AVALONBAY COMMUNITIES INC - 10-Q Quarterly Report

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

AVALONBAY COMMUNITIES, INC.
(Exact name of registrant as specified in its charter)

2900 Eisenhower Avenue, Suite 300
Alexandria, Virginia 22314
(Address of principal executive offices, including zip code)

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.

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).

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

70,717,008 shares of common stock, par value $0.01 per share, were outstanding
as of November 3, 2003


PART I — FINANCIAL INFORMATION

Item 1.	Condensed Consolidated Financial Statements	Page

	Condensed Consolidated Balance Sheets as of September 30, 2003 (unaudited) and December 31, 2002		1

	Condensed Consolidated Statements of Operations and Other Comprehensive Income (unaudited) for the three and nine months ended September 30, 2003 and 2002		2

	Condensed Consolidated Statements of Cash Flows (unaudited) for the nine months ended September 30, 2003 and 2002		3-4

	Notes to Condensed Consolidated Financial Statements (unaudited)		5-21

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		22-49

Item 3.	Quantitative and Qualitative Disclosures About Market Risk		50

Item 4.	Controls and Procedures		50

PART II — OTHER INFORMATION

Item 1.	Legal Proceedings		50

Item 2.	Changes in Securities and Use of Proceeds		50

Item 3.	Defaults Upon Senior Securities		50

Item 4.	Submission of Matters to a Vote of Security Holders		51

Item 5.	Other Information		51

Item 6.	Exhibits and Reports on Form 8-K		51-52

Signatures			53

AVALONBAY COMMUNITIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)


					9-30-03			12-31-02

					(unaudited)
ASSETS
Real estate:
	Land, including land held for development				$	934,009		$	867,117
	Buildings and improvements					4,015,673			3,771,582
	Furniture, fixtures and equipment					125,423			119,501

						5,075,105			4,758,200
	Less accumulated depreciation					(656,060	)		(544,959	)

	Net operating real estate					4,419,045			4,213,241
	Construction in progress (including land)					283,003			312,378
	Real estate assets held for sale, net					78,863			259,812

			Total real estate, net			4,780,911			4,785,431

Cash and cash equivalents						6,771			12,916
Cash in escrow						20,682			10,228
Resident security deposits						22,524			21,839
Investments in unconsolidated real estate entities						19,967			14,591
Deferred financing costs, net						18,724			20,268
Deferred development costs						26,610			31,461
Participating mortgage notes						21,483			21,483
Prepaid expenses and other assets						48,192			32,618

			Total assets		$	4,965,864		$	4,950,835

LIABILITIES AND STOCKHOLDERS’ EQUITY
Unsecured notes					$	1,835,298		$	1,985,342
Variable rate unsecured credit facility						149,350			28,970
Mortgage notes payable						452,785			417,186
Dividends payable						51,662			51,553
Payables for construction						30,079			29,768
Accrued expenses and other liabilities						91,260			88,539
Accrued interest payable						27,006			42,924
Resident security deposits						32,486			29,775
Liabilities related to real estate assets held for sale						14,027			43,053

				Total liabilities		2,683,953			2,717,110


Minority interest of unitholders in consolidated partnerships						31,016			39,185

Commitments and contingencies

Stockholders’ equity:
		Preferred stock, $0.01 par value; $25 liquidation preference; 50,000,000 shares authorized at both September 30, 2003 and December 31, 2002; 4,000,000 and 7,267,700 shares issued and outstanding at September 30, 2003 and December 31, 2002, respectively.				40			73
		Common stock, $0.01 par value; 140,000,000 shares authorized at both September 30, 2003 and December 31, 2002; 70,695,270 and 68,202,926 shares issued and outstanding at September 30, 2003 and December 31, 2002, respectively.				707			682
		Additional paid-in capital				2,305,865			2,266,130
		Deferred compensation				(6,995	)		(7,855	)
		Dividends in excess of accumulated earnings				(38,817	)		(51,850	)
		Accumulated other comprehensive loss				(9,905	)		(12,640	)

				Total stockholders’ equity		2,250,895			2,194,540

				Total liabilities and stockholders’ equity	$	4,965,864		$	4,950,835

AVALONBAY COMMUNITIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
AND OTHER COMPREHENSIVE INCOME
(Unaudited)
(Dollars in thousands, except per share data)


					For the three months ended						For the nine months ended

					9-30-03			9-30-02			9-30-03			9-30-02

Revenue:
	Rental and other income				$	153,339		$	147,662		$	453,674		$	438,305
	Management, development and other fees					234			249			744			1,866

				Total revenue		153,573			147,911			454,418			440,171


Expenses:
	Operating expenses, excluding property taxes					46,904			42,247			132,926			118,408
	Property taxes					14,443			13,477			42,853			38,489
	Interest expense					33,432			31,386			101,826			86,614
	Depreciation expense					37,996			34,723			112,898			98,618
	General and administrative expense					3,382			2,966			10,636			10,009

				Total expenses		136,157			124,799			401,139			352,138


Equity in income of unconsolidated entities						23,988			(98	)		25,192			769
Interest income						852			909			2,634			3,013
Venture partner interest in profit-sharing						(420	)		(244	)		(1,268	)		(512	)
Minority interest in consolidated partnerships						(302	)		(229	)		(754	)		(696	)

Income from continuing operations						41,534			23,450			79,083			90,607
Discontinued operations:
	Income from discontinued operations					2,278			5,261			10,001			16,169
	Gain on sale of communities					13,575			—			82,158			—

				Total discontinued operations		15,853			5,261			92,159			16,169

Net income						57,387			28,711			171,242			106,776
Dividends attributable to preferred stock						(2,175	)		(4,026	)		(8,569	)		(14,087	)


Net income available to common stockholders					$	55,212		$	24,685		$	162,673		$	92,689

Other comprehensive income (loss):
	Unrealized gain (loss) on cash flow hedges					2,245			(3,738	)		2,735			(5,412	)

Comprehensive income					$	57,457		$	20,947		$	165,408		$	87,277


Dividends declared per common share					$	0.70		$	0.70		$	2.10		$	2.10


Earnings per common share — basic:

		Income from continuing operations (net of dividends attributable to preferred stock)			$	0.57		$	0.28		$	1.04		$	1.11
		Discontinued operations				0.23			0.08			1.36			0.23

			Net income available to common stockholders		$	0.80		$	0.36		$	2.40		$	1.34


Earnings per common share — diluted:

		Income from continuing operations (net of dividends attributable to preferred stock)			$	0.56		$	0.27		$	1.02		$	1.08
		Discontinued operations				0.23			0.08			1.33			0.24

			Net income available to common stockholders		$	0.79		$	0.35		$	2.35		$	1.32

AVALONBAY COMMUNITIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(Dollars in thousands)


				For the nine months ended

				9-30-03			9-30-02

Cash flows from operating activities:
	Net income			$	171,242		$	106,776
	Adjustments to reconcile net income to cash provided by operating activities:
			Depreciation expense		112,898			98,618
			Depreciation expense from discontinued operations		1,559			7,300
			Amortization of deferred financing costs and debt premium/discount		2,908			2,879
			Amortization of deferred compensation		3,033			3,137
			Income allocated to minority interest in consolidated partnerships including discontinued operations		1,143			1,299
			Income allocated to venture partner interest in profit-sharing		1,268			512
			Gain on sale of communities		(82,158	)		—
			Gain on sale of joint venture community		(23,448	)		—
			Increase in cash in operating escrows		(1,519	)		(849	)
			Decrease (increase) in resident security deposits, accrued interest receivable on participating mortgage notes, prepaid expenses and other assets		(13,136	)		8,175
			Decrease in accrued expenses, other liabilities and accrued interest payable		(9,250	)		(7,695	)

			Net cash provided by operating activities		164,540			220,152


Cash flows used in investing activities:
		Development/redevelopment of real estate assets including land acquisitions and deferred development costs			(278,227	)		(326,671	)
		Acquisition of real estate assets			—			(106,300	)
		Capital expenditures — existing real estate assets			(7,422	)		(8,147	)
		Capital expenditures — non-real estate assets			(383	)		(1,066	)
		Proceeds from sale of communities, net of selling costs			252,528			—
		Increase (decrease) in payables for construction			311			(4,797	)
		Decrease (increase) in cash in construction escrows			(8,935	)		39,930
		Decrease in investments in unconsolidated real estate entities			1,343			245

			Net cash used in investing activities		(40,785	)		(406,806	)


Cash flows from financing activities:
		Issuance of common stock			143,461			19,489
		Repurchase of common stock			(39,877	)		—
		Issuance of preferred stock, net of related costs			81,737			14,444
		Redemption of preferred stock and related costs			(163,724	)		(72,041	)
		Dividends paid			(150,754	)		(155,082	)
		Net borrowings under unsecured credit facility			120,380			273,000
		Issuance of mortgage notes payable			38,829			—
		Repayments of mortgage notes payable			(3,230	)		(23,721	)
		Issuance (repayment) of unsecured notes			(150,000	)		50,000
		Payment of deferred financing costs			(1,408	)		(1,317	)
		Redemption of units for cash by minority partners			(295	)		—
		Contributions from (distributions to) minority and profit-sharing partners			(5,019	)		12,177

			Net cash provided by (used in) financing activities		(129,900	)		116,949

			Net decrease in cash and cash equivalents		(6,145	)		(69,705	)

Cash and cash equivalents, beginning of period					12,916			72,990


Cash and cash equivalents, end of period				$	6,771		$	3,285


Cash paid during year for interest, net of amount capitalized				$	111,920		$	97,705

Supplemental disclosures of non-cash investing and financing activities (dollars in thousands):

•

As described in Note 4, “Stockholders’ Equity,” of the Condensed Consolidated Financial Statements, 103,255 shares of common stock were issued in connection with stock grants of which 80% were restricted, 33,047 shares were withheld to satisfy employees’ tax withholding and other liabilities and 12,102 shares were forfeited, for a net value of $10,030.

•

The Company sold one community with a mortgage note payable of $27,305 that was assumed by the buyer as part of the total sales price.

•

183,031 units of limited partnership, valued at $7,266, were presented for redemption to the DownREIT partnerships that issued such units and were acquired by the Company in exchange for an equal number of shares of the Company’s common stock.

•

The Company recorded a reduction to other liabilities and a corresponding gain to other comprehensive income of $2,735 to adjust the Company’s Hedged Derivatives (as defined in Note 5, “Derivative Instruments and Hedging Activities,” of the Condensed Consolidated Financial Statements) to their fair value.

•

The Company issued 102,756 units of limited partnership in DownREIT partnerships valued at $5,000 in connection with the formation of a DownREIT partnership and the acquisition by that partnership of land.

•

141,718 shares of common stock were issued in connection with stock grants of which 80% were restricted, 12,207 shares were withheld to satisfy employees’ tax withholding and other liabilities and 6,570 shares were forfeited, for a net value of $6,000.

•

The Company assumed $33,900 in variable rate, tax-exempt debt related to the acquisition of one community.

•

The Company recorded a liability and a corresponding charge to other comprehensive loss of $5,412 to adjust the Company’s Hedged Derivatives to their fair value.

AVALONBAY COMMUNITIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(Dollars in thousands, except per share data)

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 taxed as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as amended. The Company focuses on the ownership and operation of upscale apartment communities in high barrier-to-entry markets of the United States. These markets are located in the Northeast, Mid-Atlantic, Midwest, Pacific Northwest, and Northern and Southern California regions of the country.

At September 30, 2003, the Company owned or held a direct or indirect ownership interest in 132 operating apartment communities containing 38,808 apartment homes in ten states and the District of Columbia, of which two communities containing 1,089 apartment homes were under reconstruction. In addition, the Company owned or held a direct or indirect ownership interest in ten communities under construction that are expected to contain an aggregate of 3,250 apartment homes when completed. The Company also owned a direct or indirect ownership interest in rights to develop an additional 41 communities that, if developed in the manner expected, will contain an estimated 10,326 apartment homes.

•

The Company sold one community, Amberway, located in Orange County, California. This 272 apartment home community was sold for a sales price of $33,500, resulting in a gain calculated in accordance with generally accepted accounting principles (“GAAP”) of $13,575.

•

The Falkland Chase community, located in Silver Spring, Maryland, was sold by Falkland Partners LLC, in which the Company held a 50% membership interest. This 450 apartment home community was sold for a sales price of $58,500. The Company’s share of the sales price was $29,250, resulting in a gain calculated in accordance with GAAP of $21,816. The Company also recognized an additional gain in accordance with GAAP of $1,632 in conjunction with the liquidation of the limited liability company's assets.

•

The Company completed the development of two communities. Avalon at Rock Spring, a 386 apartment home community located in North Bethesda, Maryland, was completed for a total capital cost of approximately $46,000. Avalon at Gallery Place, a 203 apartment home community located in Washington, DC, was completed for a total capital cost of approximately $49,000. The total capital cost for Avalon at Gallery Place excludes approximately $4,000 of proceeds that the Company expects to receive upon the sale of transferable development rights associated with the development of the community; however, there can be no assurance that the projected amount of proceeds will be achieved.

•

The Company commenced development on two communities, Avalon at Crane Brook, located in the Boston, Massachusetts area, and Avalon Milford I, located in the Fairfield-New Haven, Connecticut area. These communities, when completed, are expected to contain an aggregate of 633 apartment homes for a total capital cost of approximately $88,700.

The interim unaudited financial statements have been prepared in accordance with GAAP for interim financial information and in conjunction with the rules and regulations of the Securities and Exchange Commission. 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 Annual Report on Form 10-K/A for the year ended December 31, 2002. The results of operations for the nine months ended September 30, 2003 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.

The Company accounts for joint venture partnerships and subsidiary partnerships structured as DownREITs in accordance with Statement of Position (“SOP”) 78-9, “Accounting for Investments in Real Estate Ventures.” Under SOP 78-9, the Company consolidates joint venture and DownREIT partnerships when the Company controls the major operating and financial policies of the partnership through majority ownership or in its capacity as general partner. The accompanying Condensed Consolidated Financial Statements include the accounts of the Company and its wholly-owned partnerships and certain joint venture partnerships in addition to subsidiary partnerships structured as DownREITs. All significant intercompany balances and transactions have been eliminated in consolidation.

In each of the partnerships structured as DownREITs, either the Company or one of the Company’s wholly-owned subsidiaries is the general partner, and there are one or more limited partners whose interest in the partnership is represented by units of limited partnership interest. For each DownREIT partnership, limited partners are entitled to receive an initial distribution before any distribution is made to the general partner. Although the partnership agreements for each of the DownREITs are different, generally the distributions per unit paid to the holders of units of limited partnership interests have approximated the Company’s current common stock dividend per share. Each DownREIT partnership has been structured so that it is unlikely the limited partners will be entitled to a distribution greater than the initial distribution provided for in the partnership agreement. The holders of units of limited partnership interest have the right to present each unit of limited partnership interest for redemption for cash equal to the fair market value of a share of the Company’s common stock on the date of redemption. In lieu of a cash redemption by the partnership of a limited partner’s unit, the Company may elect to acquire any unit presented for redemption for one share of common stock or for such cash amount.

The Company accounts for investments in unconsolidated entities in accordance with SOP 78-9 and Accounting Principles Board (“APB”) Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock.” The Company uses the equity method to account for investments in which it owns greater than 20% of the equity value or has significant and disproportionate influence over that entity. Investments in which the Company owns 20% or less of the equity value and does not have significant and disproportionate influence are accounted for using the cost method. If there is an event or change in circumstance that indicates a loss in the value of an investment, the Company’s policy is to record the loss and reduce the value of the investment to its fair value. A loss in value would be indicated if the Company could not recover the carrying value of the investment or if the investee could not sustain an earnings capacity that would justify the carrying amount of the investment. The Company did not recognize an impairment loss on any of its investments in unconsolidated entities during the nine months ended September 30, 2003 or 2002.

Rental income related to leases is recognized on an accrual basis when due from residents in accordance with SEC Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements.” In accordance with the Company’s standard lease terms, rental payments are generally due on a monthly basis. Any cash concessions given at the inception of the lease are amortized over the approximate life of the lease, which is generally one year.

Significant expenditures which improve or extend the life of an asset are capitalized. The operating real estate assets are stated at cost and consist of land, buildings and improvements, furniture, fixtures and equipment, and other costs incurred during their development, redevelopment and acquisition. Expenditures for maintenance and repairs are charged to operations as incurred.

The Company’s policy with respect to capital expenditures is generally to capitalize only non-recurring expenditures. Improvements and upgrades are capitalized only if the item exceeds $15, extends the useful life of the

asset and is not related to making an apartment home ready for the next resident. Purchases of personal property, such as computers and furniture, are capitalized only if the item is a new addition and exceeds $2.5. The Company generally expenses purchases of personal property made for replacement purposes.

The capitalization of costs during the development of assets (including interest and related loan fees, property taxes and other direct and indirect costs) begins when active development commences and ends when the asset, or a portion of an asset, is delivered and is ready for its intended use, which is generally indicated by the issuance of a certificate of occupancy. Cost capitalization during redevelopment of apartment homes (including interest and related loan fees, property taxes and other direct and indirect costs) begins when an apartment home is taken out-of-service for redevelopment and ends when the apartment home redevelopment is completed and the apartment home is placed in-service.

In accordance with Statement of Financial Accounting Standards (“SFAS”) No. 67, “Accounting for Costs and Initial Rental Operations of Real Estate Projects,” 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 availability of capital. Pre-development costs incurred in the pursuit of Development Rights for which future development is not yet considered probable are expensed as incurred. In addition, if the status of a Development Right changes, deeming future development no longer probable, any capitalized pre-development costs are written-off with a charge to expense.

Depreciation is calculated on buildings and improvements using the straight-line method over their estimated useful lives, which range from seven to thirty years. Furniture, fixtures and equipment are generally depreciated using the straight-line method over their estimated useful lives, which range from three years (primarily computer-related equipment) to seven years.

Lease terms for apartment homes are generally one year or less. Rental income and operating costs incurred during the initial lease-up or post-redevelopment lease-up period are fully recognized as they accrue.

If there is an event or change in circumstance that indicates an impairment in the value of an operating community, the Company’s policy is to assess any impairment in value by making a comparison of the current and projected operating cash flows of the community over its remaining useful life, on an undiscounted basis, to the carrying amount of the community. If such carrying amounts are in excess of the estimated projected operating cash flows of the community, the Company would recognize an impairment loss equivalent to an amount required to adjust the carrying amount to its estimated fair market value. The Company has not recognized an impairment loss in the nine months ended September 30, 2003 or 2002 on any of its operating communities.

Deferred financing costs include fees and costs incurred to obtain debt financing and are amortized on a straight-line basis, which approximates the effective interest method, over the shorter of the term of the loan or the related credit enhancement facility, if applicable. Unamortized financing costs are written-off when debt is retired before the maturity date. Accumulated amortization of deferred financing costs was $18,404 at September 30, 2003 and $15,496 at December 31, 2002.

Cash and cash equivalents include all cash and liquid investments with an original maturity of three months or less from the date acquired. The majority of the Company’s cash, cash equivalents and cash in escrows is held at major commercial banks.

The Company utilizes derivative financial instruments to manage interest rate risk and has designated these financial instruments as hedges under the guidance of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” and SFAS No. 138, “Accounting for Certain Instruments and Certain Hedging Activities, an Amendment of Statement No. 133.” For fair value hedge transactions, changes in the fair value of the derivative instrument and changes in the fair value of the hedged item due to the risk being hedged are recognized in current period earnings. For cash flow hedge transactions, changes in the fair value of the derivative instrument are reported in other comprehensive income. For cash flow hedges where the changes in the fair value of the derivative exceed the change in fair value of the hedged item, the ineffective portion is recognized in current period earnings. Derivatives which are not part of a hedge relationship are recorded at fair value through earnings. As of September 30, 2003, the Company has approximately $165,000 in variable rate tax-exempt debt subject to cash flow hedges. See Note 5, “Derivative Instruments and Hedging Activities,” of the Condensed Consolidated Financial Statements.

Comprehensive income, as reflected on the Condensed Consolidated Statements of Operations and Other Comprehensive Income, is defined as all changes in equity during each period except for those resulting from investments by or distributions to shareholders. Accumulated other comprehensive loss as reflected in Note 4, “Stockholders’ Equity,” of the Condensed Consolidated Financial Statements reflects the changes in the fair value of effective cash flow hedges.

In accordance with the provisions of SFAS No. 128, “Earnings per Share,” basic earnings per share is computed by dividing earnings available to common shareholders by the weighted average number of shares outstanding during the period. 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:


	For the three months ended				For the nine months ended

	9-30-03		9-30-02		9-30-03		9-30-02

Basic and diluted shares outstanding

Weighted average common shares — basic		68,779,429		69,154,045		67,880,019		68,940,901
Weighted average DownREIT units outstanding		899,870		1,018,448		947,790		983,443
Effect of dilutive securities		852,621		877,206		696,419		1,019,697

Weighted average common shares and DownREIT units — diluted		70,531,920		71,049,699		69,524,228		70,944,041

Calculation of Earnings per Share — basic

Net income available to common stockholders	$	55,212	$	24,685	$	162,673	$	92,689

Weighted average common shares — basic		68,779,429		69,154,045		67,880,019		68,940,901

Earnings per common share — basic	$	0.80	$	0.36	$	2.40	$	1.34

Calculation of Earnings per Share — diluted

Net income available to common stockholders	$	55,212	$	24,685	$	162,673	$	92,689
Add: Minority interest of DownREIT unitholders in consolidated partnerships, including discontinued operations		285		406		1,047		1,216

Adjusted net income available to common stockholders	$	55,497	$	25,091	$	163,720	$	93,905

Weighted average common shares and DownREIT units — diluted		70,531,920		71,049,699		69,524,228		70,944,041

Earnings per common share — diluted	$	0.79	$	0.35	$	2.35	$	1.32

Certain options to purchase shares of common stock in the amounts of 688,834 and 1,384,115 were outstanding during the three and nine months ended September 30, 2003, respectively, and 1,480,294 and 62,602 were outstanding during the three and nine months ended September 30, 2002, respectively, but were not included in the computation of diluted

earnings per share because the options’ exercise prices were greater than the average market price of the common shares for the period.

Prior to 2003, the Company applied the intrinsic value method as provided in APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations, in accounting for its employee stock options. No stock-based employee compensation cost related to employee stock options is reflected in net income for the three and nine months ended September 30, 2002, as all options granted had an exercise price equal to the market value of the underlying common stock on the date of grant. Effective January 1, 2003, the Company adopted the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure — an amendment of FASB Statement No. 123,” prospectively to all employee awards granted, modified, or settled on or after January 1, 2003. Awards under the Company’s stock option plans vest over periods ranging from one to three years. Therefore, the cost related to stock-based employee compensation for employee stock options included in the determination of net income for the three and nine months ended September 30, 2003 is less than that which would have been recognized if the fair value based method had been applied to all awards since the original effective date of SFAS No. 123.

The following table illustrates the effect on net income and earnings per share if the fair value based method had been applied to all outstanding and unvested awards in each period based on the fair market value as determined on the date of grant:

During 2000, a fire occurred at one of the Company’s development communities, which was under construction and unoccupied at the time. The Company had property damage and insurance for lost rental income which covered this event. Insurance proceeds totaling $30,300 were received, of which $22,000 was disbursed to rebuild the community for property damage. Insurance proceeds for lost rental income of $5,800 are included in rental and other income in the accompanying Condensed Consolidated Statements of Operations and Other Comprehensive Income for the nine months ended September 30, 2002.

In January 2003, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. (“FIN”) 46, “Consolidation of Variable Interest Entities,” which changes the guidelines for consolidation of and disclosure related to unconsolidated entities, if those unconsolidated entities qualify as variable interest entities, as defined in FIN 46. The Company has adopted the provisions of FIN 46 for variable interest entities created after January

31, 2003. However, the Company has deferred the adoption of FIN 46 for variable interest entities created on or before January 31, 2003 until December 31, 2003. Although the Company is still evaluating the impact of FIN 46 on entities created on or before January 31, 2003, the Company anticipates the consolidation of one entity from which the Company holds a participating mortgage loan. The Company does not expect the final adoption of FIN 46, including the potential consolidation of this variable interest entity, to have a material impact on the Company’s consolidated financial condition or results of operations taken as a whole.

In July 2003, the Securities and Exchange Commission clarified Emerging Issues Task Force Topic D-42, “The Effect on the Calculation of Earnings per Share for the Redemption or Induced Conversion of Preferred Stock.” The clarification of Topic D-42 is effective in the first fiscal period ending after September 15, 2003 and is to be applied retroactively. As such, the Company has revised its historical 2003 results of operations, as included in the operating results for the nine months ended September 30, 2003, to reflect additional dividends attributable to preferred stock of $280; no other periods presented in this report were impacted.

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.

On January 1, 2002, the Company adopted SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” which requires that the assets and liabilities and the results of operations of any communities which have been sold since January 1, 2002, or otherwise qualify as held for sale, be presented as discontinued operations in the Company’s Condensed Consolidated Financial Statements in both current and prior periods presented. The community specific components of net income that are presented as discontinued operations include net operating income, depreciation expense, minority interest and interest expense. In addition, the net gain or loss (including any impairment loss) on the eventual disposal of communities held for sale will be presented as discontinued operations when recognized. A change in presentation for discontinued operations will not have any impact on the Company’s financial condition or results of operations. Real estate assets held for sale are measured at the lower of the carrying amount or the fair value less the cost to sell, and are presented separately in the accompanying Condensed Consolidated Balance Sheets. Subsequent to classification of a community as held for sale, no further depreciation is recorded on the assets.

Certain reclassifications have been made to amounts in prior period’s financial statements to conform with current period presentations.

Capitalized interest associated with communities under development or redevelopment totaled $6,360 and $6,733 for the three months ended September 30, 2003 and 2002, respectively, and $18,871 and $23,404 for the nine months ended September 30, 2003 and 2002, respectively.

The Company’s mortgage notes payable, unsecured notes and variable rate unsecured credit facility as of September 30, 2003 and December 31, 2002 are summarized as follows:

During the nine months ended September 30, 2003, the Company issued $17,404 in fixed rate, tax-exempt debt and $20,680 in fixed rate, conventional debt related to two operating communities. In addition, in June 2003, the Company transferred a fixed rate, tax-exempt mortgage note payable in the amount of $27,305 in connection with the sale of a community to the purchaser. In the aggregate, mortgage notes payable mature at various dates from May 2004 through April 2043 and are collateralized by certain apartment communities. As of September 30, 2003, the Company has guaranteed approximately $166,000 of mortgage notes payable held by subsidiaries; all such mortgage notes payable are consolidated for financial reporting purposes. The weighted average interest rate of the Company’s fixed rate mortgage notes payable (conventional and tax-exempt) was 6.7% at September 30, 2003 and 6.6% at December 31, 2002. The weighted average interest rate of the Company’s variable rate mortgage notes payable and its unsecured credit facility (as discussed below), including the effect of certain financing related fees, was 2.7% at September 30, 2003 and 3.5% at December 31, 2002. As of September 30, 2003, the Company had approximately $165,000 of variable rate debt effectively fixed through Hedged Derivatives, as described in Note 5, “Derivative Instruments and Hedging Activities” of the Condensed Consolidated Financial Statements. The Hedged Derivatives on approximately $87,000 of this variable rate tax-exempt bond financing mature in 2004. As a result, the Company is currently negotiating the refinancing of these variable rate bonds and, as part of the refinancing, the Company may elect to put new Hedged Derivatives in place.

During the nine months ended September 30, 2003, the Company repaid $150,000 of previously issued unsecured notes, along with any unpaid interest, pursuant to their scheduled maturity, and no prepayment fees were incurred. The Company’s unsecured notes contain a number of financial and other covenants with which the Company must comply, including, but not limited to, limits on the aggregate amount of total and secured indebtedness the Company may have on a consolidated basis and limits on the Company’s required debt service payments.

Scheduled payments and maturities of mortgage notes payable, including a mortgage note payable in the amount of $12,360 relating to an asset held for sale, and unsecured notes outstanding at September 30, 2003 are as follows:

The Company has a $500,000 revolving variable rate unsecured credit facility with J.P. Morgan Chase and Fleet National Bank serving as co-agents for a syndicate of commercial banks, which had $149,350 outstanding and $18,822 in letters of credit on September 30, 2003 and $28,970 outstanding and $79,999 in letters of credit on December 31, 2002. Under the terms of the unsecured credit facility, if the Company elects to increase the facility by up to an additional $150,000, and one or more banks (from the syndicate or otherwise) voluntarily agree to provide the additional commitment, then the Company will be able to increase the facility up to $650,000, and no member of the syndicate of banks can prohibit such increase; such an increase in the facility will only be effective to the extent banks (from the syndicate or otherwise) choose to commit to lend additional funds. The Company pays participating banks, in the aggregate, an annual facility fee of approximately $750 in quarterly installments. The unsecured 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 0.60% per annum (1.72% on September 30, 2003). Pricing could vary if there is a change in rating by either of the two leading national rating agencies; a change in rating of one level would impact the unsecured credit facility pricing by 0.05% to 0.15%. In addition, the unsecured credit facility includes a competitive bid option, which allows banks that are part of the lender consortium to bid to make loans to the Company at a rate that is lower than the stated rate provided by the unsecured credit facility for up to $400,000. The competitive bid option may result in lower pricing if market conditions allow. The Company had $100,000 outstanding under this competitive bid option at September 30, 2003 priced at LIBOR plus 0.39%, or 1.51%. The Company is subject to (i) certain customary covenants under the unsecured credit facility, including, but not limited to, maintaining certain maximum leverage ratios, a minimum fixed charges coverage ratio and minimum unencumbered assets and equity levels and (ii) prohibitions on paying dividends in amounts that exceed 95% of the Company’s Funds from Operations, as defined therein, except as may be required to maintain the Company’s REIT status. The existing facility matures in May 2005 assuming exercise of a one-year renewal option by the Company.

The following summarizes the changes in stockholders’ equity for the nine months ended September 30, 2003:


													Dividends in			Accumulated
							Additional						excess of			other
	Preferred			Common			paid-in			Deferred			accumulated			comprehensive			Stockholders'
	stock			stock			capital			compensation			earnings			loss			equity

Balance at December 31, 2002	$	73		$	682		$	2,266,130		$	(7,855	)	$	(51,850	)	$	(12,640	)	$	2,194,540
Net income		—			—			—			—			171,242			—			171,242
Unrealized gain on cash flow hedges		—			—			—			—			—			2,735			2,735
Dividends declared to common and preferred stockholders		—			—			—			—			(150,863	)		—			(150,863	)
Issuance of common stock, net of withholdings		—			36			153,496			(1,419	)		(41	)		—			152,072
Issuance of stock options		—			—			754			(754	)		—			—			—
Repurchase of common stock, including repurchase costs		—			(11	)		(32,841	)		—			(7,025	)		—			(39,877	)
Issuance of preferred stock, net of issuance costs		33			—			81,704			—			—			—			81,737
Redemption of preferred stock		(66	)		—			(163,378	)		—			(280	)		—			(163,724	)
Amortization of deferred compensation		—			—			—			3,033			—			—			3,033

Stockholders’ equity, September 30, 2003	$	40		$	707		$	2,305,865		$	(6,995	)	$	(38,817	)	$	(9,905	)	$	2,250,895

During the nine months ended September 30, 2003, the Company (i) issued 545,507 shares of common stock in connection with stock options exercised, (ii) issued 103,255 common shares in connection with stock grants to employees of which 80% are restricted, (iii) had forfeitures of 12,102 shares of restricted stock grants to employees and (iv) withheld 33,047 shares to satisfy employees’ tax withholding and other liabilities.

In addition, during the nine months ended September 30, 2003, the Company completed a common stock offering totaling 2,804,700 shares at a public offering price of $46.00 per share. The net proceeds from this offering, after underwriting discounts and commissions, of approximately $127,333 were used to repay a portion of amounts outstanding on the unsecured credit facility and for general corporate purposes.

In July 2002 the Company announced that its Board of Directors had authorized a common stock repurchase program, under which the Company may acquire shares of its common stock in open market or negotiated transactions. Actual purchases of stock will vary with market conditions. The stock repurchase program was designed so that retained cash flow, as well as the proceeds from sales of existing apartment communities and a reduction in planned acquisitions, will provide the source of funding for the program, with the Company’s unsecured credit facility providing temporary funding as needed. As of September 30, 2003, the Company had repurchased a total of 2,380,600 shares of common stock at an aggregate cost of $89,566 through this program. Of the aggregate shares repurchased, the Company repurchased 1,099,000 during the nine months ended September 30, 2003 at an aggregate cost of $39,844. The Company has not repurchased any shares of common stock since March 31, 2003.

On March 20, 2003, the Company redeemed all 3,267,700 outstanding shares of its 8.00% Series D Cumulative Redeemable Preferred Stock at a price of $25.00 per share, plus $0.0167 in accrued and unpaid dividends, for an aggregate redemption price of $81,747, including accrued dividends of $54. The redemption price was funded by the sale on March 18, 2003 of 3,336,611 shares of Series J Cumulative Redeemable Preferred Stock through a private placement to an institutional investor for a net purchase price of $81,737. The dividend rate on such shares was initially equal to 2.78% per annum (three-month LIBOR plus 1.5%) of the liquidation preference. As permitted under the terms of such preferred stock, the Company redeemed all of the Series J Cumulative Redeemable Preferred Stock on May 9, 2003, for an aggregate redemption price of $82,207, including dividends of $251.

Dividends per common share for both the nine month periods ended September 30, 2003 and 2002 were $2.10 per share. In the nine months ended September 30, 2003, average dividends for preferred shares redeemed during the period were $0.31 per share and average dividends for all non-redeemed preferred shares were $1.63 per share. In the

nine months ended September 30, 2002, average dividends for preferred shares redeemed during the period were $0.92 per share and average dividends for all non-redeemed preferred shares were $1.57 per share.

The Company has historically used interest rate swap and cap agreements (collectively, the “Hedged Derivatives”) to reduce the impact of interest rate fluctuations on its variable rate tax-exempt bonds. The Company has not entered into any interest rate hedge agreements or treasury locks for its conventional unsecured debt and does not hold interest rate hedge agreements for trading or other speculative purposes. As of September 30, 2003, the Hedged Derivatives fix approximately $165,000 of the Company’s tax-exempt debt at a weighted average interest rate of 5.9% and have maturity dates ranging from 2004 to 2010. In addition, one of the Company’s unconsolidated real estate investments (see Note 6, “Investments in Unconsolidated Entities” of the Condensed Consolidated Financial Statements) has $22,500 in variable rate debt outstanding as of September 30, 2003, which is subject to an interest rate swap. This debt is not recourse to or guaranteed by the Company. The Hedged Derivatives are accounted for in accordance with SFAS No. 133, which as amended, was adopted by the Company on January 1, 2001. SFAS No. 133 requires that every derivative instrument be recorded on the balance sheet as either an asset or liability measured at its fair value, with changes in fair value recognized currently in earnings unless specific hedge accounting criteria are met.

The Company has determined that its Hedged Derivatives qualify as effective cash-flow hedges under SFAS No. 133, resulting in the Company recording all changes in the fair value of the Hedged Derivatives in other comprehensive income. Amounts recorded in other comprehensive income will be reclassified into earnings in the period in which earnings are affected by the hedged cash flows. To adjust the Hedged Derivatives to their fair value, the Company recorded an unrealized gain to other comprehensive income of $2,735 in the nine months ended September 30, 2003 and an unrealized loss of $5,412 in the nine months ended September 30, 2002. The estimated amount, included in accumulated other comprehensive income as of September 30, 2003, expected to be reclassified into earnings within the next twelve months to offset the variability of cash flows during this period is not material.

The Company assesses, both at inception and on an on-going basis, the effectiveness of all hedges in offsetting cash flows of hedged items. Hedge ineffectiveness did not have a material impact on earnings and the Company does not anticipate that it will have a material effect in the future. The fair values of the obligations under the Hedged Derivatives are included in accrued expenses and other liabilities on the accompanying Condensed Consolidated Balance Sheets.

By using derivative financial instruments to hedge exposures to changes in interest rates, the Company exposes itself to credit risk and market risk. The credit risk is the risk of a counterparty not performing under the terms of the Hedged Derivatives. The counterparties to these Hedged Derivatives are major financial institutions which have an A+ or better credit rating by the Standard & Poor’s Ratings Group. The Company monitors the credit ratings of counterparties and the amount of the Company’s debt subject to Hedged Derivatives with any one party. Therefore, the Company believes the likelihood of realizing material losses from counterparty non-performance is remote. Market risk is the adverse effect of the value of financial instruments that results from a change in interest rates. The market risk associated with interest-rate contracts is managed by the establishment and monitoring of parameters that limit the types and degree of market risk that may be undertaken. These risks are managed by the Company’s Chief Financial Officer and Group Vice President — Finance.

The Company accounts for investments in unconsolidated real estate entities in accordance with SOP 78-9 and APB Opinion No. 18. The Company applies the equity method of accounting to an investment in an entity if it owns greater than 20% of the equity value or has significant and disproportionate influence over that entity. At September 30, 2003, the Company’s investments in unconsolidated real estate entities accounted for under the equity method of accounting consisted of:

•

a 49% general partnership interest in a partnership that owns the Avalon Run community;

•

a 50% limited liability company membership interest in a limited liability company that owns the Avalon Grove community; and

•

a 25% limited liability company membership interest (with a right to 50% of distributions after achievement of a threshold return) in a limited liability company that owns the Avalon Bedford community.

In September 2003, Falkland Chase, a 450 apartment home community located in Silver Spring, MD, was sold by Falkland Partners, LLC, in which the Company has held a 50% membership interest since 1993. The Company’s share of the $58,500 sales price for this community was $29,250, resulting in net proceeds to the Company of $16,700. The Company’s share of the GAAP gain reported by Falkland Partners, LLC is $21,816 and is included in equity in income of unconsolidated entities on the Company’s Condensed Consolidated Statements of Operations and Other Comprehensive Income. The Company recognized an additional gain in accordance with GAAP of $1,632 in conjunction with the liquidation of the limited liability company's assets, which is also included in equity in income of unconsolidated entities on the Company’s Condensed Consolidated Statements of Operations and Other Comprehensive Income. The combined summaries of financial position and operating results presented below have been revised to exclude the financial information of the Falkland Chase community.

The following is a combined summary of the financial position of the entities accounted for using the equity method, as of the dates presented:

The following is a combined summary of the operating results of the entities accounted for using the equity method, for the periods presented:

The Company also holds a 25% limited liability company membership interest in the limited liability company that owns Avalon on the Sound. The Company, which originally owned 100% of the limited liability company, sold a 75% controlling interest in the limited liability company to a third-party in 2000. As part of the sale, the Company retained an option to repurchase the 75% interest. The Company believes it is unlikely that the repurchase option will be exercised. This repurchase option will terminate in 2005. In accordance with SFAS No. 66, “Accounting for Sales of Real Estate,” the sale of the 75% interest is not recognized due to the existence of the repurchase option, and therefore the Company accounts for Avalon on the Sound as a profit-sharing arrangement. As a result, the revenues and expenses, assets and liabilities of Avalon on the Sound are included in the Company’s Condensed Consolidated Financial Statements, with the 75% interest presented as part of accrued expenses and other liabilities on the Company’s Condensed Consolidated Balance Sheets. A reclassification has been made in prior periods to move the 75% interest from minority interest to accrued expenses and other liabilities on the Company’s Condensed Consolidated Balance Sheets to conform with current period presentation. The income allocated to the controlling partner is shown as venture partner interest in profit-sharing on the Company’s Condensed Consolidated Statements of Operations and Other Comprehensive Income. These reclassifications did not have any impact on total assets, net income or any other supplemental measure of operating performance.

At September 30, 2003, the Company holds minority interest investments in three non-real estate entities, all of which are technology companies. Based on ownership and control criteria, the Company accounts for one of these investments using the equity method, with the remaining non-real estate investments accounted for at cost. The aggregate carrying value of the Company’s investment in unconsolidated non-real estate entities was $1,456 and $1,855 as of September 30, 2003 and December 31, 2002, respectively.

During the nine months ended September 30, 2003, the Company sold eight communities, five comprising the entire Minneapolis, Minnesota portfolio, and three single asset sales, one in Los Angeles, California, one in Huntington Beach, California and one in Orange County, California. These eight communities, which contained a total of 2,363 apartment homes, were sold for an aggregate sales price of $265,625, resulting in net proceeds of $235,799 and a gain calculated in accordance with GAAP of $82,158. The Company did not sell any communities during the nine months ended September 30, 2002.

In addition, as of September 30, 2003, the Company had three communities that qualified as held for sale under the provisions of SFAS No. 144. As required under SFAS No. 144, the operations for any communities sold from January 1, 2002 through September 30, 2003 and communities held for sale as of September 30, 2003 have been presented as discontinued operations in the accompanying Condensed Consolidated Financial Statements.

Accordingly, certain reclassifications have been made in prior periods to reflect discontinued operations consistent with current period presentation. The following is a summary of income from discontinued operations for the periods presented:

The Company’s Condensed Consolidated Balance Sheets include other assets (excluding net real estate) of $898 and $1,954, mortgage notes payable of $12,360 and $39,665 and other liabilities of $1,667 and $3,388 as of September 30, 2003 and December 31, 2002, respectively, relating to real estate assets sold or held for sale. The estimated proceeds less anticipated costs to sell the real estate assets held for sale as of September 30, 2003 are greater than the carrying values as of September 30, 2003, and therefore no provisions for possible losses were recorded.

The Company’s reportable operating segments include Established Communities, Other Stabilized Communities, and Development/Redevelopment Communities. Annually as of January 1st, the Company determines which of its communities fall into each of these categories and maintains that classification throughout the year for the purpose of reporting segment operations.

•

Established Communities (also known as Same Store Communities) are communities where a comparison of operating results from the prior year to the current year is meaningful, as these communities were owned and had stabilized occupancy and operating expenses as of the beginning of the prior year. For the year 2003, the Established Communities are communities that had stabilized occupancy and operating expenses as of January 1, 2002, are not conducting or planning to conduct substantial redevelopment activities and are not held for sale or planned for disposition within the current year. A community is considered to have stabilized occupancy at the earlier of (i) attainment of 95% physical occupancy or (ii) the one-year anniversary of completion of development or redevelopment.

•

Other Stabilized Communities includes all other completed communities that have stabilized occupancy, as defined above. Other Stabilized Communities do not include communities that are conducting or planning to conduct substantial redevelopment activities within the current year or are currently held for sale.

•

Development/Redevelopment Communities consists of communities that are under construction and have not received a final certificate of occupancy, communities where substantial redevelopment is in progress or is planned to begin during the current year and communities under lease-up, that had not reached stabilized occupancy, as defined above, as of January 1, 2003.

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

SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” requires that segment disclosures present the measure(s) used by the chief operating decision maker for purposes of assessing such segments’ 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 and Other Stabilized Communities. NOI is defined by the Company as total revenue less direct property operating expenses, including property taxes, and excludes corporate-level property management and other indirect operating expenses, interest income and expense, general and administrative expense, equity in income of unconsolidated entities, minority interest in consolidated partnerships, venture partner interest in profit-sharing, depreciation expense, gain on sale of communities and income from discontinued operations. 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.

A reconciliation of NOI to net income for the three and nine months ended September 30, 2003 and 2002 is as follows:

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. The segments are classified based on the individual community’s status as of the beginning of the given calendar year. Therefore, each year the composition of communities within each business segment is adjusted. Accordingly, the amounts between years are not directly comparable. The accounting policies applicable to the operating segments described above are the same as those described in the summary of significant accounting policies.


				For the three months ended									For the nine months ended

				Total				% NOI change			Gross		Total				% NOI change			Gross
				revenue		NOI		from prior year			real estate (1)		revenue		NOI		from prior year			real estate (1)

For the three and nine months ended September 30, 2003
	Established
		Northeast		$	38,000	$	24,361		(8.6	%)	$	884,519	$	114,389	$	75,494		(9.5	%)	$	884,519
		Mid-Atlantic			17,530		12,160		(3.3	%)		388,370		51,940		36,273		(5.7	%)		388,370
		Midwest			4,048		2,028		(22.4	%)		140,553		12,159		6,372		(19.1	%)		140,553
		Pacific Northwest			6,899		4,125		(7.9	%)		297,401		20,556		12,623		(12.7	%)		297,401
		Northern California			34,413		23,724		(9.0	%)		1,342,514		105,530		75,104		(11.6	%)		1,342,514
		Southern California			11,451		7,758		(1.6	%)		325,312		34,164		23,535		(1.3	%)		325,312

			Total Established		112,341		74,156		(7.6	%)		3,378,669		338,738		229,401		(9.3	%)		3,378,669

	Other Stabilized				20,670		14,184		n/a			749,865		61,063		40,761		n/a			749,865
	Development / Redevelopment				20,382		11,284		n/a			1,092,790		53,981		30,471		n/a			1,092,790
	Land Held for Future Development				n/a		n/a		n/a			116,556		n/a		n/a		n/a			116,556
	Non-allocated (2)				180		179		n/a			20,228		636		636		n/a			20,228

			Total	$	153,573	$	99,803		0.7	%	$	5,358,108	$	454,418	$	301,269		(1.5	%)	$	5,358,108

For the three and nine months ended September 30, 2002
	Established
		Northeast		$	35,557	$	23,836		(10.8	%)	$	784,157	$	107,312	$	74,670		(6.6	%)	$	784,157
		Mid-Atlantic			17,691		12,577		(5.7	%)		387,287		53,267		38,447		(1.3	%)		387,287
		Midwest			4,249		2,613		(7.8	%)		139,767		13,019		7,872		(8.2	%)		139,767
		Pacific Northwest			2,610		1,541		(16.6	%)		96,616		8,013		4,902		(13.6	%)		96,616
		Northern California			36,383		25,979		(20.9	%)		1,340,721		114,025		84,397		(18.1	%)		1,340,721
		Southern California			10,692		7,506		(0.1	%)		303,239		31,581		22,644		3.0	%		303,239

			Total Established		107,182		74,052		(13.0	%)		3,051,787		327,217		232,932		(9.8	%)		3,051,787

	Other Stabilized				20,674		13,741		n/a			772,308		63,470		45,404		n/a			772,308
	Development / Redevelopment				19,799		11,044		n/a			1,060,016		47,465		25,419		n/a			1,060,016
	Land Held for Future Development				n/a		n/a		n/a			69,766		n/a		n/a		n/a			69,766
	Non-allocated (2)				256		256		n/a			21,636		2,019		2,017		n/a			21,636

			Total	$	147,911	$	99,093		(6.4	%)	$	4,975,513	$	440,171	$	305,772		(3.7	%)	$	4,975,513

Segment information for the periods ending September 30, 2003 and 2002 has been adjusted for the communities that were designated as held for sale as of September 30, 2003 or sold from January 1, 2002 through September 30, 2003 as described in Note 7, “Discontinued Operations — Real Estate Assets Sold or Held for Sale,” of the Condensed Consolidated Financial Statements.

The Company’s Chairman and CEO is a partner of an entity that is the general partner of Arbor Commons Associates Limited Partnership (“Arbor Commons Associates”). Arbor Commons Associates owns Avalon Arbor, a 302 apartment home community in Shrewsbury, Massachusetts. Concurrently with its initial public offering in November 1993, Avalon Properties, Inc. (“Avalon”), a predecessor entity, purchased an existing participating mortgage loan made to Arbor Commons Associates that was originated by CIGNA Investments, Inc. The mortgage loan is secured by Arbor Commons Associates’ interest in Avalon Arbor. This loan accrues interest at a fixed rate of 10.2% per annum, payable at 9.0% per annum. The balance of the note receivable at both September 30, 2003 and December 31, 2002 was $21,483. The balance of accrued interest on the note receivable as of September 30, 2003 and December 31, 2002, respectively, was $5,670 and $4,965, and is included in other assets on the accompanying Condensed Consolidated Balance Sheets. Related interest income of $823 and $773 was recorded for the three months ended September 30, 2003 and 2002, respectively, and $2,429 and $2,318 was recorded for the nine months ended September 30, 2003 and 2002, respectively. Under the terms of the loan, the Company (as successor to Avalon) receives (as contingent interest) 50% of the cash flow after the 10.2% accrual rate is paid and 50% of the residual profits upon the sale of the community.

The Company manages several unconsolidated real estate joint venture entities for which it receives management fee revenue. From these entities the Company received management fee revenue of $217 and $249 in the three months ended September 30, 2003 and 2002, respectively, and $682 and $765 in the nine months ended September 30, 2003 and 2002, respectively.

The Company has a recourse loan program under which the Company lends amounts to or on behalf of employees (“Stock Loans”) equivalent to the estimated employees’ tax withholding liabilities related to the vesting of restricted stock under the 1994 Stock Incentive Plan, as amended and restated on March 31, 2001. In accordance with the Sarbanes-Oxley Act of 2002, no loans to senior officers were renewed after January 1, 2003 and all were repaid in full by March 31, 2003. The Company intends to phase out the Stock Loan program for all other participants, with all loans required to be repaid by March 1, 2004. The principal balance outstanding under the Stock Loans to employees was $140 at September 30, 2003 and $1,133 at December 31, 2002. The balance of accrued interest on the notes receivable was $3 and $45 as of September 30, 2003 and December 31, 2002, respectively. Interest income on the notes of $1 and $14 was recorded for the three months ended September 30, 2003 and 2002, respectively, and $7 and $50 was recorded for the nine months ended September 30, 2003 and 2002, respectively. Each Stock Loan was made for a one-year term, is a full personal recourse obligation of the borrower and is secured by a pledge to the Company of the stock that vested and gave rise to the tax withholding liability for which the loan was made. In addition, dividends on the pledged stock are automatically remitted to the Company and applied toward repayment of the Stock Loan.

In March 2000, the Company and Gilbert M. Meyer announced that Mr. Meyer would retire as Executive Chairman of the Company in May 2000. Although Mr. Meyer ceased his day-to-day involvement with the Company as an executive officer, he continues to serve as a director. In addition, pursuant to a consulting agreement which terminated in May 2003, Mr. Meyer agreed to serve as a consultant to the Company for three years following his retirement for an annual fee of $1,395. In such capacity he responded to requests for assistance or information concerning business matters with which he became familiar while employed and he provided business advice and counsel to the Company with respect to business strategies and acquisitions, dispositions, development and redevelopment of multifamily rental properties.

The Company’s Stock Incentive Plan provides that directors of the Company who are also employees receive no additional compensation for their services as a director. In accordance with the Company’s Stock Incentive Plan, as then in effect, on the fifth business day following each of the Company’s May 2003 and May 2002 Annual Meetings of Stockholders, each of the Company’s non-employee directors automatically received options to purchase 7,000 shares of common stock at the last reported sale price of the common stock on the NYSE on such date, and a restricted stock grant (or, in lieu thereof, a deferred stock award) of 2,500 shares of common stock. The Company recorded compensation expense relating to the restricted stock grants, deferred stock awards and stock options in the amount of $228 and $595 in the three and nine months ended September 30, 2003, respectively, and $168 and $580 in the three and nine months ended September 30, 2002, respectively. Deferred compensation relating to these restricted stock grants and deferred stock awards was $818 and $757 on September 30, 2003 and December 31, 2002, respectively. On May 14, 2003, the Company’s Board of Directors approved an amendment to the Stock Incentive Plan pursuant to which, in lieu of the stock and option awards described above, each non-employee director would receive, following the 2004 Annual Meeting of Stockholders and each annual meeting thereafter, (i) a number of shares of restricted stock (or deferred stock awards) having a value of $100 based on the last reported sale price of the common stock on the NYSE on the fifth business day following the prior year’s annual meeting and (ii) $30 cash, payable in quarterly installments of $7.5.

As an employee incentive and retention mechanism, the Company arranged for officers of the Company to hold direct or indirect economic interest in Realeum, Inc. Realeum, Inc. is a company involved in the development and deployment of a property management and leasing automation system in which the Company invested $2,300 in January 2002. The Company currently utilizes this property management and leasing automation system and has paid $124 and $118 to Realeum, Inc. under the terms of its licensing arrangements during the three months ended September 30, 2003 and 2002, respectively, and $347 and $338 during the nine months ended September 30, 2003 and 2002, respectively.

On October 7, 2003, the Company sold a parcel of land held in connection with a development right in Oakland, California and received net proceeds of approximately $6,600.

Since September 30, 2003 the Company has disposed of an additional three communities that were classified as held for sale under GAAP on the Company’s Condensed Consolidated Financial Statements as of September 30, 2003. On October 15, 2003, the Company sold Avalon at Fair Lakes, a 234 apartment home community located in Fairfax, Virginia. The Company sold Avalon Crest, a 351 apartment home community located in Fort Lee, New Jersey on October 29, 2003. On October 30, 2003, the Company sold Avalon at Dulles, a 236 apartment home community located in Sterling, Virginia. The Company sold these three communities for an aggregate sales price of $159,025, resulting in an aggregate gain reported in accordance with GAAP of approximately $77,600.

This Form 10-Q, including the footnotes to our Condensed Consolidated Financial Statements, contains “forward-looking statements” as that term is defined under the Private Securities Litigation Reform Act of 1995. You can identify forward-looking statements by our use of the words “believe,” “expect,” “anticipate,” “intend,” “estimate,” “assume,” “project,” “plan,” “may,” “shall,” “will” and other similar expressions in this Form 10-Q, that predict or indicate future events and trends or that do not report historical matters. These statements include, among other things, statements regarding our intent, belief or expectations with respect to:

	•		our potential development, redevelopment, acquisition or disposition of communities;
	•		the timing and cost of completion of apartment communities under construction, reconstruction, development or redevelopment;
	•		the timing of lease-up, occupancy and stabilization of apartment communities;
	•		the pursuit of land on which we are considering future development;
	•		the anticipated operating performance of our communities;
	•		cost, yield and earnings estimates;
	•		our declaration or payment of distributions;
	•		our policies regarding investments, indebtedness, acquisitions, dispositions, financings and other matters;
	•		our qualification as a REIT under the Internal Revenue Code;
	•		the real estate markets in Northern and Southern California and markets in selected states in the Mid-Atlantic, Northeast, Midwest and Pacific Northwest regions of the United States and in general;
	•		the availability of debt and equity financing;
	•		interest rates;
	•		general economic conditions; and
	•		trends affecting our financial condition or results of operations.

We cannot assure the future results or outcome of the matters described in these statements; rather, these statements merely reflect our current expectations of the approximate outcomes of the matters discussed. You should not rely on forward-looking statements because they involve known and unknown risks, uncertainties and other factors, some of which are beyond our control. These risks, uncertainties and other factors may cause our actual results, performance or achievements to differ materially from the anticipated future results, performance or achievements expressed or implied by these forward-looking statements. Some of the factors that could cause our actual results, performance or achievements to differ materially from those expressed or implied by these forward-looking statements include, but are not limited to, the following:

	•		we may fail to secure development opportunities due to an inability to reach agreements with third parties or to obtain desired zoning and other local approvals;
	•		we may abandon or defer development opportunities for a number of reasons, including changes in local market conditions which make development less desirable, increases in costs of development and increases in the cost of capital;
	•		construction costs of a community may exceed our original estimates;
	•		we may not complete construction and lease-up of communities under development or redevelopment on schedule, resulting in increased interest expense and construction costs and a decrease in our expected rental revenues;

	•		occupancy rates and market rents may be adversely affected by competition and local economic and market conditions which are beyond our control;
	•		financing may not be available on favorable terms or at all, and our cash flow from operations and access to cost effective capital may be insufficient for the development of our pipeline which could limit our pursuit of opportunities;
	•		our cash flow may be insufficient to meet required payments of principal and interest, and we may be unable to refinance existing indebtedness or the terms of such refinancing may not be as favorable as the terms of existing indebtedness;
	•		we may be unsuccessful in managing changes in our portfolio composition; and
	•		companies in which we have invested that develop software applications and ancillary services may be unsuccessful in achieving their business plans or unsuccessful in obtaining additional funding.

You should read our Condensed Consolidated Financial Statements and notes included in this report in conjunction with the following discussion. These forward-looking statements represent our estimates and assumptions only as of the date of this report. We do not undertake to update these forward-looking statements, and you should not rely upon them after the date of this report.

We are a Maryland corporation that has elected to be treated as a real estate investment trust, or REIT, for federal income tax purposes. We focus on the ownership and operation of upscale apartment communities (which generally command among the highest rents in their submarkets) in high barrier-to-entry markets of the United States. This is because we believe that, over the long term, the limited new supply of upscale apartment homes and lower housing affordability in these markets will result in larger increases in cash flows relative to other markets over an entire business cycle. However, we believe we are in a period of a business cycle where rents are resetting to lower levels, resulting in a decline in cash flows in 2003 as compared to prior years. Barriers-to-entry in our markets generally include a difficult and lengthy entitlement process with local jurisdictions and dense urban or suburban areas where zoned and entitled land (“in-fill locations”) is in limited supply. Our markets are located in the Northeast, Mid-Atlantic, Midwest, Pacific Northwest, and Northern and Southern California regions of the United States.

We are a fully-integrated real estate organization with in-house expertise in the following areas:

	•		development and redevelopment;
	•		construction and reconstruction;
	•		leasing and management;
	•		acquisition and disposition;
	•		financing;
	•		marketing; and
	•		information technologies.

We believe apartment communities present an attractive long-term investment opportunity compared to other real estate investments because a broad potential resident base should result in relatively stable demand over a real estate cycle. We intend to pursue real estate investments in markets where constraints to new supply exist and where new household formations are expected to out-pace multifamily permit activity over the course of the real estate cycle. A number of our markets have experienced economic contraction due to job losses, particularly in the technology, telecom and financial services sectors. We continued to experience job losses in many of our markets in 2003, and therefore we expect weakened apartment market fundamentals to continue throughout the remainder of 2003 and into 2004.

With our in-house capabilities and expertise we believe we are well-positioned to continue to pursue opportunities to develop and acquire apartment homes in our target markets. However, the level of development or acquisition volume, or any disposition activity, is heavily influenced by capital and real estate market

conditions. We evaluate the appropriate allocation of capital to various investment activities, including development and redevelopment communities, the acquisition of existing communities, and equity and debt repurchases/redemptions. During 2003, in response to market and demand conditions, we did not acquire any existing communities, but rather increased our disposition activity with respect to assets that do not meet our long-term investment criteria, allowing us to realize a portion of the value created over the past business cycle as well as providing additional liquidity. We expect to continue our disposition activity during the remainder of 2003 and into 2004. See “Liquidity and Capital Resources” and “Future Financing and Capital Needs.”

Our real estate investments consist primarily of current operating apartment communities, communities in various stages of development (“Development Communities”) and Development Rights as defined below. Our current operating communities are further distinguished as Established Communities, Other Stabilized Communities, Lease-Up Communities and Redevelopment Communities. The following is a description of each category:

Current Communities are categorized as Established, Other Stabilized, Lease-Up, or Redevelopment according to the following attributes:

•

Established Communities (also known as Same Store Communities) are communities where a comparison of operating results from the prior year to the current year is meaningful, as these communities were owned and had stabilized occupancy and operating expenses as of the beginning of the prior year. We determine which of our communities fall into the Established Communities category annually as of January 1st of each year and maintain that classification throughout the year. For the year 2003, the Established Communities are communities that had stabilized occupancy and operating expenses as of January 1, 2002 and are not conducting or planning to conduct substantial redevelopment activities, as described below, and are not held for sale or planned for disposition within the current year. We consider a community to have stabilized occupancy at the earlier of (i) attainment of 95% physical occupancy or (ii) the one-year anniversary of completion of development or redevelopment.

•

Lease-Up Communities are communities where construction has been complete for less than one year and where physical occupancy has not reached 95%.

•

Redevelopment Communities are communities where substantial redevelopment is in progress or is planned to begin during the current year. Redevelopment is considered substantial when capital invested during the reconstruction effort exceeds the lesser of $5,000,000 or 10% of the community’s acquisition cost. Throughout this report, the term “redevelopment” is used to refer in a general sense to the entire redevelopment cycle – planning and procurement of architectural and engineering designs, budgeting and actual renovation work. The actual renovation work is referred to as “reconstruction” and is only one element of the redevelopment cycle.

Development Communities are communities that are under construction and for which a final certificate of occupancy has not been received. These communities may be partially complete and operating. Throughout this report, the term “development” has been used to refer in a general sense to the entire property development cycle, including pursuit of zoning approvals, procurement of architectural and engineering designs and the construction process. References to “construction” refer only to one element of the development cycle – the actual construction of the property.

Development Rights are development opportunities in the early phase of the development process for which we either have an option to acquire land or enter into a leasehold interest, for which we are the buyer under a long-term conditional contract to purchase land or where we own land to develop a new community. We capitalize related pre-development costs incurred in pursuit of new developments for which we currently believe future development is probable.

A more detailed description of our reportable segments and other related operating information can be found in Note 8, “Segment Reporting,” of our Condensed Consolidated Financial Statements. Although each of these categories is important to our business, we generally evaluate overall operating, industry and market trends based on the operating results of our Established Communities, for which a detailed discussion can be found in “Results of Operations” as part of our discussion of overall operating results. We evaluate our current and future cash needs and future operating potential based on acquisition, disposition, development, redevelopment and financing activities within Other Stabilized, Redevelopment and Development Communities, for which detailed discussions can be found in “Liquidity and Capital Resources” and “Future Financing Needs.”

On September 30, 2003, we owned or had an ownership interest in these categories as follows:

Between October 1, 2003 and November 3, 2003 we disposed of three communities containing an aggregate of 821 homes. As of November 3, 2003 our 129 current communities consisted of 37,987 apartment homes. Of those communities, we owned:

	•		a fee simple, or absolute, ownership interest in 103 operating communities;
	•		a fee simple, or absolute, ownership interest in three operating communities which are on land subject to land leases expiring in April 2095, May 2099 and March 2142;
	•		a general partnership interest in three partnerships that each own a fee simple interest in an operating community;
	•		a general partnership interest in four partnerships structured as “DownREITs,” as described more fully below, that own an aggregate of 14 communities;
	•		a membership interest in five limited liability companies that each hold a fee simple interest in an operating community, two of which are on land subject to a land leases with one expiring in July 2029 and one expiring in November 2089; and
	•		a 100% interest in a senior participating mortgage note secured by one community, which allows us to share in part of the rental income or resale proceeds of the community.

We also hold a fee simple ownership interest in eight of the Development Communities, one of which is on land subject to a land lease expiring in January 2062 and a general partnership interest in two partnerships structured as “DownREITs” that each own one Development Community.

In each of the six partnerships structured as DownREITs, either AvalonBay or one of our wholly-owned subsidiaries is the general partner, and there are one or more limited partners whose interest in the partnership is represented by units of limited partnership interest. For each DownREIT partnership, limited partners are entitled to receive an initial distribution before any distribution is made to the general partner. Although the partnership agreements for each of the DownREITs are different, generally the distributions per unit paid to the holders of units of limited partnership interests have approximated our current common stock dividend amount. Each DownREIT partnership has been structured so that it is unlikely the limited partners will be entitled to a distribution greater than the initial distribution provided for in the applicable partnership agreement. The holders of units of limited partnership interest have the right to present each unit of limited partnership interest for redemption for cash equal to the fair market value of a share of our common stock on the date of redemption. In lieu of a cash redemption by the partnership, we may elect to acquire any unit presented for redemption for one share of our common stock or for such cash amount. As of November 3, 2003, there were 784,181 DownREIT partnership units outstanding. The DownREIT partnerships are consolidated for financial reporting purposes.

We elected to be taxed as a REIT for federal income tax purposes for the year ended December 31, 1994 and we have not revoked that election. We were incorporated under the laws of the State of California in 1978, and we were reincorporated in the State of Maryland in July 1995. Our principal executive offices are located at 2900 Eisenhower Avenue, Suite 300, Alexandria, Virginia, 22314, and our telephone number at that location is (703) 329-6300. We also maintain regional offices and administrative or specialty offices in or near the following cities:

	•		Boston, Massachusetts;
	•		Chicago, Illinois;
	•		New Canaan, Connecticut;
	•		New York, New York;
	•		Newport Beach, California;
	•		San Jose, California;
	•		Seattle, Washington; and
	•		Woodbridge, New Jersey.

Acquisition and Development Activities. During the three months ended September 30, 2003, we commenced development on two communities, Avalon at Crane Brook, located in the Boston Massachusetts area, and Avalon Milford I, located in the Fairfield-New Haven, Connecticut area. These communities, when completed, are expected to contain an aggregate of 633 apartment homes for a total capital cost of approximately $88,700,000.

During the three months ended September 30, 2003, we completed the development of two communities, Avalon at Rock Spring, located in North Bethesda, Maryland, and Avalon at Gallery Place, located in Washington, DC. Avalon at Rock Spring is a mid-rise community containing 386 apartment homes and was completed for a total capital cost of approximately $46,000,000. Avalon at Gallery Place is a high-rise community containing 203 apartment homes and was completed for a total capital cost of approximately $49,000,000. The total capital cost for Avalon at Gallery Place excludes approximately $4,000,000 of proceeds that we expect to receive upon the sale of transferable development rights associated with the development of the community; however, there can be no assurance that the projected amount of proceeds will be achieved.

The development and redevelopment of communities involves risks that the investment will fail to perform in accordance with our expectations. See “Risks of Development and Redevelopment” for our discussion of these and other risks inherent in developing or redeveloping communities.

Disposition Activities. During the three months ended September 30, 2003, we sold one community in Orange County, California. This community, which contained a total of 272 apartment homes, was sold for a sales price of $33,500,000 for net proceeds of $33,000,000.

In addition, the Falkland Chase community, located in Silver Spring, Maryland, was sold during the third quarter by Falkland Partners LLC, in which we held a 50% membership interest. This 450 apartment home community was sold for a sales price of $58,500,000. Our share of the sales price was $29,250,000, resulting in net proceeds of $16,700,000.

A comparison of our operating results for the three and nine months ended September 30, 2003 and September 30, 2002 follows (dollars in thousands):


			For the three months ended												For the nine months ended

			9-30-03			9-30-02			$ Change			% Change			9-30-03			9-30-02			$ Change			% Change

Revenue:
	Rental and other income		$	153,339		$	147,662		$	5,677			3.8	%	$	453,674		$	438,305		$	15,369			3.5	%
	Management, development and other fees			234			249			(15	)		(6.0	%)		744			1,866			(1,122	)		(60.1	%)

		Total revenue		153,573			147,911			5,662			3.8	%		454,418			440,171			14,247			3.2	%


Expenses:
	Direct property operating expenses, excluding property taxes			39,327			35,341			3,986			11.3	%		110,296			95,910			14,386			15.0	%
	Property taxes			14,443			13,477			966			7.2	%		42,853			38,489			4,364			11.3	%

		Total community operating expenses		53,770			48,818			4,952			10.1	%		153,149			134,399			18,750			14.0	%


Net operating income				99,803			99,093			710			0.7	%		301,269			305,772			(4,503	)		(1.5	%)

	Corporate-level property management and other indirect operating expenses			7,577			6,906			671			9.7	%		22,630			22,498			132			0.6	%
	Interest expense			33,432			31,386			2,046			6.5	%		101,826			86,614			15,212			17.6	%
	Depreciation expense			37,996			34,723			3,273			9.4	%		112,898			98,618			14,280			14.5	%
	General and administrative expense			3,382			2,966			416			14.0	%		10,636			10,009			627			6.3	%

		Total other expenses		82,387			75,981			6,406			8.4	%		247,990			217,739			30,251			13.9	%


	Equity in income of unconsolidated entities			23,988			(98	)		24,086			n/a			25,192			769			24,423			n/a
	Interest income			852			909			(57	)		(6.3	%)		2,634			3,013			(379	)		(12.6	%)
	Venture partner interest in profit-sharing			(420	)		(244	)		(176	)		72.1	%		(1,268	)		(512	)		(756	)		147.7	%
	Minority interest in consolidated partnerships			(302	)		(229	)		(73	)		31.9	%		(754	)		(696	)		(58	)		8.3	%


Income from continuing operations				41,534			23,450			18,084			77.1	%		79,083			90,607			(11,524	)		(12.7	%)

Discontinued operations:
	Income from discontinued operations			2,278			5,261			(2,983	)		(56.7	%)		10,001			16,169			(6,168	)		(38.1	%)
	Gain on sale of communities			13,575			—			13,575			100.0	%		82,158			—			82,158			100.0	%

		Total discontinued operations		15,853			5,261			10,592			201.3	%		92,159			16,169			75,990			470.0	%


Net income				57,387			28,711			28,676			99.9	%		171,242			106,776			64,466			60.4	%
Dividends attributable to preferred stock				(2,175	)		(4,026	)		1,851			(46.0	%)		(8,569	)		(14,087	)		5,518			(39.2	%)

Net income available to common stockholders			$	55,212		$	24,685		$	30,527			123.7	%	$	162,673		$	92,689		$	69,984			75.5	%

Net income available to common stockholders increased $30,527,000 (123.7%) to $55,212,000 for the three months ended September 30, 2003 and increased by $69,984,000 (75.5%) to $162,673,000 for the nine months ended September 30, 2003 compared to the same periods in the preceding year. These increases are primarily attributable to gains on sales of communities including gains included in equity in income of unconsolidated entities, partially offset by a decline in net operating income from our Established Communities, the absence of business interruption insurance proceeds received in 2002 and increases in interest and depreciation expense.

Net operating income (“NOI”) is defined by us as total revenue less direct property operating expenses, including property taxes, and excludes corporate-level property management and other indirect operating expenses, interest income and expense, general and administrative expense, equity in income of unconsolidated entities, minority interest in consolidated partnerships, venture partner interest in profit-sharing, depreciation expense, gain on sale of communities and income from discontinued operations. We believe that NOI is an appropriate supplemental measure to net income of the operating performance of our communities because it helps both investors and management to understand the core operations of a community or communities prior to the allocation of any corporate-level costs. This is more reflective of the operating performance of a community, and allows for an easier comparison of the operating performance of single assets or groups of assets. In addition, because prospective buyers of real estate have different overhead structures, with varying marginal impact to overhead by acquiring real estate, NOI is considered by many in the real estate industry to be a useful measure for determining the value of a real estate asset or group of assets. NOI does not represent cash generated from operating activities in accordance with generally accepted accounting principles (“GAAP”). Therefore, NOI should not be considered an alternative to net income as an indication of our performance. NOI should also not be considered an alternative to net cash flows from operating activities, as determined by GAAP, as a measure of liquidity. Additionally, NOI is not necessarily indicative of cash available to fund cash needs. A calculation of NOI, along with a reconciliation to net income, is provided in the preceding table.

The NOI increase of $710,000 and decrease of $4,503,000 for the three and nine months ended September 30, 2003, respectively, as compared to the same periods of 2002 consist of changes in the following categories:

The NOI decreases in Established Communities were largely due to the effects of the weakened economy in many of our submarkets. The continued impact of job losses in many of our submarkets, in addition to strong single-family home sales, have aggravated a weak demand environment, causing market rental rates to decline in order to keep occupancies stable. We currently expect to continue to experience weak demand, resulting in continued year over year declines in NOI, through the remainder of 2003 and into 2004.

Rental and other income increased due to rental income generated from communities acquired in 2002 and newly developed communities, partially offset by communities sold in 2002 and 2003, a decline in effective rental rates for Established Communities and the absence of business interruption proceeds received in 2002.

Overall Portfolio – The weighted average number of occupied apartment homes increased to 33,511 apartment homes for the nine months ended September 30, 2003 as compared to 31,348 apartment homes for the same period in 2002. This change is primarily the result of increased homes available from communities acquired in 2002 and newly developed communities, partially offset by communities sold in 2002 and 2003, and an increase in the overall occupancy rate. The weighted average monthly revenue per occupied apartment home decreased to $1,503 in the nine months ended September 30, 2003 as compared to $1,527 for the same period in 2002 primarily due to the weakened demand in certain of our submarkets.

Established Communities – Rental revenue decreased $4,081,000 (3.5%) in the three months ended September 30, 2003 as compared to the same period of 2002. Rental revenue decreased $16,914,000 (4.8%) in the nine months ended September 30, 2003 as compared to the same period of 2002. These decreases are due to declining effective rental rates, partially offset by a slight increase in economic occupancy during the nine months ended September 30, 2003. For the nine months ended September 30, 2003, the weighted average monthly revenue per occupied apartment home decreased (5.0%) to $1,444 compared to $1,520 for the same period of the preceding year, partially due to increased concessions granted in the latter half of 2002 and the first nine months of 2003. The average economic occupancy increased from 93.5% in the nine months ended September 30, 2002 to 93.7% in the nine months ended September 30, 2003. Economic occupancy takes into account the fact that apartment homes of different sizes and locations within a community have different economic impacts on a community’s gross revenue. Economic occupancy is defined as gross potential revenue less vacancy loss as a percentage of gross potential revenue. Gross potential revenue is determined by valuing occupied homes at leased rates and vacant homes at market rents.

Although most of our markets have experienced weak demand, rental income from Established Communities has been impacted the most by significant declines in average rental rates in certain Northern California and Northeast submarkets. Northern California, which accounted for approximately 31.1% of Established Community rental revenue during the nine months ended September 30, 2003, experienced a decline in rental revenue (7.9%) in the nine months ended September 30, 2003 as compared to the same period in 2002, partially related to the continued impact of job losses in the technology sector. Although economic occupancy increased in Northern California in the nine months ended September 30, 2003 as compared to the same period of 2002, average rental rates dropped 9.4% from $1,570 to $1,423 for those same periods.

The Northeast region accounted for approximately 33.7% of Established Community rental revenue during the nine months ended September 30, 2003 and has also experienced a decline in rental revenue (4.0%) in the nine months ended September 30, 2003 as compared to the same period of 2002, primarily the result of job losses in the financial services sector. Average rental rates dropped 4.0% from $1,889 to $1,813 in the nine months ended September 30, 2003 as compared to the same period of 2002, and economic occupancy remained flat during those same periods.

In accordance with GAAP, cash concessions are amortized as an offset to rental revenue over the approximate lease term, which is generally one year. However, we consider rental revenue with concessions stated on a cash basis to be a supplemental measure to rental revenue in conformity with GAAP in helping investors to evaluate the impact of both current and historical concessions on GAAP based rental revenue and to more readily enable comparisons to revenue as reported by other companies. In addition, rental revenue with concessions stated on a cash basis allows an investor to understand the historical trend in cash concessions, which is an indicator of current rental market conditions. The following reconciles total rental revenue in conformity with GAAP to total rental revenue adjusted to state concessions on a cash basis for our Established Communities for the three and nine months ended September 30, 2003 and 2002 (dollars in thousands):

Concessions granted per move-in for Established Communities averaged $873 during the three months ended September 30, 2003, an increase of 170.3% from $323 in the three months ended September 30,

2002. Concessions granted increased during the three and nine months ended September 30, 2003 as compared to the same periods during 2002 primarily due to declining market conditions and a weak demand environment.

Management, development and other fees decreased during the nine months ended September 30, 2003 as compared to the prior year period due to the recognition in the first quarter of 2002 of $711,000 in construction management fees in connection with the redevelopment of a community owned by a limited liability company in which we have a membership interest.

Direct property operating expenses, excluding property taxes increased due to the addition of recently developed and redeveloped apartment homes and communities acquired in 2002, partially offset by communities sold in 2002 and 2003, coupled with increased expenses due to inclement weather, insurance and bad debt expenses. In the first half of 2003, severe winter weather, primarily in the Northeast and Mid-Atlantic, increased snow removal and utility costs by approximately $1,440,000. In addition, insurance expense has increased over the past two years as the insurance and reinsurance markets have deteriorated, resulting in higher insurance costs for the entire real estate sector. Recently property insurance rates began to decline. To benefit from declining rates, we completed an early renewal of our property insurance policy effective July 31, 2003. Accordingly, we expect a decline in property insurance premiums, which will result in flat or declining overall insurance costs for the remainder of 2003 and for 2004 as compared to prior year periods. See “Insurance and Risk of Uninsured Losses” for a discussion of our insurance policies and related coverage. Capitalization of insurance and other costs associated with Development and Redevelopment Communities ends, and such costs are expensed, as the related assets, or portions of assets, within the community are delivered and are ready for their intended use. Bad debt expense has increased as a direct result of the continued impact of job losses and the weakened economy.

For Established Communities, direct property operating expenses, excluding property taxes, increased $1,240,000 (4.9%) for the three months ended and $5,159,000 (7.3%) for the nine months ended September 30, 2003 compared to the same periods of 2002. These increases are due to the increase in expenses due to inclement weather, insurance and bad debt discussed above.

Property taxes increased due to overall higher assessments, the addition of newly developed and redeveloped apartment homes and several successful appeals in 2002, partially offset by communities sold in 2002 and 2003. Property taxes on Development and Redevelopment Communities are capitalized while the community is under construction or reconstruction. We expense these costs as assets, or portions of assets, within the community are delivered and are ready for their intended use.

For Established Communities, property taxes increased $778,000 (7.2%) in the three months ended and $1,429,000 (4.4%) in the nine months ended September 30, 2003 as compared to the same periods of 2002. These increases are primarily due to higher assessments throughout all regions.

Corporate-level property management and other indirect operating expenses increased in the three months ended September 30, 2003 as a result of increased legal expenses due to construction litigation relating to a community that has completed development. The increase in corporate-level property management and other indirect operating expenses for the nine months ended September 30, 2003 is partially offset by the absence of costs associated with the implementation of a new property management leasing system in 2002, coupled with a decrease in abandoned pursuit costs. Abandoned pursuit costs related to Development Rights which are not probable for future development decreased $791,000 from $1,900,000 in the nine months ended September 30, 2002 to $1,109,000 in the nine months ended September 30, 2003.

Interest expense increased primarily due to the issuance of $300,000,000 of unsecured notes between September 2002 and September 2003, partially offset by the repayment of $250,000,000 of unsecured notes between September 2002 and September 2003 and overall lower interest rates on both short-term and long-term borrowings. In addition, higher average outstanding balances on our unsecured credit facility resulted in higher interest expense between periods.

Depreciation expense increased primarily due to 2002 acquisitions and completion of development or redevelopment activities, partially offset by communities sold in 2002 and 2003. We expect depreciation expense to continue to increase as we complete additional development and redevelopment communities, partially offset by the elimination of depreciation of communities that are sold or designated as held for sale during the remainder of the year.

General and administrative expense increased primarily as a result of an increase in our directors and officers (“D&O”) insurance which we renewed in March 2003. In the past year, the D&O market has experienced increased and high profile claim activity resulting in higher insurance premiums.

Equity in income of unconsolidated entities increased as compared to the same periods of the prior year due to our 50% share of the gain recognized on the sale of the Falkland Chase community in 2003, as well as our portion of losses recorded in 2002 for an investment in a technology company accounted for under the equity method.

Interest income during 2003 decreased due to lower average cash balances invested and lower interest rates.

Venture partner interest in profit-sharing represents the income allocated to our venture partner in a profit-sharing arrangement as discussed in Note 6, “Investments in Unconsolidated Entities,” of our Condensed Consolidated Financial Statements. The increases in both the three and nine months ended September 30, 2003 as compared to the same periods of 2002 are due to increases in the net income of the underlying real estate as the related community moved out of lease-up and achieved stabilization.

Income from discontinued operations represents the net income generated by communities held for sale as of September 30, 2003 and communities sold during the period from January 1, 2002 through September 30, 2003. The decreases in both the three and nine months ended September 30, 2003 as compared to the same periods of 2002 are primarily due to the sale of eight communities during the period from January 1, 2002 through September 30, 2003.

Gain on sale of communities of $13,575,000 and $82,158,000 were realized in the three and nine months ended September 30, 2003, respectively. These gains on the sale of communities are the result of our strategy to sell communities that do not meet our long-term strategic objectives and redeploy the proceeds to current Development and Redevelopment Communities and for general corporate purposes. The amount of gains realized depend on many factors, including the number of communities sold, the size and carrying value of those communities and the market conditions in the local area. We have completed three additional dispositions subsequent to September 30, 2003.

We consider Funds from Operations (“FFO”) to be an appropriate supplemental measure of our operating and financial performance because, by excluding gains or losses related to dispositions of property and excluding real estate depreciation, which can vary among owners of identical assets in similar condition based on historical cost accounting and useful life estimates, FFO can help one compare the operating performance of a company’s real estate between periods or as compared to different companies. We believe that in order to understand our operating results, FFO should be examined with net income as presented in the Condensed Consolidated Statements of Operations and Other Comprehensive Income included elsewhere in this report.

Consistent with the definition adopted by the Board of Governors of the National Association of Real Estate Investment Trusts^®, we calculate FFO as net income or loss computed in accordance with GAAP, adjusted for:

	•		gains or losses on sales of property;
	•		extraordinary gains or losses (as defined by GAAP);
	•		depreciation of real estate assets; and
	•		adjustments for unconsolidated partnerships and joint ventures.

FFO does not represent net income in accordance with GAAP, and therefore it should not be considered an alternative to net income, which remains the primary measure, as an indication of our performance. In addition, FFO as calculated by other REITs may not be comparable to our calculation of FFO. The following is a reconciliation of net income to FFO (dollars in thousands):

FFO also does not represent cash generated from operating activities in accordance with GAAP, and therefore should not be considered an alternative to net cash flows from operating activities, as determined by GAAP, as a measure of liquidity. Additionally, it is not necessarily indicative of cash available to fund cash needs. A presentation of GAAP based cash flow metrics is as follows (dollars in thousands):

Our policy with respect to capital expenditures is generally to capitalize only non-recurring expenditures. We capitalize improvements and upgrades only if the item:

	•		exceeds $15,000;
	•		extends the useful life of the asset; and
	•		is not related to making an apartment home ready for the next resident.

Under this policy, virtually all capitalized costs are non-recurring, as recurring make-ready costs are expensed as incurred. Recurring make-ready costs include the following:

	•		carpet and appliance replacements;
	•		floor coverings;
	•		interior painting; and
	•		other redecorating costs.

We capitalize purchases of personal property, such as computers and furniture, only if the item is a new addition and the item exceeds $2,500. We generally expense purchases of personal property made for replacement purposes. For Established and Other Stabilized Communities, we recorded non-revenue generating capitalized expenditures of approximately $252 per apartment home in the nine months ended September 30, 2003 and $213 per apartment home in the nine months ended September 30, 2002. The average maintenance costs charged to expense, including carpet and appliance replacements, related to these communities was $959 per apartment home in the nine months ended September 30, 2003 and $902 in the same period of 2002. We anticipate that capitalized costs per apartment home will gradually increase as the average age of our communities increases. We expect expensed maintenance costs to increase as the average age of our communities increases, and to fluctuate with changes in turnover.

Liquidity. The primary source of liquidity is our cash flows from operations. Operating cash flows have historically been determined by:

	•		the number of apartment homes;
	•		rental rates;
	•		occupancy levels; and
	•		our expenses with respect to these apartment homes.

The timing, source and amount of cash flows provided by financing activities and used in investing activities are sensitive to the capital markets environment, particularly to changes in interest rates. Changes in the capital markets environment affect our plans for undertaking construction and development as well as acquisition and disposition activity.

Cash and cash equivalents totaled $6,771,000 at September 30, 2003, a decrease of $6,145,000 from $12,916,000 on December 31, 2002. The following discussion relates to changes in cash due to operating, investing and financing activities, which are presented in our Condensed Consolidated Statements of Cash Flows included elsewhere in this report.

Operating Activities – Net cash provided by operating activities decreased to $164,540,000 for the nine months ended September 30, 2003 from $220,152,000 for the nine months ended September 30, 2002, primarily due to the absence of business interruption insurance proceeds, the decline in NOI from Established Communities and the loss of NOI from communities sold, partially offset by additional NOI from recently developed and redeveloped communities.

Investing Activities – Net cash used in investing activities of $40,785,000 in the nine months ended September 30, 2003 related to investments in assets through development and redevelopment of apartment communities, partially offset by proceeds from the sale of nine apartment communities, including one community previously held through an equity investment.

During the nine months ended September 30, 2003, we invested $286,032,000 in the purchase and development of real estate and capital expenditures.

•

We began the development of four new communities. These communities, if developed as expected, will contain a total of 1,265 apartment homes, and the total capital cost, including land acquisition costs, is projected to be approximately $180,700,000. We also completed the development of five communities containing a total of 1,442 apartment homes for a total capital cost, including land acquisition cost, of $274,600,000.

•

We had capital expenditures relating to current communities’ real estate assets of $7,422,000 and non-real estate capital expenditures of $383,000.

The development and redevelopment of communities involve risks that the investment will fail to perform in accordance with expectations. See “Risks of Development and Redevelopment” included elsewhere in this report for our discussion of these and other risks inherent in developing or redeveloping communities.

We sold nine communities during the nine months ended September 30, 2003, generating net proceeds of $252,528,000. These proceeds are being used to develop new communities and to partially repay amounts outstanding under our variable rate unsecured credit facility, which is discussed below.

Financing Activities – Net cash used in financing activities totaled $129,900,000 for the nine months ended September 30, 2003, primarily due to the redemption of preferred stock, dividends paid, repayment of certain unsecured notes and common stock repurchases, partially offset by an increase in borrowings under our unsecured credit facility, the issuance of mortgage notes payable and an issuance of common stock. See Note 3, “Notes Payable, Unsecured Notes and Credit Facility,” and Note 4, “Stockholders’ Equity,” in our Condensed Consolidated Financial Statements, for additional information.

We regularly review our short and long-term liquidity needs, the adequacy of cash flow from operations, and other expected liquidity sources to meet these needs. We believe our principal short-term liquidity needs are to fund:

	•		normal recurring operating expenses;
	•		debt service and maturity payments;
	•		the distributions required with respect to preferred stock and DownREIT partnership units;
	•		the minimum dividend payments required to maintain our REIT qualification under the Internal Revenue Code of 1986;
	•		opportunities for the acquisition of improved property; and
	•		development and redevelopment activity in which we are currently engaged.

We anticipate that we can fully satisfy these needs from a combination of cash flows provided by operating activities, proceeds from asset dispositions and borrowing capacity under the unsecured credit facility.

One of our principal long-term liquidity needs is the repayment of medium and long-term debt at the time that such debt matures. For unsecured notes, we anticipate that no significant portion of the principal of these notes will be repaid prior to maturity. On January 15, 2003, $50,000,000 principal amount of unsecured notes with an annual interest rate of 6.25% matured and was paid, as well as the balance of accrued interest. On July 15, 2003, $100,000,000 principal amount of unsecured notes with an annual interest rate of 6.5% matured and was paid, as well as the balance of accrued interest. In February 2004, we have $125,000,000 in unsecured notes with an annual interest rate of 6.58% maturing. If we do not have funds on hand sufficient to repay our indebtedness as it becomes due, it will be necessary for us to refinance the debt. This refinancing may be accomplished by uncollateralized private or public debt offerings, additional debt financing that is collateralized by mortgages on individual communities or groups of communities, draws on our unsecured credit facility or by additional equity offerings. We also anticipate having retained cash flow available in each year so that when a debt obligation matures, a

portion of each maturity can be satisfied from this retained cash. Although we believe we will have the capacity to meet our long-term liquidity needs, we cannot assure you that additional debt financing or debt or equity offerings will be available or, if available, that they will be on terms we consider satisfactory.

Capital Resources. We intend to match the long-term nature of our real estate assets with long-term cost-effective capital to the extent permitted by prevailing market conditions. From January 1, 2000 through November 3, 2003, we issued $1,100,000,000 of unsecured notes through public offerings. We expect the issuance of debt securities, together with cash flow from operating activities, dispositions, and other sources of capital, to remain available to meet our capital needs for the foreseeable future, although no assurance can be provided that the debt capital markets will remain available or that such debt will be available on attractive terms.

We have a $500,000,000 revolving variable rate unsecured credit facility with J.P. Morgan Chase and Fleet National Bank serving as co-agents for a syndicate of commercial banks. Under the terms of the credit facility, if we elect to increase the facility by up to an additional $150,000,000, and one or more banks (from the syndicate or otherwise) voluntarily agree to provide the additional commitment, then we will be able to increase the facility up to $650,000,000, and no member of the syndicate of banks can prohibit such increase; such an increase in the facility will only be effective to the extent banks (from the syndicate or otherwise) choose to commit to lend additional funds. We pay participating banks, in the aggregate, an annual facility fee of approximately $750,000 in quarterly installments. The unsecured credit facility bears interest at varying levels based on the London Interbank Offered Rate (“LIBOR”), rating levels achieved on our unsecured notes and on a maturity schedule selected by us. The current stated pricing is LIBOR plus 0.60% per annum (1.72% on November 3, 2003). Pricing could vary if there is a change in rating by either of the two leading national rating agencies; a change in rating of one level would impact the unsecured credit facility pricing by 0.05% to 0.15%. A competitive bid option is available for borrowings of up to $400,000,000. This option allows banks that are part of the lender consortium to bid to provide us loans at a rate that is lower than the stated pricing provided by the unsecured credit facility. The competitive bid option may result in lower pricing if market conditions allow. We had no outstanding balance under this competitive bid option at November 3, 2003. We are subject to (i) certain customary covenants under the unsecured credit facility, including, but not limited to, maintaining certain maximum leverage ratios, a minimum fixed charges coverage ratio and minimum unencumbered assets and equity levels, and (ii) prohibitions on paying dividends in amounts that exceed 95% of our FFO, except as may be required to maintain our REIT status. The existing facility matures in May 2005 assuming exercise of a one-year renewal at our option. At November 3, 2003, $55,100,000 was outstanding, $18,714,000 was used to provide letters of credit and $426,186,000 was available for borrowing under the unsecured credit facility.

We are not a party to any long-term interest rate agreements, other than interest rate protection and swap agreements on approximately $165,000,000 of our variable rate tax-exempt indebtedness. We intend, however, to evaluate the need for long-term interest rate protection agreements as interest rate market conditions dictate.

As of September 30, 2003, we had ten new communities under construction, for which a total estimated cost of $212,357,000 remained to be invested. In addition, we had two communities under reconstruction, for which a total estimated cost of $3,179,000 remained to be invested.

Substantially all of the capital expenditures necessary to complete the communities currently under construction and reconstruction will be funded from:

	•		the remaining capacity under our current $500,000,000 unsecured credit facility;
	•		the net proceeds from sales of existing communities;
	•		retained operating cash; and/or
	•		the issuance of debt or equity securities.

We expect to continue to fund development costs related to pursuing Development Rights from retained operating cash and borrowings under the unsecured credit facility. We believe these sources of capital will be adequate to take the proposed communities to the point in the development cycle where construction can begin. Before planned reconstruction activity or the construction of a Development Right begins, we intend to arrange adequate financing to complete these undertakings, although we cannot assure you that we will be able to obtain such financing. In the event that financing cannot be obtained, we may have to abandon Development Rights, write-off associated pre-development costs that were capitalized and/or forego reconstruction activity. In such instances, we will not realize the increased revenues and earnings that we expected from such Development Rights.

Our liquidity could be adversely impacted by expanding development and acquisition activities and/or reduced capital (as compared to prior years) available from asset sales. To meet the balance of our liquidity needs under such conditions, we would need to arrange additional capacity under our existing unsecured credit facility, sell additional existing communities and/or issue additional debt or equity securities. While we believe we have the financial position to expand our short-term credit capacity and support our capital markets activity, we cannot assure you that we will be successful in completing these arrangements, sales or offerings. The failure to complete these transactions on a cost-effective basis could have a material adverse impact on our operating results and financial condition, including the abandonment of Development Rights.

We sell assets and redeploy the proceeds when assets do not meet our long-term investment criteria and market conditions are favorable or when capital and real estate markets allow us to realize a portion of the value created over the past business cycle. When we decide to sell a community, we generally solicit competing bids from unrelated parties for these individual assets and consider the sales price and tax ramifications of each proposal. We intend to actively seek buyers for communities that we determine to hold for sale. We have increased our disposition program during 2003 in response to real estate and capital markets conditions, as well as strong institutional demand for product in our markets. However, we cannot assure you that assets can continue to be sold on terms that we consider satisfactory or that market conditions will continue to make the sale of assets an appealing strategy. Because the proceeds from the sale of communities may not be immediately redeployed into revenue generating assets, the immediate effect of a sale of a community is to reduce total revenues, total expenses and funds from operations. Therefore, the continuation of our disposition program in 2003 may adversely impact total revenues and funds from operations, as well as net income in periods subsequent to disposition. Since September 30, 2003, we have sold an additional three communities that were classified as held for sale on our Condensed Consolidated Financial Statements as of September 30, 2003 included elsewhere in this report. On October 15, 2003, we sold Avalon at Fair Lakes, a 234 apartment home community located in Fairfax, Virginia. On October 29, 2003, we sold Avalon Crest, a 351 apartment home community located in Fort Lee, New Jersey. We sold Avalon at Dulles, a 236 apartment home community located in Sterling, Virginia on October 30, 2003. These three communities were sold for an aggregate sales price of $159,025,000, resulting in an aggregate gain reported in accordance with GAAP of approximately $77,600,000.

We are currently considering the use of a joint venture or a joint venture investment program, pursuant to which a portion of future developments and/or current communities would be held through a partnership vehicle, although we have not definitively made such a decision. We generally employ joint ventures primarily to mitigate concentration or market risk and secondarily as a source of liquidity. Our decision whether to hold an apartment community in fee simple or to have an indirect interest in the community

through a joint venture or partnership is based on a variety of facts and considerations, including (i) the economic and tax terms required by a seller of land or of a community, who may prefer that (or who may require less payment if) the land or community is contributed to a joint venture or partnership; (ii) our desire to diversify our portfolio of communities by market, submarket and product type, which can more easily be accommodated with a given amount of capital if ownership of communities is shared through a joint venture structure; (iii) our desire at times to preserve our capital resources to maintain liquidity or balance sheet strength; and (iv) our projection, in some circumstances, that we will achieve higher returns on our invested capital or reduce our risk if a joint venture or partnership vehicle is used. Each joint venture or partnership agreement will be individually negotiated, and our ability to operate and/or dispose of a community in our sole discretion may be limited to varying degrees depending on the terms of the joint venture or partnership agreement. However, we cannot assure you that we will enter into a joint venture or joint venture investment program in the future, or that, if we do, we will achieve our objectives.

We have minority interest investments in three technology companies, including Constellation Real Technologies LLC (“Constellation”), an entity formed by a number of real estate investment trusts and real estate operating companies for the purpose of investing in multi-sector real estate technology opportunities. Our original commitment to Constellation was $4,000,000 but, as a result of an agreement among the members reducing the commitment due from each member, our commitment is currently $2,600,000, of which we have contributed $1,002,000 to date. The remaining unfunded commitment of $1,598,000 is expected to be funded over the next five years. In January 2002, we invested an additional $2,300,000 in Realeum, Inc. (“Realeum”), a company involved in the development and deployment of a property management and leasing automation system. Pursuant to an agreement with Realeum, we utilize the property management and leasing automation system in exchange for payments under a licensing arrangement. Realeum is negotiating licensing arrangements with other real estate companies with which we are unaffiliated. If Realeum were to cease to support the system, we would need to evaluate whether to support the system and continue its operation or implement an alternative system. Our third technology investment is in Rent.com, an internet-based rental housing information provider. To date, we have not received any cash distributions or proceeds from these investments. We have no obligation to contribute additional funds to these technology investments, other than the commitment to Constellation as previously described.

The following table details debt maturities for the next five years, excluding the unsecured credit facility, for debt outstanding at September 30, 2003 (dollars in thousands):


			All-In			Principal	Balance outstanding					Scheduled maturities
			interest			maturity
Community			rate (1)			date	12-31-02		9-30-03			2003		2004		2005		2006		2007		Thereafter

Tax-exempt bonds
	*Fixed rate*
		Avalon at Foxchase I		5.88	%	Nov-2007	$	16,800	$	16,800	(2)	$	—	$	—	$	—	$	—	$	16,800	$	—
		Avalon at Foxchase II		5.88	%	Nov-2007		9,600		9,600	(2)		—		—		—		—		9,600		—
		Fairway Glen		5.88	%	Nov-2007		9,580		9,580	(2)		—		—		—		—		9,580		—
		CountryBrook		6.30	%	Mar-2012		18,124		17,755			127		528		562		599		638		15,301
		Waterford		5.88	%	Aug-2014		33,100		33,100	(2)		—		—		—		—		—		33,100
		Avalon at Mountain View		5.88	%	Mar-2017		18,300		18,300	(2)		—		—		—		—		—		18,300
		Avalon at Dulles (5)		7.04	%	Jul-2024		12,360		12,360			—		—		—		—		—		12,360
		Avalon at Symphony Glen		7.00	%	Jul-2024		9,780		9,780			—		—		—		—		—		9,780
		Avalon View		7.55	%	Aug-2024		17,743		17,448			103		425		455		485		518		15,462
		Avalon at Lexington		6.56	%	Feb-2025		13,784		13,556			79		326		347		368		391		12,045
		Avalon at Nob Hill		5.80	%	Jun-2025		19,457		19,228	(2)		79		331		355		380		408		17,675
		Avalon Campbell		6.48	%	Jun-2025		35,749		35,240	(2)		175		733		786		843		904		31,799
		Avalon Pacifica		6.48	%	Jun-2025		16,216		15,985	(2)		79		332		356		382		410		14,426
		Avalon Knoll		6.95	%	Jun-2026		12,978		12,807			58		246		263		282		302		11,656
		Avalon Landing		6.85	%	Jun-2026		6,417		6,330			29		124		132		142		152		5,751
		Avalon Fields		7.05	%	May-2027		11,286		11,152			47		193		207		222		239		10,244
		Avalon West		7.73	%	Dec-2036		8,461		8,413			17		70		75		80		85		8,086
		Avalon Oaks		7.45	%	Feb-2041		17,628		17,555			25		104		112		120		128		17,066
		Avalon Oaks West		7.48	%	Apr-2043		—		17,359			23		96		103		110		117		16,910

								287,363		302,348			841		3,508		3,753		4,013		40,272		249,961
	*Variable rate (4)*
		Avalon at Laguna Niguel		2.25	%	Mar-2009		10,400		10,400			—		—		—		—		—		10,400
		The Promenade		2.88	%	Jan-2010		33,670		33,432			247		522		562		605		652		30,844
		Avalon at Mission Viejo		2.03	%	Jun-2025		7,151		7,068	(3)		29		121		129		139		149		6,501
		Avalon Devonshire (5)		—		Dec-2025		27,305		—			—		—		—		—		—		—
		Avalon Greenbriar		2.15	%	May-2026		18,755		18,755			—		—		—		—		—		18,755
		Avalon at Fairway Hills I		1.90	%	Jun-2026		11,500		11,500			—		—		—		—		—		11,500

								108,781		81,155			276		643		691		744		801		78,000
Conventional loans (6)
	*Fixed rate*
		$50 Million unsecured notes		6.25	%	Jan-2003		50,000		—			—		—		—		—		—		—
		$100 Million unsecured notes		6.50	%	Jul-2003		100,000		—			—		—		—		—		—		—
		$125 Million unsecured notes		6.58	%	Feb-2004		125,000		125,000			—		125,000		—		—		—		—
		$100 Million unsecured notes		6.625	%	Jan-2005		100,000		100,000			—		—		100,000		—		—		—
		$50 Million unsecured notes		6.50	%	Jan-2005		50,000		50,000			—		—		50,000		—		—		—
		$150 Million unsecured notes		6.80	%	Jul-2006		150,000		150,000			—		—		—		150,000		—		—
		$150 Million unsecured notes		5.00	%	Aug-2007		150,000		150,000			—		—		—		—		150,000		—
		$110 Million unsecured notes		6.875	%	Dec-2007		110,000		110,000			—		—		—		—		110,000		—
		$50 Million unsecured notes		6.625	%	Jan-2008		50,000		50,000			—		—		—		—		—		50,000
		$150 Million unsecured notes		8.25	%	Jul-2008		150,000		150,000			—		—		—		—		—		150,000
		$150 Million unsecured notes		7.50	%	Aug-2009		150,000		150,000			—		—		—		—		—		150,000
		$200 Million unsecured notes		7.50	%	Dec-2010		200,000		200,000			—		—		—		—		—		200,000
		$300 Million unsecured notes		6.625	%	Sep-2011		300,000		300,000			—		—		—		—		—		300,000
		$50 Million unsecured notes		6.625	%	Sep-2011		50,000		50,000			—		—		—		—		—		50,000
		$250 Million unsecured notes		6.125	%	Nov-2012		250,000		250,000			—		—		—		—		—		250,000
		Avalon at Pruneyard		7.25	%	May-2004		12,870		12,870			—		12,870		—		—		—		—
		Avalon Walk II		8.93	%	Aug-2004		11,748		11,516			83		11,433		—		—		—		—
		Avalon Orchards		7.65	%	Jul-2033		—		20,627			53		222		237		254		272		19,589

								2,009,618		1,880,013			136		149,525		150,237		150,254		260,272		1,169,589
	*Variable rate (4)*
		Avalon on the Sound (7)		2.67	%	Apr-2004		36,089		36,629			—		36,629		—		—		—		—

Total indebtedness — excluding unsecured credit facility							$	2,441,851	$	2,300,145		$	1,253	$	190,305	$	154,681	$	155,011	$	301,345	$	1,497,550

(1)		Includes credit enhancement fees, facility fees, trustees’ fees, etc.

(2)		Financed by variable rate tax-exempt debt, but interest rate is effectively fixed at present at the rate indicated through a swap agreement. The weighted average maturity of these swap agreements is 2.9 years.

(3)		Financed by variable rate tax-exempt debt, but interest rate is capped through an interest rate cap agreement. The remaining term of this interest rate cap agreement is 3.9 years.

(4)		Variable rates are given as of September 30, 2003.

(5)		Included in liabilities related to real estate assets held for sale on our Condensed Consolidated Balance Sheets included elsewhere in this report.

(6)		Balances outstanding do not include $298 and $342 as of September 30, 2003 and December 31, 2002, respectively, of debt premium reflected in unsecured notes on our Condensed Consolidated Balance Sheets included elsewhere in this report.

(7)		Variable rate construction loan matured in December 2002 and was refinanced in April 2003, extending the maturity date to April 2004, with a one-year extension available to April 2005.

We own interests in unconsolidated real estate entities, with ownership interests up to 50%. However, based on the provisions of the related partnership or limited liability company agreements, which grant varying degrees of control, we are not deemed to have control of these entities sufficient to require or permit consolidation for accounting purposes. One of these unconsolidated real estate entities has debt outstanding of $22,500,000 as of September 30, 2003, which matures in 2005 and is payable by the unconsolidated real estate entity with operating cash flow from the underlying real estate. We have not guaranteed this debt, nor do we have any obligation to fund this debt should the unconsolidated real estate entity be unable to do so. There are no lines of credit, side agreements, financial guarantees, or any other derivative financial instruments related to or between us and our unconsolidated real estate entities. In evaluating our capital structure and overall leverage, management takes into consideration our proportionate share of this unconsolidated debt. For more information regarding the operations of this unconsolidated entity see Note 6, “Investments in Unconsolidated Entities,” of our Condensed Consolidated Financial Statements.

In July 2002, we announced that our Board of Directors had authorized a common stock repurchase program, under which we may acquire shares of our common stock in open market or negotiated transactions. Actual purchases of stock will vary with market conditions. The stock repurchase program was designed so that retained cash flow, as well as the proceeds from sales of existing apartment communities and a reduction in planned acquisitions, will provide the source of funding for the program, with our unsecured credit facility providing temporary funding as needed. Through November 3, 2003, we have acquired 2,380,600 shares of common stock at an aggregate cost of $89,566,000 under this program. Of the aggregate shares repurchased, we repurchased 1,099,000 during the period from January 1, 2003 through November 3, 2003, at an average purchase price of $36.24 per share. We have not repurchased any shares of common stock since March 31, 2003.

During the three months ended September 30, 2003, we completed a common stock offering totaling 2,804,700 shares at a public offering price of $46.00 per share. The net proceeds from this offering, after underwriting discounts and commissions, of approximately $127,333,000 were used to repay a portion of amounts outstanding on the unsecured credit facility and for general corporate purposes.

On March 20, 2003, we redeemed all 3,267,700 outstanding shares of our 8.00% Series D Cumulative Redeemable Preferred Stock at a price of $25.00 per share, plus $0.0167 in accrued and unpaid dividends, for an aggregate redemption price of $81,747,000, including accrued dividends of $54,000. The redemption price was funded by the sale on March 18, 2003 of 3,336,611 shares of Series J Cumulative Redeemable Preferred Stock through a private placement to an institutional investor for a net purchase price of $81,737,000. The dividend rate on such shares was initially equal to 2.78% per annum (three-month LIBOR plus 1.5%) of the liquidation preference. As permitted under the terms of such preferred stock, we redeemed all of the Series J Cumulative Redeemable Preferred Stock on May 9, 2003, for an aggregate redemption price of $82,207,000, including dividends of $251,000.

We currently have the following series of redeemable preferred stock outstanding at an aggregate stated value of $100,000,000. This series has no stated maturity and is not subject to any sinking fund or mandatory redemptions.

Substantially all of our apartment leases are for a term of one year or less. In the event of significant inflation, this may enable us to realize increased rents upon renewal of existing leases or the beginning of new leases. Short-term leases generally minimize our risk from the adverse effects of inflation, although these leases generally permit residents to leave at the end of the lease term without penalty and therefore expose us to the effect of a decline in market rents. In a deflationary rent environment, as is currently being experienced, we are exposed to declining rents more quickly under these shorter-term leases.

We carry commercial general liability insurance, property insurance and terrorism insurance with respect to all of our communities. These policies, and other insurance policies we carry, have policy specifications, insured limits and deductibles that we consider commercially reasonable. There are, however, certain types of losses (such as losses arising from acts of war) that are not insured, in full or in part, because they are either uninsurable or the cost of insurance makes it, in management’s view, economically impractical. If an uninsured property loss or a property loss in excess of insured limits were to occur, we could lose our capital invested in a community, as well as the anticipated future revenues from such community. We would also continue to be obligated to repay any mortgage indebtedness or other obligations related to the community. If an uninsured liability to a third party were to occur, we would incur the cost of defense and settlement with, or court ordered damages to, that third party. A significant uninsured property or liability loss could materially and adversely affect our business and our financial condition and results of operations.

Many of our West Coast communities are located in the general vicinity of active earthquake faults. A large concentration of our communities lie near, and thus are susceptible to, the major fault lines in the San Francisco Bay Area, including the San Andreas fault and the Hayward fault. We cannot assure you that an earthquake would not cause damage or losses greater than insured levels. In July 2003, we renewed our earthquake insurance. We have in place with respect to communities located in California, for any single occurrence and in the aggregate, $75,000,000 of coverage with a deductible per building equal to five percent of the insured value of that building. The five percent deductible is subject to a minimum of $100,000 per occurrence. Earthquake coverage outside of California is subject to a $100,000,000 limit, except with respect to the state of Washington, for which the limit is $65,000,000. Our earthquake insurance outside of California provides for a $100,000 deductible per occurrence. In addition, up to an annual aggregate of $2,000,000, the next $400,000 of loss per occurrence outside California will be treated as an additional deductible.

Our annual general liability policy and workman’s compensation coverage was renewed on August 1, 2003. Although the insurance coverage provided for in the renewal policies did not materially change from the preceding year, the level of our deductible and premium costs has increased. Including the costs we may incur as a result of deductibles, we expect the cost related to these insurance categories for the policy period from August 1, 2003 to July 31, 2004 to increase approximately $500,000 as compared to the prior period.

Our property insurance policy was scheduled to renew on November 1, 2003; however, in an effort to capitalize on declining insurance rates we elected to renew effective July 31, 2003 with an expiration date of February 1, 2005. Based on this renewal, we expect a decline in property insurance premiums, which will result in flat or declining overall insurance costs as compared to prior periods.

Just as with office buildings, transportation systems and government buildings, there have been recent reports that apartment communities could become targets of terrorism. In November 2002, Congress passed the Terrorism Risk Insurance Act (“TRIA”) which is designed to make terrorism insurance available. In connection with this legislation, we have purchased insurance for property damage due to terrorism up to $200,000,000. Additionally, we have purchased insurance for certain terrorist acts, not covered under TRIA, such as domestic based terrorism. This insurance, often referred to as “non certified” terrorism insurance is subject to deductibles and exclusions. Our general liability policy provides TRIA coverage (subject to deductibles and insured limits) for liability to third parties that result from terrorist acts at our communities.

Mold growth may occur when excessive moisture accumulates in buildings or on building materials, particularly if the moisture problem remains undiscovered or is not addressed over a period of time. Although the occurrence of mold at multifamily and other structures, and the need to remediate such mold, is not a new phenomenon, there has been increased awareness in recent years that certain molds may in some instances lead to adverse health effects, including allergic or other reactions. To help limit mold growth, we educate residents about the importance of adequate ventilation and request or require that they notify us when they see mold or excessive moisture. We have established procedures for promptly addressing and remediating mold or excessive moisture from apartment homes when we become aware of its presence regardless of whether we or the resident believe a health risk is presented. However, we cannot assure that mold or excessive moisture will be detected and remediated in a timely manner. If a significant mold problem arises at one of our communities, we could be required to undertake a costly remediation program to contain or remove the mold from the affected community and could be exposed to other liabilities. We cannot assure that we will have coverage under our existing policies for property damage or liability to third parties arising as a result of exposure to mold or a claim of exposure to mold at one of our communities.

In March 2003, we renewed our D&O insurance. In the past year, the D&O insurance market has experienced increased and high profile claim activity. Our costs for this insurance increased by approximately $300,000 at renewal.

Our accounting policies are in conformity with GAAP. The preparation of financial statements in conformity with GAAP requires management to use judgment in the application of accounting policies, including making estimates and assumptions. These judgments 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. If our judgment or interpretation of the facts and circumstances relating to various transactions had been different, it is possible that different accounting policies would have been applied resulting in a different presentation of our financial statements. Below is a discussion of accounting policies which we consider critical in that they may require complex judgment in their application or require estimates about matters which are inherently uncertain. Additional discussion of accounting policies which we consider significant, including further discussion of the critical accounting policies described below, can be found in the Notes to our Condensed Consolidated Financial Statements.

We capitalize pre-development costs incurred in pursuit of Development Rights for which we currently believe future development is probable. These costs include legal fees, design fees and related overhead costs. Future development of these Development Rights is dependent upon various factors, including

zoning and regulatory approval, rental market conditions, construction costs and availability of capital. Pre-development costs incurred in the pursuit of Development Rights for which future development is not yet considered probable are expensed as incurred. In addition, if the status of a Development Right changes, deeming future development no longer probable, any capitalized pre-development costs are written-off with a charge to expense.

Rental income related to leases is recognized on an accrual basis when due from residents in accordance with SEC Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements.” In accordance with our standard lease terms, rental payments are generally due on a monthly basis. Any cash concessions given at the inception of the lease are amortized over the approximate life of the lease – generally one year.

If there is an event or change in circumstance that indicates an impairment in the value of a community, our policy is to assess the impairment by making a comparison of the current and projected operating cash flows of the community over its remaining useful life, on an undiscounted basis, to the carrying amount of the community. If the carrying amount is in excess of the estimated projected operating cash flows of the community, we would recognize an impairment loss equivalent to an amount required to adjust the carrying amount to its estimated fair market value.

On January 1, 2002, we adopted Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” which requires that the assets and liabilities and the results of operations of any communities which have been sold since January 1, 2002, or otherwise qualify as held for sale as of September 30, 2003, be presented as discontinued operations in our Condensed Consolidated Financial Statements in both current and prior periods presented. The community specific components of net income that are presented as discontinued operations include net operating income, depreciation expense, minority interest and interest expense. In addition, the net gain or loss (including any impairment loss) on the eventual disposal of communities held for sale is presented as discontinued operations when recognized. Real estate assets held for sale are measured at the lower of the carrying amount or the fair value less the cost to sell, and are presented separately in our Condensed Consolidated Balance Sheets. Subsequent to classification of a community as held for sale, no further depreciation is recorded on the assets.

We account for our investments in technology companies in accordance with Accounting Principles Board (“APB”) Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock.” If there is an event or change in circumstance that indicates a loss in the value of an investment, our policy is to record the loss and reduce the value of the investment to its fair value. A loss in value would be indicated if we could not recover the carrying value of the investment or if the investee could not sustain an earnings capacity that would justify the carrying amount of the investment. Due to the nature of these investments, an impairment in value can be difficult to determine.

Prior to 2003, we applied the intrinsic value method as provided in APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations, in accounting for employee stock options. No stock-based employee compensation cost related to employee stock options is reflected in net income for the three and nine months ended September 30, 2002, as all options granted had an exercise price equal to the market value of the underlying common stock on the date of grant. Effective January 1, 2003, we adopted the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” as amended by SFAS No. 148, “Accounting for Stock-Based Compensation – Transition

and Disclosure – an amendment of FASB Statement No. 123,” prospectively to all employee awards granted, modified, or settled on or after January 1, 2003. Awards under stock option plans vest over periods ranging from one to three years. Therefore, the cost related to stock-based employee compensation for employee stock options included in the determination of net income for the three and nine months ended September 30, 2003 is less than that which would have been recognized if the fair value based method had been applied to all awards since the original effective date of SFAS No. 123.

We are subject to various legal proceedings and claims that arise in the ordinary course of business. These matters are frequently covered by insurance. While the resolution of these matters cannot be predicted with certainty, we believe the final outcome of such matters will not have a material adverse effect on our financial position or the results of operations. Once it has been determined that a loss is probable to occur, the estimated amount of the loss is recorded in the financial statements. Both the amount of the loss and the point at which its occurrence is considered probable can be difficult to determine.

As of November 3, 2003, we had ten Development Communities under construction. We expect these Development Communities, when completed, to add a total of 3,250 apartment homes to our portfolio for a total capital cost, including land acquisition costs, of approximately $552,500,000. Statements regarding the future development or performance of the Development Communities are forward-looking statements. We cannot assure you that:

•

we will complete the Development Communities;

•

our budgeted costs or estimates of occupancy rates will be realized;

•

our schedule of leasing start dates, construction completion dates or stabilization dates will be achieved; or

•

future developments will realize returns comparable to our past developments.

You should carefully review the discussion under “Risks of Development and Redevelopment” included elsewhere in this report.

The following table presents a summary of the Development Communities. We hold a direct or indirect fee simple ownership interest in these communities except where noted.

Total

Number of

capital

Estimated

apartment

cost (1)

Construction

Initial

completion

stabilization

homes

($ millions)

start

occupancy (2)

date

date (3)

Avalon Glendale
Glendale, CA

223

40.4

Q1 2002

Q2 2003

Q1 2004

Q3 2004

Avalon at Grosvenor Station (4)
North Bethesda, MD

497

82.3

Q1 2002

Q3 2003

Q4 2004

Q2 2005

Avalon at Newton Highlands (4)
Newton, MA

294

58.7

Q2 2002

Q2 2003

Q1 2004

Q3 2004

Avalon at Glen Cove South
Glen Cove, NY

256

62.6

Q3 2002

Q1 2004

Q2 2004

Q4 2004

Avalon at Steven’s Pond
Saugus, MA

326

55.4

Q3 2002

Q1 2003

Q2 2004

Q4 2004

Avalon Darien
Darien, CT

189

43.6

Q4 2002

Q2 2003

Q3 2004

Q1 2005

Avalon Traville (5)
North Potomac, MD

520

71.5

Q4 2002

Q3 2003

Q1 2005

Q3 2005

Avalon Run East II
Lawrenceville, NJ

312

49.3

Q2 2003

Q3 2004

Q1 2005

Q3 2005

Avalon at Crane Brook
Danvers & Peabody, MA

387

56.2

Q3 2003

Q3 2004

Q2 2005

Q4 2005

10.

Avalon Milford I
Milford, CT

246

32.5

Q3 2003

Q3 2004

Q1 2005

Q3 2005

Total

3,250

552.5

(1)		Total capital cost includes all capitalized costs projected to be or actually incurred to develop the respective Development Community, determined in accordance with GAAP, including land acquisition costs, construction costs, real estate taxes, capitalized interest and loan fees, permits, professional fees, allocated development overhead and other regulatory fees.

(2)		Future initial occupancy dates are estimates.

(3)		Stabilized operations is defined as the earlier of (i) attainment of 95% or greater physical occupancy or (ii) the one-year anniversary of completion of development.

(4)		The community is owned by a DownREIT partnership in which one of our wholly-owned subsidiaries is the general partner with a majority interest. This community is consolidated for financial reporting purposes.

(5)		This is a two-phase community for which construction of the second phase commenced in the second quarter of 2003.

As of November 3, 2003, we had two communities under redevelopment. We expect the total capital cost to complete these communities, including the cost of acquisition, capital expenditures subsequent to acquisition and redevelopment, to be approximately $199,900,000, of which approximately $30,300,000 is the additional capital invested or expected to be invested during redevelopment and $5,800,000 has been invested since acquisition unrelated to redevelopment. Statements regarding the future redevelopment or performance of the Redevelopment Communities are forward-looking statements. We have found that the cost to redevelop an existing apartment community is more difficult to budget and estimate than the cost to develop a new community. Accordingly, we expect that actual costs may vary from our budget by a wider range than for a new development community. We cannot assure you that we will meet our schedules for reconstruction completion or restabilized operations, or that we will meet our budgeted costs, either individually or in the aggregate. See the discussion under “Risks of Development and Redevelopment” included elsewhere in this report.

(1)		Acquisition cost includes capital expenditures subsequent to acquisition unrelated to redevelopment.

(2)		Total capital cost includes all capitalized costs projected to be or actually incurred to redevelop the respective Redevelopment Community, including costs to acquire the community, reconstruction costs, real estate taxes, capitalized interest and loan fees, permits, professional fees, allocated redevelopment overhead and other regulatory fees determined in accordance with GAAP.

(3)		Reconstruction completion dates are estimates.

(4)		Restabilized operations is defined as the earlier of (i) attainment of 95% or greater physical occupancy or (ii) the one-year anniversary of completion of redevelopment.

As of November 3, 2003, we are considering the development of 41 new apartment communities on land that is either owned by us, under contract, subject to a leasehold interest or for which we hold a purchase option. We generally hold Development Rights through options to acquire land, although for 12 of the Development Rights we currently own the land on which a community would be built if we proceeded with development. The Development Rights range from those beginning design and architectural planning to those that have completed site plans and drawings and can begin construction almost immediately. We estimate that the successful completion of all of these communities would ultimately add 10,326 upscale apartment homes to our portfolio. Substantially all of these apartment homes will offer features like those offered by the communities we currently own. At September 30, 2003, there were cumulative capitalized costs (including legal fees, design fees and related overhead costs, but excluding land costs) of $26,610,000 relating to Development Rights. In addition, land costs related to the pursuit of Development Rights (consisting of original land and additional carrying costs) of $116,556,000 are reflected as land held for development on the accompanying Condensed Consolidated Balance Sheets as of September 30, 2003.

The properties comprising the Development Rights are in different stages of the due diligence and regulatory approval process. The decisions as to which of the Development Rights to pursue, if any, or to continue to pursue once an investment in a Development Right is made, are business judgments that we make after we perform financial, demographic and other analyses. In the event that we do not proceed with a Development Right, we generally would not recover capitalized costs incurred in the pursuit of those communities, unless we were to recover amounts in connection with the sale of land; however, we

cannot guarantee a recovery. Pre-development costs incurred in the pursuit of Development Rights for which future development is not yet considered probable are expensed as incurred. In addition, if the status of a Development Right changes, deeming future development no longer probable, any capitalized pre-development costs are written-off with a charge to expense.

Because we intend to limit the percentage of debt used to finance new developments, other financing alternatives may be required to help finance the development of those Development Rights scheduled to start construction after September 30, 2003.

Although the development of any particular Development Right cannot be assured, we believe that the Development Rights, in the aggregate, present attractive potential opportunities for future development and growth of long-term stockholder value.

Statements regarding the future development of the Development Rights are forward-looking statements. We cannot assure you that:

•

we will succeed in obtaining zoning and other necessary governmental approvals or the financing required to develop these communities, or that we will decide to develop any particular community; or

•

if we undertake construction of any particular community, that we will complete construction at the total capital cost assumed in the financial projections in the following table.

The following presents a summary of the 41 Development Rights we are currently pursuing:


					Total
			Estimated		capital
			number		cost
	Location		of homes		($ millions)

1	Coram, NY Phase I	(1)		298	$	49
2	Plymouth, MA Phase I	(1)		98		21
3	New York, NY Phase I	(1)(2)(3)		361		148
4	Kirkland, WA	(1)		211		50
5	Bedford, MA	(1)		139		21
6	Danbury, CT	(1)		234		36
7	Orange, CT	(1)		168		22
8	Seattle, WA	(1)		194		50
9	Los Angeles, CA	(1)		309		63
10	Long Island City, NY Phase II and III			552		162
11	Plymouth, MA Phase II			72		13
12	San Francisco, CA			313		100
13	Stratford, CT			146		23
14	Camarillo, CA	(1)		249		43
15	Bellevue, WA			368		71
16	Newton, MA			240		60
17	Hingham, MA			236		44
18	Quincy, MA	(1)		148		24
19	Andover, MA			115		21
20	Milford, CT			284		41
21	Dublin, CA Phase I			305		72
22	Cohasset, MA			200		38
23	New York, NY Phase II			205		88
24	Los Angeles, CA			123		36
25	Glen Cove, NY			111		31
26	New Rochelle, NY Phase II and III			588		144
27	Greenburgh, NY Phase II			766		120
28	Encino, CA			146		46
29	Coram, NY Phase II	(1)		152		26
30	Wilton, CT			100		24
31	Dublin, CA Phase II			200		47
32	Sharon, MA			190		31
33	Norwalk, CT			312		63
34	Danvers, MA			476		85
35	College Park, MD			320		44
36	Oyster Bay, NY			273		69
37	Yaphank, NY			270		41
38	New York, NY Phase III			103		46
39	West Haven, CT			170		23
40	Dublin, CA Phase III			205		49
41	Camarillo, CA			376		55

	Total			10,326	$	2,240

(1)		We own land, but construction has not yet begun.
(2)		Total capital cost for this community includes costs associated with the construction of 89,000 square feet of retail space and 30,000 square feet for a community facility.
(3)		This community will be developed under a joint venture structure with third party financing. Our portion of the Total Capital Cost for this joint venture is projected to be $30.0 million including community-based debt.

We intend to continue to pursue the development and redevelopment of apartment home communities. Our development and redevelopment activities may be exposed to the following:

•

we may abandon opportunities we have already begun to explore based on further review of, or changes in, financial, demographic, environmental or other factors;

•

we may encounter liquidity constraints, including the unavailability of financing on favorable terms for the development or redevelopment of a community;

•

we may be unable to obtain, or we may experience delays in obtaining, all necessary zoning, land-use, building, occupancy, and other required governmental permits and authorizations;

•

we may incur construction or reconstruction costs for a community that exceed our original estimates due to increased materials, labor or other expenses, which could make completion of development or redevelopment of the community uneconomical;

•

occupancy rates and rents at a newly completed development or redevelopment community may fluctuate depending on a number of factors, including competition and market and general economic conditions, and may not be sufficient to make the community profitable; and

•

we may be unable to complete construction and lease-up on schedule, resulting in increased debt service expense and construction costs.

Construction costs are projected by us based on market conditions prevailing in the community’s market at the time our budgets are prepared and reflect changes to those market conditions that we anticipated at that time. Although we attempt to anticipate changes in market conditions, we cannot predict with certainty what those changes will be. Construction costs have been increasing and, for some of our Development Communities, the total construction costs have been or are expected to be higher than the original budget. Total capital cost includes all capitalized costs projected to be incurred to develop the respective Development or Redevelopment Community, determined in accordance with GAAP, including:

•

land and/or property acquisition costs;

•

construction or reconstruction costs;

•

real estate taxes;

•

capitalized interest;

•

loan fees;

•

permits;

•

professional fees;

•

allocated development or redevelopment overhead; and

•

other regulatory fees.

Costs to redevelop communities that have been acquired have, in some cases, exceeded our original estimates and similar increases in costs may be experienced in the future. We cannot assure you that market rents in effect at the time new development communities or redevelopment communities complete lease-up will be sufficient to fully offset the effects of any increased construction or reconstruction costs.

In accordance with GAAP, we capitalize interest expense during construction or reconstruction until a building obtains a certificate of occupancy. Interest that is incurred thereafter and allocated to a completed apartment home within the community is expensed. Capitalized interest totaled $6,360,000 and $18,871,000 during the three and nine months ended September 30, 2003, respectively. Capitalized interest totaled $6,733,000 and $23,404,000 during the three and nine months ended September 30, 2002, respectively.


Item 3.	Quantitative and Qualitative Disclosures About Market Risk

	There have been no material changes to our exposures to market risk since December 31, 2002.

Item 4.	Controls and Procedures

	(a)	Evaluation of disclosure controls and procedures.

		Within the 90 days prior to the date of this report, the Company carried out an evaluation under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. We continue to review and document our disclosure controls and procedures, including our internal controls and procedures for financial reporting, and may from time to time make changes aimed at enhancing their effectiveness and to ensure that our systems evolve with our business.

	(b)	Changes in internal controls over financial reporting.

		None.

Part II. OTHER INFORMATION

Item 1.	Legal Proceedings

	We are involved in various ordinary routine litigation incidental to the conduct of our business. In addition, as reported most recently in our Form 10-Q for the quarter ended June 30, 2003, we are currently involved in litigation with York Hunter Construction, Inc. and National Union Fire Insurance Company. While the outcome of such litigation cannot be predicted with certainty, we do not expect any current litigation, including the litigation with York Hunter and National Union, to have a material effect on our business or financial condition.

Item 2.	Changes in Securities and Use of Proceeds

	During the three months ended September 30, 2003, AvalonBay issued 183,031 shares of common stock in exchange for 183,031 units of limited partnership held be certain limited partners of Avalon Grosvenor, L.P., Bay Pacific Northwest, L.P., and Avalon DownREIT V, L.P. The shares were issued in reliance on an exemption from registration under Section 4(2) of the Securities Act of 1933. AvalonBay is relying on the exemption based on factual representations received from the limited partners who received these shares.

Item 3.	Defaults Upon Senior Securities

	None.


Item 4.		Submission of Matters to a Vote of Security Holders

		None.

Item 5.		Other Information

		None.

Item 6.		Exhibits and Reports on Form 8-K

		(a) Exhibits

Exhibit No.		Description

3(i).1	—	Articles of Amendment and Restatement of Articles of Incorporation of AvalonBay Communities (the “Company”), dated as of June 4, 1998. (Incorporated by reference to Exhibit 3(i).1 to Form 10-Q of the Company filed August 14, 1998.)

3(i).2	—	Articles of Amendment, dated as of October 2, 1998. (Incorporated by reference to Exhibit 3.1(ii) to Form 8-K of the Company filed on October 6, 1998.)

3(i).3	—	Articles Supplementary, dated as of October 13, 1998, relating to the 8.70% Series H Cumulative Redeemable Preferred Stock. (Incorporated by reference to Exhibit 1 to Form 8-A of the Company filed October 14, 1998.)

3(i).4	—	Articles Supplementary of the Company relating to its Series I Cumulative Redeemable Preferred Stock. (Incorporated by reference to Exhibit 4.1 to the Company’s Form 8-K filed July 15, 2002.)

3(i).5	—	Articles Supplementary, dated as of March 17, 2003, relating to the Series J Cumulative Redeemable Preferred Stock. (Incorporated by reference to Exhibit 3(i).5 to the Company’s Form 10-Q filed August 8, 2003.)

3(ii).1	—	Amended and Restated Bylaws of the Company, as adopted by the Board of Directors on February 13, 2003. (Incorporated by reference to Exhibit 3(ii) to Form 10-K of the Company filed March 11, 2003.)

4.1	—	Indenture of Avalon Properties, Inc. (hereinafter referred to as “Avalon Properties”) dated as of September 18, 1995. (Incorporated by reference to Form 8-K of Avalon Properties dated September 18, 1995.)

4.2	—	First Supplemental Indenture of Avalon Properties dated as of September 18, 1995. (Incorporated by reference to Exhibit 4.2 to Form 10-K of the Company filed March 26, 2002.)

4.3	—	Second Supplemental Indenture of Avalon Properties dated as of December 16, 1997. (Incorporated by reference to Exhibit 4.3 to Form 10-K of the Company filed March 11, 2003.)

4.4	—	Third Supplemental Indenture of Avalon Properties dated as of January 22, 1998. (Incorporated by reference to Exhibit 4.4 to Form 10-K of the Company filed March 11, 2003.)

4.5	—	Indenture, dated as of January 16, 1998, between the Company and State Street Bank and Trust Company, as Trustee. (Incorporated by reference to Exhibit 4.5 to Form 10-K of the Company filed on March 11, 2003.)


4.6	—	First Supplemental Indenture, dated as of January 20, 1998, between the Company and the Trustee. (Incorporated by reference to Exhibit 4.6 to Form 10-K of the Company filed on March 11, 2003.)

4.7	—	Second Supplemental Indenture, dated as of July 7, 1998, between the Company and the Trustee. (Incorporated by reference to Exhibit 4.2 to Form 8-K of the Company filed on July 9, 1998.)

4.8	—	Amended and Restated Third Supplemental Indenture, dated as of July 10, 2000 between the Company and the Trustee, including forms of Floating Rate Note and Fixed Rate Note. (Incorporated by reference to Exhibit 4.4 to the Company’s Current Report on Form 8-K filed on July 11, 2000.)

4.9	—	Dividend Reinvestment and Stock Purchase Plan of the Company filed on September 14, 1999. (Incorporated by reference to Form S-3 of the Company, File No. 333-87063.)

4.10	—	Amendment to the Company’s Dividend Reinvestment and Stock Purchase Plan filed on December 17, 1999. (Incorporated by reference to the Prospectus Supplement filed pursuant to Rule 424(b)(2) of the Securities Act of 1933 on December 17, 1999.)

10.1	—	Employment Agreement, dated as of July 1, 2003, between the Company and Thomas J. Sargeant. (Incorporated by reference to Exhibit 10.1 of Form S-3 of the Company, File No. 333-103755.)

12.1	—	Statements re: Computation of Ratios. (Filed herewith.)

31.1	—	Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Chief Executive Officer.) (Filed herewith.)

31.2	—	Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (Chief Financial Officer.) (Filed herewith.)

32	—	Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Chief Executive Officer and Chief Financial Officer). (Filed herewith.)

		(b) Reports on Form 8-K

		On August 15, 2003, the Company filed a Report on Form 8-K to report, under Item 5 of such form, the commencement and pricing of an offering of 2,750,000 shares of its common stock.

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


		For the three months ended						For the nine months ended

		9-30-03			9-30-02			9-30-03			9-30-02

Net income available to common stockholders, as reported		$	55,212		$	24,685		$	162,673		$	92,689
Add: Actual compensation expense recorded under fair value based method, net of related tax effects			72			—			172			—
Deduct: Total compensation expense determined under fair value based method, net of related tax effects			(550	)		(718	)		(1,785	)		(2,275	)

Pro forma net income available to common stockholders		$	54,734		$	23,967		$	161,060		$	90,414

Earnings per share:

	Basic — as reported	$	0.80		$	0.36		$	2.40		$	1.34

	Basic — pro forma	$	0.79		$	0.35		$	2.37		$	1.31

	Diluted — as reported	$	0.79		$	0.35		$	2.35		$	1.32

	Diluted — pro forma	$	0.78		$	0.34		$	2.33		$	1.29


		9-30-03		12-31-02

Fixed rate unsecured notes (1)		$	1,835,298	$	1,985,342
Fixed rate mortgage notes payable — conventional and tax-exempt			347,361		311,981
Variable rate mortgage notes payable — tax-exempt (2)			81,155		108,781

	Total notes payable and unsecured notes		2,263,814		2,406,104

Variable rate secured short-term construction loan			36,629		36,089
Variable rate unsecured credit facility			149,350		28,970

	Total mortgage notes payable, unsecured notes and unsecured credit facility	$	2,449,793	$	2,471,163


		(Unaudited)

		9-30-03		12-31-02

Assets:
Real estate, net		$	120,402	$	122,577
Other assets			2,103		2,544

	Total assets	$	122,505	$	125,121

Liabilities and partners’ equity:
Mortgage notes payable		$	22,500	$	22,500
Other liabilities			2,329		3,369
Partners’ equity			97,676		99,252

	Total liabilities and partners’ equity	$	122,505	$	125,121


	For the three months ended						For the nine months ended
	(unaudited)						(unaudited)

	9-30-03			9-30-02			9-30-03			9-30-02

Rental income	$	5,291		$	5,560		$	16,572		$	15,692
Operating and other expenses		(2,099	)		(2,006	)		(5,430	)		(5,928	)
Interest expense, net		(442	)		(358	)		(1,256	)		(1,247	)
Depreciation expense		(993	)		(958	)		(2,769	)		(2,993	)

Net income	$	1,757		$	2,238		$	7,117		$	5,524


	For the three months ended						For the nine months ended
	(unaudited)						(unaudited)

	9-30-03			9-30-02			9-30-03			9-30-02

Rental income	$	3,829		$	12,703		$	21,545		$	38,617
Operating and other expenses		(1,327	)		(4,585	)		(8,556	)		(13,243	)
Interest expense, net		(224	)		(437	)		(1,040	)		(1,302	)
Minority interest expense		—			(201	)		(389	)		(603	)
Depreciation expense		—			(2,219	)		(1,559	)		(7,300	)

Income from discontinued operations	$	2,278		$	5,261		$	10,001		$	16,169


Maryland (State or other jurisdiction of incorporation or organization)		77-0404318 (I.R.S. Employer Identification No.)

(1)		Balances at September 30, 2003 and December 31, 2002 include $298 and $342, respectively, of debt premium received at issuance of unsecured notes.

(2)		Balances at September 30, 2003 and December 31, 2002 include $12,360 and $39,665, respectively, related to real estate assets held for sale.


		Secured notes		Secured notes		Unsecured notes		Interest rate of
Year		payments		maturities		maturities		unsecured notes

	2003	$	1,253	$	—	$	—		—
	2004		4,570		60,735		125,000		6.580	%
	2005		4,681		—		100,000		6.625	%
							50,000		6.500	%
	2006		5,011		—		150,000		6.800	%
	2007		5,365		35,980		110,000		6.875	%
							150,000		5.000	%
	2008		5,744		—		50,000		6.625	%
							150,000		8.250	%
	2009		6,151		10,400		150,000		7.500	%
	2010		5,771		29,388		200,000		7.500	%
	2011		6,176		—		300,000		6.625	%
							50,000		6.625	%
	2012		5,948		12,095		250,000		6.125	%
Thereafter			157,326		108,551		—

		$	207,996	$	257,149	$	1,835,000

(1)		Does not include real estate assets held for sale of $91,993 and $336,024 as of September 30, 2003 and September 30, 2002, respectively.

(2)		Revenue and NOI amounts represent third-party management, accounting and developer fees which are not allocated to a reportable segment.


ITEM 2.		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS


			Number of		Number of
			communities		apartment homes

Current Communities
	Established Communities:
		Northeast		30		7,559
		Mid-Atlantic		16		4,684
		Midwest		4		1,296
		Pacific Northwest		9		2,436
		Northern California		29		8,663
		Southern California		11		3,180

		Total Established		99		27,818

	Other Stabilized Communities:
		Northeast		12		3,834
		Mid-Atlantic		3		1,312
		Midwest		—		—
		Pacific Northwest		3		723
		Northern California		3		655
		Southern California		3		1,442

		Total Other Stabilized		24		7,966

	Lease-Up Communities			7		1,935

	Redevelopment Communities			2		1,089

	Total Current Communities			132		38,808

Development Communities				10		3,250

Development Rights				41		10,326


	2003 NOI Increase (Decrease)

	For the three months			For the nine months
	ended 9-30-03			ended 9-30-03


Established Communities	$	(6,128,000	)	$	(23,546,000	)

Other Stabilized Communities		3,046,000			7,694,000

Development and Redevelopment Communities		3,869,000			12,731,000

Non-allocated		(77,000	)		(1,382,000	)


Total	$	710,000		$	(4,503,000	)


	/s/ Bryce Blair
	Bryce Blair
	Chief Executive Officer and President


	/s/ Thomas J. Sargeant
	Thomas J. Sargeant
	Executive Vice President – Chief Financial Officer