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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1996
Commission file number 1-12452
AVALON PROPERTIES, INC.
(Exact name of registrant as specified in its charter)
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Maryland 06-1379111
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
15 River Road
Wilton, Connecticut 06897
(Address of principal executive offices) - (Zip Code)
(203) 761-6500
(Registrant's telephone number, including area code)
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
Yes/x/ No/ /
APPLICABLE ONLY TO CORPORATE ISSUERS:
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Indicate the number of shares outstanding of each issuer's classes of common
stock as of the latest practicable date:
30,735,694 shares outstanding as of November 1, 1996.
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AVALON PROPERTIES, INC.
INDEX
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PART I FINANCIAL INFORMATION
Item 1 Financial Statements Page
----
Condensed Consolidated Balance Sheets as of September 30, 1996
and December 31, 1995................................................................1
Condensed Consolidated Statements of Operations for the three and
nine months ended September 30, 1996 and 1995........................................2
Condensed Consolidated Statements of Cash Flows for the nine months
ended September 30, 1996 and 1995....................................................3
Notes to Condensed Consolidated Financial Statements.................................4
Item 2 Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................................9
PART II OTHER INFORMATION
Item 1 Legal Proceedings...................................................................24
Item 2 Changes in Securities...............................................................24
Item 3 Defaults upon Senior Securities.....................................................24
Item 4 Submission of Matters to a Vote of Stockholders.....................................24
Item 5 Other Information...................................................................24
Item 6 Exhibits and Reports on Form 8-K....................................................24
Signature...........................................................................25
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PART I FINANCIAL INFORMATION
ITEM 1 FINANCIAL STATEMENTS
AVALON PROPERTIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(Dollars in thousands, except share data)
ASSETS 9-30-96 12-31-95
--------------- -------------
Real estate (Notes 1, 2, 3 and 8)
Land $ 158,756 $ 128,754
Buildings and improvements 691,771 521,082
Furniture, fixtures and equipment 26,140 19,369
--------------- -------------
876,667 669,205
Less: accumulated depreciation (40,685) (27,059)
--------------- -------------
835,982 642,146
Construction in progress (including land) 141,908 113,228
--------------- -------------
TOTAL REAL ESTATE, NET 977,890 755,374
Cash and cash equivalents 2,962 1,801
Cash in escrow 3,694 3,940
Resident security deposits 5,743 4,193
Investments in joint ventures (Note 6) 2,240 1,735
Deferred financing and other costs, net (Notes 2 & 7) 9,109 9,959
Deferred development costs, prepaid expenses and other assets (Note 2) 13,368 9,709
--------------- -------------
TOTAL ASSETS $ 1,015,006 $ 786,711
=============== =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Unsecured Facilities (Notes 1, 4 and 8) $ 136,000 $ 58,000
Construction loans -- 10,477
Tax-exempt custodial receipts, net of unamortized discount 43,463 43,333
Unsecured senior notes, 7-3/8% due 2002, net of unamortized discount 99,864 99,846
Mortgage notes payable (Note 1) 134,336 114,900
Unsecured tax-exempt bonds (Note 1) -- 14,130
Payables for construction 14,031 9,710
Accrued expenses and other liabilities 16,402 11,522
Accrued interest payable 2,985 4,477
Resident security deposits 6,529 4,919
--------------- -------------
TOTAL LIABILITIES 453,610 371,314
--------------- -------------
Stockholders' equity
Preferred stock, $.01 par value; 20,000,000 shares authorized; 4,455,000
shares of 9% Series A cumulative redeemable preferred stock issued and
outstanding at September 30, 1996 (Note 8) 45 --
Common stock, $.01 par value; 80,000,000 shares authorized; 30,732,361 and
28,373,065 shares issued and outstanding at September 30, 1996 and
December 31, 1995, respectively 307 284
Additional paid-in capital 580,486 425,946
Distributions in excess of accumulated earnings (19,442) (10,833)
--------------- -------------
STOCKHOLDERS' EQUITY 561,396 415,397
--------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 1,015,006 $ 786,711
=============== =============
See accompanying notes to condensed consolidated financial statements.
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AVALON PROPERTIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(Dollars in thousands, except share data)
Three months ended Nine months ended
-------------------------------- --------------------------------
9-30-96 9-30-95 9-30-96 9-30-95
-------------- -------------- -------------- --------------
Revenue:
Rental income $ 32,364 $ 24,591 $ 89,286 $ 68,545
Management fees 355 490 1,151 1,485
Other income 92 106 313 332
-------------- -------------- -------------- --------------
Total revenue 32,811 25,187 90,750 70,362
-------------- -------------- -------------- --------------
Expenses:
Operating expenses 12,608 9,312 34,776 25,891
Interest expense 2,847 3,065 7,093 7,398
Depreciation and amortization 5,326 4,176 15,025 11,969
General and administrative expenses 996 923 2,846 2,507
-------------- -------------- -------------- --------------
Total expenses 21,777 17,476 59,740 47,765
-------------- -------------- -------------- --------------
Equity in income of joint ventures (Note 6) 282 125 598 309
Interest income 195 247 641 736
Minority interest income (Note 3) 111 143 410 481
-------------- -------------- -------------- --------------
Net income before extraordinary item 11,622 8,226 32,659 24,123
Extraordinary item (Note 7) (2,356) -- (2,356) --
-------------- -------------- -------------- --------------
Net income 9,266 8,226 30,303 24,123
Dividends attributable to preferred stock (2,468) -- (6,070) --
-------------- -------------- -------------- --------------
Net income available to common stockholders $ 6,798 $ 8,226 $ 24,233 $ 24,123
============== ============== ============== ==============
Net income per weighted average
common share outstanding (Note 2) $ 0.22 $ 0.29 $ 0.79 $ 0.85
============== ============== ============== ==============
See accompanying notes to condensed consolidated financial statements.
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AVALON PROPERTIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands)
Nine months ended
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9-30-96 9-30-95
--------------- --------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 30,303 $ 24,123
Adjustments to reconcile net income to cash provided by operating
activities:
Depreciation and amortization
Extraordinary item 15,025 11,969
Decrease in resident security deposits,
net of related liability 2,356 --
Decrease in cash in escrow 60 818
Increase in prepaid expenses
and other assets 246 204
Increase in accrued expenses, other liabilities
and accrued interest payable (4,609) (2,392)
Total adjustments 3,182 4,292
--------------- --------------
Net cash provided by operating activities 16,260 14,891
--------------- --------------
46,563 39,014
--------------- --------------
CASH FLOWS USED IN INVESTING ACTIVITIES:
Increase in construction payables 4,321 7,148
Purchase and development of real estate (230,762) (158,809)
--------------- --------------
Net cash used in investing activities (226,441) (151,661)
--------------- --------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Issuance of common stock, net 47,027 329
Issuance of preferred stock, net 107,581 --
Dividends paid (38,912) (30,915)
Borrowings under notes 7,000 150,125
Repayments of notes (7,127) (1,673)
Borrowings under Unsecured Facilities 216,500 193,625
Repayments of Unsecured Facilities (138,500) (192,395)
Borrowings under construction loans 31 3,615
Repayments of construction loans (10,508) (5,172)
Payments of deferred financing costs (2,053) (5,579)
--------------- --------------
Net cash provided by financing activities 181,039 111,960
--------------- --------------
Net increase (decrease) in cash 1,161 (687)
Cash and cash equivalents, beginning of period 1,801 2,862
--------------- --------------
Cash and cash equivalents, end of period $ 2,962 $ 2,175
=============== ==============
Cash paid during period for interest, net of amount capitalized $ 7,541 $ 5,331
=============== ==============
Non-cash investing and financing activities: $5,581 of debt was assumed in
connection with the Avalon Pines acquisition in May 1996.
See accompanying notes to condensed consolidated financial statements.
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AVALON PROPERTIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except share data)
1. Organization of the Company and Recent Developments
Avalon Properties, Inc. (the "Company") is a self-administered
and self-managed Real Estate Investment Trust ("REIT"), as defined
under the Internal Revenue Code of 1986, as amended, and was
incorporated under the General Corporation Law of Maryland on August
24, 1993. The Company is engaged principally in the development,
construction, acquisition and operation of residential apartment
communities in the Northeast and Mid-Atlantic regions of the United
States. Additionally, the Company provides management services for
communities owned by unrelated parties.
On July 3, 1996, the Company purchased a 47.4 acre tract of
land in Nanuet, New York for $7,000. A new 504 apartment home community
commenced construction in the third quarter of 1996.
On July 23, 1996, the Company purchased Avalon at Fairway
Hills II, two luxury garden-style communities (formerly Greenbriar and
Fairway Pointe) located in Columbia, Maryland for $32,430. These
communities contain a total of 527 apartment homes and, along with
another Company-owned community, Avalon Meadows (renamed Avalon at
Fairway Hills I), will be operated as two phases of one community.
On August 1, 1996, the Company completed a new
tax-exempt credit enhancement facility with the Federal National
Mortgage Association ("Fannie Mae") that will provide a long-term,
cost-effective credit enhancement source for the Company's current and
future tax-exempt bond communities. In connection with this facility,
the Company completed a refinancing of approximately $91,000. The
facility involves eleven communities, seven that are financed with
tax-exempt bonds and four previously unencumbered communities that
are pledged as additional collateral.
On September 25, 1996, the Company purchased Avalon at The
Boulders (formerly Boulder Springs) in Richmond, Virginia for $14,831.
This luxury garden-style community contains a total of 284 apartment
homes.
In September 1996, pricing on the Company's unsecured credit
facilities ("Unsecured Facilities") was reduced. The consortium of
banks providing the Company's $165,000 unsecured credit facility
lowered the interest rate charged under the facility to LIBOR plus
1.19% from LIBOR plus 1.44%. After a ratings upgrade from Moody's
Investors Service in October 1996, the interest rate was further
reduced to LIBOR plus 1.125%. Pricing under the $35,000 unsecured
credit facility provided by First Union National Bank was reduced to
LIBOR plus .95% from LIBOR plus 1.25%.
2. Summary of Significant Accounting Policies
Principles of Consolidation of the Company
The accompanying condensed consolidated financial statements
include the accounts of the Company and its wholly-owned partnerships
and subsidiaries. All significant intercompany balances and
transactions have been eliminated in consolidation.
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Real Estate
Buildings and improvements are recorded at cost and are
depreciated on a straight-line basis over their estimated useful lives
of 40 and 7 years, respectively. The Company's policy is to annually
assess any impairment in value by making a comparison of the current
and projected operating cash flows of each of its communities over its
remaining useful life, on an undiscounted basis, to the carrying amount
of each community. Such carrying amounts would be adjusted, if
necessary, to reflect an impairment in the value of the assets. The
cost of buildings and improvements include capitalized interest,
property taxes and insurance incurred during the construction period.
Furniture and fixtures are stated at cost and depreciated over their
estimated useful lives of seven years. Expenditures for maintenance and
repairs are charged to operations as incurred. Significant renovations
or betterments that exceed $15 and extend the economic useful life of
an asset are capitalized and depreciated over seven years.
Deferred Financing and Development Costs
Deferred financing costs include fees and costs incurred to
obtain financings and are amortized on a straight-line basis over the
shorter of the term of the loan or the related credit enhancement
facility, if applicable. Fees and other incremental costs incurred in
developing new communities are capitalized as deferred development
costs and are included in the cost of the community when construction
commences. The accompanying condensed consolidated financial statements
include a charge to expense for unrecoverable deferred development
costs related to pre-development communities that may not proceed to
development.
Net Income per Common Share
Net income per common share for the nine months ended
September 30, 1996 and 1995 is based upon 30,563,292 and 28,362,921
weighted average number of shares of common stock outstanding,
respectively. Net income per common share for the three months ended
September 30, 1996 and 1995 is based upon 30,726,488 and 28,372,588
weighted average number of shares of common stock outstanding,
respectively.
Interim Financial Statements
These condensed consolidated financial statements are
unaudited and were prepared pursuant to the rules and regulations of
the Securities and Exchange Commission. However, in the opinion of the
Company's management, all adjustments (consisting solely of normal
recurring adjustments) necessary for a fair presentation of the
financial statements have been included. The operating results for
these periods are not necessarily indicative of the operating results
that may be attained for a full fiscal year. The accompanying condensed
consolidated financial statements should be read in conjunction with
the consolidated financial statements included in the Company's Annual
Report on Form 10-K for the year ended December 31, 1995.
3. Senior Participating Mortgage Note
The Company's ownership of the senior participating
mortgage note related to the Town Arbor Partnership ("Avalon Arbor")
has been accounted for as an investment in real estate. Minority
interest represents the excess of the interest income at the pay-rate
on the mortgage note over the cash flow from operations generated by
the community. This excess is funded from payments drawn from an
escrow account established from contributions by the minority
partners. At September 30, 1996, the partnership had $3,229 of cash
from these contributions available to fund interest payments. The note
bears interest at 10.2%. Upon acquisition, the note was restructured
to provide for a 9% pay rate. The difference between the stated
interest and the pay rate is deferred interest and is added to the
principal. The loan also provides for contingent interest of 50% of
gross revenues, as defined, and is payable prior to any payments to
the partners. No contingent interest has been paid through September
30, 1996. The note entitles the holder
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to a 50% net residual value of the property at maturity or upon prior
disposition of the property. The note may be prepaid subject to
stipulated penalties.
4. Unsecured Facilities
The Company's three-year revolving credit facility (the
"Unsecured Facility") is provided by a consortium of nine banks ("Bank
Group"), led by JP Morgan and Fleet Bank that provides for $165,000 in
short-term credit. The Unsecured Facility expires in April 1998. As of
September 30, 1996, approximately $8,427 of available capacity was used
to provide letters of credit and $105,500 was borrowed under the
facility. Accordingly, the balance that remains available at September
30, 1996 to be drawn under the Unsecured Facility is $51,073. The
Unsecured Facility bears interest based upon a LIBOR, Prime or CD rate
election at the Company's option. Current pricing level is LIBOR plus
1.125%.
In January 1996, the Company arranged the two-year
supplemental unsecured facility provided by First Union National Bank
(the "Supplemental Unsecured Facility") in the amount of $35,000. The
Supplemental Unsecured Facility expires in January 1998 and bears a
current interest rate of LIBOR plus .95%. At September 30, 1996, $4,030
of available capacity was used to provide letters of credit and $30,500
was borrowed under the Supplemental Unsecured Facility. Accordingly,
the balance that remains available at September 30, 1996 to be drawn
under the Supplemental Unsecured Facility is $470. The weighted average
effective interest rates (excluding the cost of unused fees) on
borrowings under the Unsecured Facilities and prior year's Unsecured
Facility for the three and nine months ended September 30, 1996 and
1995 were 6.8%, 7.6%, 7.0% and 8.1%, respectively. Including the cost
of unused fees, the weighted average effective interest rates on
borrowings under the Unsecured Facilities and prior year's Unsecured
Facility for the three and nine months ended September 30, 1996 and
1995 were 7.1%, 7.8%, 7.6% and 8.2%, respectively.
On May 30, 1995, the Company entered into an interest rate
protection agreement in the form of an accreting swap agreement (the
"Swap") with a triple A rated counterparty (the "Counterparty"). The
Swap specifies that, commencing October 15, 1995, the Company shall pay
the Counterparty a fixed rate of 5.89% on an initial principal amount
that began at $8,000 and increases in varying amounts to a maximum of
$45,000 in February 1997, at which time the agreement terminates. The
principal amount in effect at September 30, 1996 is $40,000. In return,
the Counterparty will pay to the Company a variable rate payment equal
to 30-day LIBOR on the respective principal amounts. This Swap serves
to fix the variable component of the Company's total interest rate at
5.89% on the principal amounts during the term of the agreement.
Payments made by the Company under this agreement totaled $37 and $83
during the three and nine month period ended September 30, 1996,
respectively.
5. Stockholders' Equity
The following summarizes the changes in stockholders' equity
for the nine months ended September 30, 1996:
Distributions
Additional in excess of
Preferred Common paid-in accumulated
stock stock capital earnings Total
------------ ----------- -------------- ---------------- -------------
Stockholders' equity,12-31-95 $ -- $ 284 $ 425,946 $ (10,833) $ 415,397
Net income -- -- -- 30,303 30,303
Dividends declared -- -- -- (38,912) (38,912)
Issuance of common stock -- 23 47,004 -- 47,027
Issuance of preferred stock 45 -- 107,536 -- 107,581
------------ ----------- -------------- -------------- -------------
Stockholders' equity, 9-30-96 $ 45 $ 307 $ 580,486 $ (19,442) $ 561,396
============ =========== ============== ============= =============
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6. Investments in Joint Ventures
At September 30, 1996, investments in joint ventures consisted
of a 50% general partnership interest in Falkland Partners, a 49%
equity interest in Avalon Run, an 86.5% effective equity interest in
Town Close Associates (the New Canaan development right) and 100% of
the operating income from the anticipated Avalon Grove joint venture
(Development Community). At December 31, 1995, investments in joint
ventures also consisted of a 50% general partnership interest in
Evergreen Hamden Joint Venture. On February 15, 1996, the Company
assigned its 50% partnership interest in Evergreen Hamden Joint Venture
to the institutional partner in the joint venture. The following is a
combined summary of the financial position of these joint ventures for
the periods presented:
9-30-96 12-31-95
---------- -----------
Assets:
Real estate, net $89,009 $60,821
Other assets 4,217 3,964
---------- -----------
Total assets $93,226 $64,785
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Liabilities and partners' equity:
Mortgage notes payable $26,000 $34,786
Other liabilities 3,786 3,686
Partners' equity 63,440 26,313
---------- -----------
Total liabilities and partners' equity $93,226 $64,785
========== ===========
The following is a combined summary of the operating results
of these joint ventures for the periods presented. At September 30,
1995, the investments in joint ventures also included a 50% general
partnership interest in Evergreen Hamden Joint Venture:
Three months ended Nine months ended
----------------------------- -----------------------------
9-30-96 9-30-95 9-30-96 9-30-95
----------- ------------ ----------- -----------
Rental income $ 2,586 $ 2,299 $ 7,257 $ 6,685
Other income 17 18 45 52
Operating expenses (1,133) (897) (3,028) (2,538)
Mortgage interest expense (215) (239) (639) (762)
Depreciation and amortization (446) (427) (1,266) (1,278)
----------- ------------ ----------- -----------
Net income $ 809 $ 754 $ 2,369 $ 2,159
=========== ============ =========== ===========
7. Extraordinary Item
In August 1996, the Company recorded a non-recurring charge to
earnings for the recorded value of the unamortized deferred financing
costs associated with the refinancing of $91,000 of tax-exempt bonds
in conjunction with the completion of the new credit enhancement
facility with Fannie Mae.
8. Subsequent Events
On October 2, 1996, the Company purchased a 10.8 acre tract of
land in Melville, New York for $3,000. A new 154 apartment home
community, Avalon Court, will start construction in the fourth quarter
of 1996.
On October 22, 1996, the Company completed an offering of
4,300,000 shares of 8.96% Series B cumulative redeemable preferred
stock. The gross proceeds of the offering totaled $107,500. The net
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cash proceeds from the sale (approximately $104,114) were used to
retire indebtedness under the Company's Unsecured Facility.
On November 1, 1996, the Company sold two existing
communities, Avalon Brooke and Avalon Heights, located in Middletown
(Hartford), Connecticut for $32,650. These communities contained a
total of 518 apartment homes. In connection with this sale, the Company
will recognize a non-recurring gain totaling approximately $8,000. Net
proceeds from the sale (approximately $32,000) was used to reduce
outstanding balances under the Unsecured Facilities.
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PART I FINANCIAL INFORMATION (CONTINUED)
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the
condensed consolidated financial statements and notes thereto included elsewhere
herein.
This Form 10-Q contains forward-looking statements within the meaning
of Section 27A of the Securities Act of 1933 and Section 21E of the Securities
Exchange Act of 1934. Although the Company believes that the expectations
reflected in such forward-looking statements are based on reasonable
assumptions, the Company's actual results could differ materially from those set
forth in the forward-looking statements. Certain factors that might cause
such a difference include, but are not limited to, the following: development
opportunities may be abandoned; construction costs of a community may exceed
original estimates; construction and lease-up of new communities may not be
completed on schedule, resulting in increased interest expense and construction
costs and reduced rental revenues; occupancy rates and rents may be adversely
affected by local economic and market conditions; financing may not be
available on favorable terms; the Company's cash flow may be insufficient to
meet required payments of principal and interest; and the Company may not be
able to refinance existing indebtedness or the terms of such refinancing may
not be as favorable as the terms of existing indebtedness as well as other
factors discussed periodically in the Company's reports filed with the
Securities and Exchange Commission, including the reports on Form 10-Q for the
quarters ended March 31, 1996 and June 30, 1996 and the Form 10-K for the year
ended December 31, 1995. Those factors that might cause such a difference
include those set forth under the "Recent Developments," "Liquidity and Capital
Resources," "Business Conditions; Inflation" and "Development Communities"
sections of this Item 2.
RECENT DEVELOPMENTS
Acquisitions or Dispositions of Existing Communities. On July 23, 1996,
the Company purchased Avalon at Fairway Hills II, two luxury garden-style
communities (formerly Greenbriar and Fairway Pointe) located in Columbia,
Maryland for $32,430,000. These communities contain a total of 527 apartment
homes and, along with Avalon at Fairway Hills I (a community currently owned by
the Company), will be operated as two phases of one community.
On September 25, 1996, the Company purchased Avalon at The Boulders
(formerly Boulder Springs) in Richmond, Virginia for $14,831,000. This luxury
garden-style community contains a total of 284 apartment homes.
On November 1, 1996, the Company sold two existing communities, Avalon
Brooke and Avalon Heights, located in Middletown (Hartford), Connecticut for
$32,650,000. These communities contained a total of 518 apartment homes. In
connection with this sale, the Company will recognize a non-recurring gain
totaling approximately $8,000,000. Net proceeds from the sale (approximately
$32,000,000) was used to reduce outstanding balances under the Company's
revolving credit facilities ("Unsecured Facilities".)
Land Acquisitions for New Development. On July 3, 1996, the Company
purchased a 47.4 acre tract of land in Nanuet, New York for $7,000,000. A new
504 apartment home community commenced construction in the third quarter of
1996.
On October 2, 1996, the Company purchased a 10.8 acre tract of land in
Melville, New York for $3,000,000. Construction of a new 154 apartment home
community, Avalon Court, will start in the fourth quarter of 1996.
Financing Activities. On August 1, 1996, the Company completed a new
tax-exempt credit enhancement facility with the Federal National Mortgage
Association ("Fannie Mae") that will provide a long-term cost-effective credit
enhancement source for the Company's current and future tax-exempt bond
portfolio. In connection with this facility, the Company completed a refinancing
of approximately $91,000,000 of its tax-exempt bond portfolio. The facility
involves eleven communities, seven that are financed with tax-exempt bonds and
four previously unencumbered communities that are pledged as additional
collateral.
In September 1996, pricing on the Company's Unsecured Facilities was
reduced. The consortium of banks providing the Company's $165,000,000 unsecured
credit facility ("Unsecured Facility") lowered the interest rate charged under
the facility to LIBOR plus 1.19% from LIBOR plus 1.44%. After a ratings upgrade
from Moody's Investor Service in October 1996 (see "Liquidity and Capital
Resources"), the interest rate was reduced to LIBOR plus 1.125%. Pricing under
the $35,000,000 supplemental unsecured credit facility
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("Supplemental Unsecured Facility") provided by First Union National Bank was
reduced to LIBOR plus .95% from LIBOR plus 1.25%.
On October 22, 1996, the Company completed an offering of 4,300,000
shares of 8.96% Series B cumulative redeemable preferred stock. The gross
proceeds of the offering totaled $107,500,000. The net cash proceeds from the
sale (approximately $104,114,000) were used to retire indebtedness under the
Company's Unsecured Facility.
GENERAL
The Company's operations consist of the development, construction,
acquisition and operation of apartment communities in the Mid-Atlantic and
Northeast regions of the United States. At September 30, 1996, the Company owned
42 completed and operating communities, a general partnership interest in two
other communities (a 50% interest in Falkland Chase and a 49% interest in Avalon
Run) and a 100% interest in a senior participating mortgage note secured by
another community (Avalon Arbor) which is accounted for as an investment in real
estate. The Company also has a fee simple ownership interest in eight
Development Communities (as hereinafter defined). One of the eight Development
Communities is subject to an agreement to form a joint venture.
The Company's real estate holdings consist exclusively of apartment
communities in various stages of the development cycle and can be divided into
three categories:
"Current Communities" are apartment communities where construction is
complete and the community has either reached stabilized occupancy or
is in the initial lease-up process. A "Stabilized Community" is a
Current Community that has completed its initial lease-up and has
attained a physical occupancy level of 95% or has been completed for
one year, whichever occurs earlier. An "Established Community" is a
Current Community that has been a Stabilized Community with stabilized
operating costs during both the current year and the beginning of the
previous calendar year such that its year-to-date operating results are
comparable between periods.
"Development Communities" are communities that are under construction
and may be partially complete and operating and for which a final
certificate of occupancy has not been received.
"Development Rights" are development opportunities in the very earliest
phase of the development process for which the Company has an option to
acquire land or owns land to develop a new community and where related
pre-development costs have been incurred and capitalized in pursuit of
these new developments.
RESULTS OF OPERATIONS
The changes in operating results from period-to-period are primarily
the result of increases in the number of apartment homes owned due to the
development and acquisition of additional communities. Where appropriate,
comparisons are made on a weighted average basis for the number of occupied
apartment homes in order to adjust for such changes in the number of apartment
homes. For Stabilized Communities (excluding communities owned by joint
ventures), all occupied apartment homes are included in the calculation of
weighted average occupied apartment homes for each reporting period. For
communities in the initial lease-up phase, only apartment homes of communities
that are completed and occupied are included in the weighted average number of
occupied apartment homes calculation for each reporting period.
The analysis that follows compares the operating results of the Company
for the three and nine months ended September 30, 1996 and 1995.
Net income before extraordinary item increased $8,536,000 (35.4%) to
$32,659,000 from $24,123,000 for the nine months ended September 30, 1996
compared to the comparable period of the preceding year. Net
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income increased $3,396,000 (41.3%) to $11,622,000 from $8,226,000 for the three
months ended September 30, 1996 compared to the comparable period of the
preceding year. The notable reasons for these increases are additional operating
income from communities developed or acquired during 1995 and 1996 as well as
growth in operating income from existing communities.
Rental income increased $20,741,000 (30.3%) to $89,286,000 from
$68,545,000 for the nine months ended September 30, 1996 compared to the
comparable period of the preceding year. Rental income increased $7,773,000
(31.6%) to $32,364,000 from $24,591,000 for the three months ended September 30,
1996 compared to the comparable period of the preceding year. Of the increase
for the nine month period, $17,902,000 was due to newly completed or acquired
communities and $2,839,000 was due to rental rate growth from Established
Communities that were owned or completed throughout both periods.
Overall Portfolio - The $20,741,000 increase in rental income for the
nine month period is primarily due to increases in the weighted average
number of occupied apartment homes as well as an increase in the
weighted average monthly rental income per occupied apartment home. The
weighted average number of occupied apartment homes increased from
9,100 apartment homes for the nine months ended September 30, 1995 to
10,930 apartment homes for the nine months ended September 30, 1996 as
a result of the development and acquisition of new communities. For the
nine months ended September 30, 1996, the weighted average monthly
revenue per occupied apartment home increased $54 (6.5%) to $890 from
$836 compared to the comparable period of the preceding year. For the
three months ended September 30, 1996, the weighted average monthly
revenue per occupied apartment home increased $48 (5.6%) to $900 from
$852 compared to the comparable period of the preceding year.
Established Communities - For the nine months ended September 30, 1996,
the weighted average monthly revenue per occupied apartment home
increased $41 (4.9%) to $880 from $839 compared to the comparable
period of the preceding year, and the average economic occupancy
declined to 96.1% from 96.5%. For the three months ended September 30,
1996, the weighted average monthly revenue per occupied apartment home
increased $42 (4.9%) to $895 from $853, and the average economic
occupancy declined to 95.9% from 96.7%. Accordingly, rental revenue
from Established Communities increased $2,839,000 (4.5%) and $892,000
(4.1%) for the nine month and three month periods ended September 30,
1996, respectively, compared to the comparable periods of the preceding
year. When combined with other income from Established Communities,
total revenue from Established Communities increased 4.5% and 4.1% for
the nine month and three month periods ended September 30, 1996,
respectively, compared to the comparable periods of the preceding year.
Management fees decreased $334,000 (22.5%) to $1,151,000 from
$1,485,000 for the nine months ended September 30, 1996 compared to the
comparable period of the preceding year. These fees decreased $135,000 (27.6%)
to $355,000 from $490,000 for the three months ended September 30, 1996 compared
to the comparable period of the preceding year. These decreases are primarily
due to a decline in the number of apartment homes managed for third-party owners
in 1996. This decline is due to the sale and cancellation of management
contracts of some third-party communities in 1995 and 1996 as well as the
acquisition of two Current Communities in the third quarter of 1995 and one
Current Community in the second quarter of 1996 that were previously managed by
the Company for third-party owners prior to their acquisition. The Company has
decided not to aggressively pursue new fee management business at this time. New
fee management business will be accepted in cases where it is profitable and
where it presents a possible acquisition opportunity. This creates a very
selective environment under which new fee management business will be added and
will likely result in an overall decline in this revenue source in the future.
Operating expenses, including write-off of deferred development costs,
increased $8,885,000 (34.3%) to $34,776,000 from $25,891,000 for the nine months
ended September 30, 1996 compared to the comparable period of the preceding
year. These expenses increased $3,296,000 (35.4%) to $12,608,000 from $9,312,000
for the three months ended September 30, 1996 compared to the comparable period
of the preceding year.
11
14
Overall Portfolio - The $8,885,000 increase for the nine month period
is primarily due to the acquisition of new communities, as well as the
completion of Development Communities whereby maintenance, property
taxes, insurance and other costs are expensed as communities move from
the initial construction and lease-up phase to the operating phase. The
increased costs of snow removal and other weather related expenses as a
result of the severe winter weather during the first quarter of 1996
also contributed to the increase.
Established Communities - Operating expenses increased $1,278,000
(6.0%) to $22,528,000 from $21,250,000 for the nine months ended
September 30, 1996 compared to the comparable period of the preceding
year. Operating expenses increased $303,000 (4.1%) to $7,678,000 from
$7,375,000 for the three months ended September 30, 1996 compared to
the comparable period of the preceding year. These increases were
concentrated in the maintenance category partially due to the severe
winter weather throughout the Northeast and Mid-Atlantic regions during
the first quarter of 1996 as well as increases in the property taxes
for newly stabilized development communities and marketing expenses.
Interest expense decreased $305,000 (4.1%) to $7,093,000 from
$7,398,000 for the nine months ended September 30, 1996 compared to the
comparable period of the preceding year. Interest expense decreased $218,000
(7.1%) to $2,847,000 from $3,065,000 for the three months ended September 30,
1996 compared to the comparable period of the preceding year. These decreases
are primarily attributable to the sale of 2,227,000 shares of the Company's
common stock and the sale of 4,455,000 shares of the Company's preferred stock
in the first quarter of 1996, as the net cash proceeds from the sales were used
to retire indebtedness under the Company's Unsecured Facility, variable
rate construction loans and to repay the mortgage note encumbering the Avalon
at Carter Lake community. Lower short-term interest rates under the Unsecured
Facilities due to structural rate reductions achieved as well as lower LIBOR
rates also contributed to the declines. Finally, an increase in capitalized
interest due to an increase in the number of apartment homes under construc-
tion and lower interest and credit enhancement costs in connection with the
completion of the tax-exempt, credit enhancement facility with Fannie Mae are
other reasons for the overall declines.
Depreciation and amortization increased $3,056,000 (25.5%) to
$15,025,000 from $11,969,000 for the nine months ended September 30, 1996
compared to the comparable period of the preceding year. Depreciation and
amortization increased $1,150,000 (27.5%) to $5,326,000 from $4,176,000 for the
three months ended September 30, 1996 compared to the comparable period of the
preceding year. These increases reflect additional depreciation expense for
recently acquired and developed communities and the amortization of the costs
related to the issuance of tax-exempt custodial receipts in May 1995 as well as
the costs related to the closing of the Unsecured Facility and the issuance of
$100,000,000 of unsecured senior notes in September 1995, offset by lower
amortization expense due to the new Fannie Mae credit enhancement facility.
General and administrative expenses increased $339,000 (13.5%) to
$2,846,000 from $2,507,000 for the nine months ended September 30, 1996 compared
to the comparable period of the preceding year. These expenses increased $73,000
(7.9%) to $996,000 from $923,000 for the three months ended September 30, 1996
compared to the comparable period of the preceding year. These increases are
primarily due to the introduction of the amended and restated 1996 and 1995
Equity Incentive Plan (and related legal and proxy costs) as well as staff
additions related to growth in the Company's portfolio and the implementation of
the company-wide systems enhancement program.
Equity in income of joint ventures increased $289,000 (93.5%) to
$598,000 from $309,000 for the nine months ended September 30, 1996 compared to
the comparable period of the preceding year. This income increased $157,000 to
$282,000 from $125,000 for the three months ended September 30, 1996 compared to
the comparable period of the preceding year. These increases are principally the
result of increased net income from the Falkland Partners joint venture due to
an increase in rental revenue as well as the income from the Town Close
Associates joint venture that was formed in June 1995. Non-recurring income from
the anticipated Avalon Grove joint venture in which the Company is allocated
100% of the lease-up period income also contributed to the increases.
12
15
Extraordinary item of $2,356,000 for the three and nine months ended
September 30, 1996 reflects the write-off of the unamortized deferred financing
costs associated with the refinancing of the $91,000,000 of tax-exempt bonds in
conjunction with the completion of the new credit enhancement facility with
Fannie Mae.
FUNDS FROM OPERATIONS
The Company's management ("Management") generally considers Funds from
Operations ("FFO") to be an appropriate measure of the operating performance of
the Company. Management believes that in order to facilitate a clear
understanding of the operating results of the Company, Funds from Operations
should be examined in conjunction with the net income as presented in the
condensed consolidated financial statements included elsewhere in this report.
Funds from Operations is determined in accordance with a resolution adopted by
the Board of Governors of the National Association of Real Estate Investment
Trusts, Inc. ("NAREIT"). NAREIT adopted a revised definition of FFO commencing
with reporting periods ending after January 1, 1996 and is defined as net income
(loss) (computed in accordance with generally accepted accounting principles),
excluding gains (or losses) from debt restructuring and sales of property, plus
depreciation of real estate and after adjustments for unconsolidated
partnerships and joint ventures. The Company adopted the revised definition
commencing January 1, 1996.
The table on the following page presents an analysis of Funds from
Operations under the revised and former definition for the periods presented:
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16
ANALYSIS OF FUNDS FROM OPERATIONS ($ IN 000'S)
REVISED DEFINITION
Three months ended Nine months ended
-------------------------- --------------------------
9-30-96 9-30-95 9-30-96 9-30-95
------------ ------------ ------------ ------------
NET INCOME AVAILABLE TO COMMON STOCKHOLDERS $ 6,798 $ 8,226 $ 24,233 $ 24,123
Depreciation:
Community level 4,783 3,538 13,247 10,455
Corporate level (FF&E) -- -- -- --
Extraordinary item 2,356 -- 2,356 --
Amortization of deferred financing and other
deferred costs -- -- -- --
Allocated share of joint venture depreciation 81 79 240 237
Allocated share of joint venture amortization -- -- -- --
------------ ------------ ------------ ------------
FUNDS FROM OPERATIONS $ 14,018 $ 11,843 $ 40,076 $ 34,815
============ ============ ============ ============
WEIGHTED AVERAGE SHARES OUTSTANDING 30,726,488 28,372,588 30,563,292 28,362,921
============ ============ ============ ============
OTHER CAPITALIZED EXPENDITURES AND OTHER
INFORMATION
Capital expenditures:
Community level (1) $ 453 $ 360 $ 1,287 $ 834
Corporate level (2) $ 219 $ 153 $ 1,810 $ 470
Loan principal amortization payments $ 187 $ 128 $ 423 $ 383
Capitalized deferred financing costs (3) $ 1,594 $ 3,024 $ 2,053 $ 5,579
FORMER DEFINITION
Three months ended Nine months ended
-------------------------- ------------------------------
9-30-96 9-30-95 9-30-96 9-30-95
------------ ------------ -------------- --------------
NET INCOME AVAILABLE TO COMMON STOCKHOLDERS $ 6,798 $ 8,226 $ 24,233 $ 24,123
Depreciation:
Community level 4,783 3,538 13,247 10,455
Corporate level (FF&E) 132 61 362 166
Extraordinary item 2,356 -- 2,356 --
Amortization of deferred financing and other
deferred costs 411 577 1,416 1,348
Allocated share of joint venture depreciation 81 79 240 237
Allocated share of joint venture amortization 2 2 6 6
------------ ------------ -------------- --------------
FUNDS FROM OPERATIONS $ 14,563 $ $12,483 $ 41,860 $ 36,335
============ ============ ============== ==============
WEIGHTED AVERAGE SHARES OUTSTANDING 30,726,488 28,372,588 30,563,292 28,362,921
============ ============ ============== ==============
OTHER CAPITALIZED EXPENDITURES AND OTHER
INFORMATION
Capital expenditures:
Community level (1) $ 453 $ 360 $ 1,287 $ 834
Corporate level (2) $ 219 $ 153 $ 1,810 $ 470
Loan principal amortization payments $ 187 $ 128 $ 423 $ 383
Capitalized deferred financing costs (3) $ 1,594 $ 3,024 $ 2,053 $ 5,579
- ------------------
Footnotes to Analysis of Funds from Operations
(1)The Company expenses all recurring non-revenue generating community
expenditures, including carpet and appliance replacements. See
"Capitalization of Fixed Assets and Community Improvements."
(2)Represents the cost of new office leasehold improvements, office equipment
and computer costs related to the implementation of a company-wide systems
enhancement plan.
(3)Substantially all of the deferred financing costs incurred for the nine
months ended September 30, 1996 relate to the closing of the Supplemental
Unsecured Facility and costs incurred related to the credit enhancement
facility with Fannie Mae.
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CAPITALIZATION OF FIXED ASSETS AND COMMUNITY IMPROVEMENTS
The Company maintains a policy with respect to capital expenditures
that generally provides that only non-recurring expenditures are capitalized.
Community level improvements and upgrades are capitalized only if the item
exceeds $15,000, extends the useful life of the asset and is not related to
making an apartment home ready for the next resident. Under this policy,
virtually all capitalized costs are non-recurring, as recurring make ready costs
are expensed as incurred, including costs of carpet and appliance replacements,
floor coverings, interior painting and other redecorating costs. Purchases of
personal property (computers, furniture) are capitalized only if the item is a
new addition (i.e., not a replacement) and only if the item exceeds $2,500. The
application of these policies for the nine months ended September 30, 1996
resulted in capitalized expenditures for Stabilized Communities of approximately
$128 per apartment home. For the nine months ended September 30, 1996, the
Company charged to maintenance expense, including carpet and appliance
replacements, a total of approximately $7,579,000 for Stabilized Communities or
$752 per apartment home. Management anticipates that capitalized costs per
apartment home will gradually rise as the Company's portfolio of communities
matures. The table on the following page is a summary of expenditures for both
recurring maintenance costs (expensed) and community upgrades (capitalized) for
the nine months ended September 30, 1996.
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EXPENDITURES FOR COMMUNITY AND CORPORATE UPGRADES (CAPITALIZED) AND COMMUNITY
MAINTENANCE (EXPENSED)
(Dollars in thousands, except per home data)
YTD 1996 Capitalized Upgrades
Number Balance at Balance at -------------------------------
Community of Homes 12-31-95 (1) 9-30-96 (1) Total Per Home
- ---------------------------------- ----------- ------------- -------------- --------------- ------------
STABILIZED
- ----------
Avalon Park 372 $ 19,635 $ 19,716 $ 81 $ 218
Avalon at Ballston 344 36,617 36,682 65 189
Avalon at Gayton 328 9,715 9,814 99 302
Avalon at Symphony Glen 174 8,034 8,066 32 184
Avalon at Hampton I 186 3,661 3,712 51 274
Avalon at Hampton II 231 8,093 8,125 32 139
Avalon at Dulles 236 11,540 11,599 59 250
Avalon Knoll 300 7,851 7,886 35 117
Avalon Lea 296 16,057 16,100 43 145
Avalon at Fairway Hills I 192 9,281 9,344 63 328
Avalon Ridge 432 24,874 25,023 149 345
Longwood Towers 250 16,600 16,617 17 68
Avalon Farm 306 17,270 17,306 36 118
Avalon Brooke 280 13,258 13,305 47 168
Avalon Glen 238 30,066 30,075 9 38
Avalon Pavilions 932 56,418 56,491 73 78
Avalon Heights 238 12,217 12,244 27 113
Avalon View 288 17,725 17,778 53 184
4100 Massachusetts Ave. 308 34,859 34,865 6 19
Avalon at Carter Lake 259 11,413 11,484 71 274
Avalon Pointe 140 7,731 7,748 17 121
Avalon Station 127 5,920 5,925 5 39
Avalon Woods 268 8,237 8,235 (2) (7)
Avalon at Park Center 492 37,244 37,297 53 108
Avalon at Lexington 198 14,102 14,102 -- --
Avalon Watch 512 28,215 28,308 93 182
Avalon Walk I 430 34,417 34,445 28 65
Avalon Walk II 334 23,537 23,541 4 12
Avalon Landing 158 9,256 9,257 1 6
Avalon Birches 312 13,413 13,416 3 10
Avalon at Lake Arbor 209 11,895 11,899 4 19
Avalon at Decoverly 368 30,947 30,974 27 73
Avalon Summit West 125 6,764 6,764 -- --
Avalon Towers 109 15,820 15,823 3 28
Avalon Green 105 12,017 12,020 3 29
----------- ------------- -------------- --------------- ------------
10,077 624,699 625,986 1,287 128
----------- ------------- -------------- --------------- ------------
NEWLY ACQUIRED/DEVELOPED
- ------------------------
Avalon Fields 192 14,103 14,262 159 828
Avalon West 120 6,938 10,550 3,612 30,100
Avalon Station II 96 3,771 5,848 2,077 21,635
Avalon Summit East 120 6,351 9,274 2,923 24,358
Avalon Run East 206 4,421 15,238 10,817 52,510
Avalon Chase (2) 360 -- 23,611 23,611 65,586
Avalon Pines (2) 174 -- 8,577 8,577 49,293
Avalon at Fairway Hills II (2) 527 -- 33,735 33,735 64,013
Avalon at the Boulders (2) 284 -- 16,027 16,027 56,433
----------- ------------- -------------- --------------- ------------
2,079 35,584 137,122 101,538 48,840
----------- ------------- -------------- --------------- ------------
NEW DEVELOPMENTS 2,854 91,990 220,711 128,721 45,102
- ----------------
OTHER
- -----
Longwood Towers - Renovation -- 1,089 3,439 2,350 (5) 9,400
Avalon Arbor (3) 302 27,234 27,670 436 1,444
Corporate Level Expenditures -- 1,837 3,647 1,810 --
=========== ============= ============== =============== ============
Grand Total 15,312 (4) $ 782,433 $1,018,575 N/A N/A
=========== ============= ============== =============== ============
YTD 1996
Maintenance Expensed
------------------------------
Community Total Per Home
- ---------------------------------- -------------- ------------
STABILIZED
- ----------
Avalon Park $ 296 $ 796
Avalon at Ballston 243 706
Avalon at Gayton 273 832
Avalon at Symphony Glen 151 868
Avalon at Hampton I 165 887
Avalon at Hampton II 166 719
Avalon at Dulles 223 945
Avalon Knoll 299 997
Avalon Lea 215 726
Avalon at Fairway Hills I 188 979
Avalon Ridge 277 641
Longwood Towers 343 1,372
Avalon Farm 237 775
Avalon Brooke 136 486
Avalon Glen 203 853
Avalon Pavilions 486 521
Avalon Heights 164 689
Avalon View 273 948
4100 Massachusetts Ave. 297 964
Avalon at Carter Lake 211 815
Avalon Pointe 135 964
Avalon Station 99 780
Avalon Woods 159 593
Avalon at Park Center 277 563
Avalon at Lexington 165 833
Avalon Watch 396 773
Avalon Walk I 180 419
Avalon Walk II 159 476
Avalon Landing 155 981
Avalon Birches 182 583
Avalon at Lake Arbor 215 1,029
Avalon at Decoverly 233 633
Avalon Summit West 90 720
Avalon Towers 154 1,413
Avalon Green 134 1,276
-------------- ------------
7,579 752
-------------- ------------
NEWLY ACQUIRED/DEVELOPED
- ------------------------
Avalon Fields 44 229
Avalon West 38 317
Avalon Station II 24 250
Avalon Summit East 62 517
Avalon Run East 24 117
Avalon Chase (2) 347 964
Avalon Pines (2) 48 276
Avalon at Fairway Hills II (2) 83 157
Avalon at the Boulders (2) -- --
-------------- ------------
670 322
-------------- ------------
NEW DEVELOPMENTS 61 N/A
- ----------------
OTHER
- -----
Longwood Towers - Renovation -- --
Avalon Arbor (3) 225 745
Corporate Level Expenditures -- --
============== ============
Grand Total $8,535 N/A
============== ============
(1)Costs are presented in accordance with generally accepted accounting
principles ("GAAP") and exclude the step-up in basis attributed to
continuing investors.
(2)Acquired in 1996.
(3)Ownership through ownership of the Avalon Arbor mortgage note. See Note 3 to
the condensed consolidated financial statements. Increases in capitalized
value relate primarily to accrued interest and do not reflect capitalized
community upgrades.
(4)Excludes Falkland Chase and Avalon Run, 876 apartment homes owned by joint
ventures in which the Company holds a 50% interest and 49% interest,
respectively.
(5)Represents renovation costs incurred.
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LIQUIDITY AND CAPITAL RESOURCES
Liquidity. A primary source of liquidity to the Company is cash flows
from operations. Operating cash flows have historically been determined by the
number of apartment homes, rental rates and the Company's expenses with respect
to such apartment homes. Cash flows used in investing activities and provided by
financing activities have historically been dependent on the number of apartment
homes under active development and construction or that were acquired during any
given period.
Cash and cash equivalents increased from $2,175,000 at September 30,
1995 to $2,962,000 at September 30, 1996 due to the excess of cash provided by
operating and financing activities over cash used by investing activities,
primarily due to the completion of the common stock offering in January 1996 and
the preferred stock offering in February 1996 as more fully described below:
Net cash provided by operating activities increased by
$7,549,000 from $39,014,000 to $46,563,000, primarily due to an
increase in operating income from newly developed and acquired
communities and Established Communities.
Net cash used in investing activities increased by $74,780,000
from $151,661,000 to $226,441,000, primarily due to an increase in the
number of apartment homes under development from an average of 1,969 in
the first nine month period of 1995 to 2,767 in 1996.
Net cash provided by financing activities increased by
$69,079,000 from $111,960,000 to $181,039,000, primarily due to the
excess net proceeds received from the completion of the sale of
2,227,000 shares of the Company's common stock and the sale of
4,455,000 shares of the Company's Series A cumulative redeemable
preferred stock in 1996 and increased borrowings under the Unsecured
Facilities, offset by an increase in dividends paid.
The Company regularly reviews short-term liquidity needs and the
adequacy of Funds from Operations and other expected liquidity sources to meet
these needs. The Company's primary short-term liquidity needs are to fund normal
recurring operating expenses, debt service payments and the minimum dividend
payment required to maintain the Company's REIT qualification under the Internal
Revenue Code. Management anticipates that these needs will be fully funded from
cash flows provided by operating activities. Normal recurring expenditures for
maintenance and repairs (including carpet and appliance replacements) are funded
from the operating cash flows of Stabilized Communities and are expensed as
incurred. Major upgrades or community improvements are capitalized and
depreciated over the expected economic useful life of the item only if the
expenditure exceeds $15,000 per occurrence and only if the expenditure extends
the economic useful life of the community. Purchases of personal property
(computers, furniture) are capitalized only if the item is a new addition (i.e.,
not a replacement) and only if the item exceeds $2,500. The application of these
policies for the nine month period ended September 30, 1996 resulted in
capitalized expenditures for Established Communities of $128 per apartment home.
Capital Resources. To sustain the Company's active development and
acquisitions program, continuous access to the capital markets is required.
Management understands the need to match the long-term nature of its real estate
assets with long-term cost effective capital. The Company has demonstrated
regular and continuous access to the capital markets since its initial public
offering, raising approximately $553 million in seven offerings over a two-year
period and over $400 million in the last year and a half. Management follows a
focused strategy to help ensure uninterrupted access to capital. This strategy
includes:
1. Hire, train and retain associates with a strong resident service focus,
which leads to higher rents, lower turnover and reduced operation costs;
2. Manage, acquire and develop institutional quality communities with
in-fill locations that can provide consistent, sustained earnings
growth;
3. Operate in markets with growing demand (as measured by household formation
and job growth) and high barriers to entry. These characteristics combine
to provide a favorable demand-supply balance, creating a
17
20
favorable environment for future rental rate growth while protecting
existing and new communities from new supply. This strategy results in a
high level of quality to the revenue stream;
4. Maintain a conservative capital structure largely comprised of equity and
with modest, cost-effective leverage. Collateralized debt will generally be
avoided and used primarily to obtain low cost, tax-exempt debt. Such a
structure will promote an environment for ratings upgrades that can lead to
a lower cost of capital;
5. Timely, accurate and detailed disclosures to the investment community; and
6. Conservative accounting practices that provide a high level of quality to
reported earnings.
Management believes that following these strategies provides a
disciplined approach to capital access and will help ensure that capital
resources are available to fund portfolio growth.
The following is a discussion of specific capital transactions,
arrangements and agreements that are important to the capital resources of the
Company.
Unsecured Facilities and Investment Grade Ratings Upgrade
The Company's Unsecured Facility is provided by a consortium of nine
banks ("Bank Group") led by JP Morgan and Fleet Bank that provides for
$165,000,000 in short-term credit. At September 30, 1996, $105,500,000 was
borrowed, $8,427,000 was used to provide letters of credit and $51,073,000 was
available for borrowing under the Unsecured Facility.
In January 1996, the Company arranged the two-year Supplemental
Unsecured Facility provided by First Union National Bank in the amount of
$35,000,000. The Supplemental Unsecured Facility expires in January 1998 and
bears a current interest rate of LIBOR plus .95%. At September 30, 1996,
$4,030,000 of available capacity was used to provide letters of credit, and
$30,500,000 was borrowed under the Supplemental Unsecured Facility. Accordingly,
the balance that remains available at September 30, 1996 to be drawn under the
Supplemental Unsecured Facility is $470,000.
In September 1996, pricing on the Company's Unsecured Facilities was
reduced. The consortium of banks providing the Company's $165,000,000 Unsecured
Facility lowered the interest rate charged under the facility to LIBOR plus
1.19% from LIBOR plus 1.44%. Following a ratings upgrade from Moody's Investors
Service (see below), the interest rate was further reduced to LIBOR plus
1.125%. Pricing under the Supplemental Unsecured Facility provided by First
Union National Bank was reduced to LIBOR plus .95% from LIBOR plus 1.25%.
The Company will use borrowings under the Unsecured Facilities for
capital expenditures, acquisitions of developed or undeveloped communities,
construction, development and renovation costs, credit enhancement for
tax-exempt bonds and for working capital purposes.
In October 1996, Moody's Investor Service ("Moody's") raised the
Company's ratings on the 7 3/8% senior notes to Baa2 from Baa3. At the
same time, Moody's raised its rating on the Company's cumulative redeemable
preferred stock to baa3 from ba1 and the ratings on three tax-exempt bond
issues that are guaranteed by the Company to Baa2 from Baa3.
Interest Rate Protection Agreements
The Company entered into another interest rate protection agreement in
the form of an accreting swap transaction ("the Swap") with a triple A rated
counterparty (the "Counterparty") on May 30, 1995. The Swap serves to fix the
floating component of the Company's total interest rate at 5.89% on notional
amounts which increase over time. On the 15th day of each month during the term
of the agreement, the Company will pay to the Counterparty interest equal to
5.89% on the then principal amount in effect, divided by twelve months. The
Counterparty will pay to the Company interest equal to the actual 30 day LIBOR
rate on the principal amount then in effect, divided by twelve months. Payments
will be based on the following schedule:
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21
Periods Covered Principal (Notional) Amount in Effect
--------------- -------------------------------------
6/15/96 through 7/15/96 $32,000,000
7/15/96 through 8/15/96 $35,000,000
8/15/96 through 9/15/96 $37,000,000
9/15/96 through 10/15/96 $40,000,000
10/15/96 through 11/15/96 $41,000,000
11/15/96 through 12/15/96 $43,000,000
12/15/96 through 1/15/97 $44,000,000
1/15/97 through 2/15/97 $45,000,000
Payments made by the Company under the Swap totaled $37,000 and
$83,000 during the three and nine month periods ended September 30, 1996,
respectively.
The Company is not a party to any long-term interest rate agreements,
other than the interest rate protection agreements described above. The Company
intends, however, to evaluate the need for additional long-term interest rate
protection agreements as interest rate market conditions dictate and has engaged
a consultant to assist in managing the Company's interest rate risks and
exposure.
Financing Transactions Completed
On August 1, 1996, the Company completed a new tax-exempt credit
enhancement facility with Fannie Mae that will provide a long-term
cost-effective credit enhancement source for the Company's current and future
tax-exempt bond portfolio. In connection with this facility, the Company
completed a refinancing of approximately $91,000,000 of its tax-exempt bond
portfolio. The facility involves eleven communities, seven that are financed
with tax-exempt bonds and four previously unencumbered communities that are
pledged as additional collateral.
In October 1996, the Company completed an offering of 4,300,000 shares
of 8.96% Series B cumulative redeemable preferred stock. The gross proceeds of
the offering totaled $107,500,000. The net cash proceeds from the sale
(approximately $104,114,000) were used to retire indebtedness under the
Company's Unsecured Facility.
Financing Commitments
The Company has received commitments for tax-exempt financing on the
Avalon Fields and Avalon West communities. The Community Development
Administration of Maryland has issued $12.1 million of thirty-year fixed-rate
bonds, at an all-in rate of 7.55% related to Avalon Fields. The proceeds will be
made available to the Company upon completion of documentation. The
Massachusetts Housing Finance Agency has issued $8.8 million of tax-exempt bonds
to finance the Avalon West community upon completion at an all-in cost of 7.72%
for 42 years. Management expects to receive funding under both commitments
during the fourth quarter of 1996.
Future Financing Needs
Substantially all of the capital expenditures to complete the
communities currently under construction will be funded from proceeds of
permanent financing commitments already in place or from proceeds drawn under
Unsecured Facilities, and little, if any, additional capital sources are
expected to be needed to complete the communities. Except for Longwood Towers,
the Company has no present plans for any major capital improvements to any of
the Current Communities. The renovation of Longwood Towers is being funded by
advances under the Unsecured Facilities, operating cash flow or other financing
sources over a three-year period. Management expects to continue to fund
deferred development costs related to future developments from Funds from
Operations and advances under the Unsecured Facilities. The Company believes
that these sources of capital are adequate to take each of the proposed
communities to the point in the development cycle where construction can
commence.
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To continue to implement its growth strategy, the Company will pursue
additional capital as needed from sources that may include additional public or
private offerings of debt or equity securities, as well as bank or institutional
credit facilities. If all of the Development Rights proceed to development,
Management believes that additional debt or equity financing will be needed.
There can be no assurance that such additional debt financing or debt offerings
will be available on terms satisfactory to the Company. Additionally, the
Company's Funds from Operations and the availability of additional debt or
equity financing can be adversely impacted by negative changes in the economy,
particularly as those changes may relate to real estate assets or interest
rates.
BUSINESS CONDITIONS; INFLATION
The Company's principal markets are characterized by high barriers to
entry and restrictive zoning which often takes years to obtain entitlements to
build an apartment community. For this reason, little new rental product has
been added in recent years. For the markets north of Maryland, Management is not
aware of any significant level of planned apartment construction starts. For the
Washington, D.C. metropolitan area, permitting activity has increased, with
8,800 apartment homes in planning for delivery over the next 36-month period.
Estimated absorption during this period totals 12,000 apartment homes, which
would create a supply-demand balance that would be favorable for owners of
multifamily apartment communities.
At September 30, 1996, Management had positioned the Company's
portfolio of Stabilized Communities, excluding communities owned by joint
ventures, to a physical occupancy level of 96.9%, and achieved an average
economic occupancy of 95.3% for the nine months ended September 30, 1996.
Average economic occupancy for the portfolio for the nine months ended September
30, 1995 was 95.8%. This continued high occupancy was achieved through
aggressive marketing efforts combined with limited and targeted pricing
adjustments. This positioning has resulted in overall growth in rental revenue
from Stabilized Communities between periods. It is Management's strategy to
maximize total rental revenue through management of rental rates and occupancy
levels. If market and economic conditions change, Management may adopt a
strategy of maximizing rental rates, which could lead to lower occupancy levels,
if Management believes that this strategy will maximize rental revenue. Given
the currently high occupancy level of the portfolio, Management anticipates
that, for the foreseeable future, any rental revenue and net income gains from
currently owned and Stabilized Communities would be achieved primarily through
higher rental rates and enhanced operating cost leverage provided by high
occupancy, rather than through continued occupancy gains.
Substantially all of the leases at the Current Communities are for a
term of one year or less, which may enable the Company to realize increased
rents upon renewal of existing leases or commencement of new leases. Such
short-term leases generally minimize the risk to the Company of the adverse
effects of inflation, although as a general rule these leases permit residents
to leave at the end of the lease term without penalty. The Company's current
policy is to permit residents to terminate leases upon 60-days written notice
and payment of one month's rental as compensation for early termination.
Short-term leases combined with relatively consistent demand allow rents, and
therefore cash flow from the Company's portfolio of apartments, to provide an
attractive inflation hedge.
DEVELOPMENT COMMUNITIES
At September 30, 1996, eight Development Communities were under
construction. The total capitalized cost of these Development Communities, when
completed, is currently expected to be approximately $323.8 million. The Company
intends to periodically update the projections in the table on the following
page to the extent Management believes there may be or has been a material
change in these projections on an aggregate basis. There can be no assurance
that the Company will complete the Development Communities, that the Company's
budgeted costs, leasing, start dates, completion dates, occupancy or estimates
of "EBITDA as % of Total Budgeted Cost" will be realized or that future
developments will realize comparable returns.
The Company maintains an active development capacity that Management
anticipates will provide a continuing source of portfolio growth. During the
lease-up period of the development process, the Company anticipates that
Development Communities will experience operating deficits for a three-to-six
month period until such time as the new community approaches stabilized
occupancy. The amount and duration of operating deficits
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to be incurred are dependent upon a number of factors, including the size of the
community, the season in which leasing activity occurs and the extent to which
delivery of new apartment homes coincides with leasing and occupancy of these
new apartment homes (which is dependent on local market conditions). Any
operating deficits that occur during the initial lease-up phase of a new
development are expensed in accordance with GAAP. For the nine months ended
September 30, 1996, initial lease-up deficits were not material to the financial
position and operating results of the Company.
The following page presents a summary of Development Communities:
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DEVELOPMENT COMMUNITIES SUMMARY
NUMBER OF BUDGETED ESTIMATED ESTIMATED
APARTMENT COST CONSTRUCTION INITIAL COMPLETION STABILIZATION
HOMES ($ MILLIONS) START OCCUPANCY DATE DATE (1)
------------ ------------- ---------------- ----------- ------------ ---------------
Conventionally Financed
- -----------------------
Avalon Gates
Trumbull, CT 340 $ 32.7 Q3 1994 Q2 1996 Q3 1997 Q4 1997
Avalon Crossing
Rockville, MD 132 13.5 Q3 1995 Q2 1996 Q4 1996 Q1 1997
Avalon Cove
Jersey City, NJ 504 70.5(3) Q4 1994 Q2 1996 Q1 1997 Q2 1997
Avalon Grove(4)
Stamford, CT 402 51.3 Q1 1995 Q3 1996 Q2 1997 Q3 1997
Avalon Springs
Wilton, CT 102 15.2 Q3 1995 Q3 1996 Q1 1997 Q2 1997
Avalon Crescent
Tysons Corner, VA 558 56.7 Q1 1996 Q1 1997 Q4 1997 Q1 1998
Avalon Commons
Smithtown, NY 312 30.6 Q1 1996 Q1 1997 Q3 1997 Q4 1997
Avalon Gardens
Nanuet, NY 504 53.3 Q3 1996 Q3 1997 Q4 1998 Q1 1999
------------ ----------
2,854 $ 323.8
============ ==========
EBITDA AS %
OF TOTAL
BUDGETED COST (2)
-------------------
Conventionally Financed
- -----------------------
Avalon Gates
Trumbull, CT 10.0%
Avalon Crossing
Rockville, MD 11.0%
Avalon Cove
Jersey City, NJ 11.0%
Avalon Grove(4)
Stamford, CT 12.2%
Avalon Springs
Wilton, CT 11.6%
Avalon Crescent
Tysons Corner, VA 10.2%
Avalon Commons
Smithtown, NY 11.1%
Avalon Gardens
Nanuet, NY 10.1%
-------------
10.8%
=============
- ------------
The table above includes forward looking information within the meaning of the
Private Securities Litigation Reform Act of 1995 regarding the delivery,
occupancy and total budgeted cost of newly developed apartment homes. This
information is based on a series of projections, estimates and local experience
with construction practices that affect construction costs and completion as
well as market conditions that affect how quickly a community leases and at what
rental rates. The Company's ability to achieve these projections is affected by
continued market demand for the Company's new apartment homes as well as other
factors discussed periodically in the Company's reports filed with the
Securities and Exchange Commission including the reports on Form 10-Q for the
quarters ended March 31, 1996 and June 30, 1996 and the Form 10-K for the year
ended December 31, 1995. If the Company's performance differs materially from
these projections, actual results could vary significantly from the performance
projected in the forward looking information.
(1) Stabilized occupancy is defined as the first full quarter of 95% or
greater occupancy.
(2) Projected EBITDA represents gross potential earnings projected to
be achieved based on current rents prevailing in the respective
community's local market (without adjustment for potential growth
factors) and before interest, income taxes, depreciation,
amortization and extraordinary items, minus (a) economic vacancy and
(b) projected stabilized operating expenses. Total budgeted cost
includes all capitalized costs projected to be incurred to develop the
respective Development Community, including land acquisition costs,
construction costs, real estate taxes, capitalized interest and loan
fees, permits, professional fees, allocated development overhead and
other regulatory fees.
(3) In March 1996, the original contractor selected to build Avalon Cove
notified the Company that it was not able to complete the contract
within the guaranteed maximum price and subsequently defaulted on
its contractual obligations. The Company selected Tishman
Construction Company of New Jersey to be the replacement contractor,
and the replacement contractor is currently managing the construction
operations. Management expects that total actual costs to exceed the
current $70.5 million budget presented herein. The Company is pursuing
collection of any excess over the original guaranteed maximum price
contract, but no assurance can be provided that collection efforts will
be successful. Management believes that the excess cost, even if no
recovery from original contractor is made, will not have a material
adverse impact on the financial condition or results of operations of the
Company.
(4) Currently anticipated to be held by a joint venture.
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DEVELOPMENT RIGHTS
The Company is considering the development of 20 new apartment
communities. The status of these Development Rights range from land under
contract for which design and architectural planning has just commenced to land
under contract or owned by the Company with completed site plans and drawings
where construction can commence almost immediately. There can be no assurance
that the Company will succeed in obtaining zoning and other necessary
governmental approvals or the financing required to develop these communities,
or that the Company will decide to develop any particular community. Further,
there can be no assurance that construction of any particular community will be
undertaken or, if undertaken, will begin at the expected times assumed in the
financial projections or be completed at the total budgeted cost. Although there
is no assurance that all or any of these communities will proceed to
development, the successful completion of all of these communities would
ultimately add approximately 5,767 institutional-quality apartment homes to the
Company's portfolio. At September 30, 1996, the cumulative capitalized costs
incurred in pursuit of the 20 Development Rights were approximately $12.1
million, including the capitalized cost of $5.9 million related to the purchase
of land in New Canaan, Connecticut. Many of these apartment homes will offer
features like those offered by the communities currently owned by the Company.
The 20 Development Rights that the Company is currently pursuing are summarized
below.
DEVELOPMENT RIGHTS SUMMARY
TOTAL
ESTIMATED BUDGETED
NUMBER OF COST
LOCATION HOMES ($ MILLIONS)
---------------------- --------------- ----------------
1. Fairfax, VA 234 $ 23.2
2. Mamaroneck, NY 227 37.0
3. Melville-I, NY 154 17.8
4. Alexandria, VA 460 45.7
5. Freehold, NJ 452 37.5
6. Quincy, MA 171 15.0
7. New Canaan, CT(1) 104 23.2
8. Greenburgh - II, NY 500 64.2
9. Greenburgh - III, NY 294 37.7
10. Darien, CT 172 20.7
11. Fort Lee, NJ 351 52.6
12. Peabody, MA 434 35.5
13. Springfield, NJ 500 44.9
14. Hull, MA 244 20.3
15. Jersey City, NJ 221 38.5
16. New Rochelle, NY 350 49.4
17. Easton, CT 249 28.2
18. Melville-II, NY 350 36.7
19. Wilmington, MA 204 18.0
20. Gaithersburg - II, MD 96 8.1
============= ==============
Total 5,767 $ 654.2
============= ==============
The table above includes forward looking information within the meaning of the
Private Securities Litigation Reform Act of 1995 regarding the total budgeted
cost of newly developed apartment homes. This information is based on a series
of projections, estimates and local experience with construction practices that
affect construction completion. The Company's ability to achieve these
projections is affected by continued market demand for the company's new
apartment homes, availability of capital as well as other factors discussed
periodically in the company's reports filed with the Securities and Exchange
Commission, including the report on Form 10-Q for the quarter ended June 30,
1996 and the Form 10-K for the year ended December 31, 1995. If the Company's
performance differs materially from these projections, actual results could vary
significantly from the performance projected in the forward looking information.
There can be no assurance that all or any of these communities will proceed to
development.
(1) Currently anticipated that the land seller will retain a minority limited
partner interest.
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PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In March 1996, the original contractor, Procida Construction
Corporation, selected to build Avalon Cove notified the Company that it was not
able to complete the contract within the guaranteed maximum price and
subsequently defaulted on its contractual obligations. The Company expects total
actual costs to exceed the current $70.5 million budget. In April 1996, the
Company filed a demand for arbitration with the American Arbitration Association
in New York against Procida Construction Corporation to recover any excess over
the original guaranteed maximum price contract and instituted suit in the U.S.
District Court to compel arbitration. No assurance can be provided that
collection efforts will be successful. Management does not believe that the
excess cost, even if no recovery from the original contractor is made, will have
a material adverse impact on the financial condition or results of operations of
the Company.
ITEM 2. CHANGES IN SECURITIES
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS
None.
ITEM 5. OTHER INFORMATION
Not applicable.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Not applicable.
b) No reports of Form 8-K have been filed by the Company for the
period covered by this report.
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SIGNATURE
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
AVALON PROPERTIES, INC.
Date: November 12, 1996 By /s/ THOMAS J. SARGEANT
--------------------------
Thomas J. Sargeant, Chief Financial Officer,
Treasurer and Secretary
(Principal Financial and Accounting Officer)
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