Cornerstone Realty Income Trust (TCR) 10-Q 2003 Q1 Quarterly report

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2003

OR

o

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM _______ TO _______

Commission File Number 1-12875

CORNERSTONE REALTY INCOME TRUST, INC.

(Exact name of registrant as specified in its charter)

VIRGINIA
(State or other jurisdiction
of incorporation or organization)
54-1589139
(IRS Employer
Identification No.)

306 EAST MAIN STREET
RICHMOND, VIRGINIA
(Address of principal executive offices)

23219
(Zip Code)

(804) 643-1761
(Registrant’s telephone number, including area code)

Not Applicable
(Former name, former address, and former fiscal
year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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 o

At May 1, 2003, there were 49,607,283 outstanding shares of common stock, no par value, of the registrant.

CORNERSTONE REALTY INCOME TRUST, INC.
FORM 10-Q

INDEX

		Page Number
PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)
	Consolidated Balance Sheets — March 31, 2003 and December 31, 2002	3
	Consolidated Statements of Operations — Three months ended March 31, 2003 and March 31, 2002	4
	Consolidated Statement of Shareholders’ Equity — Three months ended March 31, 2003	5
	Consolidated Statements of Cash Flows — Three months ended March 31, 2003 and March 31, 2002	6
	Notes to Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	12
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	18
Item 4.	Controls and Procedures	19
PART II	OTHER INFORMATION:
Item 1.	Legal Proceedings (not applicable)
Item 2.	Changes in Securities and Use of Proceeds (not applicable).
Item 3.	Defaults Upon Senior Securities (not applicable).
Item 4.	Submission of Matters to a Vote of Security Holders (not applicable)
Item 5.	Other Information (not applicable)
Item 6.	Exhibits and Reports on Form 8-K	20

2

CORNERSTONE REALTY INCOME TRUST, INC.
CONSOLIDATED BALANCE SHEETS (UNAUDITED)

	(In thousands, except per share data)
	March 31, 2003			December 31, 2002
ASSETS
Investment in rental property:
Land	$	150,708		$	152,207
Buildings and property improvements		962,704			975,532
Furniture and fixtures		34,571			34,853
		1,147,983			1,162,592
Less accumulated depreciation		(185,146	)		(176,743	)
		962,837			985,849
Cash and cash equivalents		9,491			1,380
Prepaid expenses		3,607			4,636
Deferred financing costs, net		4,244			4,519
Other assets		18,390			18,463
Total Assets	$	998,569		$	1,014,847
LIABILITIES and SHAREHOLDERS’ EQUITY
Liabilities
Notes payable-unsecured	$	78,239		$	77,913
Notes payable-secured		603,288			604,446
Distributions payable		76			76
Accounts payable and accrued expenses		10,593			12,953
Rents received in advance		381			606
Tenant security deposits		1,573			1,574
Total Liabilities		694,150			697,568
Minority interest of unit holders in operating partnership		20,154			30,205
Shareholders’ equity
Preferred stock, no par value, authorized 25,000 shares; $25 liquidation preference, Series A Cumulative Convertible Redeemable; issued and outstanding 127 shares		2,680			2,680
Common stock, no par value, authorized 100,000 shares; issued and outstanding 49,466 shares and 48,361 shares, respectively		498,368			487,303
Deferred compensation		(609	)		(638	)
Distributions greater than net income		(216,174	)		(202,271	)
Total Shareholders’ Equity		284,265			287,074
Total Liabilities and Shareholders’ Equity	$	998,569		$	1,014,847

See accompanying notes to consolidated financial statements.

3

CORNERSTONE REALTY INCOME TRUST, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

	(In thousands, except per share data)
	Three Months Ended
	March 31, 2003			March 31, 2002
REVENUE:
Rental income	$	38,367		$	38,398
Other property income		1,631			1,569
Total revenues		39,998			39,967
EXPENSES:
Property and maintenance		11,334			10,099
Taxes and insurance		5,514			4,781
Property management		978			941
General and administrative		823			861
Other depreciation		6			7
Depreciation of rental property		12,043			11,033
Other		99			97
Total expenses		30,797			27,819
Income before interest income (expense)		9,201			12,148
Interest income		6			15
Interest expense		(10,915	)		(10,047	)
Income (loss) from continuing operations before minority interest of unit holders in operating partnership		(1,708	)		2,116
Minority interest of unit holders in operating partnership		12			(41	)
Income (loss) from continuing operations		(1,696	)		2,075
Discontinued operations:
Income from discontinued operations		11			209
Gain on sales of investments		1,400			—
Net (loss) income	$	(285	)	$	2,284
Distributions to preferred shareholders		(76	)		(76	)
Net (loss) income available to common shareholders	$	(361	)	$	2,208
Net (loss) income per share from continuing operations-basic and diluted	$	(0.04	)	$	0.04
Net income per share from discontinued operations-basic and diluted	$	0.03		$	0.01
Distributions per common share	$	0.28		$	0.28
Weighted average number of common shares outstanding-basic and diluted		48,819			47,826

See accompanying notes to consolidated financial statements.

4

CORNERSTONE REALTY INCOME TRUST, INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY (UNAUDITED)

(In thousands, except per share data)	Number of Common Shares	Common Stock Amount		Number of Preferred Shares	Preferred Stock Amount		Deferred Compensation			Distributions Greater Than Net Income			Total Shareholders’ Equity
Balance at December 31, 2002	48,361	$	487,303	127	$	2,680	$	(638	)	$	(202,271	)	$	287,074
Net income	—		—	—		—		—			(285	)		(285	)
Cash distributions declared to common shareholders ($.28 per share)	—		—	—		—		—			(13,542	)		(13,542	)
Cash distributions for Series A Convertible Preferred Shares	—		—	—		—		—			(76	)		(76	)
Conversion of minority interest of unit holders in operating partnership units	887		9,374	—		—		—			—			9,374
Restricted stock grants	5		35	—		—		(35	)		—			—
Amortization of deferred compensation	—		—	—		—		64			—			64
Shares issued through dividend reinvestment plan	213		1,656	—		—		—			—			1,656
Balance at March 31, 2003	49,466	$	498,368	127	$	2,680	$	(609	)	$	(216,174	)	$	284,265

See accompanying notes to consolidated financial statements.

5

CORNERSTONE REALTY INCOME TRUST, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

	(In thousands)
	Three Months Ended
	March 31, 2003			March 31, 2002
Cash flow from operating activities:
Net (loss) income	$	(285	)	$	2,284
Adjustments to reconcile net income to net cash provided by operating activities
Gain on sales of investments		(1,400	)		—
Depreciation and amortization		12,211			11,261
Minority interest of unit holders in operating partnership		(12	)		41
Amortization of deferred compensation		64			92
Amortization of deferred financing costs		274			204
Amortization of mortgage notes payable premium		(89	)		(89	)
Changes in operating assets and liabilities:
Operating assets		1,436			4,912
Operating liabilities		(2,279	)		(5,506	)
Net cash provided by operating activities		9,920			13,199
Cash flow from investing activities:
Development of real estate assets		(11	)		(575	)
Major renovations		(366	)		(329	)
Capital improvements		(2,629	)		(3,302	)
Net funding of real estate reserve for replacement		(440	)		(237	)
Net proceeds from the sale of rental property		15,007			—
Net cash provided by (used in) investing activities		11,561			(4,443	)
Cash flow from financing activities:
Proceeds (repayments) from/of short-term borrowings		326			(5,000	)
Proceeds from secured notes payable		—			12,600
Repayments of secured notes payable		(1,069	)		(765	)
Payment of deferred financing costs		—			(181	)
Shares issued through dividend reinvestment plan and exercise of stock options		1,656			1,723
Purchase of common stock		—			(86	)
Cash distributions to operating partnership unit holders		(665	)		(354	)
Cash distributions paid to preferred shareholders		(76	)		(76	)
Cash distributions paid to common shareholders		(13,542	)		(13,184	)
Net cash used in financing activities		(13,370	)		(5,323	)
Increase in cash and cash equivalents		8,111			3,433
Cash and cash equivalents, beginning of year		1,380			8,656
Cash and cash equivalents, end of period	$	9,491		$	12,089
Supplemental information:
Non-cash transactions:
Real estate assets acquired		—		$	10,301
Assumption of mortgage notes		—			5,500
Issuance of operating partnership units		—			4,801
Conversion of operating partnership units to common stock	$	9,374			—

See accompanying notes to consolidated financial statements.

6

CORNERSTONE REALTY INCOME TRUST, INC
Notes to Consolidated Financial Statements (Unaudited)
March 31, 2003

(1)

Basis of Presentation

The accompanying interim unaudited financial statements have been prepared in accordance with the instructions for Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information required by generally accepted accounting principles. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of financial position have been included. These unaudited financial statements should be read in conjunction with the Company’s audited consolidated financial statements contained in the Company’s December 31, 2002 Annual Report on Form 10-K. Operating results for the three months ended March 31, 2003 are not necessarily indicative of the results that may be expected for the year ending December 31, 2003.

Certain previously reported amounts have been reclassified to conform with the current year financial statement presentation.

The Company did not have any items of comprehensive income requiring separate reporting and disclosure for the periods presented.

Stock Option Compensation

The Company elected to expense its stock compensation in accordance with SFAS No. 123 and its amendment (SFAS No. 148), “Accounting for Stock Based Compensation,” effective in the first quarter of 2003. The Company did not grant any options to purchase shares during the three months ended March 31, 2003 and 2002. The Company’s options to purchase shares are vested immediately upon grant, therefore the compensation expense would occur in the period granted. The stock compensation expense reported in the Company’s financials for the periods presented are the same as those that would have been reported had the Company applied the fair value method of SFAS No. 123. The sole item of the stock compensation for these periods reflect the amortization of the restricted stock grants which is accounted for similarly under both methods. The following information about stock-based employee compensation costs reconciles the difference of accounting for employee stock based compensation under the intrinsic value method of APB No. 25 and related interpretations and the fair value method prescribed under SFAS No. 123 (in thousands):

	Three Months Ended March 31,
	2003			2002
Net (loss) income, as reported	$	(285	)	$	2,284
Add: Stock-based employee compensation expense included in reported net income		64			92
Deduct: Stock-based employee compensation expense determined under fair value based method for all awards		(64	)		(92	)
Pro forma net (loss) income as if the fair value method had been applied to all option grants	$	(285	)	$	2,284
Earnings per share
Basic-as reported	$	(0.01	)	$	0.05
Basic-pro forma		(0.01	)		0.05
Diluted-as reported		(0.01	)		0.05
Diluted-pro forma		(0.01	)		0.05

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(2)

Investment in Rental Property

Disposition of Investments

The Company closed on the sale of two apartment communities containing a total of 395 apartment homes. The Company sold the two apartment communities for a total of $15.85 million and recognized a gain of $1.4 million. As a result of the sales, the Company’s financial statements have been prepared with these two apartment communities’ results of operations and cash flows and the gain from sale isolated and shown as “discontinued operations.” All historical statements have been restated to conform to this presentation in accordance with SFAS No. 144.

The components of income from operations related to discontinued operations for the three months ended March 31, 2003 and 2002 are shown below. These include the results of operations through the date of sale for the three months ended March 31, 2003 and a full period of operations for the three months ended March 31, 2002 (dollars in thousands):

	Three Months Ended March 31,
	2003		2002
��
Rental and other property income	$	369	$	735
Expenses:
Property and maintenance		142		212
Taxes and insurance		54		93
Depreciation of rental property		162		221
Total expenses		358		526
Net income		11		209
Gain on sales of investments		1,400		—
Income from discontinued operations	$	1,411	$	209

The Company had no assets that qualified as held for disposition as defined by SFAS No. 144 at March 31, 2003.

8

(2)

Notes Payable

Secured

The aggregate maturities of principal, including monthly installments of principal, for secured debt for the five years subsequent to March 31, 2003 are as follows (in thousands):

Year	Amount
2003	$	10,504
2004		31,445
2005		67,849
2006		95,902
2007		9,183
Thereafter		388,405
	$	603,288

Unsecured

During the first quarter of 2003, the Company’s $75 million unsecured line of credit with a commercial bank was increased to $85 million and the maturity date was extended to May 30, 2003. The unsecured line of credit bears interest at one month LIBOR plus 160 basis points. The Company is obligated to pay lenders a quarterly commitment fee equal to .25% per annum of the unused portion of the line. At March 31, 2003 and 2002, borrowings on the unsecured line of credit were $78 million and $50 million, respectively.

The Company’s $7.5 million unsecured line of credit for general corporate purposes bears interest at one month LIBOR plus 120 basis points. The maturity date was extended to May 30, 2003. There were no amounts outstanding at March 31, 2003 and 2002 under this arrangement.

(3)

Operating Partnership

Effective October 1, 2001, State Street, LLC and State Street I, LLC, each a North Carolina limited liability company (collectively, the “Limited Partners”), and the Company, as the sole general partner, formed Cornerstone NC Operating Limited Partnership, a Virginia limited partnership (the “Limited Partnership”). The Company has approximately an 80% interest in the Limited Partnership. The Limited Partners are minority limited partners and are not otherwise related to the Company. The Limited Partners contributed and agreed to contribute property to the Limited Partnership in exchange for preferred and non-preferred operating partnership units. The non-preferred operating partnership units convert into preferred operating partnership units over time or as certain lease-up and stabilization criteria are met. Beginning October 1, 2002, the Limited Partners became able to elect to redeem a portion of the preferred operating partnership units. If the Limited Partners make the election, the Company, at its option, will convert the preferred operating partnership units for either common shares of the Company on a one-for-one basis or cash in an amount per unit equal to the closing price of a common share of the Company on the exercise date (or other specified price if there is no closing price on that date), subject to anti-dilution adjustments.

As of March 31, 2003, there were 1,487,430 preferred and 319,715 non-preferred operating partnership units. During the first quarter of 2003, a total of 887,125 preferred operating partnership units were converted into common shares on a one-to-one basis.

9

(4)

Earnings Per Share

The following table sets forth the computation of basic and diluted earnings per share in accordance with FAS 128 (in thousands, except per share data):

	Three Months Ended March 31,
	2003			2002
Numerator:
Net (loss) income available to common shareholders	$	(361	)	$	2,208
Numerator for basic and diluted earnings per share -income available to common stockholders after assumed conversion	$	(361	)	$	2,208
Denominator:
Denominator for basic earnings per share-weighted-average shares		48,819			47,826
Effect of dilutive securities:
Stock options		—			54
Denominator for diluted earnings per share-adjusted weighted-average shares and assumed conversions		48,819			47,880
Basic and diluted earnings per common share	$	(0.01	)	$	0.05

The conversion of the operating partnership units, weighted average of 2,092,335 and 1,284,802 for the three months ended March 31, 2003 and 2002, respectively, are not included in earnings per common share calculations since their effect is not dilutive.

(5)

Recent Accounting Pronouncements

In December 2002, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure.” SFAS No. 148 amends SFAS No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition to SFAS No. 123’s fair value method of accounting for stock-based employee compensation. SFAS No. 148 also amends the disclosure provisions of SFAS No. 123 and Accounting Principles Board (APB) Opinion No. 28, “Interim Financial Reporting,” to require disclosure in the summary of significant accounting policies of the effects of an entity’s accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. SFAS No. 148 is effective for fiscal years beginning after December 15, 2002. The Company adopted the new accounting standard effective as of the first quarter of fiscal year 2003.

In November 2002, the FASB issued Interpretation 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” This statement requires that a liability for the fair value of a guarantee be recognized at the time the obligation is undertaken. The statement also requires that the liability be measured over the term of the related guarantee. This statement is effective for all guarantees entered into subsequent to December 31, 2002. For all guarantees entered into prior to December 31, 2002, there is to be no change in accounting; however, disclosure of management’s estimate of its future obligation under the guarantee is to be made. The

10

Company currently does not have any guarantee obligations to which Interpretation 45 applies.

In January 2003, the FASB issued Interpretation 46, “Consolidation of Variable Interest Entities.” This statement refines the identification process of variable interest entities and how an entity assesses its interests in a variable interest entity to decide whether to consolidate that entity. The Company has formed wholly-owned subsidiaries for financing purposes and such financings is reflected in the consolidated financial statements. Currently, the Company does not anticipate this Statement having a material impact on its consolidated financial statements.

(6)

Subsequent Events

On February 19, 2003, the Company and Merry Land Properties, Inc, entered into a merger agreement in which Merry Land Properties, Inc. will merge into a subsidiary of the Company. Merry Land owns interests in nine apartment communities containing approximately 2,000 units in Georgia, South Carolina and Florida. Merry Land shareholders will receive 1.818 common shares of the Company and 0.220 shares of the Company’s non-dividend Series B Convertible Preferred Stock for each Merry Land common share. The preferred stock will be convertible into 0.220 common shares of the Company upon the completion and lease up of Merry Land’s Merritt at Whitemarsh project in Savannah, Georgia or in certain other circumstances. The total value of the common stock to be received by the Merry Land shareholders (including common stock received upon conversion) as of the date of the merger agreement was approximately $42 million. The Company will assume approximately $94 million in debt and other liabilities.

The transaction is expected to close in the second quarter of 2003, subject to the approval of Merry Land’s shareholders and other customary closing conditions. The proposed transaction can be terminated at Merry Land’s option, if the closing price of the Company’s common shares is below $6.50 per share for 10 of any 30 consecutive trading days prior to the consummation of the merger.

In order to facilitate the merger transaction, a private company called Merry Land & Investment Company, LLC, has been formed by members of Merry Land’s management to buy Merry Land’s non-apartment assets, which the Company did not desire, and to continue development of apartment projects for the Company.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following information should be read in conjunction with the Cornerstone Realty Income Trust, Inc. December 31, 2002 Annual Report on Form 10-K as well as the financial statements and notes included in Item 1 of this report. This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such forward-looking statements include, without limitation, statements concerning anticipated improvements in financial operations from completed and planned property renovations, and from the substitution of fixed rate for variable rate debt. Such statements involve known and unknown risks, uncertainties, and other factors which may cause the actual results, performance, or achievement of the Company to be materially different from the results of operations or plans expressed or implied by such forward-looking statements. Such factors include, among other things, unanticipated adverse business developments affecting the Company, adverse changes in the real estate markets and general and local economies and business conditions, and adverse changes with respect to the availability and terms of debt financing, and a reduction of the portion of dividends that are reinvested through the Company’s dividend reinvestment plan. Although the Company believes that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate, and therefore there can be no assurance that such statements included in this quarterly report will prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by the Company or any other person that the results or conditions described in such statements or the objectives and plans of the Company will be achieved.

Business

Cornerstone Realty Income Trust, Inc. (together with its subsidiaries, the “Company”) is a self-administered and self-managed REIT headquartered in Richmond, Virginia. The business of the Company is to acquire and operate existing residential apartment communities located in the southern United States. As of March 31, 2003, the Company owned 80 apartment communities, which comprised a total of 21,223 apartment homes. The Company’s apartment communities are located in Georgia, North Carolina, South Carolina, Texas and Virginia. The Company, as the general partner, has approximately an 80% interest in the Cornerstone NC Operating Limited Partnership. This partnership holds certain apartment communities in North Carolina and was formed by the Company and the prior owner, which is a minority limited partner and is not otherwise related to the Company.

The Company owns and operates multifamily apartment communities that generate rental and other property related income through the leasing of apartment homes to a diverse base of tenants. The Company separately evaluates the performance of each of its apartment communities. However, because each of the apartment communities has similar economic characteristics, facilities, services and tenants, the apartment communities have been aggregated into a single apartment communities segment. All segment disclosure is included in or can be derived from the Company’s consolidated financial statements.

12

Results of Operations

Income and occupancy

Substantially all of the Company’s income is from the rental operation of apartment communities. The Company’s property operations for the three months ended March 31, 2003 include the results of operations of 80 apartment communities owned on that date. The operations of the two properties sold during the first quarter of 2003 are reflected in “discontinued operations”.

Total revenue for the three months ended March 31, 2003 and 2002 was $40.0 million. At the end of the first quarter of 2003, the Company owned 818 more apartment homes than it owned for the same period in 2002. Rental income in 2003 increased over 2002 as a result of the full effect in 2003 of the 2002 acquisitions, however, the increase was offset by the increase in rental concessions and the decrease in economic occupancy, discussed below, which resulted from the continuing soft market conditions in the major markets in which the Company operates. The Company will continue to add revenue-enhancing improvements in an effort to improve the apartment communities’ marketability, economic occupancies, and rental rates.

Overall economic occupancy (scheduled rent divided by gross potential rent) for the Company’s apartment communities averaged 86% and 89% for the three months ended March 31, 2003 and 2002, respectively. The decrease in 2003 is attributable to softening in overall market conditions in the major markets in which the Company operates.

Expenses

Property operating expenses include the following expense categories: property and maintenance, taxes and insurance and property management. Property operating expenses for the three months ended March 31, 2003 were $17.8 million and $15.8 million for the same period in 2002. The increase is primarily due to the full effect in 2003 of the apartment communities acquired in 2002. The increases in property insurance costs, real estate tax assessment and higher utility costs also contributed to the increases in property operating expenses. The operating expense ratio (the ratio of property operating expenses to rental income) was 46.5% and 41.2% for the three months ended March 31, 2003 and 2002, respectively.

Depreciation expense for the three months ended March 31, 2003 was $12.0 million and $11.0 million for the same period in 2002. The increase in depreciation expense is due to the full effect of depreciation of the 2002 acquisitions and the depreciation associated with capital improvements made during 2003 and 2002.

General and administrative expenses totaled $0.8 million, or 2.1% of rental income for the three months ended March 31, 2003, and $0.9 million, or 2.2% for the same period in 2002. These expenses represent the administrative expenses of the Company as distinguished from the property operating expenses of the Company’s apartment communities.

Interest and investment income and expense

The Company’s interest income decreased to $5,616 in the three months ended March 31, 2003 from $14,653 for the same period in 2002.

The Company incurred interest expense of $10.9 million and $10.0 million during the three

13

months ended March 31, 2003 and 2002, respectively. The increase is due to the full quarter impact of the fixed and variable rate mortgage notes placed or assumed on three apartment communities during 2002 and the addition of $25 million of borrowings under the Company’s unsecured line of credit. Weighted average interest rates on the Company’s debt was 6.2% for the first quarter of 2003 and 6.4% for the same period in 2002.

Income from discontinued operations

During the first quarter on 2003, the Company sold two apartment communities containing a total of 395 apartment homes for a total sales price of $15.85 million and recognized a gain of $1.4 million. As a result of the sales, the Company’s financial statements have been prepared with these two apartment communities’ results of operations and cash flows, and the gain from sale isolated and shown as “discontinued operations.” All historical statements have been restated to conform to this presentation in accordance with SFAS No. 144. The net income for the three months ended March 31, 2003 and 2002 were approximately $11,000 and $0.2 million, respectively.

Comparable property operations

Property operating income is a measure the Company used to evaluate performance and is not deemed to be an alternative to net income, as determined in accordance with generally accepted accounting principles. In addition, this measure, as calculated by the Company, may not be comparable to similarly entitled measures reported by other companies. The Company’s “same-community property” portfolio consists of 72 stabilized apartment communities, containing 19,249 apartment homes, that the Company has owned since January 1, 2002, representing approximately 91% of the Company’s 21,223 apartment homes. The two apartment communities sold in the first quarter of 2003, have been eliminated from the calculation. For the three months ended March 31, 2003, same-community property operating income (rental income less property operating expenses), decreased 13%, rental income decreased 4% and property operating expenses increased 10% over the same period in 2002. The decrease in rental income is primarily due to the soft overall market conditions, which resulted in increased rental concessions and lower average occupancies. The Company’s property operating expenses increased primarily due to higher utility costs, real estate tax assessments and property insurance costs. Property operating expenses primarily consist of property taxes and insurance, repairs and maintenance, utilities, payroll costs, and advertising and marketing. In addition, property operating expenses excludes depreciation, general and administrative, other expenses, interest income and expenses and minority interest, as these are not considered in the operating performance of the apartment communities. The following is a reconciliation of the same community property operating income to income from continuing operations as determined in accordance with generally accepted accounting principles (in thousands):

14

	Three Months Ended March 31,
	2003			2002
Comparable properties (same communities)
Rental and other property income	$	36,079		$	37,776
Property operating expenses		(15,602	)		(14,185	)
Property operating income		20,477			23,591
Non-comparable properties (remaining communities)
Rental and other property income		3,919			2,191
Property operating expenses		(2,224	)		(1,636	)
Property operating income		1,695			555
Depreciation of rental property		(12,043	)		(11,033	)
General and administrative		(823	)		(861	)
Other depreciation		(6	)		(7	)
Other		(99	)		(97	)
Interest income		6			15
Interest expense		(10,915	)		(10,047	)
Minority interest of unit holders in operating partnership		12			(41	)
Income (loss) from continuing operations	$	(1,696	)	$	2,075

Liquidity and Capital Resources

The Company’s primary sources of liquidity are rental income generated from the apartment communities, proceeds from unsecured lines of credit, reinvestment of distributions, and proceeds from secured debt.

The Company expects to continue to meet short-term and long-term liquidity requirements, through rental income generated from the apartment communities, equity raised from its dividend reinvestment plan, through secured or unsecured borrowings, possible refinancing, or through the disposition of certain assets that, in our evaluation, may no longer meet our investment requirements. It is expected that the above will be adequate to meet all normal property operating expenses, payment of distributions, budgeted capital improvements, possible property acquisitions, scheduled debt maturities and scheduled principal payments of mortgage debt for 2003. At March 31, 2003, the Company had $9.5 million in cash and cash equivalents.

Notes Payable

Unsecured

During the first quarter of 2003, the Company’s $75 million unsecured line of credit with a commercial bank was increased to $85 million and the maturity date was extended to May 30, 2003. The unsecured line of credit bears interest at one month LIBOR plus 160 basis points. The Company is obligated to pay lenders a quarterly commitment fee equal to .25% per annum of the unused portion of the line. At March 31, 2003 and 2002, borrowings on the unsecured line of credit were $78 million and $50 million, respectively.

The Company’s $7.5 million unsecured line of credit for general corporate purposes bears

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interest at one month LIBOR plus 120 basis points. The maturity date was extended to May 30, 2003. There were no amounts outstanding at March 31, 2003 and 2002 under this arrangement.

The Company is in the process of negotiating an extension to its lines of credit and intends to replace these lines of credit within the year with a combination of a longer-term debt arrangement and a reduced line of credit. The Company has over 20 unencumbered apartment communities, which the Company has the opportunity to use as collateral for a secured financing arrangement. Given the value of these properties and current financing opportunities available to the Company, the Company believes it will be able to obtain longer-term secured financing.

Capital Requirements

The Company has an ongoing capital expenditure plan to fund its renovation program for its apartment communities. Capital expenditures include capital replacements, initial capital expenditures, and redevelopment enhancements. The Company anticipates that it will continue to operate as it did in 2002 and fund these cash needs from a variety of sources including equity raised from its dividend reinvestment plan and debt provided by its lines of credit. Given the Company’s current debt level, the Company will seek to obtain additional debt financingfrom a variety of sources, both secured and unsecured, if necessary.

Effective April 2003, the Company’s quarterly dividend rate was $.20 per common share.

The Company capitalized $3.0 million of improvements to its various apartment communities during the first quarter of 2003. The asset preservation capital expenditures, including floor coverings, HVAC equipment, roofs, appliances, siding, exterior painting, parking lots, and other non-revenue enhancing capital expenditures, totaled $2.0 million. Revenue enhancing capital expenditures, including interior upgrades, gating and access systems, totaled $0.6 million for the three months ended March 31, 2003. Redevelopment expenditures, including amenities that add a material new feature or revenue source at a property on our recently acquired apartment communities, totaled $0.4 million. It is anticipated that approximately $16 million in additional capital improvements will be completed during 2003 on the current portfolio. The Company is also required by various lenders to fund a replacement reserve in advance for capital improvements. The majority of the capital improvements funded from these reserves are included in the above capital improvements. Capital improvements during 2003 are currently expected to be at approximately the same level as those experienced in 2002. The Company’s capital improvement budget is reviewed on-going and adjustments will be made if deemed necessary.

Capital resources are expected to grow with the future sale of its shares through dividend reinvestment. Approximately 12% of the 2003 common stock distributions, or $1.7 million, was reinvested in additional common shares. In general, the Company’s liquidity and capital resources are believed to be adequate to meet its cash and debt requirements in 2003.

Operating Partnership

Effective October 1, 2001, State Street, LLC and State Street I, LLC, each a North Carolina limited liability company (collectively, the “Limited Partners”), and the Company, as the sole general partner, formed Cornerstone NC Operating Limited Partnership, a Virginia limited partnership (the “Limited Partnership”). The Company has approximately an 80% interest in the Limited Partnership. The Limited Partners are minority limited partners and are not

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otherwise related to the Company. The Limited Partners contributed and agreed to contribute property to the Limited Partnership in exchange for preferred and non-preferred operating partnership units. The non-preferred operating partnership units convert into preferred operating partnership units over time or as certain lease-up and stabilization criteria are met. Beginning October 1, 2002, the Limited Partners became able to elect to redeem a portion of the preferred operating partnership units. If the Limited Partners make the election, the Company, at its option, will convert the preferred operating partnership units for either common shares of the Company on a one-for-one basis or cash in an amount per unit equal to the closing price of a common share of the Company on the exercise date (or other specified price if there is no closing price on that date), subject to anti-dilution adjustments.

There were 1,487,430 preferred and 319,715 non-preferred operating partnership units at March 31, 2003. During the first quarter of 2003, a total of 887,125 preferred operating partnership units were converted into common shares on a one-for-one basis.

Recent Accounting Pronouncements

In December 2002, the Financial Accounting Standards Board (FASB)issued Statement of Financial Accounting Standards (SFAS) No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure.” SFAS No. 148 amends SFAS No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition to SFAS No. 123’s fair value method of accounting for stock-based employee compensation. SFAS No. 148 also amends the disclosure provisions of SFAS No. 123 and Accounting Principles Board (APB) Opinion No. 28, “Interim Financial Reporting,” to require disclosure in the summary of significant accounting policies of the effects of an entity’s accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. SFAS No. 148 is effective for fiscal years beginning after December 15, 2002. The Company adopted the new accounting standard effective as of the first quarter of fiscal year 2003.

In November 2002, the FASB issued Interpretation 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” This statement requires that a liability for the fair value of a guarantee be recognized at the time the obligation is undertaken. The statement also requires that the liability be measured over the term of the related guarantee. This statement is effective for all guarantees entered into subsequent to December 31, 2002. For all guarantees entered into prior to December 31, 2002, there is to be no change in accounting; however, disclosure of management’s estimate of its future obligation under the guarantee is to be made. The Company currently does not have any guarantee obligations to which Interpretation 45 applies.

In January 2003, the FASB issued Interpretation 46, “Consolidation of Variable Interest Entities.” This statement refines the identification process of variable interest entities and how an entity assesses its interests in a variable interest entity to decide whether to consolidate that entity. The Company has formed wholly-owned subsidiaries for financing purposes and such financings is reflected in the consolidated financial statements. Currently, the Company does not anticipate this Statement having a material impact on its consolidated financial statements.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no material changes since December 31, 2002. See the information provided in the Company’s Annual Report on Form 10-K under Item 7-Management’s Discussion and Analysis of Financial Condition and Results of Operations.

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Item 4. Controls and Procedures

The Company’s principal executive officer and principal financial officer have evaluated the effectiveness of the Company’s “disclosure controls and procedures,” as such term is defined in Rule 13a-14(c) of the Securities Exchange Act of 1934, as amended, within 90 days of the filing date of this Quarterly Report on Form 10-Q. Based upon their evaluation, the principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures are effective. There were no significant changes in the Company’s internal controls or in other factors that could significantly affect these controls, since the date the controls were evaluated.

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Item 6. Exhibits and Reports on Form 8-K

(a)

Exhibits

Exhibit No.	Description
2.1	Agreement and Plan of Merger among Cornerstone Realty Income Trust, Inc., Cornerstone Merger Sub, Inc. and Merry Land Properties, Inc. dated February 19, 2003. (Incorporated by reference to Exhibit 2.1 to Current Report on Form 8-K dated February 19, 2003; SEC File No. 1-12875).
2.2	Purchase and Sale Agreement dated February 19, 2003 by and among Merry Land Properties, Inc. and Merry Land & Investment Company, LLC. (Incorporated by reference to Exhibit 2.2 to Current Report on Form 8-K dated February 19, 2003; SEC File No. 1-12875).
3.1	Amended and Restated Articles of Incorporation of Cornerstone Realty Income Trust, Inc., as amended (Incorporated by reference to Exhibit 3.1 to Current Report on Form 8-K dated May 12, 1998; SEC File No. 1-12875).
3.2	Articles of Amendment to the Amended and Restated Articles of Incorporation of Cornerstone Realty Income Trust, Inc. (Incorporated by reference to Exhibit 3.2 to Current Report on Form 8-K dated July 23, 1999; SEC File No. 1-12875).
3.3	Bylaws of Cornerstone Realty Income Trust, Inc. (Amended Through February 13, 2003). (Incorporated by reference to Exhibit 3.3 to Annual Report on Form 10-K filed March 28, 2003; SEC File No. 1-12875).
4.1	Form of Articles of Amendment designating Series B Convertible Preferred Shares. (Incorporated by reference to Exhibit 4.1 to Current Report on Form 8-K dated February 19, 2003; SEC File No. 1-12875).
99.1	Certification pursuant to 18 U.S.C. Section 1350 as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Filed Herewith).

(b)

The following table lists the reports on Form 8-K filed by the Company during the quarter ended March 31, 2003, the items reported and the financial statements included in such filings.

Type and Date of Reports	Items Reported	Financials Statements Filed
Form 8-K dated
February 19, 2003 and	5,7(c)	None
filed February 26, 2003

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SIGNATURES

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.

	Cornerstone Realty Income Trust, Inc. (Registrant)
DATE:   5-13-03	BY:	/s/ STANLEY J. OLANDER,JR.
	Stanley J. Olander, Jr. Executive Vice President and Chief Financial Officer

CERTIFICATIONS

I, Glade M. Knight, certify that:

1.

I have reviewed this quarterly report on Form 10-Q of Cornerstone Realty Income Trust, Inc.;

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 quarterly report;

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

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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: May 13, 2003	/s/ GLADE M. KNIGHT
	Glade M. Knight Chief Executive Officer Cornerstone Realty Income Trust, Inc.

I, Stanley J. Olander, Jr., certify that:

1.

I have reviewed this quarterly report on Form 10-Q of Cornerstone Realty Income Trust, Inc.;

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 quarterly report;

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

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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: May 13, 2003
	/s/STANLEY J. OLANDER, JR.
	Stanley J. Olander, Jr. Executive Vice President Chief Financial Officer Cornerstone Realty Income Trust, Inc.

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