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FORM 10-K

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

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

 

For the Fiscal Year Ended DECEMBER 31, 2002

 

OR

 

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

 

Commission File Number: 0-24920

 

ERP OPERATING LIMITED PARTNERSHIP

(Exact Name of Registrant as Specified in Its Charter)

 

 

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

 

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

Yes  ý   No  o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ý

 

 

 

DOCUMENTS INCORPORATED BY REFERENCE

 

None.

 

 

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ERP OPERATING LIMITED PARTNERSHIP

 

TABLE OF CONTENTS

 

PART I.			PAGE
	Item 1.	Business	4
	Item 2.	The Properties	18
	Item 3.	Legal Proceedings	21
	Item 4.	Submission of Matters to a Vote of Security Holders	21
PART II.
	Item 5.	Market for Registrant’s Common Equity and Related Shareholder Matters	22
	Item 6.	Selected Financial Data	23
	Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	25
	Item 7A.	Quantitative and Qualitative Disclosure about Market Risk	41
	Item 8.	Financial Statements and Supplementary Data	42
	Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	42
PART III.
	Item 10.	Trustees and Executive Officers of the Registrant	43
	Item 11.	Executive Compensation	46
	Item 12.	Security Ownership of Certain Beneficial Owners and Management	54
	Item 13.	Certain Relationships and Related Transactions	56
	Item 14.	Disclosure Controls and Procedures	59
PART IV.
	Item 15.	Exhibits, Financial Statement Schedules and Reports on Form 8-K	60

 

 

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PART I

 

Item 1.  Business

 

General

 

ERP Operating Limited Partnership (“ERPOP”), an Illinois limited partnership, was formed in May 1993 to conduct the multifamily residential property business of Equity Residential (“EQR”).  EQR is a Maryland real estate investment trust (“REIT”) formed in March 1993 and is a fully integrated real estate company engaged in the acquisition, ownership, management and operation of multifamily properties.

 

EQR is the general partner of, and as of December 31, 2002, owned an approximate 92.4% ownership interest in ERPOP.  ERPOP is, directly or indirectly, a partner, member or shareholder of numerous partnerships, limited liability companies and corporations which have been established primarily to own fee simple title to multifamily properties or to conduct property management activities and other businesses related to the ownership and operation of multifamily residential real estate.  As used herein, the term “Operating Partnership” includes ERPOP and those entities owned or controlled by it.  As used herein, the term “Company” means EQR and the Operating Partnership.

 

As of December 31, 2002, the Operating Partnership owned or had investments in 1,039 properties in 36 states consisting of 223,591 units.  An ownership breakdown includes:

 

 

The “Wholly Owned Properties” are accounted for under the consolidation method of accounting.  The Operating Partnership beneficially owns 100% fee simple title to 912 of the 919 Wholly Owned Properties.  The Operating Partnership owns the building and improvements and leases the land underlying the improvements under a long-term ground lease that expires in 2066 for one property.  This one property is consolidated and reflected as a real estate asset while the ground lease is accounted for as an operating lease in accordance with Statement of Financial Accounting Standards (“SFAS”) No. 13, Accounting for Leases.  The Operating Partnership owns the debt collateralized by two properties and owns an interest in the debt collateralized by the remaining four properties.  The Operating Partnership consolidates its interest in these six properties in accordance with the accounting standards outlined in the AcSEC guidance for real estate acquisition, development and construction arrangements issued in the CPA letter dated February 10, 1986, and as such, reflects these assets as real estate in the consolidated financial statements.

 

The “Partially Owned Properties” are controlled and partially owned by the Operating Partnership but have partners with minority interests and are accounted for under the consolidation method of accounting.  The “Unconsolidated Properties” are partially owned but not controlled by the Operating Partnership.  With the exception of one property, the Unconsolidated Properties consist of investments in partnership interests and/or subordinated mortgages that are accounted for under the equity method of accounting.   The remaining one property consists of an investment in a limited liability company that, as a result of the terms of the operating agreement, is accounted for as a management contract right with all fees recognized as fee and asset management revenue.  The above table does not include various uncompleted development properties (see Item 2, “Properties – Development Projects”).

 

EQR is, together with the Operating Partnership, one of the largest publicly traded REIT’s (based on the aggregate market value of EQR’s outstanding Common Shares) and is the largest publicly traded

 

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REIT owner of multifamily properties (based on the number of apartment units wholly owned and total revenues earned).  The Operating Partnership’s corporate headquarters are located in Chicago, Illinois and the Operating Partnership also leases (under operating leases) over thirty-five divisional, regional and area property management offices throughout the United States.

 

Direct fee simple title for certain of the properties is owned by single-purpose nominee corporations, limited partnerships, limited liability companies or land trusts that engage in no business other than holding title to the property for the benefit of the Operating Partnership.  Holding title in such a manner is expected to make it less costly to transfer such property in the future in the event of a sale and should facilitate financing, since lenders often require title to a property to be held in a single purpose entity in order to isolate that property from potential liabilities of other properties.

 

The Company has approximately 6,400 employees as of March 1, 2003.  An on-site manager, who supervises the on-site employees and is responsible for the day-to-day operations of the property, directs each of the Operating Partnership’s properties.  An assistant manager and/or leasing staff generally assist the manager.  In addition, a maintenance director at each property supervises a maintenance staff whose responsibilities include a variety of tasks, including responding to service requests, preparing vacant apartments for the next resident and performing preventive maintenance procedures year-round.

 

Certain capitalized terms as used herein but not defined are defined in the Notes to Consolidated Financial Statements.

 

Business Objectives and Operating Strategies

 

The Operating Partnership seeks to maximize both current income and long-term growth in income, thereby increasing:
•		the value of the properties;
•		distributions on a per limited partnership interest (“OP Unit”) basis; and
•		partners’ value.
The Operating Partnership’s strategies for accomplishing these objectives are:
•		maintaining and increasing property occupancy while increasing rental rates;
•		controlling expenses, providing regular preventive maintenance, making periodic renovations and enhancing amenities;
•		maintaining a ratio of consolidated debt-to-total market capitalization of less than 50%;
•		strategically acquiring and disposing of properties, with an emphasis on acquiring attractive properties in high barrier to entry markets and on selling properties in low barrier to entry markets;
•		purchasing newly developed, as well as co-investing in the development of, multifamily communities;
•		entering into joint ventures related to the ownership of established properties; and
•		strategically investing in various businesses that will enhance services for the properties.

 

 

The Operating Partnership is committed to resident satisfaction by striving to anticipate industry trends and implementing strategies and policies consistent with providing quality resident services.  In addition, the Operating Partnership continuously surveys rental rates of competing properties and conducts resident satisfaction surveys to determine the factors they consider most important in choosing a particular apartment unit and/or property.

 

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Acquisition and Development Strategies

 

The Operating Partnership anticipates that future property acquisitions and developments will occur within the United States.  Management will continue to use market information to evaluate opportunities.  The Operating Partnership’s market database allows it to review the primary economic indicators of the markets where the Operating Partnership currently owns properties and where it expects to expand its operations.  Acquisitions and developments may be financed from various sources of capital, which may include retained cash flow, issuance of additional equity securities by EQR and debt securities by the Operating Partnership, sales of properties, joint venture agreements and collateralized and uncollateralized borrowings.  In addition, the Operating Partnership may acquire additional properties in transactions that include the issuance of OP Units as consideration for the acquired properties.  Such transactions may, in certain circumstances, enable the sellers to defer, in part, the recognition of taxable income or gain, which might otherwise result from the sales.

 

When evaluating potential acquisitions and developments, the Operating Partnership will consider:

 

•		the geographic area and type of community;
•		the location, construction quality, condition and design of the property;
•		the current and projected cash flow of the property and the ability to increase cash flow;
•		the potential for capital appreciation of the property;
•		the terms of resident leases, including the potential for rent increases;
•		income levels and employment growth trends in the relevant market;
•		employment and household growth and net migration of the relevant market’s population;
•		the potential for economic growth and the tax and regulatory environment of the community in which the property is located;
•		the occupancy and demand by residents for properties of a similar type in the vicinity (the overall market and submarket);
•		the prospects for liquidity through sale, financing or refinancing of the property;
•		the benefits of integration into existing operations;
•		barriers to entry that would limit competition (zoning laws, building permit availability, supply of undeveloped or developable real estate, local building costs and construction labor costs among other factors);
•		purchase prices and yields of available existing stabilized communities, if any; and
•		competition from existing multifamily properties, residential properties under development and the potential for the construction of new multifamily properties in the area.

 

 

Disposition Strategies

 

Management uses market information to evaluate dispositions.  Factors the Operating Partnership considers in deciding whether to dispose of its properties include the following:

 

•		potential increases in new construction;
•		submarkets that will underperform the average performance of the portfolio in the mid and long-term;
•		markets where the Operating Partnership does not intend to establish long-term concentrations; and
•		age or location of a particular property.

 

 

The Operating Partnership will reinvest the proceeds received from property dispositions primarily to fund property acquisitions as well as fund development activities.  In addition, when feasible, the Operating Partnership may structure these transactions as tax deferred exchanges.

 

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Financing Strategies

 

On October 11, 2001, the Operating Partnership effected a two-for-one split of its OP Units to unit holders of record as of September 21, 2001.  All OP Units presented have been retroactively adjusted to reflect the OP Unit split.

 

The Operating Partnership’s “Consolidated Debt-to-Total Market Capitalization Ratio” as of December 31, 2002 is presented in the following table.  The Operating Partnership calculates the equity component of its market capitalization as the sum of (i) the total outstanding OP Units at the equivalent market value of the closing price of EQR’s Common Shares on the New York Stock Exchange; (ii) the “OP Unit Equivalent” of all convertible preference interests/units; and (iii) the liquidation value of all perpetual preference interests/units outstanding.

 

Capitalization as of December 31, 2002

 

 

Convertible Preference Units, Preference Interests and Junior Preference Units
as of December 31, 2002

 

 

The Operating Partnership’s policies are to maintain a ratio of consolidated debt-to-total market capitalization of less than 50% and that EQR shall not incur indebtedness other than short-term trade, employee compensation or similar indebtedness that will be paid in the ordinary course of business.

 

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Equity Offerings For the Years Ended December 31, 2002, 2001 and 2000

 

During 2002, EQR contributed all of the net proceeds, as discussed below, to the Operating Partnership in exchange for OP Units:

 

•                  EQR issued 1,435,115 Common Shares pursuant to its Fifth Amended Option and Award Plan and received net proceeds of approximately $29.6 million.

•                  EQR issued 324,238 Common Shares pursuant to its Employee Share Purchase Plan and received net proceeds of approximately $7.4 million.

•                  EQR issued 31,354 Common Shares pursuant to its Share Purchase - DRIP Plan and received net proceeds of approximately $0.9 million.

•                  EQR issued 41,407 Common Shares pursuant to its Dividend Reinvestment – DRIP Plan and received net proceeds of approximately $1.2 million.

•                  EQR repurchased 5,092,300 of its Common Shares on the open market at an average price of $22.58 per share.  The purchases were made between October 1 and October 22, 2002.  EQR paid approximately $115.0 million in connection therewith.  These shares were subsequently retired.  Concurrent with this transaction, the Operating Partnership repurchased and retired 5,092,300 OP Units previously issued to EQR.

 

During 2001, EQR contributed all of the net proceeds, as discussed below, to the Operating Partnership in exchange for OP Units:

 

•                  EQR issued 3,187,217 Common Shares pursuant to its Fifth Amended Option and Award Plan and received net proceeds of approximately $65.4 million.

•                  EQR issued 310,261 Common Shares pursuant to its Employee Share Purchase Plan and received net proceeds of approximately $6.9 million.

•                  EQR issued 33,106 Common Shares pursuant to its Share Purchase - DRIP Plan and received net proceeds of approximately $0.9 million.

•                  EQR issued 42,649 Common Shares pursuant to its Dividend Reinvestment – DRIP Plan and received net proceeds of approximately $1.2 million.

 

During 2000, EQR contributed all of the net proceeds, as discussed below, to the Operating Partnership in exchange for OP Units:

 

•                  EQR issued 1,370,186 Common Shares pursuant to its Fifth Amended Option and Award Plan and received net proceeds of approximately $25.2 million.

•                  EQR issued 299,580 Common Shares pursuant to its Employee Share Purchase Plan and received net proceeds of approximately $5.4 million.

•                  EQR issued 26,374 Common Shares pursuant to its Share Purchase - DRIP Plan and received net proceeds of approximately $0.6 million.

•                  EQR issued 69,504 Common Shares pursuant to its Dividend Reinvestment - DRIP Plan and received net proceeds of approximately $1.7 million.

 

EQR filed with the SEC on February 3, 1998 a Form S-3 Registration Statement to register $1.0 billion of equity securities.  The SEC declared this registration statement effective on February 27, 1998.  In addition, EQR carried over $272.4 million related to the registration statement that was declared effective on August 4, 1997.  As of December 31, 2002, $1.1 billion in equity securities remained available for issuance under this registration statement.  Per the terms of ERPOP’s partnership agreement, EQR contributes the net proceeds of equity offerings to the capital of the Operating Partnership in exchange for additional OP Units (on a one-for-one common share per OP Unit basis).

 

Cumulative through December 31, 2002, a subsidiary of the Operating Partnership issued various series of Preference Interests (the “Preference Interests”) with an equity value of $246.0 million receiving

 

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net proceeds of $239.9 million.  The following table presents the issued and outstanding Preference Interests as of December 31, 2002 and December 31, 2001:

 

		Redemption Date (1)(2)		Conversion Rate (2)		Annual Dividend Rate per Unit (3)			Amounts in thousands
									December 31, 2002			December 31, 2001
Preference Interests:
8.00% Series A Cumulative Redeemable Preference Interests; liquidation value $50 per unit; 800,000 units issued and outstanding at December 31, 2002 and December 31, 2001		10/01/04		N/A		$	4.0000		$	40,000		$	40,000
8.50% Series B Cumulative Redeemable Preference Units; liquidation value $50 per unit; 1,100,000 units issued and outstanding at December 31, 2002 and December 31, 2001		03/03/05		N/A		$	4.2500		55,000			55,000
8.50% Series C Cumulative Redeemable Preference Units; liquidation value $50 per unit; 220,000 units issued and outstanding at December 31, 2002 and December 31, 2001		03/23/05		N/A		$	4.2500		11,000			11,000
8.375% Series D Cumulative Redeemable Preference Units; liquidation value $50 per unit; 420,000 units issued and outstanding at December 31, 2002 and December 31, 2001		05/01/05		N/A		$	4.1875		21,000			21,000
8.50% Series E Cumulative Redeemable Preference Units; liquidation value $50 per unit; 1,000,000 units issued and outstanding at December 31, 2002 and December 31, 2001		08/11/05		N/A		$	4.2500		50,000			50,000
8.375% Series F Cumulative Redeemable Preference Units; liquidation value $50 per unit; 180,000 units issued and outstanding at December 31, 2002 and December 31, 2001		05/01/05		N/A		$	4.1875		9,000			9,000
7.875% Series G Cumulative Redeemable Preference Units; liquidation value $50 per unit; 510,000 units issued and outstanding at December 31, 2002 and December 31, 2001		03/21/06		N/A		$	3.9375		25,500			25,500
7.625% Series H Cumulative Convertible Redeemable Preference Units; liquidation value $50 per unit; 190,000 units issued and outstanding at December 31, 2002 and December 31, 2001		03/23/06		1.5108		$	3.8125		9,500			9,500
7.625% Series I Cumulative Convertible Redeemable Preference Units; liquidation value $50 per unit; 270,000 units issued and outstanding at December 31, 2002 and December 31, 2001		06/22/06		1.4542		$	3.8125		13,500			13,500
7.625% Series J Cumulative Convertible Redeemable Preference Units; liquidation value $50 per unit; 230,000 units issued and outstanding at December 31, 2002 and December 31, 2001		12/14/06		1.4108		$	3.8125		11,500			11,500
									$	246,000		$	246,000

 

(1)                                  On or after the fifth anniversary of the respective issuance (the “Redemption Date”), all of the Preference Interests may be redeemed for cash at the option of the Company, in whole or in part, at any time or from time to time, at a redemption price equal to the liquidation preference of $50.00 per unit plus the cumulative amount of accrued and unpaid distributions, if any.

 

(2)                                  On or after the tenth anniversary of the respective issuance (the “Conversion Date”), all of the Preference Interests are exchangeable at the option of the holder (in whole but not in part) on a one-for-one basis for a respective reserved series of EQR Preferred Shares.  In addition, on or after the Conversion Date, the convertible Preference Interests (Series H, I & J) may be converted under certain circumstances at the option of the holder (in whole but not in part) to EQR Common Shares based upon the contractual conversion rate, plus accrued and unpaid distributions, if any.

 

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(3)                                  Dividends on all series of Preference Interests are payable quarterly on March 25^th, June 25^th, September 25^th, and December 25^th of each year.

 

Debt Offerings For the Years Ended December 31, 2002, 2001 and 2000

 

During 2002:

 

•                  The Operating Partnership issued $400.0 million of redeemable unsecured fixed rate notes (the “March 2012 Notes”) in a public debt offering in March 2002.  The March 2012 Notes were issued at a discount, which is being amortized over the life of the notes on a straight-line basis.  The March 2012 Notes are due March 15, 2012.  The annual interest rate on the March 2012 Notes is 6.625%, which is payable semiannually in arrears on September 15 and March 15, commencing September 15, 2002.  The Operating Partnership received net proceeds of approximately $394.5 million in connection with this issuance.

•                  The Operating Partnership issued $50.0 million of redeemable unsecured fixed rate notes (the “November 2007 Notes”) in a public debt offering in November 2002.  The November 2007 Notes are due November 30, 2007.  The annual interest rate on the November 2007 Notes is 4.861%, which is payable semiannually in arrears on May 30 and November 30, commencing May 30, 2003.  The Operating Partnership received net proceeds of approximately $49.9 million in connection with this issuance.

 

During 2001:

 

•                  The Operating Partnership issued $300.0 million of redeemable unsecured fixed rate notes (the “March 2011 Notes”) in a public debt offering in March 2001.  The March 2011 Notes were issued at a discount, which is being amortized over the life of the notes on a straight-line basis.  The March 2011 Notes are due March 2, 2011.  The annual interest rate on the March 2011 Notes is 6.95%, which is payable semiannually in arrears on September 2 and March 2, commencing September 2, 2001.  The Operating Partnership received net proceeds of approximately $297.4 million in connection with this issuance.

 

During 2000:

 

•                  The Operating Partnership did not issue new debt securities during the year ended December 31, 2000.

 

The Operating Partnership filed a Form S-3 Registration Statement on August 25, 2000 to register $1.0 billion of debt securities.  The SEC declared this registration statement effective on September 8, 2000. In addition, the Operating Partnership carried over $430.0 million related to the registration statement effective on February 27, 1998.  As of December 31, 2002, $680.0 million remained available for issuance under this registration statement.

 

Credit Facilities

 

On May 30, 2002, the Operating Partnership obtained a new three-year $700.0 million unsecured revolving credit facility maturing May 29, 2005.  The new line of credit replaced the $700.0 million unsecured revolving credit facility that was scheduled to expire in August 2002.  The prior existing revolving credit facility was terminated upon the closing of the new facility.  Advances under the new credit facility bear interest at variable rates based upon LIBOR at various interest periods, plus a spread dependent upon the Operating Partnership’s credit rating, or based upon bids received from the lending group.  As of December 31, 2002, $140.0 million was outstanding and $60.8 million was restricted (dedicated to support letters of credit and not available for borrowing) on the line of credit.  During the year ended December 31, 2002, the weighted average interest rate on borrowings under the former and new lines of credit was 2.30%.

 

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In connection with its acquisition of Globe Business Resources, Inc. (“Globe”), the Company assumed a revolving credit facility with potential borrowings of up to $55.0 million.  On May 31, 2001, this credit facility was terminated.

 

Business Combinations

 

Multifamily Properties

 

On October 31, 2000, the Company acquired Grove Property Trust (“Grove”) for a total purchase price of $463.2 million and succeeded to the ownership of 60 properties containing 7,308 units.  The Company:

 

•                  Paid $17.00 per share or $141.6 million in cash to purchase the 8.3 million outstanding common shares of Grove;

•                  Paid $17.00 per unit or $12.4 million in cash to purchase 0.7 million Grove OP Units outstanding at the merger date;

•                  Converted 2.1 million Grove OP Units to 1.6 million of the Operating Partnership’s OP Units using the conversion ratio of 0.7392 (after cash-out of fractional units).  The value of these converted OP Units totaled $37.2 million;

•                  Assumed $241.3 million in Grove debt, which included first and second mortgages totaling $203.4 million and Grove’s line of credit totaling $38.0 million.  Grove’s line of credit and two mortgage loans totaling $7.8 million were paid off immediately after the closing;

•                  Acquired $20.1 million in other Grove assets and assumed $11.2 million in other Grove liabilities, including a contingent earnout liability totaling $1.5 million.  This amount represented the estimated additional cash or OP Units required to be funded to the previous owners of Glen Meadow Apartments upon the transition of this property from subsidized to market rents; and

•                  Recorded acquisition costs of $19.5 million.

 

Furniture Rental and Corporate Housing Businesses

 

On July 11, 2000, the Company acquired Globe in an all cash and debt transaction valued at approximately $163.2 million.  Globe provided fully furnished short-term housing through an inventory of leased housing units to transferring or temporarily assigned corporate personnel, new hires, trainees, consultants and individual customers throughout the United States.  Additionally, Globe leased and sold furniture to a diversified base of commercial and residential customers throughout the United States.  Shareholders of Globe received $13.00 per share, which approximated $58.7 million in cash based on the 4.5 million Globe shares outstanding.  In addition, the Company:

 

•                  Acquired $94.8 million in other Globe assets and assumed $29.6 million in other Globe liabilities;

•                  Allocated $68.4 million to goodwill;

•                  Recorded acquisition costs of $4.5 million; and

•                  Assumed $70.4 million in debt, which included $1.4 million in mortgage debt, $39.5 million in unsecured notes, and Globe’s line of credit of $29.5 million outstanding.

 

On July 21, 2000, the Company, through its Globe subsidiary, acquired Temporary Quarters, Inc., the leading corporate housing provider in Atlanta, Georgia, in a $3.3 million all cash transaction.

 

As of September 30, 2001, the Company recorded $60.0 million of asset impairment charges related to its furniture rental business.  These charges were the result of a review of the existing intangible and tangible assets reflected on the consolidated balance sheet as of September 30, 2001.  The impairment loss is reflected on the consolidated statements of operations for the year ended December 31, 2001, in discontinued operations, net, and includes the write-down of the following assets: a) goodwill of approximately $26.0 million; b) rental furniture, net of approximately $28.6 million; c) property and

 

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equipment, net of approximately $4.5 million; and d) other assets of approximately $0.9 million.

 

On January 11, 2002, the Company sold the former Globe furniture rental business for approximately $30.0 million in cash, which approximated the net book value at the sale date.  The Company has retained ownership of the former Globe short-term furnished housing business, which is now known as Equity Corporate Housing (“ECH”).

 

For the year ended December 31, 2002, the Company recorded approximately $17.1 million of asset impairment charges related to ECH.  Following the guidance in SFAS No. 142, these charges were the result of the Company’s decision to reduce the carrying value of ECH to $30.0 million, given the continued weakness in the economy and management’s expectations for near-term performance, and were determined based upon a discounted cash flow analysis of the business.  This impairment loss is reflected on the consolidated statements of operations as impairment on corporate housing business and on the consolidated balance sheets as a reduction in goodwill, net.

 

The Company accounted for these business combinations as purchases in accordance with Accounting Principles Board (“APB”) Opinion No. 16.  The fair value of the consideration given by the Company was used as the valuation basis for each of the combinations.

 

Competition

 

All of the properties are located in developed areas that include other multifamily properties.  The number of competitive multifamily properties in a particular area could have a material effect on the Operating Partnership’s ability to lease units at the properties or at any newly acquired properties and on the rents charged.  The Operating Partnership may be competing with other entities that have greater resources than the Operating Partnership and whose managers have more experience than the Operating Partnership’s managers.  In addition, other forms of rental properties, including multifamily properties and manufactured housing, some of which may be controlled by Mr. Zell, and single-family housing provide housing alternatives to potential residents of multifamily properties.   Recently, historically low mortgage interest rates coupled with record residential construction and single-family home sales have had an adverse competitive effect on the Operating Partnership.

 

Risk Factors

 

The following Risk Factors may contain defined terms that are different from those used in the other sections of this report.  Unless otherwise indicated, when used in this section, the terms “we” and “us” refer to ERP Operating Limited Partnership, an Illinois limited partnership, and its subsidiaries.  ERP Operating Limited Partnership is controlled by its general partner Equity Residential, a Maryland real estate investment trust.

 

Set forth below are the risks that we believe are important to investors who purchase or own our preference interests (“Interests”) of a subsidiary of ERP Operating Limited Partnership; preference units (“Units”); or units of limited partnership interest (“OP Units”) of ERP Operating Limited Partnership, which are redeemable on a one-for-one basis for common shares or their cash equivalent.  In this section, we refer to the Interests, Units and the OP Units together as our “securities,” and the investors who own Interests, Units and/or OP Units as our “security holders.”

 

Our Performance and OP Unit Value are Subject to Risks Associated with the Real Estate Industry

 

General

 

Real property investments are subject to varying degrees of risk and are relatively illiquid. Several factors may adversely affect the economic performance and value of our properties.  These factors include changes in the national, regional and local economic climate, local conditions such as an

 

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oversupply of multifamily properties or a reduction in demand for our multifamily properties, the attractiveness of our properties to residents, competition from other available multifamily property owners and changes in market rental rates.  Our performance also depends on our ability to collect rent from residents and to pay for adequate maintenance, insurance and other operating costs, including real estate taxes, which could increase over time.  Also, the expenses of owning and operating a property are not necessarily reduced when circumstances such as market factors and competition cause a reduction in income from the property.

 

We May be Unable to Renew Leases or Relet Units as Leases Expire

 

When our residents decide not to renew their leases upon expiration, we may not be able to relet their units.  Even if the residents do renew or we can relet the units, the terms of renewal or reletting may be less favorable than current lease terms.  Because virtually all of our leases are for apartments, they are generally for terms of no more than one year.  If we are unable to promptly renew the leases or relet the units, or if the rental rates upon renewal or reletting are significantly lower than expected rates, then our results of operations and financial condition will be adversely affected.  Consequently, our cash flow and ability to service debt and make distributions to security holders would be reduced.  As a result of general economic conditions and competitive factors discussed above, we have experienced a trend of declining rents and increased concessions when entering into new leases across our portfolio during 2002.

 

New Acquisitions or Developments May Fail to Perform as Expected and Competition for Acquisitions May Result in Increased Prices for Properties

 

We intend to continue to actively acquire and develop multifamily properties.  Newly acquired or developed properties may fail to perform as expected.  We may underestimate the costs necessary to bring an acquired property up to standards established for its intended market position or to develop a property.  Additionally, we expect that other major real estate investors with significant capital will compete with us for attractive investment opportunities or may also develop properties in markets where we focus our development efforts.  This competition may increase prices for multifamily properties.  We may not be in a position or have the opportunity in the future to make suitable property acquisitions on favorable terms.   The total number of development units, cost of development and estimated completion dates are subject to uncertainties arising from changing economic conditions (such as the cost of labor and construction materials), competition and local government regulation.

 

Because Real Estate Investments Are Illiquid, We May Not Be Able To Sell Properties When Appropriate

 

Real estate investments generally cannot be sold quickly.  We may not be able to change our portfolio promptly in response to economic or other conditions.  This inability to respond promptly to changes in the performance of our investments could adversely affect our financial condition and ability to make distributions to our security holders.

 

Changes in Laws Could Affect Our Business

 

We are generally not able to pass through to our residents under existing leases real estate taxes, income taxes or other taxes.  Consequently, any such tax increases may adversely affect our financial condition and limit our ability to make distributions to our security holders.  Similarly, changes that increase our potential liability under environmental laws or our expenditures on environmental compliance would adversely affect our cash flow and ability to make distributions on our securities.

 

Environmental Problems are Possible and can be Costly

 

Federal, state and local laws and regulations relating to the protection of the environment may require a current or previous owner or operator of real estate to investigate and clean up hazardous or

 

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toxic substances or petroleum product releases at such property.  The owner or operator may have to pay a governmental entity or third parties for property damage and for investigation and clean-up costs incurred by such parties in connection with the contamination. These laws typically impose clean-up responsibility and liability without regard to whether the owner or operator knew of or caused the presence of the contaminants. Even if more than one person may have been responsible for the contamination each person covered by the environmental laws may be held responsible for all of the clean-up costs incurred.  In addition, third parties may sue the owner or operator of a site for damages and costs resulting from environmental contamination emanating from that site.

 

Environmental laws also govern the presence, maintenance and removal of asbestos.  These laws require that owners or operators of buildings containing asbestos properly manage and maintain the asbestos, that they notify and train those who may come into contact with asbestos and that they undertake special precautions, including removal or other abatement, if asbestos would be disturbed during renovation or demolition of a building.  These laws may impose fines and penalties on building owners or operators who fail to comply with these requirements and may allow third parties to seek recovery from owners or operators for personal injury associated with exposure to asbestos fibers.

 

Substantially all of our properties have been the subject of environmental assessments completed by qualified independent environmental consultant companies.  These environmental assessments have not revealed, nor are we aware of, any environmental liability that our management believes would have a material adverse effect on our business, results of operations, financial condition or liquidity.

 

Over the past two years, there have been an increasing number of lawsuits against owners and managers of multifamily properties other than EQR alleging personal injury and property damage caused by the presence of mold in residential real estate.  Some of these lawsuits have resulted in substantial monetary judgments or settlements.  Insurance carriers have reacted to these liability awards by excluding mold related claims from standard policies and pricing mold endorsements at prohibitively high rates.  We have adopted programs designed to minimize the existence of mold in any of our properties as well as guidelines for promptly addressing and resolving reports of mold to minimize any impact mold might have on residents or the property.

 

We cannot be assured that existing environmental assessments of our properties reveal all environmental liabilities, that any prior owner of any of our properties did not create a material environmental condition not known to us, or that a material environmental condition does not otherwise exist as to any one or more of our properties.

 

Insurance Policy Deductibles and Exclusions

 

In order to partially mitigate the substantial increase in insurance costs in recent years, management has determined to gradually increase deductible and self-insured retention amounts.  As of December 31, 2002, the Operating Partnership property insurance policy (for Wholly Owned Properties) provides for a per occurrence deductible of $250,000 and self insured retention of $1 million per occurrence, subject to a maximum annual aggregate self-insured retention of $4 million.  The Operating Partnership’s liability and worker’s compensation policies at December 31, 2002, provide for a $1 million per occurrence deductible.  While higher deductible and self-insured retention amounts expose the Operating Partnership to greater potential uninsured losses, management believes that the savings in insurance premium expense justifies this increased exposure.  Management anticipates that deductibles and self-insured retention amounts will likely further increase for 2003 policy renewals.

 

As a result of the terrorist attacks of September 11, 2001, insurance carriers have created exclusions for losses from terrorism from our “all risk” insurance policies.  While separate terrorism insurance coverage is available in certain instances, premiums for such coverage is generally very expensive, with very high deductibles.  Moreover, the terrorism insurance coverage that is available typically excludes coverage for losses from acts of foreign governments as well as nuclear, biological and

 

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chemical attacks.  The Operating Partnership has determined that it is not economically prudent to obtain terrorism insurance to the extent otherwise available, especially given the significant risks that are not covered by such insurance.  In the event of a terrorist attack impacting one or more of the properties, we could lose the revenues from the property, our capital investment in the property and possibly face liability claims from residents or others suffering injuries or losses. The Operating Partnership believes, however, that the number and geographic diversity of its portfolio helps to mitigate its exposure to the risks associated with potential terrorist attacks.

 

Debt Financing, Preferred Shares and Preference Interests and Units Could Adversely Affect Our Performance

 

General

 

The Operating Partnership’s total debt summary, as of December 31, 2002, included:

 

Debt Summary as of December 31, 2002

 

 

* Net of the effect of any interest rate protection agreements.

 

In addition to debt, the Company has issued $1.2 billion of combined liquidation value for the preferred shares of beneficial interest and preference interests and units, with a weighted average dividend preference of 8.07% per annum.  Our use of debt and preferred equity financing creates certain risks, including the following.

 

Scheduled Debt Payments Could Adversely Affect Our Financial Condition

 

In the future, our cash flow could be insufficient to meet required payments of principal and interest or to pay distributions on our securities at expected levels.

 

We may not be able to refinance existing debt (which in virtually all cases requires substantial principal payments at maturity) and, if we can, the terms of such refinancing might not be as favorable as the terms of existing indebtedness.  If principal payments due at maturity cannot be refinanced, extended or paid with proceeds of other capital transactions, such as new equity capital, our cash flow will not be sufficient in all years to repay all maturing debt.  As a result, we may be forced to postpone capital expenditures necessary for the maintenance of our properties and may have to dispose of one or more properties on terms that would otherwise be unacceptable to us.  The Operating Partnership’s debt maturity schedule as of December 31, 2002 is as follows:

 

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Debt Maturity Schedule as of December 31, 2002

 

 

* Includes $300 million with a final maturity of 2015 that is putable/callable in 2005 and $140 million related to the Operating Partnership’s unsecured revolving credit facility.

 

Financial Covenants Could Adversely Affect the Operating Partnership’s Financial Condition

 

If a property we own is mortgaged to secure payment of indebtedness and we are unable to meet the mortgage payments, the holder of the mortgage could foreclose on the property, resulting in loss of income and asset value.  Foreclosure on mortgaged properties or an inability to refinance existing indebtedness would likely have a negative impact on our financial condition and results of operations.  A foreclosure could also result in our recognition of taxable income without our actually receiving cash proceeds from the disposition of the property with which to pay the tax.  This could adversely affect our cash flow and could make it more difficult for us to meet our REIT distribution requirements.

 

The mortgages on our properties may contain customary negative covenants that, among other things, limit our ability, without the prior consent of the lender, to further mortgage the property and to reduce or change insurance coverage.  In addition, our unsecured credit facilities contain certain customary restrictions, requirements and other limitations on our ability to incur indebtedness.  The indentures under which a substantial portion of our debt was issued also contain certain financial and operating covenants including, among other things, maintenance of certain financial ratios, as well as limitations on our ability to incur secured and unsecured indebtedness (including acquisition financing), and to sell all or substantially all of our assets.  Our credit facility and indentures are cross-defaulted and also contain cross default provisions with other material indebtedness.  Our unsecured public debt covenants as of December 31, 2002 and 2001, respectively, are (terms are defined in the indentures):

 

Unsecured Public Debt Covenants

 

 

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Some of the properties were financed with tax-exempt bonds that contain certain restrictive covenants or deed restrictions.  We have retained an independent outside consultant to monitor compliance with the restrictive covenants and deed restrictions that affect these properties.  If these bond compliance requirements restrict our ability to increase our rental rates to attract low or moderate-income residents, or eligible/qualified residents, then our income from these properties may be limited.

 

Our Degree of Leverage Could Limit Our Ability to Obtain Additional Financing

 

Our Consolidated Debt-to-Total Market Capitalization Ratio was 39.8% as of December 31, 2002.  We have a policy of incurring indebtedness for borrowed money only through ERPOP and its subsidiaries and only if upon such incurrence our debt to market capitalization ratio would be approximately 50% or less.  Our degree of leverage could have important consequences to security holders.  For example, the degree of leverage could affect our ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions, development or other general corporate purposes, making us more vulnerable to a downturn in business or the economy generally.

 

Rising Interest Rates Could Adversely Affect Cash Flow

 

Advances under our credit facility bear interest at variable rates based upon LIBOR at various interest periods, plus a spread dependent upon our credit rating, or based upon bids received from the lending group.  Certain public issuances of our senior unsecured debt instruments also, from time to time, bear interest at floating rates.  We may also borrow additional money with variable interest rates in the future.  Increases in interest rates would increase our interest expenses under these debt instruments and would increase the costs of refinancing existing indebtedness and of issuing new debt.  Accordingly, higher interest rates could adversely affect cash flow and our ability to service our debt and to make distributions to security holders.

 

We Depend on Our Key Personnel

 

We depend on the efforts of the Chairman of EQR’s Board of Trustees, Samuel Zell, and EQR’s executive officers, particularly Bruce W. Duncan, EQR’s President and Chief Executive Officer (“CEO”) and Gerald A. Spector, EQR’s Chief Operating Officer.  If they resign, our operations could be temporarily adversely effected.  Mr. Zell has entered into executive compensation and retirement benefit agreements with the Company.  Mr. Duncan and Mr. Spector have entered into Deferred Compensation Agreements with the Company that under certain conditions could provide both with a salary benefit after their respective termination of employment with the Company.  In addition, Mr. Zell and Mr. Spector have entered into Noncompetition Agreements with the Company and Mr. Duncan’s Employment Agreement contains covenants not to compete in favor of the Company.  Douglas Crocker II, our former CEO, retired effective January 1, 2003.

 

Control and Influence by Significant OP Unit holders Could be Exercised in a Manner Adverse to Other OP Unit holders

 

The consent of certain affiliates of Mr. Zell is required for certain amendments to the Operating Partnership’s Fifth Amended and Restated Agreement of Limited Partnership (the “Partnership Agreement”).  As a result of their security ownership and rights concerning amendments to the Partnership Agreement, Mr. Zell may have substantial influence over the Operating Partnership.  Although these OP Unit holders have not agreed to act together on any matter, they would be in a position to exercise even more influence over the Operating Partnership’s affairs if they were to act together in the future.  This influence might be exercised in a manner that is inconsistent with the interests of other OP Unit holders.

 

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Our Success is Dependent on our General Partner’s Compliance With Federal Income Tax Requirements

 

We rely to a significant extent upon our general partner, EQR, as our source of equity capital.  EQR is required to satisfy numerous technical requirements to remain qualified as a REIT for federal income tax purposes.  EQR’s failure to qualify as a REIT could have a material adverse impact upon its, and consequently our, ability to raise equity capital.  Please see the “Risk Factors-Our Success as a REIT is Dependent on Compliance with Federal Income Tax Requirements” and “Federal Income Tax Consideration” sections in EQR’s Annual Report on Form 10-K for a discussion of these federal income tax considerations.

 

Our General Partner’s Compliance with REIT Distribution Requirements May Affect Our Financial Condition

 

Distribution Requirements May Increase the Indebtedness of the Operating Partnership

 

We may be required from time to time, under certain circumstances, to accrue as income for tax purposes interest and rent earned but not yet received.  In such event, or upon our repayment of principal on debt, we could have taxable income without sufficient cash to enable our general partner to meet the distribution requirements of a REIT.  Accordingly, we could be required to borrow funds or liquidate investments on adverse terms in order to meet these distribution requirements.

 

Available Information

 

You may access our Annual Report on Form 10-K, our Quarterly Reports on Form 10-Q, our Current Reports on Form 8-K and any amendments to any of those reports we file with the SEC free of charge at our website, www.equityapartments.com.  These reports are made available at our website as soon as reasonably practicable after we file them with the SEC.

 

Item 2.  The Properties

 

As of December 31, 2002, the Operating Partnership owned or had investments in 1,039 Properties in 36 states consisting of 223,591 units.  The Operating Partnership’s properties are more fully described as follows:

 

 

Resident leases are generally for twelve months in length and typically require security deposits.  The garden-style properties are generally defined as properties with two and/or three story buildings while the mid-rise/high-rise are defined as properties with greater than three story buildings.  These two property types typically provide residents with amenities, which may include a clubhouse, swimming pool, laundry facilities and cable television access. Certain of these properties offer additional amenities such as saunas, whirlpools, spas, sports courts and exercise rooms or other amenities.  The ranch-style properties are defined as single story properties, which do not provide additional amenities for residents other than laundry facilities and cable television access.  The military housing properties are defined as those properties located on military bases.

 

It is management’s role to monitor compliance with property policies and to provide preventive

 

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maintenance of the properties including common areas, facilities and amenities.  The Company has a dedicated training and education department that creates and coordinates training and strategic implementation for the Company’s property management personnel.  The Company believes that, due in part to its emphasis on training and employee quality, the properties historically have had high occupancy rates.

 

The distribution of the properties throughout the United States reflects the Operating Partnership’s belief that geographic diversification helps insulate the portfolio from regional and economic influences.  At the same time, the Operating Partnership has sought to create clusters of properties within each of its primary markets in order to achieve economies of scale in management and operation.  The Operating Partnership may nevertheless acquire additional multifamily properties located anywhere in the continental United States.

 

The following tables set forth certain information by type and state relating to the Operating Partnership’s properties at December 31, 2002:

 

GARDEN-STYLE PROPERTIES

 

								December 31, 2002
State		Number of Properties		Number of Units		Percentage of Total Units		Average Occupancy Percentage		Average Monthly Rent Possible per Unit
Alabama		12		2,451		1.10	%	94.1	%	$	530
Arizona		51		14,646		6.55		89.6		765
California		88		21,924		9.81		94.3		1,260
Colorado		29		8,175		3.66		91.8		810
Connecticut		23		2,705		1.21		95.4		902
Florida		83		24,277		10.86		92.7		801
Georgia		38		12,169		5.44		91.8		789
Illinois		7		2,360		1.06		94.2		1,007
Kansas		5		2,144		0.96		89.5		690
Kentucky		4		1,342		0.60		85.4		582
Maine		5		672		0.30		97.8		889
Maryland		23		5,419		2.42		94.7		923
Massachusetts		34		4,655		2.08		95.4		1,097
Michigan		8		2,388		1.07		87.3		883
Minnesota		18		4,035		1.80		91.2		962
Missouri		8		1,590		0.71		92.2		676
Nevada		7		2,078		0.93		89.3		711
New Hampshire		1		390		0.17		93.6		1,051
New Jersey		2		980		0.44		95.0		1,578
New Mexico		3		601		0.27		91.2		749
New York		1		300		0.13		93.3		1,598
North Carolina		37		10,176		4.55		91.9		608
Oklahoma		8		2,036		0.91		93.8		569
Oregon		12		4,051		1.81		91.3		734
Rhode Island		5		778		0.35		95.1		945
South Carolina		6		1,021		0.46		92.5		540
Tennessee		14		4,366		1.95		90.9		671
Texas		79		24,767		11.08		92.5		735
Utah		2		416		0.19		86.0		643
Virginia		18		5,778		2.58		93.0		897
Washington		42		10,254		4.59		91.0		841
Wisconsin		4		1,281		0.57		93.0		948
Total Garden-Style		677		180,225		80.60	%
Average Garden-Style				266				92.5	%	$	862

 

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MID-RISE/HIGH-RISE PROPERTIES

 

								December 31, 2002
State		Number of Properties		Number of Units		Percentage of Total Units		Average Occupancy Percentage		Average Monthly Rent Possible per Unit
California		1		164		0.07	%	75.6	%	$	1,524
Connecticut		2		407		0.18		87.5		2,171
Florida		2		458		0.20		94.0		1,036
Georgia		1		322		0.14		89.1		1,306
Illinois		1		1,305		0.58		93.9		841
Massachusetts		10		2,942		1.32		89.9		1,464
Minnesota		1		163		0.07		85.9		1,344
New Jersey		3		887		0.40		86.2		1,994
Ohio		1		765		0.34		74.4		1,177
Oregon		1		525		0.23		86.2		1,007
Texas		3		596		0.27		91.5		1,067
Virginia		2		865		0.39		94.4		1,326
Washington		5		800		0.36		85.5		1,200
Total Mid-Rise/High-Rise		33		10,199		4.56	%
Average Mid-Rise/High-Rise				309				88.4	%	$	1,397

 

RANCH-STYLE PROPERTIES

 

Alabama		1		69		0.03	%	92.8	%	$	396
Florida		99		9,169		4.10		93.7		518
Georgia		53		4,428		1.98		93.4		524
Indiana		44		4,059		1.82		93.0		467
Kentucky		21		1,637		0.73		92.7		451
Maryland		4		414		0.19		94.4		597
Michigan		17		1,536		0.69		93.7		601
Ohio		77		7,187		3.21		92.5		473
Pennsylvania		5		469		0.21		91.6		573
South Carolina		2		187		0.08		86.7		429
Tennessee		2		146		0.07		98.6		477
West Virginia		3		214		0.10		95.0		425
Total Ranch-Style		328		29,515		13.20	%
Average Ranch-Style				90				93.2	%	$	500

 

MILITARY HOUSING PROPERTIES

 

Washington (Ft. Lewis)		1		3,652		1.63	%	95.4	%	$	973
Total Military Housing		1		3,652		1.63	%
Average Military Housing				3,652				95.4	%	$	973
Total Residential Portfolio		1,039		223,591		100	%

 

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The properties currently under development are included in the following table.

 

DEVELOPMENT PROJECTS as of December 31, 2002

(Amounts in millions except for project and unit amounts)

 

		Location		Number of Units		Estimated Development Cost			Funded as of 12/31/2002			Estimated Future Funding Obligation			Total Funding Obligation (1)			Estimated Completion Date
Unconsolidated Projects
1210 Massachusetts Ave.		Washington, DC		142		$	36.3		$	11.4		—			$	11.4		2Q 2004
13th & N Street		Washington, DC		170		35.4			12.4			—			12.4			3Q 2003
Ball Park Lofts		Denver, CO		355		56.4			14.1			—			14.1			2Q 2003
Bella Terra (Village Green at Harbour Pointe) (2)		Mukilteo, WA		235		32.7			8.2			—			8.2			Completed
Bella Vista I&II (Warner Ridge I&II)		Woodland Hills, CA		315		80.9			18.8			$	2.9		21.7			1Q03/1Q04
Carrollton		Carrollton, TX		284		21.9			4.9			0.6			5.5			3Q 2003
City Place (Westport)		Kansas City, MO		288		34.7			8.7			—			8.7			1Q 2003
Concord Center		Concord, CA		259		52.3			13.1			—			13.1			4Q 2003
Highlands of Lombard		Lombard, IL		403		67.1			16.8			—			16.8			3Q 2003
Hudson Pointe		Jersey City, NJ		181		45.0			11.2			—			11.2			1Q 2003
Maples at Little River		Haverhill, MA		174		28.0			7.0			—			7.0			3Q 2003
Marina Bay I  (2)		Quincy, MA		136		24.8			6.6			—			6.6			Completed
Marina Bay II		Quincy, MA		108		22.8			5.7			—			5.7			4Q 2003
North Pier at Harborside		Jersey City, NJ		297		94.2			23.5			—			23.5			2Q 2003
Olympus (Legacy Towers) (2)		Seattle, WA		327		89.3			22.1			0.3			22.4			Completed
Savannah Midtown (Piedmont) (2)		Atlanta, GA		322		36.7			9.6			—			9.6			Completed
Watermarke		Irvine, CA		535		120.6			35.2			—			35.2			1Q 2004
Water Terrace I (Regatta I)		Marina Del Rey, CA		450		234.8			72.5			—			72.5			1Q 2003
Total Projects				4,981		$	1,113.9		$	301.8		$	3.8		$	305.6

 

(1)                                  The Operating Partnership’s funding obligation is generally between 25% and 35% of the estimated development cost for the unconsolidated projects.

 

(2)                                  Properties were substantially complete as of December 31, 2002.  As such, these properties are also included in the outstanding property and unit counts.

 

Item 3.  Legal Proceedings

 

Only ordinary routine litigation incidental to the business, which is not deemed material, was initiated during the year ended December 31, 2002.  As of December 31, 2002, the Operating Partnership is not aware of any other litigation threatened against the Operating Partnership other than routine litigation arising out of the ordinary course of business, some of which is expected to be covered by liability insurance, none of which is expected to have a material adverse effect on the consolidated financial statements of the Operating Partnership.

 

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

 

None

 

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