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Section 1: 10-Q


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2010

or

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ______ to ______

Commission File Number: 1-12762

MID-AMERICA APARTMENT COMMUNITIES, INC.
(Exact name of registrant as specified in its charter)

TENNESSEE
62-1543819
(State or other jurisdiction of
(I.R.S. Employer Identification No.)
incorporation or organization)
 

6584 POPLAR AVENUE, SUITE 300
 
MEMPHIS, TENNESSEE
38138
(Address of principal executive offices)
(Zip Code)

 (901) 682-6600
(Registrant's telephone number, including area code)

N/A
 
   (Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
þYes  ¨ No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
¨ Yes  ¨ No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See definitions of “accelerated filer,” “large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act

Large accelerated filer þ
Accelerated filer  ¨
Non-accelerated filer ¨ (Do not check if a smaller reporting company)
Smaller Reporting Company  ¨

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

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:

   
Number of Shares Outstanding
Class
 
at April 20, 2010
Common Stock, $0.01 par value
 
30,107,239

 
 

 

MID-AMERICA APARTMENT COMMUNITIES, INC.

TABLE OF CONTENTS

     
Page
 
PART I – FINANCIAL INFORMATION
   
Item 1.
Financial Statements.
   
 
Condensed Consolidated Balance Sheets as of March 31, 2010 (Unaudited) and December 31, 2009
 
2
 
Condensed Consolidated Statements of Operations for the three months ended March 31, 2010 (Unaudited) and 2009 (Unaudited).
 
3
 
Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2010 (Unaudited) and 2009 (Unaudited).
 
4
 
Notes to Condensed Consolidated Financial Statements (Unaudited).
 
5
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations.
 
14
Item 3.
Quantitative and Qualitative Disclosures About Market Risk.
 
26
Item 4.
Controls and Procedures.
 
26
Item 4T.
Controls and Procedures.
 
26
       
 
PART II – OTHER INFORMATION
   
Item 1.
Legal Proceedings.
 
27
Item 1A.
Risk Factors.
 
27
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds.
 
35
Item 3.
Defaults Upon Senior Securities.
 
35
Item 4.
(Removed and Reserved).
 
35
Item 5.
Other Information.
 
35
Item 6.
Exhibits.
 
36
 
Signatures
 
37

 
1

 

MID-AMERICA APARTMENT COMMUNITIES, INC.
Condensed Consolidated  Balance  Sheets
March 31, 2010 (Unaudited) and December 31, 2009
(Dollars in thousands, except per share data)

   
March 31, 2010
   
December 31, 2009
 
Assets:
           
Real estate assets:
           
Land
  $ 251,051     $ 255,425  
Buildings and improvements
    2,337,178       2,364,918  
Furniture, fixtures and equipment
    75,851       73,975  
Capital improvements in progress
    8,152       10,517  
      2,672,232       2,704,835  
Less accumulated depreciation
    (812,614 )     (788,260 )
      1,859,618       1,916,575  
                 
Land held for future development
    1,306       1,306  
Commercial properties, net
    8,200       8,721  
Investments in real estate joint ventures
    14,077       8,619  
Real estate assets, net
    1,883,201       1,935,221  
                 
Cash and cash equivalents
    32,329       13,819  
Restricted cash
    844       561  
Deferred financing costs, net
    13,869       13,369  
Other assets
    21,642       19,731  
Goodwill
    4,106       4,106  
Assets held for sale
    -       19  
Total assets
  $ 1,955,991     $ 1,986,826  
                 
Liabilities and Shareholders' Equity:
               
Liabilities:
               
Notes payable
  $ 1,358,733     $ 1,399,596  
Accounts payable
    1,158       1,702  
Fair market value of interest rate swaps
    52,691       51,160  
Accrued expenses and other liabilities
    65,355       69,528  
Security deposits
    8,842       8,789  
Liabilities associated with assets held for sale
    -       23  
Total liabilities
    1,486,779       1,530,798  
                 
Redeemable stock
    2,805       2,802  
                 
Shareholders' equity:
               
Preferred stock, $0.01 par value per share, 20,000,000 shares authorized, $155,000 or $25 per share liquidation preference; 8.30% Series H Cumulative Redeemable Preferred Stock, 6,200,000 shares authorized, 6,200,000 shares issued and outstanding
    62       62  
Common stock, $0.01 par value per share, 50,000,000 shares authorized; 29,684,303 and 29,095,251 shares issued and outstanding at March 31, 2010 and December 31, 2009, respectively (1)
    296       290  
Additional paid-in capital
    1,017,163       988,642  
Accumulated distributions in excess of net income
    (523,298 )     (510,993 )
Accumulated other comprehensive income
    (50,713 )     (47,435 )
Total Mid-America Apartment Communities, Inc. shareholders' equity
    443,510       430,566  
Noncontrolling interest
    22,897       22,660  
Total Equity
    466,407       453,226  
Total liabilities and equity
  $ 1,955,991     $ 1,986,826  

(1)
Number of shares issued and outstanding represent total shares of common stock regardless of classification on the consolidated balance sheet. The number of shares classified as redeemable stock on the consolidated balance sheet for March 31, 2010 and December 31, 2009 are 54,167 and 58,038, respectively.

See accompanying notes to consolidated financial statements.

 
2

 

MID-AMERICA APARTMENT COMMUNITIES, INC.
Condensed Consolidated Statements of Operations
Three months ended March 31, 2010 and 2009
(Dollars in thousands, except per share data)

   
Three months ended
 
   
March 31,
 
   
2010
   
2009
 
Operating revenues:
           
Rental revenues
  $ 90,308     $ 89,198  
Other property revenues
    7,020       4,402  
Total property revenues
    97,328       93,600  
Management fee income
    136       64  
Total operating revenues
    97,464       93,664  
Property operating expenses:
               
Personnel
    12,358       11,364  
Building repairs and maintenance
    3,327       2,812  
Real estate taxes and insurance
    11,898       11,984  
Utilities
    5,599       5,508  
Landscaping
    2,515       2,304  
Other operating
    5,854       4,323  
Depreciation
    25,080       23,585  
Total property operating expenses
    66,631       61,880  
Acquisition expenses
    (24 )     2  
Property management expenses
    4,277       4,241  
General and administrative expenses
    2,811       2,457  
Income from continuing operations before non-operating items
    23,769       25,084  
Interest and other non-property income
    315       80  
Interest expense
    (13,891 )     (14,229 )
Gain on debt extinguishment
    -       3  
Amortization of deferred financing costs
    (595 )     (606 )
Net casualty gain (loss) and other settlement proceeds
    527       (144 )
Income from continuing operations before loss from real estate joint ventures
    10,125       10,188  
Loss from real estate joint ventures
    (276 )     (196 )
Income from continuing operations
    9,849       9,992  
Discontinued operations:
               
Income from discontinued operations before gain on sale
    -       421  
Gain on sale of discontinued operations
    -       1,432  
Consolidated net income
    9,849       11,845  
Net income attributable to noncontrolling interests
    437       706  
Net income attributable to Mid-America Apartment Communities, Inc.
    9,412       11,139  
Preferred dividend distributions
    3,216       3,216  
Net income available for common shareholders
  $ 6,196     $ 7,923  
                 
Weighted average shares outstanding (in thousands):
               
Basic
    29,130       28,085  
Effect of dilutive securities
    74       80  
Diluted
    29,204       28,165  
                 
Net income available for common shareholders
  $ 6,196     $ 7,923  
Discontinued property operations
    -       (1,853 )
Income from continuing operations available for common shareholders
  $ 6,196     $ 6,070  
                 
Earnings per share - basic:
               
Income from continuing operations available for common shareholders
  $ 0.21     $ 0.21  
Discontinued property operations
    -       0.07  
Net income available for common shareholders
  $ 0.21     $ 0.28  
                 
Earnings per share - diluted:
               
Income from continuing operations available for common shareholders
  $ 0.21     $ 0.21  
Discontinued property operations
    -       0.07  
Net income available for common shareholders
  $ 0.21     $ 0.28  
                 
Dividends declared per common share
  $ 0.615     $ 0.615  

See accompanying notes to consolidated financial statements.

 
3

 

Mid-America Apartment Communities, Inc.
Condensed Consolidated Statements of Cash Flows
Three Months Ended March 31, 2010 and 2009
(Dollars in thousands)

   
2010
   
2009
 
Cash flows from operating activities:
           
Consolidated net income
  $ 9,849     $ 11,845  
Adjustments to reconcile net income to net cash provided by operating activities:
               
                 
Depreciation and amortization of deferred financing costs
    25,675       24,191  
Stock compensation expense
    348       303  
Redeemable stock issued
    92       84  
Amortization of debt premium
    (90 )     (90 )
Loss from investments in real estate joint ventures
    276       196  
Gain on debt extinguishment
    -       (3 )
Derivative interest expense (income)
    140       (396 )
Gain on sale of discontinued operations
    -       (1,432 )
Net casualty (gains) loss and other settlement proceeds
    (527 )     144  
Changes in assets and liabilities:
               
Restricted cash
    (283 )     (288 )
Other assets
    (734 )     3,372  
Accounts payable
    (559 )     223  
Accrued expenses and other
    (9,108 )     (6,395 )
Security deposits
    54       233  
Net cash provided by operating activities
    25,133       31,987  
Cash flows from investing activities:
               
Purchases of real estate and other assets
    (100 )     (163 )
Improvements to existing real estate assets
    (8,425 )     (8,426 )
Renovations to existing real estate assets
    (1,247 )     (2,332 )
Development
    -       (3,256 )
Distributions from real estate joint ventures
    159       44  
Contributions to real estate joint ventures
    (5,894 )     (115 )
Proceeds from disposition of real estate assets
    47,007       11,337  
Net cash provided by (used in) investing activities
    31,500       (2,911 )
Cash flows from financing activities:
               
Net change in credit lines
    (60,000 )     31,815  
Proceeds from notes payable
    19,500       -  
Principal payments on notes payable
    (273 )     (535 )
Payment of deferred financing costs
    (4,381 )     (136 )
Repurchase of common stock
    (506 )     (220 )
Proceeds from issuances of common shares and units
    30,106       284  
Distributions to noncontrolling interests
    (1,467 )     (1,561 )
Dividends paid on common shares
    (17,886 )     (17,267 )
Dividends paid on preferred shares
    (3,216 )     (3,216 )
Net cash (used in) provided by financing activities
    (38,123 )     9,164  
Net increase in cash and cash equivalents
    18,510       38,240  
Cash and cash equivalents, beginning of period
    13,819       9,426  
Cash and cash equivalents, end of period
  $ 32,329     $ 47,666  
                 
Supplemental disclosure of cash flow information:
               
Interest paid
  $ 14,186     $ 12,682  
Supplemental disclosure of noncash investing and financing activities:
               
Accrued construction in progress
  $ 5,451     $ 5,987  
Interest capitalized
  $ -     $ 62  
Marked-to-market adjustment on derivative instruments
  $ (3,570 )   $ 5,852  
Reclass of redeemable stock from equity and redeemable stock to liabilities
  $ 273     $ -  

See accompanying notes to consolidated financial statements.

 
4

 

Mid-America Apartment Communities, Inc.
Notes to Condensed Consolidated Financial Statements
March 31, 2010 (Unaudited) and 2009 (Unaudited)

1.           Consolidation and Basis of Presentation

Mid-America Apartment Communities, Inc., or Mid-America, is a self-administered real estate investment trust, or REIT, that owns, acquires, renovates, develops and manages apartment communities in the Sunbelt region of the United States. As of March 31, 2010, we owned or owned interests in a total of 147 multifamily apartment communities comprising 43,605 apartments located in 13 states, including two communities comprising 626 apartments owned through our joint venture, Mid-America Multifamily Fund I, LLC, and two communities comprising 773 apartments owned through our joint venture, Mid-America Multifamily Fund II, LLC.

The accompanying unaudited condensed consolidated financial statements have been prepared by our management in accordance with U.S. generally accepted accounting principles for interim financial information and applicable rules and regulations of the Securities and Exchange Commission and our accounting policies in effect as of December 31, 2009 as set forth in our annual consolidated financial statements, as of such date. The accompanying unaudited condensed consolidated financial statements include the accounts of Mid-America Apartment Communities, Inc. and its subsidiaries, including Mid-America Apartments, L.P.  In our opinion, all adjustments necessary for a fair presentation of the condensed consolidated financial statements have been included and all such adjustments were of a normal recurring nature. All significant intercompany accounts and transactions have been eliminated in consolidation. The results of operations for the three month period ended March 31, 2010 are not necessarily indicative of the results to be expected for the full year. These financial statements should be read in conjunction with our audited financial statements and notes thereto included in our Annual Report on Form 10-K filed on February 25, 2010.

The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent liabilities at the dates of the financial statements and the amounts of revenues and expenses during the reporting periods.  Actual amounts realized or paid could differ from those estimates.

2.           Segment Information

As of March 31, 2010, we owned or had an ownership interest in 147 multifamily apartment communities in 13 different states from which we derived all significant sources of earnings and operating cash flows. Our operational structure is organized on a decentralized basis with individual property managers having overall responsibility and authority regarding the operations of their respective properties. Each property manager individually monitors local, market and submarket trends in rental rates, occupancy percentages and operating costs. Property managers are given the on-site responsibility and discretion to react to such trends in our best interest. Our property management group evaluates the performance of each individual property based on its contribution to net operating income in order to ensure that the individual property continues to meet our return criteria and long-term investment goals. We define each of our multifamily communities as an individual operating segment. Each segment on a stand alone basis is less than 10% of the revenues, profit or loss, and assets of the combined reporting operating segments and meets all of the aggregation criteria under FASB ASC 280, Fair Value Measurements and Disclosures, or ASC 280. The operating segments are aggregated into same store and non-same store communities.

We evaluate our same store portfolio on the first day of each calendar year. Generally, the same store portfolio consists of those properties which we have owned and have been stabilized for at least a full 12 months and have not been classified as held for sale. This allows us to evaluate full period over period operating comparisons. The non-same store portfolio consists of all other communities, which may from time-to time include recent acquisitions, communities in development or lease-up, or communities that have been classified as held for sale.

We utilize net operating income, or NOI, in evaluating the performance of our same store portfolio. Total NOI represents total property revenues less total property operating expenses, excluding depreciation, for all properties held during the period regardless of their status as held for sale. We believe NOI is a helpful tool in evaluating the operating performance of our segments because it measures the core operations of property performance by excluding corporate level expenses and other items not related to property operating performance.

 
5

 

Revenues, NOI, and assets for each reportable segment for the three month periods ended March 31, 2010 and 2009, were as follows (dollars in thousands):

   
Three months ended
 
   
March 31,
 
   
2010
   
2009
 
Revenues
           
Same Store
  $ 87,368     $ 87,511  
Non-Same Store
    9,960       6,089  
Total property revenues
    97,328       93,600  
Management fee income
    136       64  
Total operating revenues
  $ 97,464     $ 93,664  
                 
NOI
               
Same Store
  $ 50,016     $ 51,804  
Non-Same Store
    5,761       3,947  
Total NOI
    55,777       55,751  
Discontinued operations NOI included above
    -       (446 )
Management fee income
    136       64  
Depreciation
    (25,080 )     (23,585 )
Acquisition expense
    24       (2 )
Property management expense
    (4,277 )     (4,241 )
General and administrative expense
    (2,811 )     (2,457 )
Interest and other non-property income
    315       80  
Interest expense
    (13,891 )     (14,229 )
Gain on debt extinguishment
    -       3  
Amortization of deferred financing costs
    (595 )     (606 )
Net casualty gains (loss) and other settlement proceeds
    527       (144 )
Loss from real estate joint ventures
    (276 )     (196 )
Discontinued operations
    -       1,853  
Nest income attributable to noncontrolling interests
    (437 )     (706 )
Net income attributable to Mid-America Apartment Communities, Inc.
  $ 9,412     $ 11,139  
                 
Assets
               
Same Store
  $ 1,593,034     $ 1,635,136  
Non-Same Store
    293,149       231,657  
Corporate assets
    69,808       73,022  
Total assets
  $ 1,955,991     $ 1,939,815  

 
6

 

3.           Comprehensive Income and Equity

Total comprehensive income, equity and their components for the three month periods ended March 31, 2010, and 2009, were as follows (dollars in thousands, except per share and per unit data):

               
Mid-America Apartment Communities, Inc. Shareholders
       
                                 
Accumulated
   
Accumulated
       
                           
Additional
   
Distributions
   
Other
       
         
Comprehensive
   
Preferred
   
Common
   
Paid-In
   
in Excess of
   
Comprehensive
   
Noncontrolling
 
   
Total
   
Income
   
Stock
   
Stock
   
Capital
   
Net Income
   
Income (Loss)
   
Interest
 
EQUITY AT DECEMBER 31, 2009
  $ 453,226           $ 62     $ 290     $ 988,642     $ (510,993 )   $ (47,435 )   $ 22,660  
Equity Activity Excluding Comprehensive Income:
                                                             
Issuance and registration of common shares
    30,094                     6       30,088                          
Shares repurchased and retired
    (506 )                           (506 )                        
Exercise of stock options
    12                             12                          
Shares issued in exchange for units
    -                             35                       (35 )
Redeemable stock fair market value
    (180 )                                   (180 )                
Adjustment for Noncontrolling Interest Ownership in operating partnership
    -                             (1,452 )                     1,452  
Amortization of unearned compensation
    344                             344                          
Dividends on common stock ($0.615 per share)
    (18,321 )                                   (18,321 )                
Dividends on noncontrolling interest units ($0.615 per unit)
    (1,465 )                                                   (1,465 )
Dividends on preferred stock
    (3,216 )                                   (3,216 )                
Comprehensive income:
                                                             
Net income
    9,849       9,849                               9,412               437  
Other comprehensive income - derivative instruments (cash flow hedges)
    (3,430 )     (3,430 )                                     (3,278 )     (152 )
Comprehensive income
    6,419       6,419                                                  
EQUITY BALANCE MARCH 31, 2010
  $ 466,407             $ 62     $ 296     $ 1,017,163     $ (523,298 )   $ (50,713 )   $ 22,897  

               
Mid-America Apartment Communities, Inc. Shareholders
       
                                 
Accumulated
   
Accumulated
       
                           
Additional
   
Distributions
   
Other
       
         
Comprehensive
   
Preferred
   
Common
   
Paid-In
   
in Excess of
   
Comprehensive
   
Noncontrolling
 
   
Total
   
Income
   
Stock
   
Stock
   
Capital
   
Net Income
   
Income (Loss)
   
Interest
 
EQUITY AT DECEMBER 31, 2008
  $ 442,617             $ 62     $ 282     $ 954,127     $ (464,617 )   $ (72,885 )   $ 25,648  
Equity Activity Excluding Comprehensive Income:
                                                               
Issuance and registration of common shares
    278                               278                          
Shares repurchased and retired
    (220 )                             (220 )                        
Exercise of stock options
    10                               10                          
Shares issued in exchange for units
    -                               -                       -  
Redeemable stock fair market value
    301                                       301                  
Adjustment for Noncontrolling Interest Ownership in operating partnership
    -                               298                       (298 )
Amortization of unearned compensation
    314                               314                          
Dividends on common stock ($0.615 per share)
    (17,268 )                                     (17,268 )             -  
Dividends on noncontrolling interest units ($0.615 per unit)
    (1,561 )                                                     (1,561 )
Dividends on preferred stock
    (3,216 )                                     (3,216 )                
Comprehensive income:
                                                               
Net income
    11,845       11,845                               11,139               706  
Other comprehensive income - derivative instruments (cash flow hedges)
    5,456       5,456                                       5,131       325  
Comprehensive income
    17,301       17,301                                                  
EQUITY BALANCE MARCH 31, 2009
  $ 438,556             $ 62     $ 282     $ 954,807     $ (473,661 )   $ (67,754 )   $ 24,820  

The marked-to-market adjustment on derivative instruments is based upon the change of interest rates available for derivative instruments with similar terms and remaining maturities existing at each balance sheet date.

4.           Real Estate Dispositions

On December 30, 2009, we purchased the Legacy at Western Oaks apartments, a 479-unit community located in Austin, Texas. On January 28, 2010, Mid-America Apartments, LP sold Legacy at Western Oaks to Mid-America Multifamily Fund II, LLC, one of our joint ventures. For tax purposes, this transaction was considered a contribution.

 
7

 

5.           Real Estate Acquisitions

On August 27, 2008, we purchased 215 units of the 234-unit Village Oaks apartments located in Temple Terrace, Florida, a suburb of Tampa. The remaining 19 units had previously been sold as condominiums and it is our intent to acquire these units if and when they become available, and operate them as apartment rentals with the rest of the community. During the remainder of 2008 and during 2009, we acquired 11 of the remaining 19 units and on February 18, 2010, we acquired one additional unit.

6.           Discontinued Operations

As part of our portfolio strategy to selectively dispose of mature assets that no longer meet our investment criteria and long-term strategic objectives, in July 2008, we entered into marketing contracts to list the 440-unit River Trace apartments in Memphis, Tennessee, the 96-unit Riverhills apartments in Grenada, Mississippi, and the 304-unit Woodstream apartments in Greensboro, North Carolina. All of these apartments were subsequently sold during 2009. In accordance with accounting standards governing the disposal of long lived assets, all of these communities are considered discontinued operations in the accompanying condensed consolidated financial statements.

The following is a summary of discontinued operations for the three month periods ended March 31, 2010 and 2009, (dollars in thousands):

   
Three Months Ended
 
   
March 31,
 
   
2010
   
2009
 
Revenues
           
Rental revenues
  $ -     $ 969  
Other revenues
    -       37  
Total revenues
    -       1,006  
Expenses
               
Property operating expenses
    -       560  
Depreciation
    -       -  
Interest expense
    -       25  
Total expense
    -       585  
Income from discontinued operations before gain on sale
    -       421  
Gain (loss) on sale of discontinued operations
    -       1,432  
Income from discontinued operations
  $ -     $ 1,853  

7.           Share and Unit Information

On March 31, 2010, 29,684,303 common shares and 2,302,504 operating partnership units were outstanding, representing a total of 31,986,807 shares and units. Additionally, we had outstanding options for the purchase of 22,382 shares of common stock at March 31, 2010, of which 11,369 were anti-dilutive. At March 31, 2009, 28,221,253 common shares and 2,403,515 operating partnership units were outstanding, representing a total of 30,624,768 shares and units. Additionally, Mid-America had outstanding options for the purchase of 24,882 shares of common stock at March 31, 2009, of which 21,860 were anti-dilutive.

During the three months ended March 31, 2010, we issued a total of 571,000 shares of common stock through at-the-market offerings or negotiated transactions for net proceeds of $29.9 million under a controlled equity offering program.

 
8

 

8.           Derivatives and Hedging Activities

Risk Management Objective of Using Derivatives

We are exposed to certain risk arising from both our business operations and economic conditions.  We principally manage our exposures to a wide variety of business and operational risks through management of our core business activities. We manage economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources, and duration of our debt funding and the use of derivative financial instruments.  Specifically, we enter into derivative financial instruments to manage exposures that arise from business activities that result in the payment of future contractual and forecasted cash amounts, the value of which are determined by changing interest rates.  Our derivative financial instruments are used to manage differences in the amount, timing, and duration of our known or expected cash payments principally related to our borrowings.

Cash Flow Hedges of Interest Rate Risk

Our objectives in using interest rate derivatives are to add stability to interest expense and to manage our exposure to interest rate movements. To accomplish this objective, we use interest rate swaps and interest rate caps as part of our interest rate risk management strategy.  Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for us making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.  Interest rate caps designated as cash flow hedges involve the receipt of variable amounts from a counterparty if interest rates rise above the strike rate on the contract in exchange for an up front premium.

The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in accumulated other comprehensive income and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. During the three months ended March 31, 2010, such derivatives were used to hedge the variable cash flows associated with existing variable-rate debt.  The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings. During the three months ended March 31, 2010 and 2009, we recorded ineffectiveness of $105,000 as an increase to interest expense, and $435,000 as a decrease to interest expense, respectively, attributable to a mismatch in the underlying indices of the derivatives and the hedged interest payments made on our variable-rate debt.

We also have nine interest rate caps, totaling a notional amount of $56.3 million, where only the changes in intrinsic value are recorded in accumulated other comprehensive income.  Changes in fair value of these interest rate caps due to changes in time value (e.g. volatility, passage of time, etc.) are excluded from effectiveness testing and are recognized directly in earnings.  During the three months ended March 31, 2010 and 2009, we recorded a loss of $31,000 and a gain of $8,000, respectively, due to changes in the time value of these interest rate caps.

Amounts reported in accumulated other comprehensive income related to derivatives designated in qualifying cash flow hedges will be reclassified to interest expense as interest payments are made on our variable-rate debt. During the next twelve months, we estimate that an additional $30.8 million will be reclassified to earnings as an increase to interest expense, which represents the difference between our fixed interest rate swap payments and the projected variable interest rate swap payments.

As of March 31, 2010 we had the following outstanding interest rate derivatives that were designated as cash flow hedges of interest rate risk:

Interest Rate Derivatives
 
Number of Instruments
   
Notional
 
Interest Rate Cap
   
19
    $ 222,286,000  
Interest Rate Swap
   
33
    $ 843,165,000  

Non-designated Hedges

We do not use derivatives for trading or speculative purposes and currently do not have any derivatives that are not designated as qualifying accounting hedges under ASC 815.

 
9

 

Tabular Disclosure of Fair Values of Derivative Instruments on the Balance Sheet

The table below presents the fair value of our derivative financial instruments as well as their classification on the Condensed Consolidated Balance Sheet as of March 31, 2010 and December 31, 2009, respectively:
 
Fair Values of Derivative Instruments on the Condensed Consolidated Balance Sheet as of
March 31, 2010 and December 31, 2009 (dollars in thousands)
 
   
Asset Derivatives
 
Liability Derivatives
 
       
31-Mar-10
   
31-Dec-09
     
31-Mar-10
   
31-Dec-09
 
   
Balance
           
Balance
           
Derivatives designated as
 
Sheet
           
Sheet
           
hedging instruments
 
Location
 
Fair Value
   
Fair Value
 
Location
 
Fair Value
   
Fair Value
 
                 
Fair market
           
                 
value of
           
                 
interest rate
           
Interest rate contracts
 
 Other assets
  $ 4,676     $ 3,430  
swaps
  $ 52,691     $ 51,160  
                                       
Total derivatives designated as hedging instruments
      $ 4,676     $ 3,430       $ 52,691     $ 51,160  
 
Tabular Disclosure of the Effect of Derivative Instruments on the Income Statement

The tables below present the effect of our derivative financial instruments on the Condensed Consolidated Statement of Operations for the three months ended March 31, 2010 and 2009, respectively.

Effect of Derivative Instruments on the Condensed Consolidated Statement of Operations for the
Three Months Ended March 31, 2010 and 2009 (dollars in thousands)

                           
Location of Gain or
           
                           
(Loss) Recognized in
           
             
Location of Gain
           
Income on Derivative
 
Amount of Gain or
 
             
or (Loss)
 
Amount of Gain or
 
(Ineffective Portion
 
(Loss) Recognized in
 
   
Amount of Gain or
 
Reclassified from
 
(Loss) Reclassified
 
and Amount
 
Income on Derivative
 
   
(Loss) Recognized in
 
Accumulated OCI
 
from Accumulated OCI
 
Excluded from
 
(Ineffective Portion and
 
Derivative in Cash Flow
 
OCI on Derivative
   
into Income
 
into Income (Effective
   
Effectiveness
 
amount Excluded from
 
Hedging Relationships
 
(Effective Portion)
 
(Effective Portion)
 
Portion)
 
Testing)
 
Effectiveness Testing)
 
   
3/31/2010
   
3/31/2009
     
3/31/2010
   
3/31/2009
     
3/31/2010
   
3/31/2009
 
                                         
Interest rate contracts
  $ (12,833 )   $ (871 )
Interest expense
  $ (9,402 )   $ (6,327 )
Interest expense
  $ (136 )   $ 443  
                                                     
Total derivatives in cash flow hedging relationships
  $ (12,833 )   $ (871 )     $ (9,402 )   $ (6,327 )     $ (136 )   $ 443  

Credit-risk-related Contingent Features

As of March 31, 2010, derivatives that were in a net liability position and subject to credit-risk-related contingent features had a termination value of $56.8 million, which includes accrued interest but excludes any adjustment for nonperformance risk. These derivatives had a fair value, gross of asset positions, of $52.7 million at March 31, 2010.

Certain of our derivative contracts contain a provision where if we default on any of our indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then we could also be declared in default on our derivative obligations. As of March 31, 2010, we had not breached the provisions of these agreements.  If we had breached these provisions, we could have been required to settle our obligations under the agreements at their termination value of $17.7 million.

 
10

 

Certain of our derivative contracts are credit enhanced by either Federal National Mortgage Association, or FNMA, and the Federal Home Loan Mortgage Corporation, or Freddie Mac.  These derivative contracts require that our credit enhancing party maintain credit ratings above a certain level.  If our credit support providers were downgraded below Baa1 by Moody’s or BBB+ by Standard & Poor’s, or S&P, we may be required to either post 100 percent collateral or settle the obligations at their termination value of $56.8 million as of March 31, 2010.  Both FNMA and Freddie Mac are currently rated Aaa by Moody’s and AAA by S&P, and therefore, the provisions of this agreement have not been breached and no collateral has been posted related to these agreements as of March 31, 2010.

Although our derivative contracts are subject to master netting arrangements which serve as credit mitigants to both us and our counterparties under certain situations, we do not net our derivative fair values or any existing rights or obligations to cash collateral on the consolidated balance sheet.

See also discussions in Item 1. Financial Statements – Notes to Consolidated Financial Statements, Note 9.

9.           Fair Value Disclosure of Financial Instruments

Cash and cash equivalents, restricted cash, accounts payable, accrued expenses and other liabilities and security deposits are carried at amounts which reasonably approximate their fair value due to their short term nature.

Fixed rate notes payable at March 31, 2010 and December 31, 2009, total $100 million and $81 million, respectively, and have estimated fair values of $84 million and $74 million (excluding prepayment penalties), respectively, based upon interest rates available for the issuance of debt with similar terms and remaining maturities as of March 31, 2010 and December 31, 2009. The carrying value of variable rate notes payable (excluding the effect of interest rate swap and cap agreements) at March 31, 2010 and December 31, 2009, total $1,258 million and $1,318 million, respectively, and have estimated fair values of $1,150 million and $1,193 million (excluding prepayment penalties), respectively, based upon interest rates available for the issuance of debt with similar terms and remaining maturities as of March 31, 2010 and December 31, 2009.
 
On January 1, 2008, we adopted FASB ASC 820 Fair Value Measurements and Disclosures, or ASC 820.  ASC 820 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements.  ASC 820 applies to reported balances that are required or permitted to be measured at fair value under existing accounting pronouncements; accordingly, the standard does not require any new fair value measurements of reported balances.
 
ASC 820 emphasizes that fair value is a market-based measurement, not an entity-specific measurement.  Therefore, a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability.  As a basis for considering market participant assumptions in fair value measurements, ASC 820 establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy).
 
Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that we have the ability to access. Level 2 inputs are inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs may include quoted prices for similar assets and liabilities in active markets, as well as inputs that are observable for the asset or liability (other than quoted prices), such as interest rates, foreign exchange rates, and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability, which are typically based on an entity’s own assumptions, as there is little, if any, related market activity. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

 
11

 
 
Derivative financial instruments
 
Currently, we use interest rate swaps and interest rate caps (options) to manage its interest rate risk.   The valuation of these instruments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatilities.  The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts).  The variable cash payments (or receipts) are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. 

The fair values of interest rate options are determined using the market standard methodology of discounting the future expected cash receipts that would occur if variable interest rates rise above the strike rate of the caps.  The variable interest rates used in the calculation of projected receipts on the cap are based on an expectation of future interest rates derived from observable market interest rate curves and volatilities.

To comply with the provisions of ASC 820, we incorporate credit valuation adjustments to appropriately reflect both our own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements.  In adjusting the fair value of our derivative contracts for the effect of nonperformance risk, we have considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees.

Although we have determined that the majority of the inputs used to value our derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with our derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by ourself and our counterparties.  In prior periods, we classified our derivative valuations within the Level 3 fair value hierarchy because those valuations contain certain Level 3 inputs (e.g. credit spreads).  At the beginning of the three months ended March 31, 2010, we determined that the significance of the impact of the credit valuation adjustments made to our derivative contracts, which determination was based on the fair value of each individual contract, was not significant to the overall valuation.  As a result, all of our derivatives held as of March 31, 2010 were transferred from Level 3 of the fair value hierarchy to Level 2 at the beginning of the three months ended March 31, 2010.

The table below presents a reconciliation of the beginning and ending balances of assets and liabilities having fair value measurements based on significant other observable inputs (Level 2) and significant unobservable inputs (Level 3) for the three months ended March 31, 2010.

Reconciliation of Level 2 and Level 3 Fair Value Measurements for the
Three Months Ended March 31, 2010 (dollars in thousands)

   
Assets
   
Liabilities
 
   
Level 2
   
Level 3
   
Level 2
   
Level 3
 
                         
Beginning fair value as of 12/31/2009
    -       3,430       -       51,160  
                                 
Transfers in
    3,430       -       51,160       -  
                                 
Purchase, issuances and settlements
    3,286       -       -       -  
                                 
Transfers out
    -       (3,430 )     -       (51,160 )
                                 
Total gains/(loss)
    (2,040 )     -       (1,531 )     -  
                                 
Ending fair value
    4,676       -       52,691       -  

 
12

 

The table below presents our assets and liabilities measured at fair value on a recurring basis as of March 31, 2010 and December 31, 2009, aggregated by the level in the fair value hierarchy within which those measurements fall.
 
Assets and Liabilities Measured at Fair Value on a Recurring Basis at March 31, 2010
(dollars in thousands)
 
   
Quoted Prices in
Active Markets
for Identical
Assets and Liabilities
(Level 1)
   
Significant
Other
Observable
Inputs (Level 2)
   
Significant
Unobservable
Inputs (Level 3)
   
Balance at
March 31, 2010
 
Assets
                       
Derivative financial instruments
  $     $ 4,676     $     $ 4,676  
Liabilities
                               
Derivative financial instruments
  $     $ 52,691     $     $ 52,691  
 
Assets and Liabilities Measured at Fair Value on a Recurring Basis at December 31, 2009
(dollars in thousands)
 
   
Quoted Prices in
Active Markets
for Identical
Assets and Liabilities
(Level 1)
   
Significant
Other
Observable
Inputs (Level 2)
   
Significant
Unobservable
Inputs (Level 3)
   
Balance at
December 31,
2009
 
Assets
                       
Derivative financial instruments
  $     $     $ 3,430     $ 3,430  
Liabilities
                               
Derivative financial instruments
  $     $     $ 51,160     $ 51,160  

The fair value estimates presented herein are based on information available to management as of March 31, 2010 and December 31, 2009.  These estimates are not necessarily indicative of the amounts we could ultimately realize.  See also discussions in Item 1. Financial Statements – Notes to Consolidated Financial Statements, Note 8.

10.         Recent Accounting Pronouncements

Impact of Recently Issued Accounting Standards
 
In June 2009, the FASB issued ASC 105-10, Generally Accepted Accounting Principles – Overall, which establishes the FASB Accounting Standards Codification, or the Codification, as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with U.S. generally accepted accounting principles, or GAAP. Rules and interpretive releases of the Securities and Exchange Commission, or SEC, under authority of federal securities laws are also sources of authoritative U.S. GAAP for SEC registrants. All guidance contained in the Codification carries an equal level of authority. The Codification superseded all existing non-SEC accounting and reporting standards.  All other non-grandfathered, non-SEC accounting literature not included in the Codification is non-authoritative. The FASB will not issue new standards in the form of Statements, FASB Staff Positions or Emerging Issues Task Force Abstracts.  Instead, it will issue Accounting Standards Updates, or ASUs. The FASB will not consider ASUs as authoritative in their own right. ASUs will serve only to update the Codification, provide background information about the guidance and provide the bases for conclusions on the change(s) in the Codification. We adopted ASC 105-10 effective July 1, 2009 and all references made to FASB guidance throughout this document have been updated for the Codification.

 
13

 

In April 2008, the FASB issued ASC 825-10-65-1, Interim Disclosures About Fair Market Value of Financial Instruments, or ASC 825-10-65-1, which extends the disclosure requirements concerning the fair value of financial instruments to interim financial statements of publicly traded companies. ASC 825-10-65-1 is effective for interim financial periods ending after June 15, 2009, and the required disclosures are included in Note 8 to the condensed consolidated financial statements.

In June 2008, the FASB issued ASC 810-10-05, Amendments to FASB Interpretation No. 46(R), or ASC 810-10-05, which amends events that would require reconsidering whether an entity is a variable interest entity; it amends the criteria used to determine the primary beneficiary of a variable interest entity; and it expands disclosures about an enterprise’s involvement in variable interest entities.   ASC 810-10-05 is effective for annual reporting periods beginning after November 15, 2009 and earlier application is prohibited. We adopted ASC 810-10-05 effective January 1, 2010. The adoption did not have a material impact on our consolidated financial condition or results of operations taken as a whole.

11.         Subsequent Events

8.30% Series H Cumulative Redeemable Preferred Stock
 
On May 3, 2010, we announced an approximate 50% redemption, subject to rounding of fractional shares, of the 6,200,000 outstanding shares of our 8.30% Series H Cumulative Redeemable Preferred Stock on June 2, 2010. The redemption will be funded by proceeds raised through common share issuances made through our controlled equity program.

Real Estate Acquisitions

On April 30, 2010, we purchased the Broadstone Cypress apartments, a 312-unit community located in Cypress, Texas, a sub-market of Houston, Texas. We plan to contribute this community to Mid-America Multifamily Fund II, LLC, one of our joint ventures.

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 appearing elsewhere in this report.  Historical results and trends which might appear in the condensed consolidated financial statements should not be interpreted as being indicative of future operations.

Forward Looking Statements

We consider this and other sections of this Quarterly Report on Form 10-Q to contain 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, with respect to our expectations for future periods. Forward looking statements do not discuss historical fact, but instead include statements related to expectations, projections, intentions or other items related to the future.  Such forward-looking statements include, without limitation, statements concerning property acquisitions and dispositions, development and renovation activity as well as other capital expenditures, capital raising activities, rent growth, occupancy, and rental expense growth.  Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates,” and variations of such words and similar expressions are intended to identify such forward-looking statements.  Such statements involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements to be materially different from the results of operations or plans expressed or implied by such forward-looking statements.  Such factors include, among other things, unanticipated adverse business developments affecting us, or our properties, adverse changes in the real estate markets and general and local economies and business conditions.  Although we believe that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate, and therefore such forward-looking statements included in this report may not prove to be accurate.  In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by us or any other person that the results or conditions described in such statements or our objectives and plans will be achieved.

 
14

 

The following factors, among others, could cause our future results to differ materially from those expressed in the forward-looking statements:

 
·
inability to generate sufficient cash flows due to market conditions, changes in supply and/or demand, competition, uninsured losses, changes in tax and housing laws, or other factors;
 
·
increasing real estate taxes and insurance costs;
 
·
failure of new acquisitions to achieve anticipated results or be efficiently integrated into us;
 
·
failure of development communities to lease-up as anticipated;
 
·
inability of a joint venture to perform as expected;
 
·
inability to acquire additional or dispose of existing apartment units on favorable economic terms;
 
·
losses from catastrophes in excess of our insurance coverage;
 
·
unexpected capital needs;
 
·
inability to attract and retain qualified personnel;
 
·
potential liability for environmental contamination;
 
·
adverse legislative or regulatory tax changes;
 
·
litigation and compliance costs associated with laws requiring access for disabled persons;
 
·
imposition of federal taxes if we fail to qualify as a REIT under the Internal Revenue Code in any taxable year or foregone opportunities to ensure REIT status;
 
·
inability to acquire funding through the capital markets;
 
·
inability to pay required distributions to maintain REIT status due to required debt payments;
 
·
changes in interest rate levels, including that of variable rate debt, such as extensively used by us;
 
·
loss of hedge accounting treatment for interest rate swaps and caps;
 
·
the continuation of the good credit of our interest rate swap and cap providers;
 
·
the availability of credit, including mortgage financing, and the liquidity of the debt markets, including a material deterioration of the financial condition of the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation;
 
·
inability to meet loan covenants; and
 
·
significant decline in market value of real estate serving as collateral for mortgage obligations.

Critical Accounting Policies and Estimates

The following discussion and analysis of financial condition and results of operations are based upon our condensed consolidated financial statements, and the notes thereto, which have been prepared in accordance with U.S. generally accepted accounting principles, or GAAP. The preparation of these condensed consolidated financial statements requires us to make a number of estimates and assumptions that affect the reported amounts and disclosures in the condensed consolidated financial statements. On an ongoing basis, we evaluate our estimates and assumptions based upon historical experience and various other factors and circumstances. We believe that our estimates and assumptions are reasonable under the circumstances; however, actual results may differ from these estimates and assumptions.

We believe that the estimates and assumptions listed below are most important to the portrayal of our financial condition and results of operations because they require the greatest subjective determinations and form the basis of accounting policies deemed to be most critical. These critical accounting policies include revenue recognition, capitalization of expenditures and depreciation of assets, impairment of long-lived assets, including goodwill, and fair value of derivative financial instruments.

 
15

 

Revenue Recognition

We lease multifamily residential apartments under operating leases primarily with terms of one year or less. Rental revenues are recognized using a method that represents a straight-line basis over the term of the lease and other revenues are recorded when earned.

We record all gains and losses on real estate in accordance with accounting standards governing the sale of real estate.

Capitalization of expenditures and depreciation of assets

We carry real estate assets at depreciated cost.  Depreciation is computed on a straight-line basis over the estimated useful lives of the related assets, which range from 8 to 40 years for land improvements and buildings, 5 years for furniture, fixtures, and equipment, 3 to 5 years for computers and software, and 6 months for acquired leases, all of which are subjective determinations. Repairs and maintenance costs are expensed as incurred while significant improvements, renovations and replacements are capitalized. The cost to complete any deferred repairs and maintenance at properties acquired by us in order to elevate the condition of the property to our standards are capitalized as incurred.

Development costs are capitalized in accordance with accounting standards for costs and initial rental operations of real estate projects and standards for the capitalization of interest cost.

Impairment of long-lived assets, including goodwill

We account for long-lived assets in accordance with the provisions of accounting standards for the impairment or disposal on long-lived assets and evaluate our goodwill for impairment under accounting standards for goodwill and other intangible assets. We evaluate goodwill for impairment on at least an annual basis, or more frequently if a goodwill impairment indicator is identified. We periodically evaluate long-lived assets, including investments in real estate and goodwill, for indicators that would suggest that the carrying amount of the assets may not be recoverable. The judgments regarding the existence of such indicators are based on factors such as operating performance, market conditions and legal factors.

Long-lived assets, such as real estate assets, equipment and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of are separately presented on the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. The assets and liabilities of a disposed group classified as held for sale are presented separately in the appropriate asset and liability sections of the balance sheet.

Goodwill is tested annually for impairment, and is tested for impairment more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss for goodwill is recognized to the extent that the carrying amount exceeds the asset’s fair value. This determination is made at the reporting unit level and consists of two steps. First, we determine the fair value of a reporting unit and compare it to its carrying amount. In the apartment industry, the primary method used for determining fair value is to divide annual operating cash flows by an appropriate capitalization rate. We determine the appropriate capitalization rate by reviewing the prevailing rates in a property’s market or submarket. Second, if the carrying amount of a reporting unit exceeds its fair value, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of that goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation, in accordance accounting standards for business combinations. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill.

Fair value of derivative financial instruments

We utilize certain derivative financial instruments, primarily interest rate swaps and caps, during the normal course of business to manage, or hedge, the interest rate risk associated with our variable rate debt or as hedges in anticipation of future debt transactions to manage well-defined interest rate risk associated with the transaction.

 
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In order for a derivative contract to be designated as a hedging instrument, changes in the hedging instrument must be highly effective at offsetting changes in the hedged item. The historical correlation of the hedging instruments and the underlying hedged items are assessed before entering into the hedging relationship and on a quarterly basis thereafter, and have been found to be highly effective.

We measure ineffectiveness using the change in the variable cash flows method for interest rate swaps and the hypothetical derivative method for interest rate caps for each reporting period through the term of the hedging instruments. Any amounts determined to be ineffective are recorded in earnings.  The change in fair value of the interest rate swaps and the intrinsic value or fair value of caps designated as cash flow hedges are recorded to accumulated other comprehensive income in the statement of shareholders’ equity.

The valuation of our derivative financial instruments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash payments and the discounted expected variable cash receipts.  The variable cash receipts are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves.  The fair values of interest rate caps are determined using the market standard methodology of discounting the future expected cash receipts that would occur if variable interest rates rise above the strike rate of the caps.  The variable interest rates used in the calculation of projected receipts on the cap are based on an expectation of future interest rates derived from observable market interest rate curves and volatilities. Additionally, we incorporate credit valuation adjustments to appropriately reflect both our own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements.  Changes in the fair values of our derivatives are primarily the result of fluctuations in interest rates. See Notes 8 and 9 of the accompanying Condensed Consolidated Financial Statements.

Overview of the Three Months Ended March 31, 2010

As anticipated, weaker demand for apartment housing caused our same store revenues to decrease from the three months ended March 31, 2009 as we continued to absorb the effects of reducing pricing on new leases in the portfolio to maintain occupancy. Core same store expenses increased only slightly in the three months ended March 31, 2010 from the three months ended March 31, 2009, but affecting both same store revenues and expenses was the introduction of a new bulk cable program. The new program requires revenues and expenses to be booked separately on the condensed consolidated financial statements, rather than netted together in revenues as our previous program allowed, resulting in increased revenue and expense comparisons over the prior period.

Generally, the same store portfolio consists of those properties that we have owned and have been stabilized for at least a full 12 months and have not been classified as held for sale. This allows us to evaluate full period over period operating comparisons. Communities not included in the same store portfolio would include recent acquisitions, communities in development or lease-up, communities undergoing extensive renovations or communities which have been classified as held for sale.

We benefited from acquisitions made during 2009 and the completion and leaseup of some development communities.

We also experienced a decrease in interest expense during the three months ended March 31, 2010 compared to the three months ended March 31, 2009, mainly as a result of a decrease in our average borrowing costs.

The following is a discussion of our consolidated financial condition and results of operations for the three month period ended March 31, 2010. This discussion should be read in conjunction with the condensed consolidated financial statements appearing elsewhere in this report. These financial statements include all adjustments, which are, in the opinion of management, necessary to reflect a fair statement of the results for the interim period presented, and all such adjustments are of a normal recurring nature.

 
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Results of Operations

Comparison of the Three Months Ended March 31, 2010 to the Three Months Ended March 31, 2009

Property revenues for the three months ended March 31, 2010 were approximately $97.3 million, an increase of $3.7 million from the three months ended March 31, 2009 due to (i) a $3.1 million increase in property revenues from the four properties acquired during 2009, (ii) a $0.5 million increase in property revenues from our development and lease-up communities, and (iii) a $0.1 million increase in property revenues from all other communities. All other communities consists primarily of our same store portfolio which included a $1.3 million increase due to the introduction of a new bulk cable program. The new program requires revenues and expenses to be booked separately on the condensed consolidated financial statements, rather than netted together in revenues as our previous program allowed.

Property operating expenses include costs for property personnel, property personnel bonuses, building repairs and maintenance, real estate taxes and insurance, utilities, landscaping and other property related costs. Property operating expenses for the three months ended March 31, 2010 were approximately $41.6 million, an increase of approximately $3.3 million from the three months ended March 31, 2009 due primarily to increases in property operating expenses of (i) $1.4 million from the four properties acquired during 2009, (ii) $0.1 million from our development and lease-up communities, and (iii) $1.8 million from all other communities. The increase in property operating expenses from all other communities was generated primarily by our same store portfolio and was driven by a $1.4 million increase due to the introduction of a new bulk cable program. The new program requires revenues and expenses to be booked separately on the condensed consolidated financial statements, rather than netted together in revenues as our previous program allowed.

Depreciation expense for the three months ended March 31, 2010 was approximately $25.1 million, an increase of approximately $1.5 million from the three months ended March 31, 2009 primarily due to the increases in depreciation expense of (i) $0.8 million from the four properties acquired during 2009, and (ii) $0.7 million from all other communities. Increases of depreciation expense from all other communities resulted from asset additions made during the normal course of business.

Property management expenses for the three months ended March 31, 2010 were approximately $4.3 million, a slight increase from the $4.2 million of property management expenses for the three months ended March 31, 2009. General and administrative expenses increased from $2.5 million for the three months ended March 31, 2009 to $2.8 million for the three months ended March 31, 2010, primarily as a result of increased personnel incentives as a result of improved performance and charitable contributions made during the three months ended March 31, 2010 as compared to March 31, 2009.

Interest expense for the three months ended March 31, 2010 was approximately $13.9 million, a decrease of $0.3 million from the three months ended March 31, 2009. The decrease was primarily related to the decrease in our average cost of debt from 4.32% to 4.06%.  The decrease in our average cost of debt was only partially offset by an increase in our average debt outstanding from the three months ended March 31, 2009 to the three months ended March 31, 2010 of approximately $29.3 million.

For the three months ended March 31, 2010, we booked approximately $0.5 million of gains related to settlement proceeds primarily related to the contribution of Legacy at Western Oaks to Mid-America Multifamily Fund II, LLC, one of our joint ventures. For the three months ended March 31, 2009, we booked approximately $1.4 million of gain on sale of discontinued operations primarily related to the sale of the Woodstream apartments.

Primarily as a result of the foregoing, net income attributable to Mid-America Apartment Communities, Inc. decreased by approximately $1.7 million in the three months ended March 31, 2010 from the three months ended March 31, 2009.

 
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Funds From Operations and Net Income

Funds from operations, or FFO, represents net income attributable to Mid-America Apartment Communities, Inc. (computed in accordance with GAAP), excluding extraordinary items, gains or losses on disposition of real estate assets, plus depreciation of real estate, and adjustments for joint ventures to reflect FFO on the same basis. This definition of FFO is in accordance with the National Association of Real Estate Investment Trust’s, or NAREIT, definition.  Disposition of real estate assets includes sales of discontinued operations as well as proceeds received from insurance and other settlements from property damage.

In response to the Securities and Exchange Commission’s Staff Policy Statement relating to Emerging Issues Task Force Topic D-42 concerning the calculation of earnings per share for the redemption of preferred stock, we include the amount charged to retire preferred stock in excess of carrying values in our FFO calculation.

Our policy is to expense the cost of interior painting, vinyl flooring, and blinds as incurred for stabilized properties. During the stabilization period for acquisition properties, these items are capitalized as part of the total repositioning program of newly acquired properties, and thus are not deducted in calculating FFO.

FFO should not be considered as an alternative to net income attributable to Mid-America Apartment Communities, Inc. or any other GAAP measurement of performance, as an indicator of operating performance, or as an alternative to cash flow from operating, investing, and financing activities as a measure of liquidity. We believe that FFO is helpful to investors in understanding our operating performance in that such calculation excludes depreciation expense on real estate assets. We believe that GAAP historical cost depreciation of real estate assets is generally not correlated with changes in the value of those assets, whose value does not diminish predictably over time, as historical cost depreciation implies. Our calculation of FFO may differ from the methodology for calculating FFO utilized by other REITs and, accordingly, may not be comparable to such other REITs.

The following table is a reconciliation of FFO to net income attributable to Mid-America Apartment Communities, Inc. for the three month periods ended March 31, 2010, and 2009 (dollars and shares in thousands):

   
Three months
 
   
ended March 31,
 
   
2010
   
2009
 
Net income attributable to Mid-America Apartment Communities, Inc.
  $ 9,412     $ 11,139  
Depreciation of real estate assets
    24,569       23,120  
Net casualty (gain) loss and other settlement proceeds
    (527 )     144  
Gains on sales of discontinued operations
    -       (1,432 )
Depreciation of real estate assets of real estate joint ventures
    402       264  
Preferred dividend distribution
    (3,216 )     (3,216 )
Net income attributable to noncontrolling interests
    437       706  
Funds from operations
  $ 31,077     $ 30,725  

FFO for the three month period ended March 31, 2010 increased primarily as the result of recently acquired properties and reduced interest expense as discussed above in Results of Operations.

Trends

During the three months ended March 31, 2010, rental demand for apartments, while not yet substantially improved, stabilized somewhat when compared to early 2009.  This was evident primarily through higher occupancy as compared to the same period last year.  However, one of the primary drivers of apartment demand is job formation, and the job losses that have occurred across the nation and our markets have continued to impact apartment demand and pricing.

An important part of our portfolio strategy is to maintain a broad diversity of markets across the Sunbelt region of the United States. The diversity of markets tends to mitigate exposure to economic issues in any one geographic market or area. We have found that a well diversified portfolio, including both large and select secondary markets, has tended to perform well in “up” cycles as well as weather “down” cycles better. At the end of the three months ended March 31, 2010, we were invested in over 48 separate markets, with 59% of our gross assets in large markets and 41% of our gross assets in select secondary markets.

 
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We have continued to see lower resident turnover, significantly impacted by fewer move-outs from buying homes.  A primary reason that our residents leave us is to buy a house.  In the three months ended March 31, 2010, we saw the number of total move-outs due to home buying drop almost 8% compared to the same period of 2009.  According to the Census Bureau, homeownership increased from 65% to 69% of households over the ten years ending 2005. Despite the tightened credit market, in the three months ended March 31, 2010 the home ownership rate was still around 67%.  The increase from historical levels was driven primarily by the availability of new mortgage products, many requiring no down-payment and minimal credit ratings. With a reversion of mortgage underwriting back to more traditional standards, it is possible that a long-term correction will occur, and that home ownership may return to more sustainable levels. This could be quite significant for the apartment business, and we believe, if this occurs, it could benefit us for several years.

We also continue to benefit on the supply side.  Supply declined in 2009 and continues to run well below historical new supply delivery averages. Competition from condominiums reverting back to rental units, or new condominiums being converted to rental, was not a major factor in our markets because most of our markets and submarkets have not been primary areas for condominium development. We have found the same to be true for rental competition from single family homes. We have avoided committing a significant amount of capital to markets where most of the excessive inflation in house prices has occurred. We saw significant rental competition from condominiums and/or single family houses in only a few submarkets.  We expect this relative new supply compression to be an even larger factor over the next several quarters as supply is expected to contract even further.

Our focus during the three months ended March 31, 2010 was on building on the strong occupancy performance we captured in the three months ended December 31, 2009 as we operated in a weakened employment market. By focusing our efforts on reducing turnover, we were largely successful at this, as our same store occupancy at March 31, 2010 was 120 basis points higher than at March 31, 2009 and increased 140 basis points from December 31, 2009.

Overall same store revenues decreased 0.2% for the three months ended March 31, 2010 from the three months ended March 31, 2009. This included an increase of $1.3 million due to a new bulk cable program. Without the impact of this new program, same store revenues decreased 1.7% over this period. We believe that the decline in same store revenue will continue through 2010, primarily due to the impact of lower rents on leases signed in the latter half of 2009. However, revenue growth should resume after the economic growth returns and, most importantly, when sustainable job growth resumes. We also believe reduced availability of financing for new apartment construction will likely limit new apartment supply, and more sustainable credit terms for residential mortgages should work to favor rental demand at existing multi-family properties. At the same time, we expect long-term demographic trends, including the growth of prime age groups for rentals, immigration, and population movement to the southeast and southwest will continue to build apartment rental demand for our markets.

While expected continued weak employment growth is expected to keep new demand subdued, we think that the supply of new apartments is not excessive, and that positive absorption of apartments will return for most of our markets later in 2010. Should the economy fall into a deeper recession, the limited new supply of apartments and the more disciplined mortgage financing for single family home buying should lessen the impact.

We continue to develop improved products, operating systems and procedures that enable us to capture more revenues.  The continued roll-out of ancillary services (such as re-selling cable television), improved collections, and utility reimbursements enable us to capture increased revenue dollars. We also actively work on improving processes and products to reduce expenses, such as new web-sites and internet access for our residents that enable them to transact their business with us more simply and effectively.

During the three months ended March 31, 2010, we continued to have the benefit of lower interest rates resulting from an improved market for Federal National Mortgage Association and Federal Home Loan Mortgage Corporation debt securities.  Much of this was due to government action to improve liquidity in the credit markets, and resulted in a lower cost of debt for us.  Short term interest rates continue to be at historically low levels, and as a result, we are forecasting a continuation of favorable interest rates in the near term with the expectation of rising rates as the economy improves.

 
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Liquidity and Capital Resources

Net cash flow provided by operating activities decreased from $32.0 million for the three months ended March 31, 2009 to $25.1 million for the three months ended March 31, 2010. This change was a result of various items including changes in cash flows associated with the timing of interest payments and capital improvements in progress.

Net cash used in investing activities was approximately $2.9 million during the three months ended March 31, 2009 compared to net cash provided by investing activities of approximately $31.5 million during the three months ended March 31, 2010, mainly related to disposition activity. In the three months ended March 31, 2009, we had cash inflows of $11.3 million, mainly related to the disposition of the Woodstream apartments. This compares to net cash inflows of approximately $41.1 million in the three months ended March 31, 2010, mainly related to the contribution of Legacy at Western Oaks to Mid-America Multifamily Fund II, LLC, one of our joint ventures. We also spent approximately $4.3 million more on development and renovations during the three months ended March 31, 2009 than in the same period of 2010.

Net cash provided by financing activities was approximately $9.2 million for the three months ended March 31, 2009, compared to net cash used in financing activities of approximately $38.1 million during the three months ended March 31, 2010. During the three months ended March 31, 2010, we received proceeds of approximately $29.9 million from the issuance of shares of common stock through our continuous equity offering program, or CEO, which we use for general corporate business, including paying down loans and partially financing acquisitions. We made no issuances through the CEO during the three months ended March 31, 2009. During the three months ended March 31, 2010, we decreased our borrowings under our credit lines by approximately $60 million. During the comparable period in 2009, we increased our borrowings by $31.8 million through our credit facilities primarily to provide the cash to pay off a $38.3 million mortgage that matured April 1, 2009.

The weighted average interest rate at March 31, 2010 for the $1.4