ended
September 30,
------------------------
2002 2001
----------- -----------
Revenues:
Southern California $ 18,696 $ 17,843
Northern California 14,399 16,483
Pacific Northwest 10,534 11,357
----------- -----------
Total segment revenues 43,629 45,683
Interest and other income 5,166 5,553
----------- -----------
Total revenues $ 48,795 $ 51,236
=========== ===========
Net operating income:
Southern California $ 13,304 $ 12,481
Northern California 10,427 12,614
Pacific Northwest 7,060 7,843
----------- -----------
Total segment net operating income 30,791 32,938
Interest and other income 5,166 5,553
Depreciation and amortization:
Southern California (3,543) (3,507)
Northern California (2,796) (2,797)
Pacific Northwest (2,790) (2,798)
Interest (8,621) (10,016)
Amortization of deferred financing costs (147) (143)
General and administrative (1,482) (1,838)
----------- -----------
Income from continuing operations before gain
on sale of real estate, minority interests
and discontinued operations $ 16,578 $ 17,392
=========== ===========
Nine Months Ended
September 30,
------------ -----------
2002 2001
----------- -----------
Revenues:
Southern California $ 54,508 $ 52,997
Northern California 43,972 50,072
Pacific Northwest 31,747 34,135
----------- -----------
Total segment revenues 130,227 137,204
Interest and other income 18,961 14,149
----------- -----------
Total revenues $ 149,188 $ 151,353
=========== ===========
Net operating income:
Southern California $ 38,441 $ 36,763
Northern California 32,813 38,746
Pacific Northwest 21,561 23,489
----------- -----------
Total segment net operating income 92,815 98,998
Interest and other income 18,961 14,149
Depreciation and amortization:
Southern California (10,453) (10,230)
Northern California (8,395) (8,063)
Pacific Northwest (8,381) (8,373)
Interest (26,062) (28,896)
Amortization of deferred financing costs (442) (510)
General and administrative (4,747) (5,566)
----------- -----------
Income from continuing operations before gain
on sale of real estate, minority interests
and discontinued operations $ 53,296 $ 51,509
=========== ===========
September 30,December 31,
2002 2001
----------- -----------
Assets:
Southern California $ 470,165 $ 456,639
Northern California 299,318 302,408
Pacific Northwest 253,015 259,884
----------- -----------
Total segment net real estate assets 1,022,498 1,018,931
Non-segment assets 334,167 310,527
----------- -----------
Total assets $ 1,356,665 $ 1,329,458
=========== ===========
(6)Net Income Per Unit
Three Months Ended Three Months Ended
September 30, 2002 September 30, 2001
------------------------------ ------------------------------
Weighted Per Weighted Per
Average Unit Average Unit
Income Units Amount Income Units Amount
--------- --------- -------- --------- --------- --------
Net income $ 16,551 $ 21,311
Less: dividends on limited
partner preferred equity (4,580) (4,580)
--------- ---------
Basic:
Income available to
common units 11,971 20,586 $ 0.58 16,731 20,779 $ 0.81
======== ========
Effect of Dilutive Securities:
Convertible preferred stock (1) -- -- -- --
Stock options -- 163 -- 315
--------- --------- --------- ---------
Diluted:
Income available to common
units plus assumed
conversions $ 11,971 20,749 $ 0.58 $ 16,731 21,094 $ 0.79
========= ========= ======== ========= ========= ========
Nine Months Ended Nine Months Ended
September 30, 2002 September 30, 2001
------------------------------ ------------------------------
Weighted Per Weighted Per
Average Unit Average Unit
Income Units Amount Income Units Amount
--------- --------- -------- --------- --------- --------
Net income $ 62,495 $ 55,721
Less: dividends on limited
partner preferred equity (13,741) (13,739)
--------- ---------
Basic:
Income available to
common units 48,754 20,724 $ 2.35 41,982 20,680 $ 2.03
======== ========
Effect of Dilutive Securities:
Convertible preferred stock (1) -- -- -- --
Stock options -- 159 -- 323
--------- --------- --------- ---------
Diluted:
Income available to common
units plus assumed
conversions $ 48,754 20,883 $ 2.33 $ 41,982 21,003 $ 2.00
========= ========= ======== ========= ========= ========
(1) Securities not included because they were anti- dilutive.
Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion is based primarily on the consolidated unaudited financial statements of Essex Portfolio, L.P. (the "Operating Partnership") for the three and nine months ended September 30, 2002 and 2001. This information should be read in conjunction with the accompanying consolidated unaudited financial statements and notes thereto. These consolidated financial statements include all adjustments which are, in the opinion of management, necessary to reflect a fair statement of the results and all such adjustments are of a normal recurring nature.
The Operating Partnership holds, directly or indirectly, all of the Company's interests in the Operating Partnership's properties and all of the Company's operations relating to the Company's properties are conducted through the Operating Partnership. The Company is the sole general partner of the Operating Partnership and, as of September 30, 2002, December 31, 2001 and September 30, 2001, with an economic ownership of 88.7%, 89.0% and 89.0% general partnership interest in the Operating Partnership, respectively.
General Background
The Operating Partnership's property revenues are generated primarily from multifamily property operations, which accounted for greater than 99% of its property revenues for the three and nine months ended September 30, 2002 and 2001. The Operating Partnership's multifamily properties (the "Properties") are located in Southern California (Los Angeles, Ventura, Orange and San Diego counties), Northern California (the San Francisco Bay Area) and the Pacific Northwest (the Seattle, Washington and Portland, Oregon metropolitan areas).
Essex Apartment Value Fund, L.P. (the "Fund"), is an investment fund managed by the Operating Partnership and will be, subject to specific exceptions, the Operating Partnership's exclusive investment vehicle for new investments until the Fund's committed capital has been invested or committed for investments, or if earlier, December 31, 2003. The Fund has total capital commitments of $250 million and is expected to utilize leverage of approximately 65% of the value of the underlying real estate portfolio. The Operating Partnership is committed to invest 21.4% of the aggregate capital committed to the Fund. In addition, the Operating Partnership will be compensated by the Fund for its asset management, property management, development and redevelopment services and may receive incentive payments if the Fund exceeds certain financial return benchmarks. Since its formation, the Fund has acquired eight multifamily residential properties, representing 2,102 apartment units with an aggregate purchase price of approximately $218 million, excluding redevelopment expenses, and disposed of one multifamily residential property, consisting of 500 apartment units at a gross sales price of approximately $69.0 million resulting in a net realized gain of approximately $5.7 million. In addition, three development land parcels, where approximately 615 apartment units are planned for construction, have been purchased by the Fund with a total estimated cost for the projects of approximately $122.3 million. As of September 30, 2002, the remaining commitments to fund these projects is approximately $89.9 million of which approximately $19.2 million is the Operating Partnership's commitment.
Since the Operating Partnership began operations in June 1994, the Operating Partnership has acquired ownership interests in 78 multifamily residential properties, of which 44 are located in Southern California, 14 are located in Northern California, 15 are located in the Seattle Metropolitan Area and 5 are located in the Portland Metropolitan Area. In total, these acquisitions consist of 16,899 units with total capitalized acquisition costs of approximately $1,444.0 million. Also, the Operating Partnership has acquired its headquarters building and its Southern California office building. Additionally, since it began operations, the Operating Partnership has developed and has ownership interests in nine multifamily development properties that have reached stabilized operations. These development properties consist of 1,944 units with total capitalized development costs of $236.8 million. As part of its active portfolio management strategy, the Operating Partnership has disposed of, since it began operations, twelve multifamily residential properties (six in Northern California, five in Southern California and one in the Pacific Northwest) consisting of a total of 2,014 units, six retail shopping centers in the Portland, Oregon metropolitan area and its former headquarters building located in Northern California at an aggregate gross sales price of approximately $259.5 million resulting in a net realized gain of approximately $53.8 million.
The Operating Partnership (including the Fund's development communities) has an ownership interest in and is developing six multifamily residential communities, with an aggregate of 1,521 multifamily units. In connection with these development projects, the Operating Partnership has directly, or in some cases through its joint venture partners, entered into contractual construction related commitments with unrelated third parties and the total projected estimated cost for these projects is approximately $292.0 million. As of September 30, 2002, the remaining commitment to fund these projects is approximately $124.5 million of which approximately $46.7 million is the Operating Partnership's commitment.
Results of Operations
Comparison of the Three Months Ended September 30, 2002 to the Three Months Ended September 30, 2001
Average financial occupancy rates of the Operating Partnership's multifamily Quarterly Same Store Properties (properties consolidated by the Operating Partnership for each of the three months ended September 30, 2002 and 2001) was 96.1% and 94.7%, for the three months ended September 30, 2002 and 2001, respectively. "Financial occupancy" is defined as the percentage resulting from dividing actual rental income by total possible rental income. Total possible rental income is determined by valuing occupied units at contractual rents and vacant units at market rents. The regional breakdown of average financial occupancy for the multifamily Quarterly Same Store Properties for the three months ended September 30, 2002 and 2001 are as follows:
Three months ended
September 30,
--------------------
2002 2001
--------- ---------
Southern California 96.4% 95.3%
Northern California 96.8% 94.6%
Pacific Northwest 94.8% 94.0%
Total Revenues decreased by $2,441,000 or 4.8% to $48,795,000 in the third quarter of 2002 from $51,236,000 in the third quarter of 2001. The following table sets forth a breakdown of these revenue amounts, including the revenues attributable to the Quarterly Same Store Properties.
Three Months Ended
September 30,
Number of -------------------- Dollar Percentage
Properties 2002 2001 Change Change
----------- --------- --------- --------- -----------
Revenues:
Property revenues - quarterly
Quarterly Same Store Properties
Southern California 19 $ 14,325 $ 13,761 $ 564 4.1 %
Northern California 14 12,227 14,119 (1,892) (13.4)
Pacific Northwest 23 10,534 11,357 (823) (7.2)
----------- --------- --------- --------- -----------
Properties 56 37,086 39,237 (2,151) (5.5)
Property revenues - properties
acquired/disposed of
subsequent to June 30, 2001 (1) 6,543 6,446 97 1.5
--------- --------- --------- -----------
Total property revenues 43,629 45,683 (2,054) (4.5)
Interest and other income 5,166 5,553 (387) (7.0)
--------- --------- --------- -----------
Total revenues $ 48,795 $ 51,236 $ (2,441) (4.8)%
========= ========= ========= ===========
(1) Also includes two commercial properties, redevelopment communities, and development communities.
As set forth in the above table, the $2,441,000 net decrease in total revenues was mainly attributable to a decrease in property revenues from the Quarterly Same Store Properties. Property revenues from the Quarterly Same Store Properties decreased by $2,151,000 or 5.5% to $37,086,000 in the third quarter of 2002 from $39,237,000 in the third quarter of 2001. The majority of this decrease was attributable to the 14 Quarterly Same Store Properties located in Northern California and the 23 Quarterly Same Store Properties located in the Pacific Northwest. The property revenues of the Quarterly Same Store Properties in Northern California decreased by $1,892,000 or 13.4% to $12,227,000 in the third quarter of 2002 from $14,119,000 in the third quarter of 2001. The decrease in Northern California is primarily attributable to rental rate decreases offset by an increase in financial occupancy to 96.8% in the third quarter of 2002 from 94.6% in the third quarter of 2001. The property revenues of the Quarterly Same Store Properties in the Pacific Northwest decreased by $823,000 or 7.2% to $10,534,000 in the third quarter of 2002 from $11,357,000 in the third quarter of 2001. The $823,000 decrease in the Pacific Northwest is primarily attributable to rental rate decreases offset by an increase in financial occupancy to 94.8% in the third quarter of 2002 from 94.0% in the third quarter of 2001. The 19 multifamily residential properties located in Southern California offset the net decrease in total revenues. The property revenues of these properties increased by $564,000 or 4.1% to $14,325,000 in the third quarter of 2002 from $13,761,000 in the third quarter of 2001. The $564,000 increase is primarily attributable to rental rate increases and an increase in financial occupancy to 96.4% in the third quarter of 2002 from 95.3% in the third quarter of 2001.
Interest and other income decreased by $387,000 or 7.0% to $5,166,000 in the third quarter of 2002 from $5,553,000 in the third quarter of 2001. The decrease of $387,000 primarily related to the sale of co-investment assets resulting in the decrease in income earned on the Operating Partnership's co-investments and the payoff of notes receivable resulting in the decrease in interest income on notes receivables.
Total Expenses decreased by $1,627,000 or approximately 4.8% to $32,217,000 in the third quarter of 2002 from $33,844,000 in the third quarter of 2001. This decrease was mainly due to a decrease in interest expense, which decreased by $1,395,000 or 13.9% to $8,621,000 in the third quarter of 2002 from $10,016,000 in the third quarter of 2001. The interest expense decrease was primarily due to declining interest rates and an increase in the capitalization of interest costs relating to the Operating Partnership's development and redevelopment communities.
General and administrative expenses represent the costs of the Operating Partnership's various acquisition and administrative departments as well as partnership administration and non-operating expenses. Such expenses decreased by $356,000 or 19.4% to $1,482,000 in the third quarter of 2002 from $1,838,000 in the third quarter of 2001. This decrease is largely due to a reduction in bonus expense as compared to the third quarter of 2001.
Net incomedecreased by $4,760,000 or 22.3% to $16,551,000 in the third quarter of 2002 from $21,311,000 in the third quarter of 2001. The decrease in net income is mainly attributable to the gain on sale of real estate of $3,788,000 recognized in the third quarter of 2001.
Comparison of the Nine Months Ended September 30, 2002 to the Nine Months Ended September 30, 2001
Average financial occupancy rates of the Operating Partnership's multifamily Same Store Properties (properties consolidated by the Operating Partnership for each of the nine months ended September 30, 2002 and 2001) was 94.2% and 95.3%, for the nine months ended September 30, 2002 and 2001, respectively. "Financial occupancy" is defined as the percentage resulting from dividing actual rental income by total possible rental income. Total possible rental income is determined by valuing occupied units at contractual rents and vacant units at market rents. The regional breakdown of average financial occupancy for the multifamily Same Store Properties for the nine months ended September 30, 2002 and 2001 are as follows:
Three months ended
September 30,
--------------------
2002 2001
--------- ---------
Southern California 96.4% 95.3%
Northern California 96.8% 94.6%
Pacific Northwest 94.8% 94.0%
Total Revenues decreased by $2,165,000 or 1.4% to $149,188,000 in the nine months ended September 30, 2002 from $151,353,000 in the nine months ended September 30, 2001. The following table sets forth a breakdown of these revenue amounts, including the revenues attributable to the Same Store Properties.
Three Months Ended
September 30,
Number of -------------------- Dollar Percentage
Properties 2002 2001 Change Change
----------- --------- --------- --------- -----------
Revenues:
Property revenues - quarterly
Quarterly Same Store Properties
Southern California 19 $ 14,325 $ 13,761 $ 564 4.1 %
Northern California 14 12,227 14,119 (1,892) (13.4)
Pacific Northwest 23 10,534 11,357 (823) (7.2)
----------- --------- --------- --------- -----------
Properties 56 37,086 39,237 (2,151) (5.5)
Property revenues - properties
acquired/disposed of
subsequent to June 30, 2001 (1) 6,543 6,446 97 1.5
--------- --------- --------- -----------
Total property revenues 43,629 45,683 (2,054) (4.5)
Interest and other income 5,166 5,553 (387) (7.0)
--------- --------- --------- -----------
Total revenues $ 48,795 $ 51,236 $ (2,441) (4.8)%
========= ========= ========= ===========
(1) Also includes two commercial properties, redevelopment communities, and development communities.
As set forth in the above table, the $2,165,000 net decrease in total revenues was mainly attributable to a decrease in property revenues from the Same Store Properties. Property revenues from the Same Store Properties decreased by $7,034,000 or 5.9% to $111,307,000 in the nine months ended September 30, 2002 from $118,341,000 in the nine months ended September 30, 2001. The majority of this decrease was attributable to the 14 Same Store Properties located in Northern California and the 23 Same Store Properties located in the Pacific Northwest. The property revenues of the Same Store Properties in Northern California decreased by $5,572,000 or 12.8% to $37,808,000 in the nine months ended September 30, 2002 from $43,380,000 in the nine months ended September 30, 2001. The decrease in Northern California is primarily attributable to rental rate decreases and a decrease in financial occupancy to 95.4% in the nine months ended September 30, 2002 from 95.7% in the nine months ended September 30, 2001. The Operating Partnership estimates that in general, market rents for its multifamily properties in Northern California have decreased on average by approximately 6% from December 31, 2001 through June 30, 2002 and on average by approximately 2% from June 30, 2002 through September 30, 2002. The property revenues of the Same Store Properties in the Pacific Northwest decreased by $2,388,000 or 7.0% to $31,747,000 in the nine months ended September 30, 2002 from $34,135,000 in the nine months ended September 30, 2001. The $2,388,000 decrease in the Pacific Northwest is primarily attributable to rental rate decreases and a decrease in financial occupancy to 92.8% in the nine months ended September 30, 2002 from 94.5% in the nine months ended September 30, 2001. The Operating Partnership estimates that in general, market rents for its multifamily properties in the Pacific Northwest have decreased on average by approximately 7% from December 31, 2001 through June 30, 2002 and on average by approximately 2% from June 30, 2002 through September 30, 2002. The 19 multifamily residential properties located in Southern California offset the net decrease in total revenues. The property revenues of these properties increased by $926,000 or 2.3% to $41,752,000 in the nine months ended September 30, 2002 from $40,826,000 in the nine months ended September 30, 2001. The $926,000 increase is primarily attributable to rental rate increases as offset by a decrease in financial occupancy to 94.2% in the nine months ended September 30, 2002 from 95.5% in the nine months ended September 30, 2001. The Operating Partnership estimates that in general, market rents for its multifamily properties in Southern California are on average unchanged from December 31, 2001 through June 30, 2002 and remained on average unchanged from June 30, 2002 through September 30, 2002.
The $2,165,000 net decrease in total revenues was offset by an increase in interest and other income. Interest and other income increased by $4,812,000 or 34.0% to $18,961,000 in the nine months ended September 30, 2002 from $14,149,000 in the nine months ended September 30, 2001. The increase of $4,812,000 primarily related to $2,108,000 of equity in income from the gain on sale of co-investment assets, $1,585,000 in fees earned in conjunction with the sale of two co-investment assets, and interest income on notes receivables and income earned on the Operating Partnership's co-investments, which were offset by a $700,000 reduction of the Operating Partnership's book value in a real estate technology fund investment accounted for under the equity method based on the fund's general partner's valuation of real estate technology fund assets.
The net decrease in property revenues was offset by a $57,000 net increase attributable to properties acquired subsequent to December 31, 2000, redevelopment communities, development communities and two office buildings. Subsequent to December 31, 2000 the Operating Partnership acquired interests in three multifamily properties, had six communities under redevelopment and two communities in development (the "Post - 2000 Acquisition Properties").
Total Expensesdecreased by $3,952,000 or approximately 4.0% to $95,892,000 in the nine months ended September 30, 2002 from $99,844,000 in the nine months ended September 30, 2001. This decrease was mainly due to a decrease in interest expense, which decreased by $2,834,000 or 9.8% to $26,062,000 in the nine months ended September 30, 2002 from $28,896,000 in the nine months ended September 30, 2001. The interest expense decrease was primarily due to declining interest rates and the capitalization of interest costs relating to the Operating Partnership's development and redevelopment communities. Property operating expenses, exclusive of depreciation and amortization, decreased by $794,000 or 2.1% to $37,412,000 in the nine months ended September 30, 2002 from $38,206,000 in the nine months ended September 30, 2001. Of such property operating expense decrease, $1,053,000 was attributable to the Post - 2000 Acquisition Properties as offset by an increase in insurance expense which increased by $644,000 or approximately 81.3% to $1,436,000 in the nine months ended September 30, 2002 from $792,000 in the nine months ended September 30, 2001. This increase is due to the current conditions in the insurance industry resulting in greater costs. Depreciation and amortization increased by $563,000 or approximately 2.1% to $27,229,000 in nine months ended September 30, 2002 from $26,666,000 in the nine months ended September 30, 2001, primarily due to the acquisition of properties.
General and administrative expenses represent the costs of the Operating Partnership's various acquisition and administrative departments as well as partnership administration and non-operating expenses. Such expenses decreased by $819,000 or 14.7% to $4,747,000 in the nine months ended September 30, 2002 from $5,566,000 in the nine months ended September 30, 2001. This decrease is largely due to an increase in the allocation of general and administrative expenses to EMC due to the increase in fee income earned by EMC and a reduction in bonus expense as compared to the nine months ended September 30, 2001.
Income from discontinued operations increased by $8,805,000 or 1,765% to $9,304,000 in the nine months ended September 30, 2002 from $499,000 in the nine months ended September 30, 2001 due to gain on sale of real estate.
Net incomeincreased by $6,774,000 or 12.2% to $62,495,000 in the nine months ended September 30, 2002 from $55,721,000 in the nine months ended September 30, 2001. The increase in net income is attributable to the gain on sale of real estate of $9,051,000 in the nine months ended September 30, 2002 and the increase in interest and other income as offset by the decrease in net operating income from the Same Store Properties and the gain on sale of real estate of $3,788,000 in the nine months ended September 30, 2001.
Liquidity and Capital Resources
At September 30, 2002 the Operating Partnership had $2,147,000 of unrestricted cash and cash equivalents. The Operating Partnership expects to meet its short-term liquidity requirements by using its working capital, cash generated from operations and amounts available under line of credit. The Operating Partnership believes that its current net cash flows will be adequate to meet operating requirements and to provide for payment of dividends by the Company in accordance with REIT qualification requirements. The Operating Partnership expects to meet its long-term liquidity requirements relating to property acquisition and development (beyond the next 12 months) by using a combination of some or all of the following: working capital, amounts available from its line of credit, net proceeds from public and private debt and equity issuances, and proceeds from the disposition of properties that may be sold from time to time. There can, however, be no assurance that the Operating Partnership will have access to the debt and equity markets in a timely fashion to meet such future funding requirements or that future working capital and borrowings under its line of credit will be available, or if available, will be sufficient to meet the Operating Partnership's requirements or that the Operating Partnership will be able to dispose of properties in a timely manner and under terms and conditions that the Operating Partnership deems acceptable.
The Operating Partnership has an outstanding unsecured line of credit for an aggregate amount of $165,000,000. The facility carries an interest rate, based on a tiered rate structure, which currently is equal to LIBOR plus 1.10%. The credit line matures in May 2004, with an option to extend it for one year thereafter. At September 30, 2002 the Operating Partnership had $121,959,000 outstanding on this line of credit, with an interest rate of approximately 2.9%.
The Fund has an unsecured line of credit for an aggregate amount of $125,000,000 and bears interest at LIBOR plus 0.875%. As of September 30, 2002, the line had an outstanding balance of $67,624,000, with an interest rate of approximately 2.7%. The credit line matures in December 2003.
In addition to the unsecured line of credit, the Operating Partnership had $559,900,000 of secured indebtedness at September 30, 2002. Such indebtedness consisted of $501,080,000 in fixed rate debt with interest rates varying from 6.5% to 8.8% and maturity dates ranging from 2002 to 2026. The indebtedness also includes $58,820,000 of debt represented by tax exempt variable rate demand bonds with interest rates paid during the nine months ended September 30, 2002 ranging from 4.5% to 5.5% and maturity dates ranging from 2020 to 2026. The tax- exempt variable rate demand bonds are capped at interest rates ranging from 7.1% to 7.3%.
The Operating Partnership's unrestricted cash balance decreased by $4,293,000 or 66.7% to $2,147,000 as of September 30, 2002 from $6,440,000 as of December 31, 2001. This decrease was primarily a result of $37,215,000 of net cash used in investing activities and $34,970,000 of net cash used in financing activities which was offset by $67,892,000 net cash provided by operating activities. The $37,215,000 of net cash used in investing activities was primarily a result of $41,935,000 used to fund real estate under development, $20,938,000 in additions to real estate, and $4,109,000 in additions to notes receivable and investments made to finance real estate property acquisitions by the Operating Partnership's investees, related party notes and other receivables which was offset in part by $16,469,000 in proceeds received from investments in corporations and limited partnerships. The $34,970,000 of net cash used in financing activities was primarily a result of $55,301,000 in repayments of mortgage and other notes payable and lines of credit, $41,546,000 used to pay distributions to the general partner, $19,715,000 used to purchase shares of the Company's stock, and $18,851,000 used to pay distributions to limited partners, which was offset in part by $98,500,000 received in proceeds from mortgage and other notes payable and lines of credit.
Non-revenue generating capital expenditures are improvements and upgrades that extend the useful life of the property and are not related to preparing a multifamily property unit to be rented to a tenant. The Operating Partnership expects to incur approximately $350 per weighted average occupancy unit in non- revenue generating capital expenditures for the year ended December 31, 2002. These expenditures do not include the improvements required in connection with the origination of mortgage loans, expenditures for renovations and improvements on recently acquired properties which are expected to generate additional revenue, and renovation expenditures required pursuant to tax-exempt bond financings. The Operating Partnership expects that cash from operations and/or its line of credit will fund such expenditures. However, there can be no assurance that the actual expenditures incurred during 2002 and/or the funding thereof will not be significantly different than the Operating Partnership's current expectations.
The Operating Partnership (including the Fund's development communities) has an ownership interest in and is developing six multifamily residential communities, with an aggregate of 1,521 multifamily units. Such projects involve certain risks inherent in real estate development. See "Potential Factors Affecting Future Operating Results-Development and Redevelopment Activities" below. In connection with these development projects, the Operating Partnership has directly, or in some cases through its joint venture partners, entered into contractual construction related commitments with unrelated third parties for a total amount of approximately $292,000,000. As of September 30, 2002, the remaining commitment to fund the estimated cost to complete is approximately $124,500,000 of which approximately $53,800,000 is the Operating Partnership's commitment. The Operating Partnership expects to fund such commitments by using a combination of some or all of the following sources: its working capital, operating cash flows, amounts available on its line of credit, net proceeds from public and private equity and debt issuances, and proceeds from the disposition of properties, which may be sold from time to time.
The Operating Partnership carries comprehensive liability, fire, extended coverage and rental loss insurance for each of the Properties. Conditions in the insurance industry have resulted in greater costs, increasing more than 50% from the prior year, along with increased deductibles and reduced coverages. In some cases, the Operating Partnership is not in technical compliance with the insurance requirements of loan agreements, and is discussing this issue with applicable lenders. The Operating Partnership does not believe that this non- compliance will have a material impact on its operations or future financing efforts. As further described in the Company's Annual Report on Form 10-K for the year ended December 31, 2001, the Operating Partnership may incur losses due to deductibles, self-insured retentions, co-payments and losses in excess of appropriate coverages. See "Insurance" in Item 1 of the Company's Annual Report on Form 10-K for the year ended December 31, 2001.
Pursuant to existing shelf registration statements, the Company has the capacity to issue up to $342,000,000 of equity securities and the Operating Partnership has the capacity to issue up to $250,000,000 of debt securities.
The Company pays quarterly dividends from cash available for distribution. Until it is distributed, cash available for distribution is invested by the Operating Partnership primarily in short-term investment grade securities or is used by the Operating Partnership to reduce balances outstanding under its line of credit.
Essex Apartment Value Fund, L.P. (the "Fund"), is an investment fund managed by the Operating Partnership and will be, subject to specific exceptions, the Operating Partnership's exclusive investment vehicle for new investments until the Fund's committed capital has been invested or committed for investment, or if earlier, December 31, 2003. The Fund has total capital commitments of $250 million and is expected to utilize leverage of approximately 65% of the value of the underlying real estate portfolio. The Operating Partnership is committed to invest 21.4% of the aggregate capital committed to the Fund. In addition, Essex will be compensated by the Fund for its asset management, property management, development and redevelopment services and may receive incentive payments if the Fund exceeds certain financial return benchmarks. See the discussion in the "General Background" section of this "Management's Discussion and Analysis of Financial Condition and Results of Operation."
During the quarter ended September 30, 2002 the Operating Partnership purchased 400,000 shares of the Company's common stock at $48.00 per share. Since May 2001, the Operating Partnership has purchased approximately 511,200 shares at an average price per share of $48.00 totaling approximately $24,536,000 of the $50,000,000 aggregate amount authorized for repurchase by the Board of Directors. The amount paid for the shares is reflected as a reduction of the general partner's equity in the Operating Partnership's consolidated balance sheet.
Forward Looking Statements
Certain statements in this "Management's Discussion and Analysis of Financial Condition and Results of Operations," and elsewhere in this quarterly report on Form 10-Q which are not historical facts may be considered forward looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended, including statements regarding the Operating Partnership's expectations, hopes, intentions, beliefs and strategies regarding the future. Forward looking statements include statements about decreases and increases in market rent for its multifamily properties and trends of such decreases and increases, statements regarding the expected additional fees from, and the expected tax treatment of, property dispositions, the Operating Partnership's expectations as to the total projected costs of current development and redevelopment projects and the projected stabilized operation dates for such projects, beliefs as to the adequacy of future cash flows to meet operating requirements and to provide for dividend payments in accordance with REIT requirements, expectations as to the amount of non-revenue generating capital expenditures for the year ended December 31, 2002, future acquisitions and developments, the anticipated performance of the Essex Apartment Value Fund, L.P. (the "Fund"), the anticipated performance of existing properties, and statements regarding the Operating Partnership's financing activities. The Operating Partnership's actual results may differ materially from those projected in such forward-looking statements. Factors that might cause such a difference include, but are not limited to, that market rental rates may decrease or increase beyond what is currently expected, that the ultimate return from property dispositions will differ from what is expected, that the total costs of current development and redevelopment projects will exceed expectations, that such projects will experience unexpected delays in completing development or in leasing, that acquisitions will fail to meet expectations, that future cash flows will be inadequate to meet operating requirements and/or will be insufficient to provide for dividend payments in accordance with REIT requirements, that the actual non-revenue generating capital expenditures will exceed the Operating Partnership's current expectations, that the Fund will fail to perform as anticipated, the Operating Partnership will not have access to the debt and equity markets in a timely fashion in order to meet future funding requirements, as well as those risks, special considerations, and other factors discussed under the caption "Potential Factors Affecting Operating Results" below and those discussed under the caption "Other Matters/Risk Factors" in Item 1 of the Operating Partnership's Annual Report on Form 10-K for the year ended December 31, 2001.
Potential Factors Affecting Future Operating Results
Many factors affect the Operating Partnership's actual financial performance and may cause the Operating Partnership's future results to be different from past performance or trends. These factors include those factors discussed under the caption "Other Matters/Risk Factors" in Item 1 of the Operating Partnership's Annual Report on Form 10-K for the year ended December 31, 2001 and the following:
Economic Environment and Impact on Operating Results
Both the national economy and the economies of the western states in which the Operating Partnership owns, manages and develops properties have been and continue to be in a recession. The impacts of such recession on operating results can include, and are not limited to, reduction in rental rates, occupancy levels, property valuations and increases in operating costs such as advertising, turnover and repair and maintenance expense.
The Operating Partnership's property type and diverse geographic locations provide some degree of risk moderation but are not immune to a prolonged down cycle in the real estate markets in which the Operating Partnership operates. Although the Operating Partnership believes it is well positioned to meet the challenges ahead, it is possible that further reductions in occupancy and market rental rates will result in reduction of rental revenues, operating income, cash flows, and market value of the Company's shares. Prolonged recession could also affect the Operating Partnership's ability to obtain financing at acceptable rates of interest and to access funds from the disposition of properties at acceptable prices.
Development and Redevelopment Activities
The Operating Partnership pursues multifamily residential properties and development and redevelopment projects from time to time. Development projects generally require various government and other approvals, the receipt of which cannot be assured. The Operating Partnership's development and redevelopment activities generally entail certain risks, including the following:
| | | funds may be expended and management's time devoted to projects that may not be completed; |
| | | construction costs of a project may exceed original estimates possibly making the project economically unfeasible; |
| | | projects may be delayed due to, among other things, adverse weather conditions; |
| | | occupancy rates and rents at a completed project may be less than anticipated; and |
| | | expenses at a completed development project may be higher than anticipated. |
These risks may reduce the funds available for distribution to the Company's stockholders. Further, the development and redevelopment of properties is also subject to the general risks associated with real estate investments.
Interest Rate Fluctuations
The Operating Partnership monitors changes in interest rates and believes that it is well positioned from both a liquidity and interest rate risk perspective. However, current interest rates are at historic lows and potentially could increase rapidly to levels more in line with recent levels. The immediate effect of significant and rapid interest rate increases would result in higher interest expense on the Operating Partnership's variable interest rate debt. The effect of prolonged interest rate increases could negatively impact the Operating Partnership's ability to make acquisitions and develop properties at economic returns on investment and the Operating Partnership's ability to refinance existing borrowings at acceptable rates.
Inflation
Inflationary increases would likely have a negative effect on property operating results and such increases may be at greater rates of increases than property rental rates in a period of recession. The Operating Partnership believes it effectively manages its property and other expenses but understands that a return to higher annual rates of inflation would result in increases to operating expense.
Funds from Operations
Industry analysts generally consider funds from operations, ("Funds From Operations"), an appropriate measure of performance of an equity REIT. Generally, Funds From Operations adjusts the net income of equity REITs for non- cash charges such as depreciation and amortization of rental properties, gains/losses on sales of real estate property and extraordinary items. Management considers Funds From Operations to be a useful financial performance measurement of an equity REIT because, together with net income and cash flows, Funds From Operations provides investors with an additional basis to evaluate the ability of a REIT to incur and service debt and to fund acquisitions and other capital expenditures. Funds From Operations does not represent net income or cash flows from operations as defined by accounting principles generally accepted in the United States of America ("GAAP") and is not intended to indicate whether cash flows will be sufficient to fund cash needs. It should not be considered as an alternative to net income as an indicator of the REIT's operating performance or to cash flows as a measure of liquidity. Funds From Operations does not measure whether cash flow is sufficient to fund all cash needs including principal amortization, capital improvements and distributions to shareholders. Funds From Operations also does not represent cash flows generated from operating, investing or financing activities as defined under GAAP. Further, Funds from Operations as disclosed by other REITs may not be comparable to the Operating Partnership's presentation of Funds From Operations.
The following table sets forth the Operating Partnership's calculation of Funds from Operations for the three and nine months ended September 30, 2002 and 2001.
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------- --------------------------
2002 2001 2002 2001
------------ ------------ ------------ ------------
Income from continuing operations before gain on sale of
real estate, minority interests and discontinued operations $ 16,578,000 $ 17,392,000 $ 53,296,000 $ 51,509,000
Adjustments:
Gain on sale of co-investment activities, net (1) (19,000) -- (1,408,000) --
Depreciation and amortization 9,129,000 9,102,000 27,229,000 26,666,000
Depreciation and amortization-unconsolidated co-investment 2,170,000 1,201,000 5,892,000 3,647,000
Minority interests (4,607,000) (4,582,000) (13,816,000) (13,759,000)
Income from discontinued operations -- 141,000 225,000 444,000
Depreciation - discontinued operations -- 95,000 191,000 284,000
------------ ------------ ------------ ------------
Funds From Operations $ 23,251,000 $ 23,349,000 $ 71,609,000 $ 68,791,000
============ ============ ============ ============
Weighted average number
units outstanding diluted (2) 21,829,211 21,093,631 20,962,971 21,003,100
============ ============ ============ ============
(1) Gain on sale of co-investment activities has been decreased by $700,000 for the nine months ended September 30, 2002 due to reducing the Operating Partnership's carrying value in a real estate technology fund investment.
(2)Includes all outstanding units of the general partner common equity and assumes conversion of all limited partner common equity into shares of the Company's common stock.
Item 3: Quantitative and Qualitative Disclosures About Market Risk
The Operating Partnership is exposed to interest rate changes primarily as a result of its line of credit and long-term debt used to maintain liquidity and fund capital expenditures and expansion of the Operating Partnership's real estate investment portfolio and operations. The Operating Partnership's interest rate risk management objective is to limit the impact of interest rate changes on earnings and cash flows and to lower its overall borrowing costs. To achieve its objectives the Operating Partnership borrows primarily at fixed rates and may enter into derivative financial instruments such as interest rate swaps, caps and treasury locks in order to mitigate its interest rate risk on a related financial instrument. The Operating Partnership does not enter into derivative or interest rate transactions for speculative purposes.
The Operating Partnership's interest rate risk is monitored using a variety of techniques. The table below presents the principal amounts and weighted average interest rates by year of expected maturity to evaluate the expected cash flows and sensitivity to interest rate changes. The Operating Partnership believes that the principal amounts of the Operating Partnership's mortgage notes payable and line of credit approximate fair value as of September 30, 2002 as interest rates and other terms are consistent with yields currently available to the Operating Partnership for similar instruments.
For Year Ended 2002 2003 2004 2005 2006 Thereafter Total
-------- -------- --------- -------- -------- ----------- ---------
Fixed rate debt (In thousands)
Amount $ 9,615 $ 24,110 $ 6,445 $ 39,309 $ 18,607 $ 402,994 $ 501,080
Average interest rate 7.3% 7.3% 7.3% 7.3% 7.3% 7.3%
Variable rate LIBOR debt (In thousands)
Amount $ -- $ $ 121,959 $ -- $ -- $ 58,820 (1) $ 180,779
Average interest -- 2.9% -- -- 5.1%
(1) Capped at interest rates ranging from 7.1% to 7.3%.
The Operating Partnership does not have any exposures related to forward contracts at September 30, 2002.
Item 4: Controls and Procedures
Within 90 days prior to the filing date of this report, we carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rules 13a-14 and 15d-14 of the Securities Exchange Act of 1934, as amended. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting management to material information relating to the Operating Partnership that is required to be included in our periodic filings with the Securities and Exchange Commission. There have been no significant changes in our internal controls or in other factors that could significantly affect internal controls subsequent to the date we carried out our evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Part II -- Other Information
Item 6: Exhibits and Reports on Form 8-K
- Exhibits
99.1 Certification of Keith R. Guericke, Chief Executive Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Certification of Michael J. Schall, Chief Financial Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
- Reports on Form 8-K
None
SIGNATURE
Pursuant to the requirements 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.
| ESSEX PORTFOLIO, L.P. A California Limited Partnership |
| (Registrant) |
| |
Date: November 14, 2002
| | |
| By: | /S/ MARK J. MIKL |
| Mark J. Mikl |
| Vice President and Controller
(Authorized Officer and Principal Accounting Officer) |
ESSEX PORTFOLIO, L.P.
CERTIFICATIONpursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
I, Keith R. Guericke, Chief Executive Officer of Essex Property Trust, Inc., the general partner of the registrant Essex Portfolio, L.P., hereby certify that:
1. I have reviewed this quarterlyreport on Form10-Q of Essex Portfolio, L.P.;
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterlyreport;
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: November 14, 2002
/s/ Keith R. Guericke
Keith R. Guericke
Chief Executive Officer
ESSEX PORTFOLIO, L.P.
CERTIFICATIONpursuant to Section 302 of the
Sarbanes-Oxley Act of 2002
I, Michael J. Schall, Chief Financial Officer of Essex Property Trust, Inc., the general partner of the registrant Essex Portfolio, L.P., hereby certify that:
1. I have reviewed this quarterlyreport on Form10-Q of Essex Portfolio, L.P.;
2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterlyreport;
3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function):
a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Date: November 14, 2002
/s/ Michael J. Schall
Michael J. Schall
Chief Financial Officer
