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Section 1: 10-Q (10-Q)

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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, 2018
 
Commission file number 1-12672
 
AVALONBAY COMMUNITIES, INC.
(Exact name of registrant as specified in its charter)
 
Maryland
 
77-0404318
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
 
Ballston Tower
671 N. Glebe Rd, Suite 800
Arlington, Virginia  22203
(Address of principal executive offices, including zip code)
 
(703) 329-6300
(Registrant's telephone number, including area code) 
 
(Former name, if changed since last report) 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve (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 ninety (90) days.
Yes ý                    No o

Indicate by check mark whether the registrant has submitted electronically, every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Yes ý                    No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company.  See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
Accelerated filer o
Non-accelerated filer o
Smaller reporting company o
Emerging growth company o
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
Yes o                    No ý


APPLICABLE ONLY TO CORPORATE ISSUERS
 
Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date:

138,222,567 shares of common stock, par value $0.01 per share, were outstanding as of October 31, 2018.


Table of Contents

AVALONBAY COMMUNITIES, INC.
FORM 10-Q
INDEX
 
 
PAGE
PART I - FINANCIAL INFORMATION
 
 
 
ITEM 1.
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 




Table of Contents



AVALONBAY COMMUNITIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)
 
9/30/2018
 
12/31/2017
 
(unaudited)
 
 
ASSETS
 

 
 

Real estate:
 

 
 

Land and improvements
$
4,186,360

 
$
4,237,318

Buildings and improvements
15,808,498

 
15,708,666

Furniture, fixtures and equipment
673,013

 
615,288

 
20,667,871

 
20,561,272

Less accumulated depreciation
(4,585,609
)
 
(4,218,379
)
Net operating real estate
16,082,262

 
16,342,893

Construction in progress, including land
1,651,406

 
1,306,300

Land held for development
116,582

 
68,364

Real estate assets held for sale, net
79,963

 

Total real estate, net
17,930,213

 
17,717,557

 
 
 
 
Cash and cash equivalents
55,887

 
67,088

Cash in escrow
225,704

 
134,818

Resident security deposits
34,132

 
32,686

Investments in unconsolidated real estate entities
173,563

 
163,475

Deferred development costs
45,869

 
45,819

Prepaid expenses and other assets
196,751

 
253,378

Total assets
$
18,662,119

 
$
18,414,821

 
 
 
 
LIABILITIES AND EQUITY
 

 
 

Unsecured notes, net
$
6,153,945

 
$
5,852,764

Variable rate unsecured credit facility
56,000

 

Mortgage notes payable, net
1,323,283

 
1,476,706

Dividends payable
203,624

 
196,094

Payables for construction
92,323

 
85,377

Accrued expenses and other liabilities
300,827

 
308,189

Accrued interest payable
66,546

 
43,116

Resident security deposits
61,059

 
58,473

Liabilities related to real estate assets held for sale
1,037

 

Total liabilities
8,258,644

 
8,020,719

 
 
 
 
Commitments and contingencies


 


 
 
 
 
Redeemable noncontrolling interests
6,077

 
6,056

 
 
 
 
Equity:
 

 
 

Preferred stock, $0.01 par value; $25 liquidation preference; 50,000,000 shares authorized at September 30, 2018 and December 31, 2017; zero shares issued and outstanding at September 30, 2018 and December 31, 2017

 

Common stock, $0.01 par value; 280,000,000 shares authorized at September 30, 2018 and December 31, 2017; 138,222,168 and 138,094,154 shares issued and outstanding at September 30, 2018 and December 31, 2017, respectively
1,382

 
1,381

Additional paid-in capital
10,249,311

 
10,235,475

Accumulated earnings less dividends
167,946

 
188,609

Accumulated other comprehensive loss
(21,241
)
 
(37,419
)
Total equity
10,397,398

 
10,388,046

Total liabilities and equity
$
18,662,119

 
$
18,414,821

 
See accompanying notes to Condensed Consolidated Financial Statements.

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Table of Contents

AVALONBAY COMMUNITIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(unaudited)
(Dollars in thousands, except per share data)
 
For the three months ended
 
For the nine months ended
 
9/30/2018
 
9/30/2017
 
9/30/2018
 
9/30/2017
Revenue:
 

 
 

 
 
 
 
Rental and other income
$
575,070

 
$
549,507

 
$
1,703,263

 
$
1,600,047

Management, development and other fees
912

 
993

 
2,752

 
3,290

Total revenue
575,982

 
550,500

 
1,706,015

 
1,603,337

 
 
 
 
 
 
 
 
Expenses:
 

 
 

 
 
 
 
Operating expenses, excluding property taxes
132,918

 
129,590

 
396,703

 
379,319

Property taxes
61,230

 
57,698

 
181,120

 
164,195

Interest expense, net
54,097

 
47,741

 
165,795

 
147,138

Loss on extinguishment of debt, net
1,678

 

 
2,717

 
24,162

Depreciation expense
156,538

 
144,990

 
472,282

 
427,050

General and administrative expense
13,905

 
11,655

 
42,013

 
38,808

Expensed transaction, development and other pursuit costs, net of recoveries
1,020

 
789

 
2,709

 
2,087

Casualty and impairment (gain) loss, net
(554
)
 

 
(612
)
 
11,688

Total expenses
420,832

 
392,463

 
1,262,727

 
1,194,447

 
 
 
 
 
 
 
 
Income before equity in income of unconsolidated real estate entities, gain (loss) on sale of communities and other real estate, and income taxes
155,150

 
158,037

 
443,288

 
408,890

 
 
 
 
 
 
 
 
Equity in income of unconsolidated real estate entities
10,031

 
52,568

 
12,560

 
70,386

Gain on sale of communities
27,243

 
27,738

 
132,444

 
159,754

Gain (loss) on other real estate transactions, net
12

 
(120
)
 
335

 
246

 
 
 
 
 
 
 
 
Income before income taxes
192,436

 
238,223

 
588,627

 
639,276

Income tax expense
29

 
24

 
87

 
102

 
 
 
 
 
 
 
 
Net income
192,407

 
238,199

 
588,540

 
639,174

Net loss attributable to noncontrolling interests
79

 
49

 
251

 
174

 
 
 
 
 
 
 
 
Net income attributable to common stockholders
$
192,486

 
$
238,248

 
$
588,791

 
$
639,348

 
 
 
 
 
 
 
 
Other comprehensive income (loss):
 

 
 

 
 
 
 
Gain (loss) on cash flow hedges

 
359

 
11,499

 
(15,654
)
Cash flow hedge losses reclassified to earnings
1,466

 
1,767

 
4,679

 
5,301

Comprehensive income
$
193,952

 
$
240,374

 
$
604,969

 
$
628,995

 
 
 
 
 
 
 
 
Earnings per common share - basic:
 

 
 

 
 
 
 
Net income attributable to common stockholders
$
1.39

 
$
1.73

 
$
4.26

 
$
4.64

 
 
 
 
 
 
 
 
Earnings per common share - diluted:
 

 
 

 
 
 
 
Net income attributable to common stockholders
$
1.39

 
$
1.72

 
$
4.26

 
$
4.63

 
 
 
 
 
 
 
 
Dividends per common share
$
1.47

 
$
1.42

 
$
4.41

 
$
4.26


See accompanying notes to Condensed Consolidated Financial Statements.

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Table of Contents

AVALONBAY COMMUNITIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(Dollars in thousands)
 
For the nine months ended
 
9/30/2018
 
9/30/2017
Cash flows from operating activities:
 
 
 
Net income
$
588,540

 
$
639,174

Adjustments to reconcile net income to cash provided by operating activities:
 
 
 
Depreciation expense
472,282

 
427,050

Amortization of deferred financing costs
6,066

 
5,729

Amortization of debt discount (premium)
1,259

 
(6,254
)
Loss on extinguishment of debt, net
2,717

 
24,162

Amortization of stock-based compensation
15,617

 
13,979

Equity in loss (income) of, and return on, unconsolidated real estate entities and noncontrolling interests, net of eliminations
4,514

 
(21,627
)
Casualty and impairment (gain) loss, net
(58
)
 
8,568

Abandonment of development pursuits
725

 
388

Cash flow hedge losses reclassified to earnings
4,679

 
5,301

Gain on sale of real estate assets
(141,415
)
 
(200,110
)
Decrease (increase) in resident security deposits, prepaid expenses and other assets
16,691

 
(27,384
)
Increase in accrued expenses, other liabilities and accrued interest payable
9,742

 
64,802

Net cash provided by operating activities
981,359

 
933,778

 
 
 
 
Cash flows from investing activities:
 
 
 
Development/redevelopment of real estate assets including land acquisitions and deferred development costs
(864,550
)
 
(743,275
)
Acquisition of real estate assets, including partnership interest
(84,088
)
 
(228,011
)
Capital expenditures - existing real estate assets
(59,950
)
 
(41,809
)
Capital expenditures - non-real estate assets
(2,142
)
 
(5,308
)
Proceeds from sale of real estate, net of selling costs
466,187

 
336,542

Insurance proceeds for property damage claims
58

 
13,268

Mortgage note receivable lending
(2,880
)
 
(14,244
)
Mortgage note receivable payments
50,929

 

Increase (decrease) in payables for construction
6,946

 
(16,660
)
Distributions from unconsolidated real estate entities
2,013

 
89,305

Investments in unconsolidated real estate entities
(7,979
)
 
(14,560
)
Net cash used in investing activities
(495,456
)
 
(624,752
)
 
 
 
 
Cash flows from financing activities:
 
 
 
Issuance of common stock, net
1,224

 
110,117

Dividends paid
(602,152
)
 
(576,685
)
Net borrowings under unsecured credit facility
56,000

 
242,000

Issuance of mortgage notes payable

 
185,100

Repayments of mortgage notes payable, including prepayment penalties
(157,164
)
 
(1,289,234
)
Issuance of unsecured notes
299,442

 
948,616

Payment of deferred financing costs
(3,347
)
 
(11,743
)
Payment of capital lease obligation
(802
)
 
(18,683
)
Receipts for termination of forward interest rate swaps
12,598

 
391

Payments related to tax withholding for share-based compensation
(10,543
)
 
(10,460
)
Distributions to DownREIT partnership unitholders
(33
)
 
(32
)
Contributions from joint venture and profit-sharing partners

 
1,038

Distributions to joint venture and profit-sharing partners
(321
)
 
(317
)
Preferred interest obligation redemption and dividends
(1,120
)
 
(2,000
)
Net cash used in financing activities
(406,218
)
 
(421,892
)
 
 
 
 
Net increase (decrease) in cash and cash equivalents
79,685

 
(112,866
)
 
 
 
 
Cash and cash equivalents and restricted cash, beginning of period
201,906

 
329,977

Cash and cash equivalents and restricted cash, end of period
$
281,591

 
$
217,111

 
 
 
 
Cash paid during the period for interest, net of amount capitalized
$
130,361

 
$
124,585

See accompanying notes to Condensed Consolidated Financial Statements.

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Table of Contents

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

The following table provides a reconciliation of cash, cash equivalents and restricted cash reported in the Condensed Consolidated Statements of Cash Flows (dollars in thousands):
 
 
For the nine months ended
 
 
9/30/2018
 
9/30/2017
Cash and cash equivalents
 
$
55,887

 
$
36,042

Cash in escrow
 
225,704

 
181,069

Cash, cash equivalents and restricted cash reported in the Condensed Consolidated Statements of Cash Flows
 
$
281,591

 
$
217,111


Supplemental disclosures of non-cash investing and financing activities:

During the nine months ended September 30, 2018:

As described in Note 4, "Equity," 187,010 shares of common stock were issued as part of the Company's stock-based compensation plans, of which 88,297 shares related to the conversion of performance awards to restricted shares, and the remaining 98,713 shares valued at $15,950,000 were issued in connection with new stock grants; 1,713 shares valued at $290,000 were issued through the Company's dividend reinvestment plan; 67,963 shares valued at $10,543,000 were withheld to satisfy employees' tax withholding and other liabilities; and 4,622 restricted shares with an aggregate value of $679,000 previously issued in connection with employee compensation were canceled upon forfeiture.

Common stock dividends declared but not paid totaled $203,624,000.

The Company recorded an increase of $626,000 in redeemable noncontrolling interest with a corresponding decrease to accumulated earnings less dividends to adjust the redemption value associated with the put options held by joint venture partners and DownREIT partnership units.  For further discussion of the nature and valuation of these items, see Note 10, "Fair Value."

The Company reclassified $4,679,000 of cash flow hedge losses from other comprehensive income to interest expense, net, to record the impact of the Company's derivative and hedge accounting activity.

During the nine months ended September 30, 2017:

The Company issued 201,314 shares of common stock as part of the Company's stock-based compensation plans, of which 128,482 shares related to the conversion of performance awards to restricted shares, and the remaining 72,832 shares valued at $13,079,000 were issued in connection with new stock grants; 2,466 shares valued at $452,000 were issued through the Company's dividend reinvestment plan; 60,165 shares valued at $10,514,000 were withheld to satisfy employees' tax withholding and other liabilities; and 3,045 restricted shares with an aggregate value of $528,000 previously issued in connection with employee compensation were canceled upon forfeiture.

Common stock dividends declared but not paid totaled $196,079,000.

The Company recorded an increase of $458,000 in redeemable noncontrolling interest with a corresponding decrease to accumulated earnings less dividends to adjust the redemption value associated with the put options held by joint venture partners and DownREIT partnership units.

The Company recorded an increase in prepaid expenses and other assets of $1,422,000 and an increase in accrued expenses and other liabilities of $1,998,000, and a corresponding adjustment to other comprehensive income, and reclassified $5,301,000 of cash flow hedge losses from other comprehensive income to interest expense, net, to record the impact of the Company's derivative and hedge accounting activity.

As discussed in Note 5, "Investments in Real Estate Entities," the Company recognized a non-cash charge of $16,361,000 to write-off the net book value of the fixed assets destroyed by the fire that occurred in February 2017 at Avalon Maplewood community ("Maplewood").


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Table of Contents

AVALONBAY COMMUNITIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)  

1.  Organization, Basis of Presentation and Significant Accounting Policies

Organization and Basis of Presentation

AvalonBay Communities, Inc. (the "Company," which term, unless the context otherwise requires, refers to AvalonBay Communities, Inc. together with its subsidiaries), is a Maryland corporation that has elected to be treated as a real estate investment trust ("REIT") for federal income tax purposes under the Internal Revenue Code of 1986 (the "Code"). The Company focuses on the development, redevelopment, acquisition, ownership and operation of multifamily communities primarily in New England, the New York/New Jersey metro area, the Mid-Atlantic, the Pacific Northwest, and Northern and Southern California.

At September 30, 2018, the Company owned or held a direct or indirect ownership interest in 271 operating apartment communities containing 78,383 apartment homes in 12 states and the District of Columbia, of which 15 communities containing 6,242 apartment homes were under redevelopment. In addition, the Company owned or held a direct or indirect ownership interest in 19 communities under development that are expected to contain an aggregate of 6,107 apartment homes when completed. The Company also owned or held a direct or indirect ownership interest in land or rights to land on which the Company expects to develop an additional 25 communities that, if developed as expected, will contain an estimated 8,600 apartment homes.

The interim unaudited financial statements have been prepared in accordance with U.S. generally accepted accounting principles ("GAAP") for interim financial information and in conjunction with the rules and regulations of the Securities and Exchange Commission ("SEC"). Certain information and footnote disclosures normally included in financial statements required by GAAP have been condensed or omitted pursuant to such rules and regulations. These unaudited financial statements should be read in conjunction with the financial statements and notes included in the Company's 2017 Annual Report on Form 10-K. The results of operations for the three and nine months ended September 30, 2018 are not necessarily indicative of the operating results for the full year. Management believes the disclosures are adequate to ensure the information presented is not misleading.  In the opinion of management, all adjustments and eliminations, consisting only of normal, recurring adjustments necessary for a fair presentation of the financial statements for the interim periods, have been included.

Capitalized terms used without definition have meanings provided elsewhere in this Form 10-Q.

Earnings per Common Share

Basic earnings per share is computed by dividing net income attributable to common stockholders by the weighted average number of shares outstanding during the period. All outstanding unvested restricted share awards contain rights to non-forfeitable dividends and participate in undistributed earnings with common shareholders and, accordingly, are considered participating securities that are included in the two-class method of computing basic earnings per share ("EPS"). Both the unvested restricted shares and other potentially dilutive common shares, and the related impact to earnings, are considered when calculating earnings per share on a diluted basis. The Company's earnings per common share are determined as follows (dollars in thousands, except per share data):

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Table of Contents

 
For the three months ended
 
For the nine months ended
 
9/30/2018
 
9/30/2017
 
9/30/2018
 
9/30/2017
Basic and diluted shares outstanding
 

 
 

 
 
 
 
Weighted average common shares - basic
137,848,788

 
137,715,192

 
137,818,076

 
137,457,293

Weighted average DownREIT units outstanding
7,500

 
7,500

 
7,500

 
7,500

Effect of dilutive securities
466,776

 
584,354

 
405,148

 
541,399

Weighted average common shares - diluted
138,323,064

 
138,307,046

 
138,230,724

 
138,006,192

 
 
 
 
 
 
 
 
Calculation of Earnings per Share - basic
 

 
 

 
 
 
 
Net income attributable to common stockholders
$
192,486

 
$
238,248

 
$
588,791

 
$
639,348

Net income allocated to unvested restricted shares
(555
)
 
(672
)
 
(1,722
)
 
(1,794
)
Net income attributable to common stockholders, adjusted
$
191,931

 
$
237,576

 
$
587,069

 
$
637,554

 
 
 
 
 
 
 
 
Weighted average common shares - basic
137,848,788

 
137,715,192

 
137,818,076

 
137,457,293

 
 
 
 
 
 
 
 
Earnings per common share - basic
$
1.39

 
$
1.73

 
$
4.26

 
$
4.64

 
 
 
 
 
 
 
 
Calculation of Earnings per Share - diluted
 

 
 

 
 
 
 
Net income attributable to common stockholders
$
192,486

 
$
238,248

 
$
588,791

 
$
639,348

Add: noncontrolling interests of DownREIT unitholders in consolidated partnerships
11

 
11

 
33

 
32

Adjusted net income attributable to common stockholders
$
192,497

 
$
238,259

 
$
588,824

 
$
639,380

 
 
 
 
 
 
 
 
Weighted average common shares - diluted
138,323,064

 
138,307,046

 
138,230,724

 
138,006,192

 
 
 
 
 
 
 
 
Earnings per common share - diluted
$
1.39

 
$
1.72

 
$
4.26

 
$
4.63

 

All options to purchase shares of common stock outstanding as of September 30, 2018 and 2017 are included in the computation of diluted earnings per share.

Derivative Instruments and Hedging Activities

The Company enters into interest rate swap and interest rate cap agreements (collectively, "Hedging Derivatives") for interest rate risk management purposes and in conjunction with certain variable rate secured debt to satisfy lender requirements. The Company does not enter into Hedging Derivative transactions for trading or other speculative purposes. The Company assesses the effectiveness of qualifying cash flow and fair value hedges, both at inception and on an on-going basis. Hedge ineffectiveness is reported as a component of interest expense, net. The fair values of Hedging Derivatives that are in an asset position are recorded in prepaid expenses and other assets. The fair value of Hedging Derivatives that are in a liability position are included in accrued expenses and other liabilities. The Company does not present or disclose the fair value of Hedging Derivatives on a net basis. Fair value changes for derivatives that are not in qualifying hedge relationships are reported as a component of interest expense, net.  For the Hedging Derivative positions that the Company has determined qualify as effective cash flow hedges, the Company has recorded the cumulative changes in the fair value of Hedging Derivatives in other comprehensive loss.  Amounts recorded in accumulated other comprehensive loss will be reclassified into earnings in the periods in which earnings are affected by the hedged cash flow. The effective portion of the change in fair value of the Hedging Derivatives that the Company has determined qualified as effective fair value hedges is reported as an adjustment to the carrying amount of the corresponding debt being hedged. See Note 10, "Fair Value," for further discussion of derivative financial instruments.

Legal and Other Contingencies

Edgewater Casualty Loss

In January 2015, a fire occurred at the Company's Avalon at Edgewater apartment community located in Edgewater, New Jersey ("Edgewater"). Edgewater consisted of two residential buildings. One building, containing 240 apartment homes, was destroyed and the Company is completing its reconstruction. The second building, containing 168 apartment homes, suffered minimal damage and has been repaired.


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In conjunction with legal matters associated with the Edgewater casualty loss, the Company has established protocols for processing claims from third parties who suffered losses as a result of the fire, and many third parties have contacted the Company's insurance carrier and settled their claims. See Part II, Item 1, "Legal Proceedings," for further discussion of the lawsuits associated with the Edgewater casualty loss.

With regard to the building that was destroyed, three class action lawsuits have been filed against the Company and consolidated in the United States District Court for the District of New Jersey. The Company has agreed with class counsel to the terms of a settlement which provides a claims process (with agreed upon protocols for instructing the adjuster as to how to evaluate claims) and, if needed, an arbitration process to determine damage amounts to be paid to individual claimants covered by the class settlement. In July 2017 the District Court granted final approval of the settlement and all claims have been submitted to the independent claims adjuster. A total of 66 units (consisting of residents who did not previously settle their claims and who did not opt out of the class settlement) are included in the class action settlement and bound by its terms. However, only 44 units submitted claims. The independent claims adjuster is currently reviewing the claims submitted; the submitted claims total approximately $6,900,000 but, based on the Company's review of the initial determinations made by the adjuster on a number of claims, the Company believes that the total amount actually awarded will be significantly less. To date, the claims adjuster has completed his evaluation of 35 of these claims and it is expected that the evaluation of the remaining claims should be completed within the next two months. In addition to the class action lawsuits described above, the Company has resolved litigated claims with approximately 60 units. There is currently one remaining resident lawsuit with respect to the destroyed building filed in the Superior Court of New Jersey, Bergen County - Law Division; the Company believes it has meritorious defenses to the extent of damages claimed in that suit. A number of subrogation lawsuits had been filed against the Company by insurers of Edgewater residents who obtained renters insurance; these lawsuits have been or are expected to be resolved in 2018. A fourth class action, being heard in the same federal court, was filed against the Company on behalf of a purported class of residents of the second Edgewater building that suffered minimal damage.

Having settled many third party claims as described above, the Company currently believes that any potential remaining liability to third parties (including any potential liability to third parties determined in accordance with the class settlement described above) will not be material to the Company and will in any event be substantially covered by the Company's insurance policies. However, the Company can give no assurances in this regard and continues to evaluate this matter. See Part II, Item 1, "Legal Proceedings," for further discussion of and updates about the casualty gains and losses and lawsuits associated with the Edgewater casualty loss through the date this Form 10-Q is filed.

Other Matters

The Company is involved in various other claims and/or administrative proceedings unrelated to the Edgewater casualty loss that arise in the ordinary course of its business. While no assurances can be given, the Company does not currently believe that any of these other outstanding litigation matters, individually or in the aggregate, will have a material adverse effect on its financial condition or results of operations.

Acquisitions of Investments in Real Estate

The Company accounts for acquisitions of investments in real estate in accordance with the authoritative guidance for the initial measurement, which first requires that the Company determine if the real estate investment is the acquisition of an asset or a business combination. Under either model, the Company must identify and determine the fair value of any assets acquired, liabilities assumed and any noncontrolling interest in the acquiree. Typical assets acquired and liabilities assumed include land, building, furniture, fixtures and equipment, debt and identified intangible assets and liabilities, consisting of the value of above or below market leases and in-place leases. In making estimates of fair values for purposes of allocating purchase price, the Company utilizes various sources, including its own analysis of recently acquired and existing comparable properties in its portfolio and other market data. Consideration for acquisitions is typically in the form of cash unless otherwise disclosed. For a business combination, the Company records the assets acquired and liabilities assumed based on the fair value of each respective item. For an asset acquisition, the allocation of the purchase price is based on the relative fair value of the net assets. The Company expenses all applicable acquisition costs for a business combination and capitalizes all applicable acquisition costs for an asset acquisition. The Company expects that acquisitions of individual operating communities will generally be viewed as asset acquisitions.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make certain estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods.  Actual results could differ from those estimates.


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Reclassifications

Certain reclassifications have been made to amounts in prior years' notes to financial statements to conform to current year presentations as a result of changes in held for sale classification, disposition activity and segment classification.

Revenue and Gain Recognition

As of January 1, 2018, the Company adopted ASU 2014-09, Revenue from Contracts with Customers, using the modified retrospective approach, which applies the new standard to contracts that are not completed as of the date of adoption. Under the new standard, revenue is recognized in accordance with the transfer of goods and services to customers at an amount that reflects the consideration the Company expects to be entitled for those goods and services. The majority of the Company’s revenue is derived from residential and retail rental income and other lease income, which are scoped out from this standard and included in the current lease accounting framework, and will be accounted for under ASU 2016-02, Leases, discussed under Recently Issued Accounting Standards below. Revenue streams that are scoped into ASU 2014-09 include:

Management fees - The Company has investment interests in real estate joint ventures, for which the Company may manage (i) the venture, (ii) the associated operating communities owned by the ventures and/or (iii) the development or redevelopment of those operating communities. For these activities, the Company receives asset management, property management, development and/or redevelopment fee revenue. The performance obligation is the management of the venture, community or other defined task such as the development or redevelopment of the community. While the individual activities that comprise the performance obligation of the management fees can vary day to day, the nature of the overall performance obligation to provide management service is the same and considered by the Company to be a series of services that have the same pattern of transfer to the customer and the same method to measure progress toward satisfaction of the performance obligation. The Company recognizes revenue for fees as earned on a monthly basis and has concluded this is appropriate under the new standard.

Rental and non-rental related income - The Company recognizes revenue for new rental related income not included as components of a lease, such as reservation and application fees, as well as for non-rental related income, as earned, and has concluded this is appropriate under the new standard.

Gains or losses on sales of real estate - The Company accounts for the sale of real estate assets and any related gain recognition in accordance with the accounting guidance applicable to sales of real estate, which establishes standards for recognition of profit on all real estate sales transactions, other than retail land sales. The Company recognizes the sale, and associated gain or loss from the disposition, provided that the earnings process is complete and the Company does not have significant continuing involvement. Subsequent to the adoption of the new standard, a gain or loss is recognized when the criteria for an asset to be derecognized are met, which include when (i) a contract exists and (ii) the buyer obtained control of the nonfinancial asset that was sold. As a result, the Company may recognize a gain on a real estate disposition transaction that previously did not qualify as a sale or for full profit recognition due to the timing of the transfer of control or certain forms of continuing involvement. In addition, subsequent to the adoption of the new standard, a gain or loss recognized on the sale of a nonfinancial asset to an unconsolidated entity will be recognized at 100%, and not the Company’s proportionate ownership percentage.

The Company concluded that the adoption of the new standard did not require an adjustment to the opening balance of retained earnings.

The following table provides details of the Company’s revenue streams disaggregated by the Company’s reportable operating segments, further discussed in Note 7, “Segment Reporting,” for the three and nine months ended September 30, 2018 and 2017. Segment information for total revenue has been adjusted to exclude the real estate assets that were sold from January 1, 2017 through September 30, 2018, or otherwise qualify as held for sale as of September 30, 2018, as described in Note 6, "Real Estate Disposition Activities," (dollars in thousands):

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Table of Contents

 
 
For the three months ended
 
 
Established
Communities
 
Other
Stabilized
Communities
 
Development/
Redevelopment
Communities
 
Non-
allocated (1)
 
Total
For the period ended September 30, 2018
 
 
 
 
 
 
 
 
 
 
Management, development and other fees
 
$

 
$

 
$

 
$
912

 
$
912

Rental and non-rental related income (2)
 
2,695

 
1,751

 
512

 

 
4,958

Total non-lease revenue (3)
 
2,695

 
1,751

 
512

 
912

 
5,870

 
 
 
 
 
 
 
 
 
 
 
Lease income (4)
 
424,328

 
64,791

 
76,987

 

 
566,106

 
 


 
 
 
 
 
 
 
 
Total revenue
 
$
427,023

 
$
66,542

 
$
77,499

 
$
912

 
$
571,976

 
 
 
 
 
 
 
 
 
 
 
For the period ended September 30, 2017
 
 
 
 
 
 
 
 
 
 
Management, development and other fees
 
$

 
$

 
$

 
$
993

 
$
993

Rental and non-rental related income (2)
 
2,667

 
1,734

 
450

 

 
4,851

Total non-lease revenue (3)
 
2,667

 
1,734

 
450

 
993

 
5,844

 
 
 
 
 
 
 
 
 
 
 
Lease income (4)
 
414,663

 
51,151

 
59,067

 

 
524,881

Business interruption insurance proceeds (5)
 

 

 
3,495

 

 
3,495

 
 
 
 
 
 
 
 
 
 
 
Total revenue
 
$
417,330

 
$
52,885

 
$
63,012

 
$
993

 
$
534,220

 
 
For the nine months ended
 
 
Established
Communities
 
Other
Stabilized
Communities
 
Development/
Redevelopment
Communities
 
Non-
allocated (1)
 
Total
For the period ended September 30, 2018
 
 
 
 
 
 
 
 
 
 
Management, development and other fees
 
$

 
$

 
$

 
$
2,752

 
$
2,752

Rental and non-rental related income (2)
 
7,823

 
4,940

 
1,439

 

 
14,202

Total non-lease revenue (3)
 
7,823

 
4,940

 
1,439

 
2,752

 
16,954

 
 
 
 
 
 
 
 
 
 
 
Lease income (4)
 
1,258,243

 
190,094

 
215,977

 

 
1,664,314

 
 
 
 
 
 
 
 
 
 
 
Total revenue
 
$
1,266,066

 
$
195,034

 
$
217,416

 
$
2,752

 
$
1,681,268

 
 
 
 
 
 
 
 
 
 
 
For the period ended September 30, 2017
 
 
 
 
 
 
 
 
 
 
Management, development and other fees
 
$

 
$

 
$

 
$
3,290

 
$
3,290

Rental and non-rental related income (2)
 
7,798

 
4,778

 
1,095

 

 
13,671

Total non-lease revenue (3)
 
7,798

 
4,778

 
1,095

 
3,290

 
16,961

 
 
 
 
 
 
 
 
 
 
 
Lease income (4)
 
1,228,410

 
132,961

 
166,707

 

 
1,528,078

Business interruption insurance proceeds (5)
 

 

 
3,495

 

 
3,495

 
 
 
 
 
 
 
 
 
 
 
Total revenue
 
$
1,236,208

 
$
137,739

 
$
171,297

 
$
3,290

 
$
1,548,534

__________________________________

(1)
Revenue represents third-party management, asset management and developer fees and miscellaneous income which are not allocated to a reportable segment.
(2)
Amounts include revenue streams related to leasing activities that are not considered components of a lease, including but not limited to, apartment hold fees and application fees, as well as revenue streams not related to leasing activities, including but not limited to, vendor revenue sharing, building advertising, vending and dry cleaning revenue.
(3)
Represents all revenue accounted for under ASC 2014-09.
(4)
Amounts include all revenue streams derived from residential and retail rental income and other lease income, which are scoped out from ASC 2014-09 and accounted for under the lease accounting framework.
(5)
Amounts for the three and nine months ended September 30, 2017 are composed of business interruption insurance proceeds resulting from the final insurance settlement of the Maplewood casualty loss.


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Table of Contents

Due to the nature and timing of the Company’s identified revenue streams, there are no material amounts of outstanding or unsatisfied performance obligations as of September 30, 2018.

Recently Issued Accounting Standards

In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities. This ASU expands hedge accounting for both nonfinancial and financial risk components and aligns the recognition and presentation of the effects of the hedging instrument and the hedged item in the financial statements. This update also simplifies the application of hedge accounting guidance and eases the administrative burden of hedge documentation requirements and assessing hedge effectiveness. The Company adopted the guidance as of January 1, 2018 and it did not have a material effect on the Company’s financial position or results of operations.

In February 2017, the FASB issued ASU 2017-05, Other Income-Gains and Losses from the Derecognition of Nonfinancial Assets (Subtopic 610-20): Clarifying the Scope of Asset Derecognition Guidance and Accounting for Partial Sales of Nonfinancial Assets. This ASU (i) clarifies the scope of the nonfinancial asset guidance and the derecognition of certain businesses and nonprofit activities, (ii) eliminates the exception in the financial asset guidance for transfers of investments (including equity method investments) in real estate entities and supersedes the guidance in the Exchanges of a Nonfinancial Asset for a Noncontrolling Ownership Interest and (iii) provides guidance on the accounting of partial sales of nonfinancial assets and contributions of nonfinancial assets to a joint venture or other noncontrolled investee. The new standard allows for either a retrospective or modified retrospective approach. The Company adopted the new standard as of January 1, 2018 using the modified retrospective approach, applying the provisions to open contracts as of the date of adoption. See "Revenue and Gain Recognition" above for additional discussion of the impact of adopting the guidance.

In February 2016, the FASB issued ASU 2016-02, Leases, amending the existing accounting standards for lease accounting, including requiring lessees to recognize most leases on their balance sheets and making targeted changes to lessor accounting. The guidance will be effective in the first quarter of 2019 and allows for early adoption. The new standard requires a modified retrospective transition approach for all leases existing at the date of initial application, with an option to use certain transition relief. ASU 2016-02 provides for transition relief, which includes electing to not (i) reassess whether any expired or existing contract is a lease or contains a lease, (ii) reassess the lease classification of any expired or existing leases and (iii) expense any capitalized initial direct costs for any existing leases. Subsequently, the FASB issued ASU 2018-01 and ASU 2018-11 which provides further transition relief by providing (i) an option to not evaluate land easements that exist or have expired prior to the date of adoption under ASC 842, (ii) prospective adoption as a transition method and (iii) a practical expedient for lessors to not separate lease and non-lease components by class of underlying asset when certain conditions are met.
The Company plans to adopt ASC 842 on January 1, 2019 using the prospective adoption method, and plans to apply certain practical expedients allowed under the standard including:
not reassessing (i) whether any expired or existing contracts are or contain leases, (ii) the lease classification for any expired or existing leases, and (iii) the accounting for initial direct costs for any existing leases;
not evaluating short term leases;
not assessing whether existing land easements are, or contain leases; and
making an accounting policy election by class of underlying asset, to not separate non-lease components from lease components and instead to account for each separate lease and non- lease component as a single lease component.

The Company anticipates adoption of the standard to have a material impact on its financial position resulting from the recognition of the right to use asset and corresponding lease obligation for its long-term ground leases, currently accounted for as operating leases. The Company will continue to assess the impact of the new standard until adoption in 2019.

Change in Accounting Principle

As of October 1, 2017, the Company adopted ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash. The guidance requires statements of cash flows to explain the change during the period in the total of cash, cash equivalents, and amounts generally described as restricted cash or restricted cash equivalents, and was adopted retrospectively. The prior period amounts that have been impacted by the new guidance and retrospectively adjusted include (i) an increase in cash in operating escrows (cash provided by operating activities), (ii) an increase in cash in deposit escrows (cash used in investing activities) and (iii) repayments of mortgage notes payable, including prepayment penalties (cash used in financing activities), located on the Condensed Consolidated Statements of Cash Flows.

The following tables present the impact of the change in accounting principle to the Condensed Consolidated Statement of Cash Flows for the nine months ended September 30, 2017 (dollars in thousands):

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Table of Contents

 
 
9/30/2017
(as previously reported)
 
Impact of ASU 2016-18
 
9/30/2017
(as adjusted and currently reported)
 
 
 
Net cash provided by operating activities
$
917,573

 
$
16,205

 
$
933,778

Net cash used in investing activities
(676,231
)
 
51,479

 
(624,752
)
Net cash used in financing activities
(420,294
)
 
(1,598
)
 
(421,892
)
 
 
 
 
 
 
Net (decrease) increase in cash, cash equivalents
(178,952
)
 
178,952

 

Net increase in cash, cash equivalents and restricted cash

 
(112,866
)
 
(112,866
)
 
 
 
 
 
 
Cash, cash equivalents, beginning of period
214,994

 
(214,994
)
 

Cash, cash equivalents and restricted cash, beginning of period

 
329,977

 
329,977

Cash, cash equivalents, end of period
$
36,042

 

 

Cash, cash equivalents and restricted cash, end of period
 
 
$
181,069

 
$
217,111


2.  Interest Capitalized

The Company capitalizes interest during the development and redevelopment of real estate assets. Capitalized interest associated with the Company's development or redevelopment activities totaled $16,277,000 and $16,223,000 for the three months ended September 30, 2018 and 2017, respectively, and $44,008,000 and $51,323,000 for the nine months ended September 30, 2018 and 2017, respectively.

3.  Mortgage Notes Payable, Unsecured Notes and Credit Facility

The Company's mortgage notes payable, unsecured notes, variable rate unsecured term loans ("Term Loans") and Credit Facility, as defined below, as of September 30, 2018 and December 31, 2017 are summarized below.  The following amounts and discussion do not include the mortgage notes related to the communities classified as held for sale, if any, as of September 30, 2018 and December 31, 2017, as shown in the accompanying Condensed Consolidated Balance Sheets (dollars in thousands) (see Note 6, "Real Estate Disposition Activities").
 
9/30/2018
 
12/31/2017
 
 
 
 
Fixed rate unsecured notes (1)
$
5,650,000

 
$
5,350,000

Variable rate unsecured notes (1)
300,000

 
300,000

Term Loans (1)
250,000

 
250,000

Fixed rate mortgage notes payable - conventional and tax-exempt (2)
534,629

 
593,987

Variable rate mortgage notes payable - conventional and tax-exempt (2)
813,163

 
910,326

Total mortgage notes payable, unsecured notes and Term Loans
7,547,792

 
7,404,313

Credit Facility
56,000

 

Total mortgage notes payable, unsecured notes, Term Loans and Credit Facility
$
7,603,792

 
$
7,404,313

_____________________________________

(1)
Balances at September 30, 2018 and December 31, 2017 exclude $10,293 and $10,850, respectively, of debt discount, and $35,762 and $36,386, respectively, of deferred financing costs, as reflected in unsecured notes, net on the accompanying Condensed Consolidated Balance Sheets.
(2)
Balances at September 30, 2018 and December 31, 2017 exclude $14,618 and $16,351, respectively, of debt discount, and $9,891 and $11,256, respectively, of deferred financing costs, as reflected in mortgage notes payable on the accompanying Condensed Consolidated Balance Sheets.

The following debt activity occurred during the nine months ended September 30, 2018:

In February 2018, the Company repaid $15,174,000 principal amount of 6.60% fixed rate debt secured by Avalon Oaks West in advance of its scheduled maturity date, incurring a charge of $426,000, consisting of a prepayment penalty of $152,000 and the non-cash write-off of unamortized deferred financing costs of $274,000.


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Table of Contents

In February 2018, the Company repaid $11,038,000 principal amount of 4.61% fixed rate debt secured by AVA Pasadena at par in advance of its scheduled maturity date.

In March 2018, the Company issued $300,000,000 principal amount of unsecured notes in a public offering under its existing shelf registration statement for net proceeds of approximately $296,210,000. The notes mature in April 2048 and were issued at a 4.35% interest rate. The effective interest rate of the notes for the first 10 years is 3.97%, including the impact of an interest rate hedge and offering costs, and for the remainder of the term the effective interest rate is 4.39%.

In April 2018, the Company repaid $13,380,000 principal amount of 3.06% fixed rate debt secured by Avalon Andover at par at its scheduled maturity date.

In June 2018, the Company repaid $15,295,000 principal amount of 6.90% fixed rate debt secured by Avalon Orchards in advance of its scheduled maturity date, incurring a charge of $635,000, consisting of a prepayment penalty of $282,000 and the non-cash write-off of unamortized deferred financing costs of $353,000.

In August 2018, the Company repaid $95,859,000 aggregate principal amount of variable rate debt secured by Avalon Calabasas, of which $51,449,000 was repaid at par at its scheduled maturity date, and $44,410,000 was repaid at par in advance of its April 2028 maturity date. The Company recognized a non-cash charge of $1,678,000 for the write-off of unamortized debt discount.

At September 30, 2018, the Company has a $1,500,000,000 revolving variable rate unsecured credit facility with a syndicate of banks (the "Credit Facility") which matures in April 2020. The Company may extend the maturity for up to nine months, provided the Company is not in default and upon payment of a $1,500,000 extension fee. The Credit Facility bears interest at varying levels based on the London Interbank Offered Rate ("LIBOR"), rating levels achieved on the Company's unsecured notes and on a maturity schedule selected by the Company. The current stated pricing is LIBOR plus 0.825% per annum (3.08% at September 30, 2018), assuming a one month borrowing rate. The annual facility fee is 0.125% (or approximately $1,875,000 annually based on the $1,500,000,000 facility size and based on the Company's current credit rating).

The Company had $56,000,000 outstanding under the Credit Facility as of September 30, 2018 and no borrowings outstanding under the Credit Facility as of December 31, 2017. The Company had $39,760,000 and $47,315,000 outstanding in letters of credit that reduced the borrowing capacity as of September 30, 2018 and December 31, 2017, respectively.

In the aggregate, secured notes payable mature at various dates from April 2019 through July 2066, and are secured by certain apartment communities (with a net carrying value of $2,073,747,000, excluding communities classified as held for sale, as of September 30, 2018).

As of September 30, 2018, the Company has guaranteed a wholly-owned subsidiary's $100,000,000 secured note payable that is consolidated for financial reporting purposes. The weighted average interest rate of the Company's fixed rate secured notes payable (conventional and tax-exempt) was 3.8% and 4.0% at September 30, 2018 and December 31, 2017, respectively. The weighted average interest rate of the Company's variable rate secured notes payable (conventional and tax-exempt) including the effect of certain financing related fees, was 3.4% and 3.2% at September 30, 2018 and December 31, 2017, respectively.

Scheduled payments and maturities of secured notes payable and unsecured notes outstanding at September 30, 2018 are as follows (dollars in thousands):

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Year
 
Secured notes payments
 
Secured notes maturities
 
Unsecured notes maturities
 
Stated interest rate of unsecured notes
2018
 
1,638

 

 

 
N/A

2019
 
3,824

 
114,722

 

 
N/A

2020
 
2,682

 
140,430

 
250,000

 
6.100
%

 


 


 
400,000

 
3.625
%
2021
 
2,549

 
27,844

 
250,000

 
3.950
%

 


 


 
300,000

 
LIBOR + 0.43%

2022
 
2,723

 

 
450,000

 
2.950
%
 
 
 
 
 
 
100,000

 
LIBOR + .90%

2023
 
2,899

 

 
350,000

 
4.200
%

 


 


 
250,000

 
2.850
%
2024
 
3,077

 

 
300,000

 
3.500
%
 
 
 
 
 
 
150,000

 
LIBOR + 1.50%

2025
 
3,268

 
84,835

 
525,000

 
3.450
%
 
 
 
 
 
 
300,000

 
3.500
%
2026
 
3,485

 

 
475,000

 
2.950
%
 
 
 
 
 
 
300,000

 
2.900
%
2027
 
2,974

 
185,100

 
400,000

 
3.350
%
Thereafter
 
127,593

 
638,149

 
350,000

 
3.900
%
 
 
 
 
 
 
300,000

 
4.150
%
 
 
 
 
 
 
450,000

 
3.200
%
 
 
 
 
 
 
300,000

 
4.350
%
 
 
$
156,712

 
$
1,191,080

 
$
6,200,000

 
 

 

The Company was in compliance at September 30, 2018 with customary financial and other covenants under the Credit Facility, the Term Loans and the Company's fixed rate unsecured notes.

4.  Equity

The following summarizes the changes in equity for the nine months ended September 30, 2018 (dollars in thousands):
 
Common
stock
 
Additional
paid-in
capital
 
Accumulated
earnings
less
dividends
 
Accumulated
other
comprehensive
loss
 
Total
equity
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2017
$
1,381

 
$
10,235,475

 
$
188,609

 
$
(37,419
)
 
$
10,388,046

Net income attributable to common stockholders

 

 
588,791

 

 
588,791

Gain on cash flow hedges, net

 

 

 
11,499

 
11,499

Cash flow hedge losses reclassified to earnings

 

 

 
4,679

 
4,679

Change in redemption value of redeemable noncontrolling interest

 

 
(626
)
 

 
(626
)
Dividends declared to common stockholders

 

 
(609,972
)
 

 
(609,972
)
Issuance of common stock, net of withholdings
1

 
(11,217
)
 
1,144

 

 
(10,072
)
Amortization of deferred compensation

 
25,053

 

 

 
25,053

Balance at September 30, 2018
$
1,382

 
$
10,249,311

 
$
167,946

 
$
(21,241
)
 
$
10,397,398


As of September 30, 2018 and December 31, 2017, the Company's charter had authorized for issuance a total of 280,000,000 shares of common stock and 50,000,000 shares of preferred stock.


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Table of Contents

During the nine months ended September 30, 2018, the Company:

i.
issued 5,263 shares of common stock in connection with stock options exercised;
ii.
issued 1,713 common shares through the Company's dividend reinvestment plan;
iii.
issued 187,010 common shares in connection with restricted stock grants and the conversion of performance awards to restricted shares;
iv.
withheld 67,963 common shares to satisfy employees' tax withholding and other liabilities;
v.
issued 6,613 common shares through the Employee Stock Purchase Plan; and
vi.
canceled 4,622 common shares of restricted stock upon forfeiture.

Any deferred compensation related to the Company's stock option, restricted stock and performance award grants during the nine months ended September 30, 2018 is not reflected on the accompanying Condensed Consolidated Balance Sheets as of September 30, 2018, and will not be reflected until recognized as compensation cost.

In December 2015, the Company commenced a fourth continuous equity program ("CEP IV") under which the Company may sell (and/or enter into forward sale agreements for the sale of) up to $1,000,000,000 of its common stock from time to time. Actual sales will depend on a variety of factors to be determined by the Company, including market conditions, the trading price of the Company's common stock and determinations by the Company of the appropriate sources of funding for the Company. In conjunction with CEP IV, the Company engaged sales agents who will receive compensation of up to 2.0% of the gross sales price for shares sold. The Company expects that, if entered into, it will physically settle each forward sale agreement on one or more dates specified by the Company on or prior to the maturity date of that particular forward sale agreement, in which case the Company will expect to receive aggregate net cash proceeds at settlement equal to the number of shares underlying the particular forward agreement multiplied by the relevant forward sale price. However, the Company may also elect to cash settle or net share settle a forward sale agreement. In connection with each forward sale agreement, the Company will pay the relevant forward seller, in the form of a reduced initial forward sale price, a commission of up to 2.0% of the sales prices of all borrowed shares of common stock sold. As of September 30, 2018, there are no outstanding forward sales agreements. During the three and nine months ended September 30, 2018, the Company had no sales under the program. As of September 30, 2018, the Company had $892,915,000 of shares remaining authorized for issuance under this program.

5.  Investments in Real Estate Entities

Investments in Unconsolidated Real Estate Entities

As of September 30, 2018, the Company had investments in six unconsolidated real estate entities with ownership interest percentages ranging from 20.0% to 55.0%, excluding joint ventures formed with Equity Residential as part of the Archstone acquisition. The Company accounts for its investments in unconsolidated real estate entities under the equity method of accounting. The significant accounting policies of the Company's unconsolidated real estate entities are consistent with those of the Company in all material respects.

The Company has an equity interest of 31.3% in AvalonBay Value Added Fund II, L.P. ("Fund II"), and upon achievement of a threshold return, the Company has a right to incentive distributions for its promoted interest based on the current returns earned by Fund II, which currently represents 40.0% of further Fund II distributions, which is in addition to its proportionate share of the remaining 60.0% of distributions. During 2017, Fund II sold its final apartment communities. During the nine months ended September 30, 2018, the Company recognized income of $925,000 for its promoted interest, which is reported as a component of equity in income of unconsolidated real estate entities on the accompanying Condensed Consolidated Statements of Comprehensive Income.

During the three and nine months ended September 30, 2018, Archstone Multifamily Partners AC LP (the "U.S. Fund") sold Avalon Kirkland at Carillon, located in Kirkland, WA, containing 131 apartment homes, for $85,500,000. The Company's share of the gain was $8,636,000. In conjunction with the disposition of this community, during the three and nine months ended September 30, 2018, the U.S. Fund repaid $27,928,000 of secured indebtedness in advance of its scheduled maturity date. This resulted in a charge for a prepayment penalty and the write-off of deferred financing costs, of which the Company's portion was $89,000, which is reported as a reduction of equity in income (loss) of unconsolidated real estate entities on the accompanying Condensed Consolidated Statements of Comprehensive Income.


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Table of Contents

The following is a combined summary of the financial position of the entities accounted for using the equity method discussed above as of the dates presented (dollars in thousands):
 
9/30/2018
 
12/31/2017
 
(unaudited)
 
(unaudited)
Assets:
 

 
 

Real estate, net
$
731,006

 
$
695,077

Other assets
90,712

 
39,976

Total assets
$
821,718

 
$
735,053

 
 
 
 
Liabilities and partners' capital:
 

 
 

Mortgage notes payable, net and credit facility
$
492,965

 
$
523,815

Other liabilities
16,583

 
10,540

Partners' capital
312,170

 
200,698

Total liabilities and partners' capital
$
821,718

 
$
735,053

 

The following is a combined summary of the operating results of the entities accounted for using the equity method discussed above for the periods presented (dollars in thousands):
 
For the three months ended
 
For the nine months ended
 
9/30/2018
 
9/30/2017
 
9/30/2018
 
9/30/2017
 
(unaudited)
 
(unaudited)
Rental and other income
$
24,535

 
$
24,568

 
$
68,324

 
$
79,999

Operating and other expenses
(8,749
)
 
(9,378
)
 
(26,066
)
 
(30,386
)
Gain on sale of communities
30,597

 
107,067

 
30,597

 
136,514

Interest expense, net
(5,938
)
 
(7,867
)
 
(17,130
)
 
(21,415
)
Depreciation expense
(6,288
)
 
(5,938
)
 
(18,704
)
 
(20,059
)
Net income
$
34,157

 
$
108,452

 
$
37,021

 
$
144,653


In conjunction with the acquisition of the "U.S. Fund", Multifamily Partners AC JV LP (the "AC JV") and Brandywine Apartments of Maryland, LLC ("Brandywine"), the Company incurred costs in excess of its equity in the underlying net assets of the respective investments. These costs represent $34,225,000 and $35,402,000 at September 30, 2018 and December 31, 2017, respectively, of the Company's respective investment balances. These amounts are being amortized over the lives of the underlying assets as a component of equity in income of unconsolidated real estate entities on the accompanying Condensed Consolidated Statements of Comprehensive Income.

Investments in Consolidated Real Estate Entities

In September 2018, the Company acquired Avalon Arundel Crossing, a consolidated community, located in Linthicum Heights, MD. Avalon Arundel Crossing contains 310 apartment homes and was acquired for a purchase price of $83,000,000.

The Company accounted for this as an asset acquisition and recorded the acquired assets and assumed liabilities, including identifiable intangibles, at their relative fair values based on the purchase price and acquisition costs incurred. The Company used third party pricing or internal models for the values of the land, a valuation model for the values of the buildings, and an internal model to determine the fair values of the remaining real estate assets and in-place leases. Given the heterogeneous nature of multifamily real estate, the fair values for the land, debt, real estate assets and in-place leases incorporated significant unobservable inputs and therefore are considered to be Level 3 prices within the fair value hierarchy.


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Table of Contents

In conjunction with the development of Avalon Brooklyn Bay, the Company entered into a joint venture agreement to construct a mixed-use building that contains rental apartments, for-sale residential condominium units and related common elements. The Company owns a 70.0% interest in the venture, which represents a 100% interest in the rental apartments, and the venture partner owns the remaining 30.0% interest, which represents a 100% interest in the for-sale residential condominium units. The Company was responsible for the development and construction of the structure, and provided a loan to the venture partner for the venture partner's share of costs. The development of Avalon Brooklyn Bay was completed during the nine months ended September 30, 2018. The Company has a receivable from the venture partner in the form of a variable rate mortgage note, secured by the remaining for-sale residential condominium units. Beginning in 2018, the mortgage note is being repaid by the venture partner with the proceeds the venture partner receives from the sales of the residential condominium units. The balance as of September 30, 2018 was $14,001,000, representing outstanding principal and interest, net of repayments, and as of December 31, 2017, was $44,831,000, representing outstanding principal and interest. These amounts are reported as a component of prepaid expenses and other assets on the accompanying Condensed Consolidated Balance Sheets. The Company recognizes interest income on the accrual basis. The venture is considered a VIE, and the Company consolidates its interest in the rental apartments and common areas.

Expensed Transaction, Development and Other Pursuit Costs and Casualty and Impairment of Long-Lived Assets

The Company capitalizes pre-development costs incurred in pursuit of new development opportunities for which the Company currently believes future development is probable ("Development Rights"). Future development of these Development Rights is dependent upon various factors, including zoning and regulatory approval, rental market conditions, construction costs and the availability of capital. Initial pre-development costs incurred for pursuits for which future development is not yet considered probable are expensed as incurred. In addition, if the status of a Development Right changes, making future development by the Company no longer probable, any capitalized pre-development costs are expensed. The Company expensed costs related to the abandonment of Development Rights and costs for pursuits where development is not yet considered probable, as well as costs incurred in pursuing the acquisition or disposition of assets for which such acquisition and disposition activity did not occur, in the amounts of $1,020,000 and $789,000 for the three months ended September 30, 2018 and 2017, respectively, and $2,709,000 and $2,087,000 for the nine months ended September 30, 2018 and 2017, respectively. These costs are included in expensed transaction, development and other pursuit costs, net of recoveries on the accompanying Condensed Consolidated Statements of Comprehensive Income. Abandoned pursuit costs can vary greatly, and the costs incurred in any given period may be significantly different in future periods.

The Company evaluates its real estate and other long-lived assets for impairment when potential indicators of impairment exist. Such assets are stated at cost, less accumulated depreciation and amortization, unless the carrying amount of the asset is not recoverable. If events or circumstances indicate that the carrying amount of a property or long-lived asset may not be recoverable, the Company assesses its recoverability by comparing the carrying amount of the property or long-lived asset to its estimated undiscounted future cash flows. If the carrying amount exceeds the aggregate undiscounted future cash flows, the Company recognizes an impairment loss to the extent the carrying amount exceeds the estimated fair value of the property or long-lived asset. Based on periodic tests of recoverability of long-lived assets for the three and nine months ended September 30, 2018 and 2017, the Company did not recognize any impairment losses for wholly-owned operating real estate assets, and did not record any impairment losses other than those related to the impairment on land held for investment and casualty gains and losses from property damage, as discussed below.

The Company assesses its portfolio of land held for both development and investment for impairment if the intent of the Company changes with respect to either the development of, or the expected holding period for, the land. During the nine months ended September 30, 2017, the Company recognized an impairment charge of $9,350,000 relating to a land parcel which the Company had acquired for development in 2004 and sold during 2017. This charge was determined as the excess of the Company's carrying basis over the expected sale price for the parcel, and is included in casualty and impairment (gain) loss, net on the accompanying Condensed Consolidated Statements of Comprehensive Income. There were no impairment losses recognized on the Company's investment in land during the three and nine months ended September 30, 2018.

The Company evaluates its unconsolidated investments for other than temporary impairment, considering both the extent and amount by which the carrying value of the investment exceeds the fair value, and the Company's intent and ability to hold the investment to recover its carrying value. The Company also evaluates its proportionate share of any impairment of assets held by unconsolidated investments. There were no other than temporary impairment losses recognized by any of the Company's investments in unconsolidated real estate entities during the three and nine months ended September 30, 2018 and 2017.


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Table of Contents

Casualty Gains and Losses

During the three months ended September 30, 2018, the Company recognized a gain of $554,000 for legal settlement proceeds relating to construction defects at a community acquired as part of the Archstone acquisition, which is included in casualty and impairment (gain) loss, net on the accompanying Condensed Consolidated Statements of Comprehensive Income.

During the nine months ended September 30, 2017, the Company recorded a casualty loss of $19,481,000 composed of a charge of $16,361,000 to write-off the net book value of the fixed assets destroyed in the Maplewood casualty loss, and an accrual for demolition and additional incident expenses of $3,120,000. The casualty loss was partially offset by $17,143,000 of property damage insurance proceeds. The net casualty loss of $2,338,000 for the nine months ended September 30, 2017 is included in casualty and impairment (gain) loss, net on the accompanying Condensed Consolidated Statements of Comprehensive Income.

During the three months ended September 30, 2017, the Company reached a final insurance settlement for the property damage and lost income for the Maplewood casualty loss of $19,696,000, after self-insurance and deductibles. Of this amount, the Company received $7,076,000 and $13,268,000 during the three and nine months ended September 30, 2017, respectively. As part of the settlement, the Company recognized $3,495,000 as business interruption insurance proceeds for the three and nine months ended September 30, 2017, which is recorded as a component of rental and other income on the accompanying Condensed Consolidated Statements of Comprehensive Income.

6.  Real Estate Disposition Activities

The following real estate sales occurred during the nine months ended September 30, 2018:

In May 2018, the Company sold Avalon Blue Hills and Avalon Canton at Blue Hills, located in Randolph, MA, and Canton, MA, respectively, containing an aggregate of 472 apartment homes for $131,250,000. The Company's gain on disposition was $57,666,000, reported in gain on sale of communities on the accompanying Condensed Consolidated Statements of Comprehensive Income.

In May 2018, the Company sold Eaves North Quincy, located in Quincy, MA, containing 224 apartment homes for $64,250,000. The Company's gain on disposition was $18,055,000, reported in gain on sale of communities on the accompanying Condensed Consolidated Statements of Comprehensive Income.

In June 2018, the Company sold Avalon Anaheim Stadium, located in Anaheim, CA, containing 251 apartment homes for $111,600,000. The Company's gain on disposition was $29,490,000, reported in gain on sale of communities on the accompanying Condensed Consolidated Statements of Comprehensive Income.

In August 2018, the Company sold Avalon Ballston Place, located in Arlington, VA, containing 383 apartment homes for $169,000,000. The Company's gain on disposition was $27,215,000, reported in gain on sale of communities on the accompanying Condensed Consolidated Statements of Comprehensive Income. The sale of Avalon Ballston Place was part of a tax deferred exchange, under which the Company had restricted $85,828,000 of the cash proceeds in an escrow account, classified as cash in escrow on the accompanying Condensed Consolidated Balance Sheets.

At September 30, 2018, the Company had three communities and one land parcel that qualified as held for sale.

During 2016, the Company completed the construction of and sold an affordable restricted apartment building, containing 77 apartment homes. The Company received consideration for the sale in the form of a mortgage note secured by the underlying real estate. During the three months ended September 30, 2018, the Company received a payment of $16,627,000, of which $15,900,000 represents a repayment of substantially all of the outstanding principal, with the balance representing interest income on the note.

7.  Segment Reporting

The Company's reportable operating segments include Established Communities, Other Stabilized Communities, and Development/Redevelopment Communities.  Annually as of January 1, the Company determines which of its communities fall into each of these categories and generally maintains that classification throughout the year for the purpose of reporting segment operations, unless disposition or redevelopment plans regarding a community change.

In addition, the Company owns land for future development and has other corporate assets that are not allocated to an operating segment.


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Table of Contents

The Company's segment disclosures present the measure(s) used by the chief operating decision maker for purposes of assessing each segment's performance. The Company's chief operating decision maker is comprised of several members of its executive management team who use net operating income ("NOI") as the primary financial measure for Established Communities and Other Stabilized Communities. NOI is defined by the Company as total property revenue less direct property operating expenses (including property taxes), and excluding corporate-level income (including management, development and other fees), corporate-level property management and other indirect operating expenses, investments and investment management expenses, expensed transaction, development and other pursuit costs, net of recoveries, interest expense, net, loss on extinguishment of debt, net, general and administrative expense, equity in income of unconsolidated real estate entities, depreciation expense, corporate income tax expense, casualty and impairment (gain) loss, net, gain on sale of communities, gain on other real estate transactions, net and net operating income from real estate assets sold or held for sale. Although the Company considers NOI a useful measure of a community's or communities' operating performance, NOI should not be considered an alternative to net income or net cash flow from operating activities, as determined in accordance with GAAP. NOI excludes a number of income and expense categories as detailed in the reconciliation of NOI to net income.

A reconciliation of NOI to net income for the three and nine months ended September 30, 2018 and 2017 is as follows (dollars in thousands):
 
For the three months ended
 
For the nine months ended
 
9/30/2018
 
9/30/2017
 
9/30/2018
 
9/30/2017
Net income
$
192,407

 
$
238,199

 
$
588,540

 
$
639,174

Indirect operating expenses, net of corporate income
18,855

 
15,752

 
55,850

 
48,472

Investments and investment management expense
1,726

 
1,501

 
4,898

 
4,277

Expensed transaction, development and other pursuit costs, net of recoveries
1,020

 
789

 
2,709

 
2,087

Interest expense, net
54,097

 
47,741

 
165,795

 
147,138

Loss on extinguishment of debt, net
1,678

 

 
2,717

 
24,162

General and administrative expense
13,905

 
11,655

 
42,013

 
38,808

Equity in income of unconsolidated real estate entities
(10,031
)
 
(52,568
)
 
(12,560
)
 
(70,386
)
Depreciation expense
156,538

 
144,990

 
472,282

 
427,050

Income tax expense
29

 
24

 
87

 
102

Casualty and impairment (gain) loss, net
(554
)
 

 
(612
)
 
11,688

Gain on sale of communities
(27,243
)
 
(27,738
)
 
(132,444
)
 
(159,754
)
(Gain) loss on other real estate transactions, net
(12
)
 
120

 
(335
)
 
(246
)
Net operating income from real estate assets sold or held for sale
(2,545
)
 
(10,340
)
 
(15,913
)
 
(35,162
)
        Net operating income
$
399,870

 
$
370,125

 
$
1,173,027

 
$
1,077,410


The following is a summary of NOI from real estate assets sold or held for sale for the periods presented (dollars in thousands):
 
For the three months ended
 
For the nine months ended
 
9/30/2018
 
9/30/2017
 
9/30/2018
 
9/30/2017
Rental income from real estate assets sold or held for sale
$
4,006

 
$
16,280

 
$
24,747

 
$
54,803

Operating expenses from real estate assets sold or held for sale
(1,461
)
 
(5,940
)
 
(8,834
)
 
(19,641
)
Net operating income from real estate assets sold or held for sale
$
2,545

 
$
10,340

 
$
15,913

 
$
35,162


The primary performance measure for communities under development or redevelopment depends on the stage of completion.  While under development, management monitors actual construction costs against budgeted costs as well as lease-up pace and rent levels compared to budget.

The following table provides details of the Company's segment information as of the dates specified (dollars in thousands). The segments are classified based on the individual community's status at January 1, 2018. Segment information for the three and nine months ended September 30, 2018 and 2017 has been adjusted to exclude the real estate assets that were sold from January 1, 2017 through September 30, 2018, or otherwise qualify as held for sale as of September 30, 2018, as described in Note 6, "Real Estate Disposition Activities."

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Table of Contents

 
For the three months ended
 
For the nine months ended
 
 
 
Total
revenue
 
NOI
 
Total
revenue
 
NOI
 
Gross real estate (1)
For the period ended September 30, 2018
 
 
 
 
 
 

Established
 

 
 

 
 
 
 
 
 

New England
$
60,690

 
$
40,005

 
$
178,841

 
$
117,008

 
$
2,006,671

Metro NY/NJ
106,341

 
74,562

 
315,683

 
219,396

 
3,729,612

Mid-Atlantic
59,752

 
41,432

 
177,342

 
123,056

 
2,223,386

Pacific Northwest
22,014

 
15,681

 
64,609

 
45,753

 
726,752

Northern California
92,292

 
70,465

 
274,206

 
209,866

 
2,983,019

Southern California
85,934

 
60,931

 
255,385

 
182,875

 
2,916,530

Total Established
427,023

 
303,076

 
1,266,066

 
897,954

 
14,585,970

 
 
 
 
 
 
 
 
 
 
Other Stabilized
66,542

 
45,196

 
195,034

 
132,498

 
2,740,944

Development / Redevelopment
77,499

 
51,598

 
217,416

 
142,575

 
4,895,487

Land Held for Development
N/A

 
N/A

 
N/A

 
N/A

 
116,582

Non-allocated (2)
912

 
N/A

 
2,752

 
N/A

 
96,876

 
 
 
 
 
 
 
 
 
 
Total
$
571,976

 
$
399,870

 
$
1,681,268

 
$
1,173,027

 
$
22,435,859

 
 
 
 
 
 
 
 
 
 
For the period ended September 30, 2017
 
 
 
 
 
 

Established
 

 
 

 
 
 
 
 
 

New England
$
58,872

 
$
38,635

 
$
174,018

 
$
113,423

 
$
1,988,987

Metro NY/NJ
105,225

 
71,864

 
311,301

 
215,187

 
3,617,773

Mid-Atlantic
58,561

 
40,020

 
174,653

 
120,186

 
2,213,522

Pacific Northwest
21,531

 
15,692

 
62,833

 
45,632

 
723,674

Northern California
89,798

 
68,731

 
267,316

 
205,168

 
2,966,133

Southern California
83,343

 
59,013

 
246,087

 
177,326

 
2,901,525

Total Established
417,330

 
293,955

 
1,236,208

 
876,922

 
14,411,614

 
 
 
 
 
 
 
 
 
 
Other Stabilized
52,885

 
34,746

 
137,739

 
88,946

 
2,477,846

Development / Redevelopment (3)
63,012

 
41,424

 
171,297

 
111,542

 
3,847,578

Land Held for Development
N/A

 
N/A

 
N/A

 
N/A

 
85,863

Non-allocated (2)
993

 
N/A

 
3,290

 
N/A

 
93,778

Real estate disposed or held for sale (4)
 
 
 
 
 
 
 
 
629,970

 
 
 
 
 
 
 
 
 
 
Total
$
534,220

 
$
370,125

 
$
1,548,534

 
$
1,077,410

 
$
21,546,649

__________________________________

(1)
Does not include gross real estate assets held for sale of $109,900 and $53,723 as of September 30, 2018 and 2017, respectively.
(2)
Revenue represents third-party management, asset management and developer fees and miscellaneous income which are not allocated to a reportable segment.
(3)
Total revenue and NOI for the three and nine months ended September 30, 2017 includes $3,495 in business interruption insurance proceeds related to the Maplewood casualty loss.
(4)
Represents real estate sold or held for sale during the period of September 30, 2017 to September 30, 2018, which is not allocated to a reportable segment.


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Table of Contents

8.  Stock-Based Compensation Plans

As part of its long term compensation plans, the Company has granted stock options, performance awards and restricted stock. Details of the outstanding awards and activity are presented below.

Information with respect to stock options granted under the Company's 1994 Stock Option and Incentive Plan (the "1994 Plan") and its Second Amended and Restated 2009 Equity Incentive Plan (the "2009 Plan") for the nine months ended September 30, 2018, is as follows:
 
 
2009 Plan
shares
 
Weighted average
exercise price
per share
 
1994 Plan
shares
 
Weighted average
exercise price
per share
Options Outstanding, December 31, 2017
 
149,973

 
$
126.77

 
7,778

 
$
48.60

Exercised
 
(3,000
)
 
130.23

 
(2,263
)
 
48.60

Granted (1)
 
6,995

 
161.10

 

 

Forfeited
 

 

 

 

Options Outstanding, September 30, 2018
 
153,968

 
$
128.26

 
5,515

 
$
48.60

Options Exercisable, September 30, 2018
 
146,973

 
$
126.70

 
5,515

 
$
48.60

__________________________________

(1)
Options granted during the nine months ended September 30, 2018 are a result of recipient elections to receive a portion of earned performance awards and time-vesting restricted stock in the form of stock options.

Information with respect to performance awards granted is as follows:
 
 
Performance awards
 
Weighted average grant date fair value per award
Outstanding at December 31, 2017
 
251,770

 
$