SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 8-K
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
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Date of Report (Date of earliest event reported): DECEMBER 21, 1998
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AVALONBAY COMMUNITIES, INC.
(Exact name of Registrant as specified in charter)
MARYLAND 1-12672 77-0404318
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(State or other jurisdiction (Commission file number) (IRS employer
of incorporation) identification no.)
2900 EISENHOWER AVENUE, SUITE 300, ALEXANDRIA, VIRGINIA 22314
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(Address of principal executive offices) (Zip Code)
(703) 329-6300
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(Registrant's telephone number, including area code)
Item 5. Other Events
COMMENCEMENT OF MEDIUM-TERM NOTES OFFERING
On December 21, 1998, AvalonBay Communities, Inc., a Maryland corporation
(the "Company"), commenced a Medium-Term Note Program (the "Program") which
provides that the Company may offer and sell from time to time its Medium-Term
Notes Due Nine Months or More from Date of Issue in an aggregate principal
amount of up to $400,000,000 (the "MTNs"), as described in the Company's
Prospectus Supplement dated September 30, 1998 (the "Prospectus Supplement") to
the Company's Prospectus dated August 18, 1998. The Prospectus Supplement was
filed with the Securities and Exchange Commission under Rule 424(b)(2) on
September 30, 1998. The MTNs will be issued pursuant to the Company's existing
registration statement on Form S-3 (Registration No. 333-60875).
The MTNs will be offered and sold by PaineWebber Incorporated, First Union
Capital Markets, J.P. Morgan & Co., NationsBanc Montgomery Securities LLC, and
Warburg Dillon Read LLC, as agents for the Company or as principals for resale
to investors and other purchasers (the "Agents"), subject to the Company's right
to solicit offers from and sell the MTNs itself directly to investors, pursuant
to that certain Distribution Agreement among the Company and the Agents dated
December 21, 1998 (the "Distribution Agreement"). The MTNs will be issued under
an Indenture between the Company and State Street Bank and Trust Company, as
trustee (the "Trustee"), dated as of January 16, 1998, as supplemented by a
First Supplemental Indenture dated as of January 20, 1998, a Second Supplemental
Indenture dated as of July 7, 1998, and a Third Supplemental Indenture dated as
of December 21, 1998.
RISK FACTORS
An investment in the MTNs involves various risks. Prospective purchasers
of the MTNs should carefully consider the following risk factors. You should
read these together with the Company's other reports and documents that we file
with the Securites and Exchange Commission, which may include additional or more
current information that is important for you to consider.
THE COMPANY MAY FAIL TO MANAGE GROWTH AND INTEGRATE OPERATIONS AFTER THE MERGER
The Company is the surviving entity from the merger of Avalon Properties,
Inc. ("Avalon") with and into Bay Apartment Communities, Inc. (before the
merger, "Bay") on June 4, 1998. We have experienced a period of rapid growth as
a result of the merger and through the acquisition and development of additional
apartment communities. We currently own 147 apartment communities with
approximately 42,952 apartment homes (including those under development and
redevelopment). This represents an increase of 24,311 from the number of
apartment homes in Bay's pre-merger portfolio. In addition, the integration of
the departments, systems, operating procedures and information technologies of
Bay and Avalon, as well as future acquisitions, developments and redevelopments,
will be challenging, and we cannot assure you
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that we will be able to integrate and manage these operations effectively. If we
are unable to successfully manage our growth or integrate these systems and
procedures into one operating philosophy, it could materially and adversely
affect our results of operations and financial condition.
THE COMPANY MAY NOT REALIZE THE EXPECTED BENEFITS OF THE MERGER
Based on anticipated savings in expenses and other factors related to the
merger, we expect that our FFO per share for the second half of fiscal year 1998
and for future periods will increase compared to FFO per share for Bay prior to
the merger. However, these anticipated savings may not be realized and
unanticipated costs may arise as a result of the merger. For example, although
we believe that we have reasonably estimated the likely costs of integrating the
operations of Bay and Avalon, as well as the incremental costs of operating as a
combined company, unexpected future operating expenses (such as increased
personnel costs, increased property taxes or increased travel expenses) could
materially and adversely affect our operations and financial condition. If we
do not realize the expected savings or if we incur unexpected costs, the merger
could significantly dilute our FFO per share.
THE COMPANY MAY NOT BE ABLE TO CONTINUE ITS EXTERNAL GROWTH RATE
Our asset base should allow us to access capital for the acquisition,
development and redevelopment of apartment communities on more favorable terms
than would be available with a smaller asset base. However, we may be forced to
limit our acquisition, development and redevelopment activities as we attempt to
integrate the operations of Bay and Avalon. Furthermore, we have increased our
minimum target returns, particularly for new community acquisitions that do not
require redevelopment. As a result of this increase, as well as current market
conditions, we anticipate that we will acquire significantly fewer apartment
communities during the remainder of 1998, and we believe that this is also
likely to be true in 1999. Accordingly, we cannot assure you that our external
growth rate will equal or exceed our recent historical external growth rates.
MARKET CONDITIONS AND THE COST OF FINANCING NEW ACQUISITIONS AND DEVELOPMENT MAY
LIMIT OUR GROWTH RATE
The cost of equity and debt financing for new acquisitions and development
has recently been increasing. The increased cost of financing, combined with
increases in the sales prices of existing apartment communities, results in a
lower margin of profit on new acquisitions. While these market conditions
continue, we expect that we will acquire fewer existing apartment communities.
If the current market conditions continue for an extended period, our current
earnings growth rates may decline. As a result, there could be material adverse
effects on our ability to pay distributions to our stockholders and on the
market prices of our equity securities.
RISKS RELATED TO ACQUISITIONS OF APARTMENT COMMUNITIES
The acquisition of apartment communities has historically been an important
component
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of our business strategy. When we acquire an apartment community, we expose
ourselves to the risk that our investment will fail to generate expected
returns, and that estimates of the costs of improvements to bring the acquired
community up to standards established for the market position intended for that
community, will prove inaccurate. Acquisitions also involve general investment
risks associated with any new real estate investment. Although we will undertake
an evaluation of the physical condition of each new community before it is
acquired, certain defects or necessary repairs may not be detected until after
the community is acquired, which could significantly increase our total
acquisition costs and reduce the profitability of the acquired community.
RISKS RELATED TO DEVELOPMENT AND REDEVELOPMENT OF APARTMENT COMMUNITIES
We intend to continue to develop and redevelop apartment home communities
using integrated development, redevelopment and underwriting policies derived
from the respective strengths of Bay and Avalon. In addition to the risk that
we will be unable to successfully integrate these policies, our development and
redevelopment activities may be exposed to the following risks:
* we may abandon development and redevelopment opportunities we have
already begun to explore;
* we may incur construction or reconstruction costs for a community which
exceed our original estimates due to increased materials, labor or other costs,
which could make completion of the community uneconomical;
* occupancy rates and rents at a newly completed development or
redevelopment community may fluctuate depending on a number of factors,
including market and economic conditions, and may not be sufficient to make the
original estimated unleveraged returns on cost for the community;
* we may not be able to obtain financing with favorable terms for the
development or redevelopment of a community; and
* we may be unable to complete construction or reconstruction and lease-up
of a community on schedule, resulting in increased debt service expense and
construction or reconstruction costs.
Our development activities are also subject to the risk that we will be
unable to obtain, or will face delays in obtaining, necessary zoning, land-use,
building, occupancy, and other required governmental permits and authorizations.
If any of these events occurs, it could adversely affect our ability to achieve
our projected yields on communities under development or redevelopment and could
prevent us from making expected distributions to stockholders. See "--Real
Estate Investment Risks."
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Construction costs have been increasing in our target markets, and the cost
to develop new communities and redevelop acquired communities has, in some
cases, exceeded our original estimates. We may experience similar cost
increases in the future. We cannot assure you that we will be able to charge
rents upon completing the development or redevelopment of communities that will
be sufficient to offset the effects of any increases in construction or
reconstruction costs.
RISKS ASSOCIATED WITH ENTERING NEW MARKETS
Although our historical management expertise is in Northern California, the
Mid-Atlantic and the Northeast, we have expanded our ownership and operation of
apartment communities into new markets in recent years. If appropriate
opportunities arise, we may also make other selective investments in high
barrier-to-entry markets outside of our current market areas. Our entry into
new market areas will require us to apply our experience to these new market
areas, but we cannot assure you that we will be able to successfully accomplish
this or that our historical expertise will assist us in our expansion into new
markets. If we expand into new markets in the future, we may be exposed to
risks associated with:
* a lack of market knowledge and understanding of the local economy;
* an inability to obtain land for development or to identify property
acquisition opportunities;
* an inability to obtain construction tradespeople;
* sudden adverse shifts in supply and demand factors; and
* an unfamiliarity with local governmental and permitting procedures.
DEPENDENCE ON MARKET CONDITIONS IN PRIMARY MARKETS
Of the 147 communities we currently own, 41 are located in Northern
California (primarily in the San Francisco Bay Area), 18 are located in Southern
California and 71 are located in the Mid-Atlantic and Northeast markets.
Consequently, economic conditions in these primary markets will significantly
influence our future performance. As a result of the merger, we have a more
geographically diverse portfolio than either Bay or Avalon had before the
merger. We believe that our increased geographical diversity will provide
additional stability in the event of adverse economic conditions in any one
region or market. However, a decline in the economy in one or more of our
primary markets, or in the United States generally, could materially and
adversely affect our operating results and our ability to make expected
distributions to stockholders.
REAL ESTATE FINANCING RISKS
No Limitation on the Company's Debt. Debt covenants in our credit
facilities and our unsecured senior notes limit the amount of debt we can incur,
but our charter and bylaws do not
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contain any such limitations. Because we do not have any debt incurrence
restrictions in our charter or bylaws, we could increase the amount of
outstanding debt at any time.
Existing Debt Maturities, Balloon Payments and Refinancing Risks. We are
subject to the risks normally associated with debt financing, including the risk
that our cash flow will be insufficient to meet required payments of principal
and interest. We anticipate that only a small portion of the principal of our
debt will be repaid prior to maturity. Although we may be able to use cash flow
to make future principal payments, we cannot assure you that sufficient cash
flow will be available to make all required principal payments. Therefore, we
may need to refinance at least a portion of our outstanding debt as it matures.
Accordingly, there is a risk that we may not be able to refinance existing debt
or that the terms of any refinancing will not be as favorable as the terms of
the existing debt.
Risk of Rising Interest Rates. We expect to incur variable rate debt under
credit facilities or in connection with the acquisition, construction and
reconstruction of apartment communities in the future, as well as for other
purposes. Accordingly, if interest rates increase, so will our interest costs.
Bond Compliance Requirements. Some of our apartment communities are
financed with obligations issued by various local government agencies or
instrumentalities, the interest on which is exempt from federal income taxation.
These obligations are commonly referred to as "tax-exempt bonds." Compared to
unsecured debt, tax-exempt bonds are less cost competitive than in prior years
and, moreover, generally must be secured by communities. Since we plan to use
more unsecured debt in the future compared to prior experience, we expect that
our use of tax-exempt bonds to finance communities will decline.
Nevertheless, the bond compliance requirements for our current tax-exempt
bonds, and the requirements of any future tax-exempt bond financing, may have
the effect of limiting our income from communities subject to such financing.
Under the terms of our tax-exempt bonds, we must comply with various
restrictions on the use of the communities financed by such bonds, including a
requirement that a percentage of apartments be made available to low and middle
income households.
In addition, some of our tax-exempt bond financing documents require that a
financial institution guarantee payment of the principal of, and interest on,
the bonds (a "credit enhancement"). The credit enhancement may take the form of
a letter of credit, surety bond, guarantee agreement or other additional
collateral. If the financial institution defaults in its credit enhancement
obligations, or we are unable to renew the applicable credit enhancement or
otherwise post satisfactory collateral, a default will occur under the
applicable tax-exempt bonds and the community could be foreclosed upon.
REAL ESTATE INVESTMENT RISKS
General Real Estate Ownership Risks. If our communities do not generate
revenues sufficient to meet our operating expenses, including debt service and
capital expenditures, our
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cash flow and ability to pay distributions to our stockholders will be adversely
affected. The following factors, among others, may adversely affect the revenues
generated by our apartment communities:
* the national economic climate;
* the perceptions by prospective residents of the safety, convenience and
attractiveness of the communities;
* our ability to provide adequate management, maintenance and insurance;
* increased operating costs (including real estate taxes and utilities);
and
* other market and economic conditions that may affect the local economy,
which are described below.
Certain significant expenditures associated with each equity investment
(such as mortgage payments, if any, real estate taxes, insurance and maintenance
costs) are generally not reduced when circumstances cause a reduction in income
from the investment. For example, if we mortgage a community to secure payment
of debt and are unable to meet the mortgage payments, we could sustain a loss as
a result of foreclosure on the community or the exercise of other remedies by
the mortgagee. In addition, real estate values and income from communities are
also affected by such factors as the cost of compliance with government
regulations, including zoning and tax laws, interest rate levels and the
availability of financing.
Risks Associated with Local Market Conditions. Local market and economic
conditions may significantly affect apartment home occupancy or rental rates in
that market. Occupancy and rental rates, in turn, may significantly affect our
profitability and our ability to satisfy our financial obligations. These risks
include:
* the local economic climate (which may be adversely impacted by plant
closings, industry slowdowns and other factors);
* local real estate conditions (such as an oversupply of, or a reduced
demand for, apartment homes);
* a decline in household formation that adversely affects occupancy or
rental rates;
* the inability or unwillingness of residents to pay rent increases;
* the potential effect of rent control or rent stabilization laws, or
other laws regulating housing, on some of our communities, which could prevent
us from raising rents to offset increases in operating costs; and
* the local rental market may limit the extent to which rents may be
increased to meet increased expenses without decreasing occupancy rates.
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Any of these risks could adversely affect our ability to achieve our desired
yields on our communities and to make expected distributions to stockholders.
Difficulty of Selling Apartment Communities. Real estate can be hard to
sell, especially if local market conditions are poor. This may limit our
ability to change our portfolio promptly in response to changes in economic or
other conditions. In addition, federal tax laws limit our ability to sell
communities that we have owned for fewer than four years, and this may affect
our ability to sell communities without adversely affecting returns to
stockholders.
Competition. Our apartment communities compete with numerous housing
alternatives in attracting residents, including other rental apartments and
single-family homes that are available for rent, as well as new and existing
single-family homes for sale. Competitive residential housing in a particular
area could adversely affect our ability to lease apartment homes and increase or
maintain rents.
In addition, competitors for acquisitions and development communities may
have greater resources than us, putting us at a competitive disadvantage.
RISK OF EARTHQUAKE DAMAGE IN CALIFORNIA MARKETS
Many of our West Coast communities are located in the general vicinity of
active earthquake faults. In July 1998, we obtained a seismic risk analysis
from an engineering firm which estimated the probable maximum damage ("PMD") for
each of the 60 West Coast communities that we owned at that time and for each of
the five West Coast communities under development, individually and for all of
those communities combined. To establish a PMD, the engineers first define a
severe earthquake event for the applicable geographic area, which is an
earthquake that has only a 10% likelihood of occurring over a 50-year period.
The PMD is determined as the structural and architectural damage and business
interruption loss that has a 10% probability of being exceeded in the event of
such an earthquake. Because a significant number of our communities are located
in the San Francisco Bay Area, the engineers' analysis defined an earthquake on
the Hayward Fault with a Richter Scale magnitude of 7.1 as a severe earthquake
with a 10% probability of occurring within a 50-year period. The engineers then
established an aggregate PMD at that time of $113 million for the 60 West Coast
communities that we owned at that time and the five West Coast communities under
development. The $113 million PMD for those communities was a PMD level that
the engineers expected to be exceeded only 10% of the time in the event of such
a severe earthquake. The actual aggregate PMD could be higher or lower as a
result of variations in soil classification and structural vulnerabilities. For
each community, the engineers' analysis calculated an individual PMD as a
percentage of the community's replacement cost and projected revenues. We
cannot assure you that an earthquake would not cause damage or losses greater
than the PMD assessments indicate, that future PMD levels will not be higher
than the current PMD levels for our communities located on the West Coast, or
that future acquisitions or developments will not have PMD assessments
indicating the possibility of greater damages or losses than currently
indicated.
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In August 1998, we renewed our earthquake insurance, both for physical
damage and lost revenue, with respect to all of the communities we owned at that
time and all of the communities under development. For any single occurrence,
we self-insure the first $25 million of loss, and we have in place $75 million
of coverage above this amount. In addition, our general liability and property
casualty insurance provides coverage for personal liability and fire damage. In
the event that an uninsured disaster or a loss in excess of insured limits were
to occur, we could lose the capital we have invested in the affected community,
as well as anticipated future revenue from that community, and we would continue
to be obligated to repay any mortgage indebtedness or other obligations related
to the community. Any such loss could materially and adversely affect our
business and our financial condition and results of operations.
RISKS OF PROPERTY DAMAGE AND INCREASED EXPENSES RESULTING FROM INCLEMENT WEATHER
Our communities in the Northeast and Midwest expose us to risks associated
with inclement winter weather, including increased costs for the removal of snow
and ice as well as from delays in the construction, reconstruction, development
or redevelopment of apartment communities. In addition, inclement weather could
increase the need for maintenance and repair of our communities. Similarly,
unusually high rainfall or other inclement weather could result in increased
costs due to delays in the construction, reconstruction, development or
redevelopment of apartment communities. These costs and delays could adversely
effect our financial performance.
POTENTIAL LIABILITY FOR ENVIRONMENTAL CONTAMINATION
Under various federal, state and local environmental laws, a current or
previous owner or operator of real estate may be required (often regardless of
knowledge or responsibility) to investigate and remediate the effects of
hazardous or toxic substances or petroleum product releases at its properties,
and may be held liable to a governmental entity or to third parties for property
damage and for investigation and remediation costs incurred by them in
connection with the contamination. These costs could be substantial. The
presence of such substances (or the failure to properly remediate the
contamination) may materially and adversely affect the owner's ability to borrow
against, sell or rent the affected property. In addition, certain environmental
laws create liens on contaminated sites in favor of the government for damages
and costs it incurs in connection with the contamination.
Certain federal, state and local laws govern the removal, encapsulation or
disturbance of asbestos-containing materials ("ACMs") when such materials are in
poor condition or in the event of reconstruction, remodeling, renovation, or
demolition of a building. Those laws may impose liability for release of ACMs
and may provide for third parties to seek recovery from owners or operators of
real properties for personal injury associated with ACMs. In connection with
our ownership and operation of the communities, we may potentially be liable for
such costs.
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We are not aware that any ACMs were used in connection with the
construction of the communities we developed. However, ACMs were used in
connection with the construction of several of the communities that we have
acquired. We do not anticipate that we will incur any material liabilities in
connection with the presence of ACMs at our communities. We currently have or
intend to implement an operations and maintenance program for each of the
communities at which ACMs have been detected.
All of our stabilized operating communities, and all of the communities
that we are currently developing or redeveloping, have been subjected to a Phase
I or similar environmental assessment (which generally does not involve invasive
techniques such as soil or ground water sampling). These assessments have not
revealed any environmental conditions that we believe will have a material
adverse effect on our business, assets, financial condition or results of
operations. We are not aware of any other environmental conditions which would
have such a material adverse effect.
However, we are aware that the migration of contamination from an
upgradient landowner near Toscana, one of our communities which is under
development, has affected the groundwater there. The upgradient landowner is
undertaking remedial response actions and we expect that the upgradient
landowner will take all necessary response actions. The upgradient landowner
has also provided an indemnity that runs to current and future owners of the
Toscana property and upon which we may be able to rely if we incur environmental
liability arising from the groundwater contamination at issue.
We are also aware that certain communities have lead paint and we are
undertaking or intend to undertake appropriate remediation or management
activity.
Additionally, prior to their respective initial public offerings, Bay and
Avalon had each been occasionally involved in developing, managing, leasing and
operating various properties for third parties. Consequently, each may be
considered to have been an operator of such properties and, therefore,
potentially liable for removal or remediation costs or other potential costs
which could relate to hazardous or toxic substances. We are not aware of any
material environmental liabilities with respect to properties managed or
developed by either Bay or Avalon for such third parties.
We cannot assure you that:
* the environmental assessments identified all potential environmental
liabilities;
* that no prior owner created any material environmental condition not
known to us or the consultants who prepared the assessments;
* that no environmental liabilities developed since such environmental
assessments were prepared;
* that the condition of land or operations in the vicinity of our
communities (such as the presence of underground storage tanks) will not affect
the environmental condition of such communities; or
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* that future uses or conditions (including, without limitation, changes
in applicable environmental laws and regulations) will not result in the
imposition of environmental liability.
FEDERAL INCOME TAX RISKS--FAILURE TO QUALIFY AS A REAL ESTATE INVESTMENT TRUST
We intend to operate in a manner that will allow us to continue to qualify
as a REIT. Although we believe that we have been organized and our past and
present operations qualify us as a REIT, we cannot assure you that this is true,
or that we will remain qualified as a REIT in the future. This is because
qualification as a REIT involves the application of highly technical and complex
Internal Revenue Code provisions for which there are only limited judicial or
administrative interpretations and involves the determination of various factual
matters and circumstances not entirely within our control.
If either Bay or Avalon failed to qualify as a REIT prior to the merger,
this failure could disqualify us as a REIT. If we fail to qualify as a REIT, we
will be subject to federal income tax at regular corporate rates for both
current and past years. In this event, we could be subject to potentially
significant tax liabilities, and the amount of cash available for distribution
to stockholders would be reduced and possibly eliminated. Unless entitled to
relief under certain statutory provisions, we would also be disqualified from
treatment as a REIT for the four taxable years following the year during which
qualification was lost.
Item 7. Financial Statements, Pro Forma Financial Information and Exhibits
(c) Exhibits
1.1 Distribution Agreement, dated December 21, 1998, among the
Company and the Agents, including Administrative Procedures,
relating to the MTNs.
4.1 Indenture, dated as of January 16, 1998, between the Company and
the Trustee (incorporated by reference to Exhibit 4.1 to the
Company's Form 8-K filed on January 21, 1998).
4.2 First Supplemental Indenture, dated January 20, 1998, between the
Company and the Trustee (incorporated by reference to Exhibit 4.2
to the Company's Form 8-K filed on January 21, 1998).
4.3 Second Supplemental Indenture, dated July 7, 1998 between the
Company and the Trustee (incorporated by reference to Exhibit 4.2
to the Company's Form 8-K filed on July 9, 1998).
4.4 Third Supplemental Indenture, dated December 21, 1998, between
the Company and the Trustee, including forms of Floating Rate
Note and Fixed Rate Note.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as
amended, the registrant has duly caused this report to be filed on its behalf by
the undersigned hereunto duly authorized.
AVALONBAY COMMUNITIES, INC.
By: /s/ Joanne Lockridge
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Dated: December 21, 1998 Joanne Lockridge
Vice President-Finance
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