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FORM 10-Q

 

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

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

 

For the quarterly period ended SEPTEMBER 30, 2003

 

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)

 

Illinois

 

36-3894853

(State or Other Jurisdiction of Incorporation or Organization)

 

(I.R.S. Employer Identification No.)

 

 

 

Two North Riverside Plaza, Chicago, Illinois

 

60606

(Address of Principal Executive Offices)

 

(Zip Code)

 

(312) 474-1300

(Registrant’s Telephone Number, Including Area Code)

 

http://www.equityapartments.com

(Registrant’s web site)

 

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

 

 



 

ERP OPERATING LIMITED PARTNERSHIP
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands)
(Unaudited)

 

 

 

September 30,
2003

 

December 31,
2002

 

ASSETS

 

 

 

 

 

Investment in real estate

 

 

 

 

 

Land

 

$

1,816,571

 

$

1,803,577

 

Depreciable property

 

11,062,709

 

11,240,245

 

Construction in progress

 

2,617

 

2,441

 

Investment in real estate

 

12,881,897

 

13,046,263

 

Accumulated depreciation

 

(2,303,479

)

(2,112,017

)

Investment in real estate, net of accumulated depreciation

 

10,578,418

 

10,934,246

 

 

 

 

 

 

 

Cash and cash equivalents

 

372,586

 

29,875

 

Investments in unconsolidated entities

 

521,750

 

509,789

 

Rents receivable

 

1,038

 

2,926

 

Deposits – restricted

 

287,838

 

141,278

 

Escrow deposits – mortgage

 

44,648

 

50,565

 

Deferred financing costs, net

 

31,616

 

32,144

 

Goodwill, net

 

30,000

 

30,000

 

Other assets

 

122,204

 

80,094

 

Total assets

 

$

11,990,098

 

$

11,810,917

 

 

 

 

 

 

 

LIABILITIES AND PARTNERS’ CAPITAL

 

 

 

 

 

Liabilities:

 

 

 

 

 

Mortgage notes payable

 

$

2,818,321

 

$

2,927,614

 

Notes, net

 

2,748,345

 

2,456,085

 

Line of credit

 

 

140,000

 

Accounts payable and accrued expenses

 

89,545

 

64,369

 

Accrued interest payable

 

71,767

 

63,151

 

Rents received in advance and other liabilities

 

178,280

 

165,095

 

Security deposits

 

44,987

 

45,333

 

Distributions payable

 

145,214

 

140,844

 

Total liabilities

 

6,096,459

 

6,002,491

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

Minority Interests – Partially Owned Properties

 

8,034

 

9,811

 

 

 

 

 

 

 

Partners’ capital:

 

 

 

 

 

Preference Units

 

994,661

 

946,157

 

Preference Interests

 

246,000

 

246,000

 

Junior Preference Units

 

5,846

 

5,846

 

General Partner

 

4,329,129

 

4,306,873

 

Limited Partners

 

344,766

 

349,646

 

Deferred compensation

 

(5,535

)

(12,118

)

Accumulated other comprehensive loss

 

(29,262

)

(43,789

)

Total partners’ capital

 

5,885,605

 

5,798,615

 

Total liabilities and partners’ capital

 

$

11,990,098

 

$

11,810,917

 

 

See accompanying notes

 

2



 

ERP OPERATING LIMITED PARTNERSHIP

CONSOLIDATED STATEMENTS OF OPERATIONS

(Amounts in thousands except per OP Unit data)

(Unaudited)

 

 

 

Nine Months Ended
September 30,

 

Quarter Ended
September 30,

 

 

 

2003

 

2002

 

2003

 

2002

 

REVENUES

 

 

 

 

 

 

 

 

 

Rental income

 

$

1,393,278

 

$

1,396,069

 

$

469,893

 

$

466,379

 

Fee and asset management

 

10,961

 

6,957

 

3,083

 

2,647

 

Total revenues

 

1,404,239

 

1,403,026

 

472,976

 

469,026

 

 

 

 

 

 

 

 

 

 

 

EXPENSES

 

 

 

 

 

 

 

 

 

Property and maintenance

 

384,772

 

358,252

 

132,406

 

123,887

 

Real estate taxes and insurance

 

149,202

 

141,624

 

50,008

 

47,087

 

Property management

 

48,827

 

56,101

 

16,633

 

18,438

 

Fee and asset management

 

5,556

 

5,409

 

1,949

 

1,789

 

Depreciation

 

341,723

 

322,615

 

115,346

 

109,331

 

General and administrative

 

28,854

 

33,000

 

8,708

 

10,673

 

Impairment on technology investments

 

872

 

872

 

291

 

291

 

Impairment on corporate housing business

 

 

17,122

 

 

17,122

 

Total expenses

 

959,806

 

934,995

 

325,341

 

328,618

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

444,433

 

468,031

 

147,635

 

140,408

 

Interest and other income

 

13,740

 

11,526

 

6,612

 

2,231

 

Interest:

 

 

 

 

 

 

 

 

 

Expense incurred, net

 

(246,793

)

(252,892

)

(82,792

)

(83,141

)

Amortization of deferred financing costs

 

(4,406

)

(4,267

)

(1,319

)

(1,344

)

 

 

 

 

 

 

 

 

 

 

Income before allocation to Minority Interests, loss from investments in unconsolidated entities, net gain (loss) on sales of unconsolidated entities and discontinued operations

 

206,974

 

222,398

 

70,136

 

58,154

 

Allocation to Minority Interests – Partially Owned Properties

 

(77

)

(1,584

)

166

 

(259

)

Loss from investments in unconsolidated entities

 

(3,594

)

(1,746

)

(1,850

)

(1,979

)

Net gain (loss) on sales of unconsolidated entities

 

4,673

 

(626

)

(2

)

(5,872

)

Income from continuing operations

 

207,976

 

218,442

 

68,450

 

50,044

 

Net gain on sales of discontinued operations

 

218,975

 

61,209

 

77,983

 

32,763

 

Discontinued operations, net

 

9,494

 

42,252

 

(7

)

11,137

 

Net income

 

$

436,445

 

$

321,903

 

$

146,426

 

$

93,944

 

 

 

 

 

 

 

 

 

 

 

ALLOCATION OF NET INCOME:

 

 

 

 

 

 

 

 

 

Preference Units

 

$

57,713

 

$

57,568

 

$

19,564

 

$

19,055

 

Preference Interests

 

$

15,159

 

$

15,158

 

$

5,053

 

$

5,052

 

Junior Preference Units

 

$

243

 

$

243

 

$

81

 

$

81

 

 

 

 

 

 

 

 

 

 

 

General Partner

 

$

335,896

 

$

229,867

 

$

112,575

 

$

64,473

 

Limited Partners

 

27,434

 

19,067

 

9,153

 

5,283

 

Net income available to OP Units

 

$

363,330

 

$

248,934

 

$

121,728

 

$

69,756

 

Earnings per OP Unit – basic:

 

 

 

 

 

 

 

 

 

Income from continuing operations available to OP Units

 

$

0.46

 

$

0.49

 

$

0.15

 

$

0.09

 

Net income available to OP Units

 

$

1.24

 

$

0.84

 

$

0.41

 

$

0.24

 

Weighted average OP Units outstanding

 

293,900

 

295,483

 

295,032

 

296,519

 

Earnings per OP Unit – diluted:

 

 

 

 

 

 

 

 

 

Income from continuing operations available to OP Units

 

$

0.46

 

$

0.49

 

$

0.15

 

$

0.08

 

Net income available to OP Units

 

$

1.23

 

$

0.83

 

$

0.41

 

$

0.23

 

Weighted average OP Units outstanding

 

296,184

 

298,690

 

297,941

 

299,057

 

Distributions declared per OP Unit outstanding

 

$

1.2975

 

$

1.2975

 

$

0.4325

 

$

0.4325

 

 

See accompanying notes

 

3



 

ERP OPERATING LIMITED PARTNERSHIP
CONSOLIDATED STATEMENTS OF OPERATIONS (Continued)
(Amounts in thousands except per OP Unit data)
(Unaudited)

 

 

 

Nine Months Ended
September 30,

 

Quarter Ended
September 30,

 

 

 

2003

 

2002

 

2003

 

2002

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

436,445

 

$

321,903

 

$

146,426

 

$

93,944

 

Other comprehensive income (losses) – derivative and other instruments:

 

 

 

 

 

 

 

 

 

Unrealized holding gains (losses) arising during the period

 

8,355

 

(10,602

)

6,476

 

(11,687

)

Equity in unrealized holding gains (losses) arising during the period – unconsolidated entities

 

4,997

 

(2,003

)

2,238

 

(2,908

)

Losses reclassified into earnings from other comprehensive income

 

1,175

 

615

 

474

 

230

 

Comprehensive income

 

$

450,972

 

$

309,913

 

$

155,614

 

$

79,579

 

 

See accompanying notes

 

4



 

ERP OPERATING LIMITED PARTNERSHIP
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
(Unaudited)

 

 

 

Nine Months Ended
September 30,

 

 

 

2003

 

2002

 

CASH FLOWS FROM OPERATING ACTIVITIES:

 

 

 

 

 

Net income

 

$

436,445

 

$

321,903

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Allocation to Minority Interests – Partially Owned Properties

 

77

 

1,584

 

Depreciation

 

354,898

 

353,206

 

Amortization of deferred financing costs

 

4,544

 

4,350

 

Amortization of discounts and premiums on debt

 

(728

)

(589

)

Amortization of deferred settlements on derivative instruments

 

556

 

(238

)

Impairment on corporate housing business

 

 

17,122

 

Impairment on technology investments

 

872

 

872

 

Loss from investments in unconsolidated entities

 

3,594

 

1,746

 

Net (gain) on sales of discontinued operations

 

(218,975

)

(61,209

)

Net (gain) loss on sales of unconsolidated entities

 

(4,673

)

626

 

Loss on debt extinguishments

 

1,465

 

468

 

Unrealized (gain) loss on derivative instruments

 

(115

)

383

 

Compensation paid with Company Common Shares

 

11,545

 

15,158

 

 

 

 

 

 

 

Changes in assets and liabilities:

 

 

 

 

 

Decrease (increase) in rents receivable

 

1,580

 

(551

)

(Increase) decrease in deposits – restricted

 

(2,002

)

8,186

 

(Increase) decrease in other assets

 

(19,530

)

11,849

 

Increase in accounts payable and accrued expenses

 

25,189

 

32,102

 

Increase in accrued interest payable

 

8,619

 

5,365

 

(Decrease) in rents received in advance and other liabilities

 

(4,306

)

(579

)

(Decrease) in security deposits

 

(702

)

(1,037

)

Net cash provided by operating activities

 

598,353

 

710,717

 

 

 

 

 

 

 

CASH FLOWS FROM INVESTING ACTIVITIES:

 

 

 

 

 

Investment in real estate – acquisitions

 

(308,689

)

(232,097

)

Investment in real estate – development/other

 

(6,818

)

(86,115

)

Improvements to real estate

 

(128,479

)

(110,291

)

Additions to non-real estate property

 

(2,307

)

(5,562

)

Interest capitalized for real estate under development

 

 

(6,952

)

Interest capitalized for unconsolidated entities under development

 

(16,013

)

(12,492

)

Proceeds from disposition of real estate, net

 

750,433

 

291,368

 

Proceeds from disposition of furniture rental business

 

 

28,741

 

Proceeds from disposition of unconsolidated entities

 

8,595

 

34,796

 

Proceeds from refinancing of unconsolidated entities

 

 

4,375

 

Investments in unconsolidated entities

 

(13,587

)

(97,582

)

Distributions from unconsolidated entities

 

16,800

 

31,021

 

(Increase) decrease in deposits on real estate acquisitions, net

 

(144,565

)

42,046

 

Decrease in mortgage deposits

 

6,062

 

19,605

 

Business combinations, net of cash acquired

 

(487

)

(658

)

Consolidation of previously Unconsolidated Properties

 

(827

)

 

Acquisition of Minority Interests – Partially Owned Properties

 

(125

)

 

Other investing activities, net

 

(10,147

)

192

 

Net cash provided by (used for) investing activities

 

149,846

 

(99,605

)

 

See accompanying notes

 

5



 

ERP OPERATING LIMITED PARTNERSHIP
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Amounts in thousands)
(Unaudited)

 

 

 

Nine Months Ended
September 30,

 

 

 

2003

 

2002

 

CASH FLOWS FROM FINANCING ACTIVITIES:

 

 

 

 

 

Loan and bond acquisition costs

 

$

(4,416

)

$

(10,495

)

Mortgage notes payable:

 

 

 

 

 

Proceeds

 

48,680

 

104,572

 

Lump sum payoffs

 

(211,240

)

(283,681

)

Scheduled principal repayments

 

(23,958

)

(24,351

)

Prepayment premiums/fees

 

(1,557

)

(468

)

Notes, net:

 

 

 

 

 

Proceeds

 

398,816

 

397,064

 

Lump sum payoffs

 

(100,000

)

(225,000

)

Scheduled principal repayments

 

(4,480

)

(4,669

)

Line of credit:

 

 

 

 

 

Proceeds

 

172,000

 

368,500

 

Repayments

 

(312,000

)

(528,500

)

(Payments on) settlement of derivative instruments

 

(12,999

)

(1,534

)

Proceeds from sale of OP Units

 

5,559

 

8,425

 

Proceeds from exercise of EQR options

 

50,669

 

28,542

 

Proceeds from sale of Preference Units

 

150,000

 

 

Payment of offering costs

 

(5,273

)

(170

)

Redemption of Preference Units

 

(100,000

)

 

Distributions:

 

 

 

 

 

OP Units – General Partner

 

(353,211

)

(354,683

)

Preference Units

 

(55,012

)

(57,919

)

Preference Interests

 

(15,158

)

(15,185

)

Junior Preference Units

 

(243

)

(243

)

OP Units – Limited Partners

 

(28,910

)

(29,859

)

Minority Interests – Partially Owned Properties

 

(2,755

)

(11,568

)

Principal receipts on employee notes, net

 

 

263

 

Net cash (used for) financing activities

 

(405,488

)

(640,959

)

Net increase (decrease) in cash and cash equivalents

 

342,711

 

(29,847

)

Cash and cash equivalents, beginning of period

 

29,875

 

51,603

 

Cash and cash equivalents, end of period

 

$

372,586

 

$

21,756

 

 

 

 

 

 

 

SUPPLEMENTAL INFORMATION:

 

 

 

 

 

Cash paid during the period for interest

 

$

255,456

 

$

270,885

 

 

 

 

 

 

 

Real estate acquisitions/dispositions:

 

 

 

 

 

Mortgage loans assumed

 

$

81,024

 

$

14,000

 

 

 

 

 

 

 

Valuation of OP Units issued

 

$

105

 

$

 

 

 

 

 

 

 

Mortgage loans (assumed) by purchaser

 

$

(31,668

)

$

(8,840

)

 

 

 

 

 

 

Consolidation of previously Unconsolidated Properties:

 

 

 

 

 

Mortgage loans assumed

 

$

28,084

 

$

 

 

 

 

 

 

 

Valuation of OP Units issued

 

$

4,231

 

$

 

 

 

 

 

 

 

Investments in unconsolidated entities

 

$

1,159

 

$

 

 

 

 

 

 

 

Net (assets) liabilities recorded

 

$

579

 

$

 

 

See accompanying notes

 

6



 

ERP OPERATING LIMITED PARTNERSHIP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

 

1.                                      Business

 

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 September 30, 2003 owned an approximate 92.6% 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 September 30, 2003, the Operating Partnership owned or had investments in 990 properties in 34 states consisting of 212,147 units.  An ownership breakdown includes:

 

 

 

Number of
Properties

 

Number of
Units

 

Wholly Owned Properties

 

867

 

182,163

 

Partially Owned Properties (Consolidated)

 

36

 

6,931

 

Unconsolidated Properties

 

87

 

23,053

 

Total Properties

 

990

 

212,147

 

 

2.                                      Summary of Significant Accounting Policies

 

Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring accruals) and certain reclassifications considered necessary for a fair presentation have been included.  Certain reclassifications have been made to the prior period financial statements in order to conform to the current year presentation.  Operating results for the nine months ended September 30, 2003 are not necessarily indicative of the results that may be expected for the year ending December 31, 2003.

 

The balance sheet at December 31, 2002 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.

 

For further information, including definition of capitalized terms not defined herein, refer to the consolidated financial statements and footnotes thereto included in the Operating Partnership’s annual report on Form 10-K for the year ended December 31, 2002.

 

Stock-Based Compensation

 

Prior to 2003, the Company had chosen to account for its stock-based compensation in accordance with APB No. 25, Accounting for Stock Issued to Employees, which resulted in no

 

7



 

compensation expense for options issued with an exercise price equal to or exceeding the market value of EQR’s Common Shares on the date of grant (intrinsic method).  The Company has elected to expense its stock-based compensation in accordance with SFAS No. 123 and its amendment (SFAS No. 148), Accounting for Stock Based Compensation, effective in the first quarter of 2003, which resulted in compensation expense being recorded based on the fair value of the stock compensation granted or modified.  Any Common Shares issued pursuant to EQR’s incentive equity compensation and employee share purchase plans will result in the Operating Partnership issuing OP Units to EQR on a one-for-one basis, with the Operating Partnership receiving the net cash proceeds of such issuances.

 

SFAS No. 148 provides three transition methods for entities that adopt the fair value recognition provisions of SFAS No. 123.  The Company has chosen to use the “Prospective Method”.  This method requires that companies apply the recognition provisions of SFAS No. 123 to only employee awards granted or modified after the beginning of the fiscal year in which the recognition provisions are first applied, or January 1, 2003.  Compensation expense under all of the Company’s plans is generally recognized over periods ranging from three months to five years.  Therefore, the cost related to stock-based employee compensation included in the determination of net income for the nine months and quarter 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 OP Unit if the fair value based method had been applied to all outstanding and unvested awards in each period presented:

 

 

 

Nine Months Ended
September 30,

 

Quarter Ended
September 30,

 

 

 

2003

 

2002

 

2003

 

2002

 

 

 

(Amounts in thousands except per OP Unit amounts)

 

 

 

 

 

 

 

 

 

 

 

Net income available to OP Units – as reported

 

$

363,330

 

$

248,934

 

$

121,728

 

$

69,756

 

Add:  Stock-based employee compensation expense included in reported net income:

 

 

 

 

 

 

 

 

 

EQR’s restricted/performance shares

 

8,157

 

15,204

 

2,911

 

5,060

 

EQR’s share options (1)

 

2,321

 

 

307

 

 

EQR’s ESPP discount

 

1,049

 

 

244

 

 

Deduct:  Stock-based employee compensation expense determined under fair value based method for all awards:

 

 

 

 

 

 

 

 

 

EQR’s restricted/performance shares

 

(8,157

)

(15,204

)

(2,911

)

(5,060

)

EQR’s share options (1)

 

(5,503

)

(4,616

)

(1,338

)

(1,565

)

EQR’s ESPP discount

 

(1,049

)

(1,194

)

(244

)

(269

)

Net income available to OP Units – pro forma

 

$

360,148

 

$

243,124

 

$

120,697

 

$

67,922

 

Earnings per OP Unit:

 

 

 

 

 

 

 

 

 

Basic – as reported

 

$

1.24

 

$

0.84

 

$

0.41

 

$

0.24

 

Basic – pro forma

 

$

1.23

 

$

0.82

 

$

0.41

 

$

0.23

 

 

 

 

 

 

 

 

 

 

 

Diluted – as reported

 

$

1.23

 

$

0.83

 

$

0.41

 

$

0.23

 

Diluted – pro forma

 

$

1.22

 

$

0.81

 

$

0.41

 

$

0.23

 

 


(1)       Share options for the nine months ended September 30, 2003 included $1.4 million of expense recognition related to options granted in the first quarter of 2003 to EQR’s former chief executive officer.  These options vested immediately upon grant.

 

8



 

Other

 

In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections.  SFAS No. 145, among other items, rescinds the automatic classification of costs incurred on debt extinguishment as extraordinary charges.  Instead, gains and losses from debt extinguishment should only be classified as extraordinary if they meet the “unusual and infrequently occurring” criteria outlined in APB No. 30.  SFAS No. 145 is effective for fiscal years beginning after May 15, 2002.  The Operating Partnership adopted the standard effective January 1, 2003.

 

In January 2003, the FASB issued Interpretation (“FIN”) No. 46, Consolidation of Variable Interest Entities.  FIN No. 46 requires a variable interest entity to be consolidated if a company is subject to a majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns or both.  The Operating Partnership will adopt FIN No. 46 as required effective December 31, 2003.  FASB Staff Position (“FSP”) No. FIN 46-6 deferred the effective date for applying the provisions of FIN No. 46 (for entities created before February 1, 2003) from July 1, 2003 to December 31, 2003.  The Operating Partnership has preliminarily determined that its unconsolidated stabilized development projects and projects under development (see Note 7) are variable interest entities in which the Operating Partnership is the primary beneficiary as of the date of the original formation of the respective joint ventures.  On such respective formation dates, the fair value of the assets, liabilities and non-controlling interests of these development projects approximates carryover basis.  If these development projects had been consolidated as of September 30, 2003, the Operating Partnership’s investment in real estate and mortgage notes payable would have increased by $1.4 billion and $890.3 million, respectively, and investments in unconsolidated entities would have decreased by $514.6 million.  The Operating Partnership does not anticipate that the adoption of FIN No. 46 will have any material effect on net income.

 

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.  SFAS No. 150 establishes standards for classifying and measuring as liabilities certain financial instruments that embody obligations of the issuer and have characteristics of both liabilities and equity.  On November 7, 2003, the FASB issued FSP No. FAS 150-3, which deferred for an indefinite period the classification and measurement provisions, but not the disclosure provisions (see discussion below), of SFAS No. 150 as it relates to noncontrolling interests that are classified as equity in the financial statements of a subsidiary but would be classified as a liability in the parent’s financial statements under SFAS No. 150 (e.g., minority interests in consolidated limited-life subsidiaries).  The Operating Partnership does not have any mandatorily redeemable preferred shares/units that fall within the scope of SFAS No. 150.

 

With regards to the aforementioned disclosure provisions, the Operating Partnership is presently the controlling partner in various consolidated partnerships consisting of 36 properties and 6,931 units.  These partnerships contain provisions that require the partnerships to be liquidated through the sale of its assets upon reaching a date specified in each respective partnership agreement.  The Operating Partnership, as controlling partner, has an obligation to cause the property owning partnerships to distribute proceeds of liquidation to the Minority Interests in these Partially Owned Properties only to the extent that the net proceeds received by the partnerships from the sale of its assets warrant a distribution based on the partnership agreements.  As of September 30, 2003, the Operating Partnership estimates the value of Minority Interest distributions would have been approximately $100 million (“Settlement Value”) had the partnerships been liquidated.  This Settlement Value is based on estimated third party consideration realized by the partnerships upon disposition of the Partially Owned Properties and is net of all other assets and liabilities including yield maintenance on the mortgages encumbering the properties that would have been due on September 30, 2003 had those mortgages been prepaid.  Due to, among other things, the inherent uncertainty in the sale of real estate assets, the amount of any potential distribution to the Minority Interests in the Operating Partnership’s Partially Owned Properties is subject to change.  To the extent that the partnerships’ underlying assets are worth less than the underlying liabilities, the Operating Partnership has no obligation to remit any

 

9



 

consideration to the Minority Interests in Partially Owned Properties.

 

On July 31, 2003, the SEC clarified its position with respect to Emerging Issues Task Force (“EITF”) Topic D-42, The Effect on the Calculation of Earnings per Share for the Redemption or Induced Conversion of Preferred Stock.  Under the SEC’s revised interpretation, in connection with the redemption of preferred shares/units, the original issuance costs of these shares/units must be treated in a manner similar to preferred distributions and deducted from net income in arriving at net income available to OP Units.  The clarification of EITF Topic D-42 was required to be adopted effective July 1, 2003 on a retroactive basis by restating prior periods included in the current financial statements.  The adoption of the clarification of EITF Topic D-42 did not have any impact on the Operating Partnership’s consolidated financial position or cash flows nor did it impact the reported consolidated results of operations for the periods presented herein.

 

3.                                      Partners’ Capital

 

The following table presents the changes in the Operating Partnership’s issued and outstanding units of limited partnership interest (“OP Units”) for the nine months ended September 30, 2003:

 

 

 

2003

 

 

 

 

 

Operating Partnership’s OP Units outstanding at January 1,

 

293,396,124

 

 

 

 

 

Issued to General Partner:

 

 

 

Conversion of Series E Preference Units

 

66,560

 

Employee Share Purchase Plan

 

258,327

 

Exercise of EQR options

 

2,472,322

 

Restricted EQR share grants, net

 

938,361

 

 

 

 

 

Issued to Limited Partners:

 

 

 

Issuance through acquisitions

 

159,427

 

 

 

 

 

Operating Partnership’s OP Units outstanding at September 30,

 

297,291,121

 

 

The limited partners of the Operating Partnership as of September 30, 2003 include various individuals and entities that contributed their properties to the Operating Partnership in exchange for OP Units (the “Limited Partners”) and own an approximate 7.4% ownership interest in ERPOP.  Subject to applicable securities law restrictions, the Limited Partners may exchange their OP Units for EQR Common Shares on a one-for-one basis.

 

EQR contributes all net proceeds from its various equity offerings (including proceeds from exercise of options for EQR Common Shares) to the Operating Partnership.  In return for those contributions, EQR receives a number of OP Units in ERPOP equal to the number of Common Shares it has issued in the equity offering (or in the case of a preferred equity offering, a number of preference units in ERPOP equal in number and having the same terms as the preferred shares issued in the equity offering).

 

During the nine months ended September 30, 2003, the Operating Partnership issued 159,427 OP Units to various limited partners at an average price of $27.48 per unit.

 

The following table presents the Operating Partnership’s issued and outstanding “Preference Units” as of September 30, 2003 and December 31, 2002:

 

10



 

 

 

Annual
Dividend
Rate per
Unit (1)

 


Amounts in thousands

 

September
30, 2003

 

December
31, 2002

Preference Units:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

9 1/8% Series B Cumulative Redeemable Preference Units; liquidation value $250 per unit; 500,000 units issued and outstanding at September 30, 2003 and December 31, 2002

 

$

22.81252

 

$

125,000

 

$

125,000

 

 

 

 

 

 

 

 

 

9 1/8% Series C Cumulative Redeemable Preference Units; liquidation value $250 per unit; 460,000 units issued and outstanding at September 30, 2003 and December 31, 2002

 

$

22.81252

 

115,000

 

115,000

 

 

 

 

 

 

 

 

 

8.60% Series D Cumulative Redeemable Preference Units; liquidation value $250 per unit; 700,000 units issued and outstanding at September 30, 2003 and December 31, 2002

 

$

21.50

 

175,000

 

175,000

 

 

 

 

 

 

 

 

 

7.00% Series E Cumulative Convertible Preference Units; liquidation value $25 per unit; 2,488,290 and 2,548,114 units issued and outstanding at September 30, 2003 and December 31, 2002, respectively

 

$

1.75

 

62,207

 

63,703

 

 

 

 

 

 

 

 

 

7 1/4% Series G Convertible Cumulative Preference Units; liquidation value $250 per unit; 1,264,692 units issued and outstanding at September 30, 2003 and December 31, 2002

 

$

18.125

 

316,173

 

316,173

 

 

 

 

 

 

 

 

 

7.00% Series H Cumulative Convertible Preference Units; liquidation value $25 per unit; 51,228 units issued and outstanding at September 30, 2003 and December 31, 2002

 

$

1.75

 

1,281

 

1,281

 

 

 

 

 

 

 

 

 

8.29% Series K Cumulative Redeemable Preference Units; liquidation value $50 per unit; 1,000,000 units issued and outstanding at September 30, 2003 and December 31, 2002

 

$

4.145

 

50,000

 

50,000

 

 

 

 

 

 

 

 

 

7.625% Series L Cumulative Redeemable Preference Units; liquidation value $25 per unit; 0 and 4,000,000 units issued and outstanding at September 30, 2003 and December 31, 2002, respectively

 

(2

)

 

100,000

 

 

 

 

 

 

 

 

 

6.48% Series N Cumulative Redeemable Preference Units; liquidation value $250 per unit; 600,000 and 0 units issued and outstanding at September 30, 2003 and December 31, 2002, respectively (3)

 

$

16.20

 

150,000

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

994,661

 

$

946,157

 

 


(1)          Dividends on all series of Preference Units are payable quarterly at various pay dates.  Dividend rates listed for Series B, C, D, G and N are Preference Unit rates and the equivalent depositary unit annual dividend rates are $2.281252, $2.281252, $2.15, $1.8125 and $1.62, respectively.

 

(2)         On June 19, 2003, the Operating Partnership redeemed all of its outstanding Series L Cumulative Redeemable Preference Units at liquidation value for total cash consideration of $100.0 million in conjunction with the concurrent redemption of the corresponding Preferred Shares of EQR.  The Operating Partnership did not incur any original issuance costs as these units were issued by Merry Land and Investment Company, Inc. prior to its merger with the Company.

 

(3)         On June 19, 2003, EQR issued 600,000 Series N Cumulative Redeemable Preferred Shares in a public offering.  The Company received $145.3 million in net proceeds from this offering after payment of the underwriters’ fee.  These net proceeds were contributed by EQR to the Operating Partnership in exchange for 600,000 of the Operating Partnership’s 6.48% Series N Cumulative Redeemable Preference Units.

 

11



 

The following table presents the issued and outstanding “Preference Interests” as of September 30, 2003 and December 31, 2002:

 

 

 

Annual
Dividend
Rate per
Unit (1)

 


Amounts in thousands

 

September
30, 2003

 

December
31, 2002

Preference Interests:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

8.00% Series A Cumulative Redeemable Preference Interests; liquidation value $50 per unit; 800,000 units issued and outstanding at September 30, 2003 and December 31, 2002

 

$

4.00

 

$

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 September 30, 2003 and December 31, 2002

 

$

4.25

 

55,000

 

55,000

 

 

 

 

 

 

 

 

 

8.50% Series C Cumulative Redeemable Preference Units; liquidation value $50 per unit; 220,000 units issued and outstanding at September 30, 2003 and December 31, 2002

 

$

4.25

 

11,000

 

11,000

 

 

 

 

 

 

 

 

 

8.375% Series D Cumulative Redeemable Preference Units; liquidation value $50 per unit; 420,000 units issued and outstanding at September 30, 2003 and December 31, 2002

 

$

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 September 30, 2003 and December 31, 2002

 

$

4.25

 

50,000

 

50,000

 

 

 

 

 

 

 

 

 

8.375% Series F Cumulative Redeemable Preference Units; liquidation value $50 per unit; 180,000 units issued and outstanding at September 30, 2003 and December 31, 2002

 

$

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 September 30, 2003 and December 31, 2002

 

$

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 September 30, 2003 and December 31, 2002

 

$

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 September 30, 2003 and December 31, 2002

 

$

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 September 30, 2003 and December 31, 2002

 

$

3.8125

 

11,500

 

11,500

 

 

 

 

 

$

246,000

 

$

246,000

 

 


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

 

The following table presents the Operating Partnership’s issued and outstanding Junior Convertible Preference Units (the “Junior Preference Units”) as of September 30, 2003 and December 31, 2002:

 

12



 

 

 

Annual
Dividend
Rate per
Unit (1)

 


Amounts in thousands

 

September
30, 2003

 

December
31, 2002

Junior Preference Units:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Series A Junior Convertible Preference Units; liquidation value $100 per unit; 56,616 units issued and outstanding at September 30, 2003 and December 31, 2002

 

$

5.46934

 

$

5,662

 

$

5,662

 

 

 

 

 

 

 

 

 

Series B Junior Convertible Preference Units; liquidation value $25 per unit; 7,367 units issued and outstanding at September 30, 2003 and December 31, 2002

 

$

2.00

 

184

 

184

 

 

 

 

 

$

5,846

 

$

5,846

 

 


(1)          Dividends on both series of Junior Preference Units are payable quarterly at various pay dates.

 

4.                                      Real Estate Acquisitions

 

During the nine months ended September 30, 2003, the Operating Partnership acquired the entire equity interest in the eight properties listed below from unaffiliated parties, and two additional units at an existing property, for a total purchase price of $389.7 million.

 

Date
Acquired

 

Property

 

Location

 

Number
of Units

 

Acquisition Price
(in thousands)

 

01/30/03

 

The Reserve at Eisenhower

 

Alexandria, VA

 

226

 

$

41,000

 

02/14/03

 

Artisan Square

 

Northridge, CA

 

140

 

27,466

 

03/05/03

 

LaSalle (1)

 

Beaverton, OR

 

554

 

43,000

 

05/01/03

 

Gateway at Malden Center (2)

 

Malden, MA

 

203

 

34,900

 

06/17/03

 

Mill Creek

 

Milpitas, CA

 

516

 

70,000

 

06/30/03

 

Carlyle Mill

 

Alexandria, VA

 

317

 

61,200

 

08/01/03

 

Gatewood

 

Pleasanton, CA

 

200

 

27,000

 

08/19/03

 

The Oaks of Santa Clarita

 

Santa Clarita, CA

 

520

 

85,000

 

Various

 

Rivers Bend (condo units)

 

Windsor, CT

 

2

 

125

 

 

 

 

 

 

 

2,678

 

$

389,691

 

 


(1)          Includes 8,167 square feet of retail space.

(2)          Includes 36,326 square feet of office space and a 324-space parking garage.

 

During the nine months ended September 30, 2003, the Operating Partnership acquired the remaining third party equity interests it did not previously own in the following three properties:

 

                  Liberty Park, a 202-unit property located in Braintree, Massachusetts;

                  Hickory Mill II, a 44-unit property located in Hurricane, West Virginia (property was subsequently sold – see Note 5); and

                  Winter Woods II, a 44-unit property located in Winter Garden, Florida.

 

These properties were accounted for under the equity method of accounting and subsequent to each purchase were consolidated.  The Operating Partnership recorded $34.9 million in investment in real estate at carryover basis and the following:

 

                  Assumed $28.1 million in mortgage debt;

                  Issued 153,851 OP Units having a value of $4.2 million;

                  Reduced investments in unconsolidated entities by $1.2 million;

 

13



 

                  Paid cash of $0.8 million; and

                  Assumed $0.6 million of other liabilities net of other assets acquired.

 

5.                                      Real Estate Dispositions

 

During the nine months ended September 30, 2003, the Operating Partnership disposed of the sixty-three properties and various individual condominium units listed below to unaffiliated parties.  The Operating Partnership recognized a net gain on sales of discontinued operations of approximately $219.0 million and a net gain on sales of unconsolidated entities of approximately $4.7 million.

 

Date
Disposed

 

Property

 

Location

 

Number
of Units

 

Disposition
Price

 

 

 

 

 

 

 

 

 

(in thousands)

 

01/14/03

 

Strawberry Place

 

Plant City, FL

 

55

 

$

1,400

 

01/14/03

 

Smoketree Polo Club

 

Indio, CA

 

288

 

18,900

 

01/29/03

 

Amberwood I

 

Lake City, FL

 

50

 

1,175

 

01/30/03

 

Emerald Place

 

Bermuda Dunes, CA

 

240

 

20,125

 

01/30/03

 

Rolido Parque

 

Houston, TX

 

369

 

14,660

 

02/27/03

 

Fox Hill Commons

 

Vernon, CT

 

74

 

4,700

 

02/27/03

 

The Landings

 

Winter Haven, FL

 

60

 

1,475

 

02/27/03

 

Morningside

 

Titusville, FL

 

183

 

3,980

 

03/04/03

 

Colony Woods

 

Birmingham, AL

 

414

 

25,000

 

03/04/03

 

Hearthstone

 

San Antonio, TX

 

252

 

7,700

 

03/04/03

 

Northgate Village

 

San Antonio, TX

 

264

 

10,150

 

03/19/03

 

Lincoln Green I, II & III

 

San Antonio, TX

 

680

 

24,900

 

03/20/03

 

Meadows on the Lake

 

Birmingham, AL

 

200

 

10,900

 

03/20/03

 

Meadows in the Park

 

Birmingham, AL

 

200

 

10,900

 

03/20/03

 

Shoal Run

 

Birmingham, AL

 

276

 

14,350

 

03/31/03

 

Colony Place

 

Fort Myers, FL

 

300

 

20,600

 

04/08/03

 

Mallgate (1)

 

Louisville, KY

 

540

 

15,500

 

04/15/03

 

Summit Chase

 

Coral Springs, FL

 

140

 

8,875

 

04/16/03

 

Bayside

 

Sebring, FL

 

59

 

885

 

04/30/03

 

Essex Place II (Vacant Land)

 

Tampa, FL

 

 

575

 

05/08/03

 

Pueblo Villas

 

Albuquerque, NM

 

232

 

9,250

 

05/14/03

 

Emerald Bay

 

Winter Park, FL

 

432

 

17,200

 

05/16/03

 

Meadowood

 

Flatwoods, KY

 

52

 

975

 

05/29/03

 

Spicewood Springs

 

Jacksonville, FL

 

512

 

28,000

 

05/30/03

 

Princeton Square

 

Jacksonville, FL

 

288

 

16,750

 

05/30/03

 

Boulder Creek

 

Wilsonville, OR

 

296

 

16,700

 

05/30/03

 

Bridge Creek

 

Wilsonville, OR

 

315

 

18,100

 

05/30/03

 

Settlers Point/Brookfield

 

Salt Lake City, UT

 

416

 

21,500

 

05/30/03

 

Ridgewood (2)

 

Russellville, KY

 

52

 

 

06/04/03

 

Lake Point

 

Charlotte, NC

 

296

 

12,401

 

06/05/03

 

Clearlake Pines II

 

Cocoa, FL

 

52

 

1,392

 

06/05/03

 

Sky Pines I & II

 

Orlando, FL

 

140

 

3,694

 

06/05/03

 

Brandywine East

 

Winter Haven, FL

 

38

 

884

 

06/05/03

 

Woodland I & II

 

Orlando, FL

 

169

 

5,175

 

06/12/03

 

Parkville

 

Parkersburg, WV

 

49

 

1,063

 

06/12/03

 

Cedarwood I

 

Belpre, OH

 

44

 

889

 

06/24/03

 

Greenwood Village

 

Tempe, AZ

 

270

 

14,600

 

06/25/03

 

Woodbine

 

Portsmouth, OH

 

41

 

660

 

06/26/03

 

Laurel Gardens

 

Coral Springs, FL

 

384

 

34,550

 

06/27/03

 

Crystal Creek

 

Phoenix, AZ

 

273

 

12,775

 

06/30/03

 

Harbor Pointe

 

Milwaukee, WI

 

595

 

27,800

 

 

14



 

Date
Disposed

 

Property

 

Location

 

Number
of Units

 

Disposition
Price

 

 

 

 

 

 

 

 

 

(in thousands)

 

06/30/03

 

Calais

 

Arlington, TX

 

264

 

$

12,500

 

07/25/03

 

Wood Lane Place I

 

Woodbury, MN

 

216

 

21,600

 

07/31/03

 

Cambridge Village

 

Lewisville, TX

 

200

 

9,400

 

08/05/03

 

Hickory Mill I & II

 

Hurricane, WV

 

92

 

2,050

 

08/26/03

 

Bear Canyon

 

Tucson, AZ

 

238

 

18,350

 

08/26/03

 

Harrison Park I & II

 

Tucson, AZ

 

360

 

23,875

 

08/26/03

 

La Reserve

 

Tucson, AZ

 

240

 

16,750

 

08/26/03

 

Suntree Village

 

Tucson, AZ

 

424

 

22,025

 

08/27/03

 

Carleton Court

 

Cross Lanes, WV

 

73

 

2,000

 

09/02/03

 

Waterford at Regency

 

Jacksonville, FL

 

159

 

8,650

 

09/17/03

 

Watermark Square

 

Portland, OR

 

390

 

18,400

 

09/22/03

 

Arbors at Century Center

 

Memphis, TN

 

420

 

14,800

 

09/22/03

 

Autumn Creek

 

Cordova, TN

 

210

 

8,439

 

09/22/03

 

Trinity Lakes

 

Cordova, TN

 

330

 

13,261

 

09/23/03

 

Breckinridge Court

 

Lexington, KY

 

382

 

17,800

 

09/30/03

 

Sunny Oak Village

 

Overland Park, KS

 

548

 

25,150

 

09/30/03

 

Copperfield

 

San Antonio, TX

 

258

 

11,933

 

09/30/03

 

Songbird

 

San Antonio, TX

 

262

 

13,933

 

09/30/03

 

Villas of Oak Creste

 

San Antonio, TX

 

280

 

10,133

 

09/30/03

 

Belmont Landing

 

Riverdale, GA

 

424

 

22,500

 

Various

 

Four Lakes (condo units)

 

Lisle, IL

 

156

 

19,075

 

Various

 

Pointe East (condo units)

 

Redmond, WA

 

54

 

10,269

 

Various

 

Squaw Peak (condo units)

 

Phoenix, AZ

 

103

 

10,863

 

 

 

Wholly Owned Properties

 

 

 

15,673

 

794,864

 

02/28/03

 

Kings Crossing I (3)

 

Jacksonville, FL

 

69

 

963

 

05/14/03

 

Culbreath Key (3)

 

Tampa, FL

 

254

 

7,382

 

 

 

Unconsolidated Properties

 

 

 

323

 

8,345

 

  Total

 

 

 

 

 

15,996

 

$

803,209

 

 


(1)          The Operating Partnership was leasing the land under a long-term operating ground lease.

(2)          The Operating Partnership attempted to sell this property subject to assumption of the existing mortgage debt.  When the lender would not accept a credit-worthy purchaser to assume the debt, title to this property was transferred to the lender in a deed-in-lieu of foreclosure transaction.  The Operating Partnership recognized a net gain on debt extinguishment of approximately $92,000 as a component of interest and other income.

(3)          Disposition listed represents the Operating Partnership’s share of the net disposition proceeds.  Culbreath Key was sold for $26.4 million with a portion of the net sales proceeds used to payoff the mortgage debt of $16.2 million.

 

6.                                      Commitments to Acquire/Dispose of Real Estate

 

As of November 4, 2003, in addition to the properties that were subsequently acquired as discussed in Note 18, the Operating Partnership had entered into separate agreements to acquire seven multifamily properties containing 2,265 units from unaffiliated parties.  The Operating Partnership expects a combined purchase price of approximately $220.4 million, including the assumption of mortgage debt of approximately $21.5 million.

 

As of November 4, 2003, in addition to the properties that were subsequently disposed of as discussed in Note 18, the Operating Partnership had entered into separate agreements to dispose of thirty-three

 

15



 

multifamily properties containing 8,404 units to unaffiliated parties.  The Operating Partnership expects a combined disposition price of approximately $456.9 million.

 

The closings of these pending transactions are subject to certain contingencies and conditions; therefore, there can be no assurance that these transactions will be consummated or that the final terms thereof will not differ in material respects from those summarized in the preceding paragraphs.

 

7.                                      Investments in Unconsolidated Entities

 

The Operating Partnership has co-invested in various properties with unrelated third parties.  The following table summarizes the Operating Partnership’s investments in unconsolidated entities as of September 30, 2003 (amounts in thousands except for project and unit amounts):

 

 

 

Institutional
Joint
Ventures

 

Stabilized
Development
Projects (1)

 

Projects
Under
Development

 

Lexford/
Other

 

Totals

 

 

 

 

 

 

 

 

 

 

 

 

 

Total projects

 

45

 

12

 

16

 

22

 

95

(2)

 

 

 

 

 

 

 

 

 

 

 

 

Total units

 

10,846

 

3,812

 

4,336

 

2,616

 

21,610

(2)

 

 

 

 

 

 

 

 

 

 

 

 

Operating Partnership’s percentage share of outstanding debt

 

25.0

%

100.0

%

100.0

%

11.0

%

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating Partnership’s share of outstanding debt (4)

 

$

121,200

 

$

331,063

 

$

559,201

(3)

$

5,089

 

$

1,016,553

 

 


(1)          The Operating Partnership determines a project to be stabilized once it has maintained an average physical occupancy of 90% or more for a three-month period or one year from the cessation of major development activities, whichever is earlier.

 

(2)          Includes nine projects under development containing 2,356 units, which are not included in the Operating Partnership’s property/unit counts at September 30, 2003.   Totals exclude Fort Lewis Military Housing consisting of one property and 3,799 units, which is not accounted for under the equity method of accounting.  The Fort Lewis Military Housing is included in the Operating Partnership’s property/unit counts at September 30, 2003.

 

(3)          A total of $706.3 million is available for funding under this construction debt, of which $559.2 million was funded and outstanding at September 30, 2003.

 

(4)          As of November 4, 2003, the Operating Partnership has funded $44.0 million as additional collateral on selected debt (see Note 8).  All remaining debt is non-recourse to EQR and the Operating Partnership.

 

Investments in unconsolidated entities include the Unconsolidated Properties as well as various development properties under construction or pending construction.  These investments are accounted for utilizing the equity method of accounting.  Under the equity method of accounting, the net equity investment of the Operating Partnership is reflected on the consolidated balance sheets and after the project is completed, the consolidated statements of operations include the Operating Partnership’s share of net income or loss from the unconsolidated entity.  Prior to the project being completed, the Operating Partnership capitalizes interest on its equity contribution in accordance with the provisions of SFAS No. 58, Capitalization of Interest Cost in Financial Statements That Include Investments Accounted for by the Equity Method.  During the nine months ended September 30, 2003 and 2002, the Operating Partnership capitalized $16.0 million and $12.5 million, respectively, in interest cost related to its unconsolidated

 

16



 

development projects (which reduced interest expense incurred in the consolidated statements of operations).

 

The Operating Partnership generally contributes between 25% and 35% of the project cost of the unconsolidated projects under development (constituting 100% of the equity), with the remaining cost financed through third-party construction mortgages.  Voting rights are shared equally between the Operating Partnership and its respective development partners.

 

See Note 2 for further discussion regarding FIN No. 46 and its anticipated effect on the Operating Partnership’s unconsolidated development projects.

 

8.                                      Deposits - Restricted

 

As of September 30, 2003, deposits-restricted totaled $287.8 million and primarily included the following:

 

                  Deposits in the amount of $51.0 million held in third party escrow accounts to provide collateral for third party construction financing in connection with unconsolidated development projects;

                  Approximately $169.5 million in tax-deferred (1031) exchange proceeds; and

                  Approximately $67.3 million for resident security, utility, and other deposits.

 

9.                                      Mortgage Notes Payable

 

As of September 30, 2003, the Operating Partnership had outstanding mortgage indebtedness of approximately $2.8 billion.

 

During the nine months ended September 30, 2003, the Operating Partnership:

 

                  Repaid $235.2 million of mortgage loans;

                  Assumed $109.1 million of mortgage debt on certain properties in connection with their acquisitions and/or consolidation;

                  Obtained $48.7 million of mortgage loans on certain properties; and

                  Relinquished $31.7 million of mortgage debt assumed by the purchaser on disposed properties.

 

As of September 30, 2003, scheduled maturities for the Operating Partnership’s outstanding mortgage indebtedness were at various dates through October 1, 2033.  At September 30, 2003, the interest rate range on the Operating Partnership’s mortgage debt was 1.04% to 12.465%.  During the nine months ended September 30, 2003, the weighted average interest rate on the Operating Partnership’s mortgage debt was 5.84%.

 

10.                               Notes

 

As of September 30, 2003, the Operating Partnership had outstanding unsecured notes of approximately $2.7 billion.

 

On June 5, 2003, the Operating Partnership filed a Form S-3 registration statement with the SEC to register $2.0 billion of debt securities.  The SEC declared this registration statement effective on June 11, 2003.  In addition, the Operating Partnership carried over $280.0 million related to the registration statement effective on September 8, 2000.  As of September 30, 2003, $2.28 billion remained available for issuance under this registration statement.

 

During the nine months ended September 30, 2003, the Operating Partnership:

 

                  Issued $400.0 million of ten-year 5.20% fixed-rate public notes, receiving net proceeds of $397.5

 

17



 

million;

                  Repaid $100.0 million of floating rate public notes at maturity; and

                  Repaid $4.5 million of other unsecured notes.

 

As of September 30, 2003, scheduled maturities for the Operating Partnership’s outstanding notes were at various dates through 2029.  At September 30, 2003, the interest rate range on the Operating Partnership’s notes was 4.75% to 7.75%. During the nine months ended September 30, 2003, the weighted average interest rate on the Operating Partnership’s notes was 6.48%.

 

11.                               Line of Credit

 

The Operating Partnership has a revolving credit facility with potential borrowings of up to $700.0 million.  As of September 30, 2003, no amounts were outstanding and $57.0 million was restricted (dedicated to support letters of credit and not available for borrowing) on the line of credit.  During the nine months ended September 30, 2003, the weighted average interest rate was 1.85%.  EQR has guaranteed the Operating Partnership’s line of credit up to the maximum amount and for the full term of the facility.

 

12.                               Derivative Instruments

 

The following table summarizes the consolidated derivative instruments at September 30, 2003 (dollar amounts are in thousands):

 

 

 

Cash Flow
Hedges

 

Fair Value
Hedges

 

Forward
Starting
Swaps

 

Interest
Rate Caps

 

Offsetting
Receive
Floating
Swaps/Caps

 

Offsetting
Pay
Floating
Swaps/Caps

 

Current Notional Balance

 

$

150,000

 

$

120,000

 

$

150,000

 

$

37,000

 

$

255,121

 

$

255,121

 

Lowest Possible Notional

 

$

150,000

 

$

120,000

 

$

150,000

 

$

37,000

 

$

251,410

 

$

251,410

 

Highest Possible Notional

 

$

150,000

 

$

120,000

 

$

150,000

 

$

37,000

 

$

431,444

 

$

431,444

 

Lowest Interest Rate

 

3.683

%

7.25

%

4.34

%

6.50

%

4.53

%

4.46

%

Highest Interest Rate

 

3.683

%

7.25

%

4.48

%

6.50

%

6.00

%

6.00

%

Earliest Maturity Date

 

2005

 

2005

 

2014

 

2004

 

2003

 

2003

 

Latest Maturity Date

 

2005

 

2005

 

2014

 

2004

 

2007

 

2007

 

Estimated Asset (Liability) Fair Value

 

$

(7,433

)

$

7,464

 

$

2,576

 

$

 

$

478

 

$

(486

)

 

During the nine months ended September 30, 2003, the Operating Partnership paid approximately $13.0 million to terminate eight forward starting interest rate swaps in conjunction with the issuance of $400.0 million of ten-year unsecured notes.  The $13.0 million payment has been deferred and will be recognized as additional interest expense over the ten-year life of the unsecured notes.

 

At September 30, 2003, certain unconsolidated development partnerships in which the Operating Partnership invested had entered into swaps to hedge the interest rate risk exposure on unconsolidated floating rate construction mortgage loans.  The Operating Partnership has recorded its proportionate share of these hedges on its consolidated balance sheets.  These swaps have been designated as cash flow hedges with a current aggregate notional amount of $307.5 million (notional amounts range from $76.5 million to $335.9 million over the terms of the swaps) at interest rates ranging from 1.78% to 6.94% maturing at various dates ranging from 2003 to 2005 with a net liability fair value of $7.8 million.  During the nine months ended September 30, 2003, the Operating Partnership recognized an unrealized gain of $1.1 million due to ineffectiveness of certain of these unconsolidated development derivatives (included in loss from investments in unconsolidated entities).

 

On September 30, 2003, the net derivative instruments were reported at their fair value as other assets of approximately $10.0 million, as other liabilities of approximately $7.4 million and as a reduction to investments in unconsolidated entities of approximately $7.8 million.  As of September 30, 2003, there were approximately $28.9 million in deferred losses, net, included in accumulated other comprehensive loss.

 

18



 

Based on the estimated fair values of the net derivative instruments at September 30, 2003, the Operating Partnership may recognize an estimated $11.7 million of accumulated other comprehensive loss as additional interest expense ($6.1 million related to its consolidated derivatives) or as additional loss on investments in unconsolidated entities ($5.6 million related to its unconsolidated development partnerships) during the twelve months ending September 30, 2004.

 

13.                               Calculation of Net Income Per Weighted Average OP Unit

 

The following tables set forth the computation of net income per OP Unit – basic and net income per OP Unit – diluted:

 

 

 

Nine Months Ended
September 30,

 

Quarter Ended
September 30,

 

 

 

2003

 

2002

 

2003

 

2002

 

 

 

(Amounts in thousands except per OP Unit amounts)

 

Numerator for net income per OP Unit basic:

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

$

207,976

 

$

218,442

 

$

68,450

 

$

50,044

 

Allocation to Preference Units

 

(57,713

)

(57,568

)

(19,564

)

(19,055

)

Allocation to Preference Interests

 

(15,159

)

(15,158

)

(5,053

)

(5,052

)

Allocation to Junior Preference Units

 

(243

)

(243

)

(81

)

(81

)

 

 

 

 

 

 

 

 

 

 

Income from continuing operations available to OP Units

 

134,861

 

145,473

 

43,752

 

25,856

 

Net gain on sales of discontinued operations

 

218,975

 

61,209

 

77,983

 

32,763

 

Discontinued operations, net

 

9,494

 

42,252

 

(7

)

11,137

 

 

 

 

 

 

 

 

 

 

 

Numerator for net income per OP Unit – basic

 

$

363,330

 

$

248,934

 

$

121,728

 

$

69,756

 

 

 

 

 

 

 

 

 

 

 

Numerator for net income per OP Unit – diluted:

 

 

 

 

 

 

 

 

 

Income from continuing operations

 

$

207,976

 

$

218,442

 

$

68,450

 

$

50,044

 

Allocation to Preference Units

 

(57,713

)

(57,568

)

(19,564

)

(19,055

)

Allocation to Preference Interests

 

(15,159

)

(15,158

)

(5,053

)

(5,052

)

Allocation to Junior Preference Units

 

(243

)

(243

)

(81

)

(81

)

Effect of dilutive securities:

 

 

 

 

 

 

 

 

 

Distributions on convertible preference units/interests

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income from continuing operations available to OP Units

 

134,861

 

145,473

 

43,752

 

25,856

 

Net gain on sales of discontinued operations

 

218,975

 

61,209

 

77,983

 

32,763

 

Discontinued operations, net

 

9,494

 

42,252

 

(7

)

11,137

 

 

 

 

 

 

 

 

 

 

 

Numerator for net income per OP Unit – diluted

 

$

363,330

 

$

248,934

 

$

121,728

 

$

69,756

 

 

 

 

 

 

 

 

 

 

 

Denominator for net income per OP Unit – basic and diluted:

 

 

 

 

 

 

 

 

 

Denominator for net income per OP Unit – basic

 

293,900

 

295,483

 

295,032

 

296,519

 

 

 

 

 

 

 

 

 

 

 

Effect of dilutive securities:

 

 

 

 

 

 

 

 

 

Convertible preference units/interests

 

 

 

 

 

Dilution for OP Units issuable upon assumed exercised/vesting of EQR’s share options/restricted shares

 

2,284

 

3,207

 

2,909

 

2,538

 

 

 

 

 

 

 

 

 

 

 

Denominator for net income per OP Unit diluted

 

296,184

 

298,690

 

297,941

 

299,057

 

 

 

 

 

 

 

 

 

 

 

Net income per OP Unit – basic

 

$

1.24

 

$

0.84

 

$

0.41

 

$

0.24

 

 

 

 

 

 

 

 

 

 

 

Net income per OP Unit – diluted

 

$

1.23

 

$

0.83

 

$

0.41

 

$

0.23

 

 

19



 

 

 

Nine Months Ended
September 30,

 

Quarter Ended
September 30,

 

 

 

2003

 

2002

 

2003

 

2002

 

 

 

(Amounts in thousands except per OP Unit amounts)

 

Net income per OP Unit – basic:

 

 

 

 

 

 

 

 

 

Income from continuing operations available to OP Units

 

$

0.46

 

$

0.49

 

$

0.15

 

$

0.09

 

Net gain on sales of discontinued operations

 

0.75

 

0.21

 

0.26

 

0.11

 

Discontinued operations, net

 

0.03

 

0.14

 

 

0.04

 

 

 

 

 

 

 

 

 

 

 

Net income per OP Unit – basic

 

$

1.24

 

$

0.84

 

$

0.41

 

$

0.24

 

 

 

 

 

 

 

 

 

 

 

Net income per OP Unit – diluted:

 

 

 

 

 

 

 

 

 

Income from continuing operations available to OP Units

 

$

0.46

 

$

0.49

 

$

0.15

 

$

0.08

 

Net gain on sales of discontinued operations

 

0.74

 

0.20

 

0.26

 

0.11

 

Discontinued operations, net

 

0.03

 

0.14

 

 

0.04

 

 

 

 

 

 

 

 

 

 

 

Net income per OP Unit – diluted

 

$

1.23

 

$

0.83

 

$

0.41

 

$

0.23

 

 

Convertible preference units/interests that could be converted into 14,932,069 and 15,461,855 weighted average Common Shares (which would be contributed to the Operating Partnership in exchange for OP Units) for the nine months ended September 30, 2003 and 2002, respectively, and 14,911,158 and 15,095,576 weighted average Common Shares for the quarters ended September 30, 2003 and 2002, respectively, were outstanding but were not included in the computation of diluted earnings per OP Unit because the effects would be anti-dilutive.

 

14.                               Discontinued Operations

 

The Operating Partnership has presented separately as discontinued operations in all periods the results of operations for all wholly owned assets disposed of on or after January 1, 2002 (the date of adoption of SFAS No. 144).

 

The components of discontinued operations are outlined below and include the results of operations for the respective periods that the Operating Partnership owned such assets during the nine months and quarters ended September 30, 2003 and 2002, including the following:

 

                  The sixty-one Wholly Owned Properties and various individual condominium units containing 15,673 units sold during 2003 (see Note 5); and

                  The fifty-two Wholly Owned Properties and various individual condominium units containing 9,586 units and the furniture rental business sold during 2002.

 

20



 

 

 

Nine Months Ended
September 30,

 

Quarter Ended
September 30,

 

 

 

2003

 

2002

 

2003

 

2002

 

 

 

(Amounts in thousands)

 

REVENUES

 

 

 

 

 

 

 

 

 

Rental income

 

$

51,306

 

$

127,964

 

$

8,050

 

$

37,069

 

Furniture income

 

 

1,361

 

 

 

Total revenues

 

51,306

 

129,325

 

8,050

 

37,069

 

 

 

 

 

 

 

 

 

 

 

EXPENSES (1)

 

 

 

 

 

 

 

 

 

Property and maintenance

 

20,639

 

37,680

 

4,345

 

12,031

 

Real estate taxes and insurance

 

5,994

 

13,504

 

777

 

3,745

 

Property management

 

103

 

123

 

(9

)

40

 

Depreciation

 

13,175

 

30,591

 

2,160

 

9,029

 

Furniture expenses

 

 

1,303

 

 

 

Total expenses

 

39,911

 

83,201

 

7,273

 

24,845

 

 

 

 

 

 

 

 

 

 

 

Discontinued operating income

 

11,395

 

46,124

 

777

 

12,224

 

 

 

 

 

 

 

 

 

 

 

Interest and other income

 

175

 

26

 

53

 

 

Interest:

 

 

 

 

 

 

 

 

 

Expense incurred, net

 

(1,938

)

(3,815

)

(722

)

(1,069

)

Amortization of deferred financing costs

 

(138

)

(83

)

(115

)

(18

)

 

 

 

 

 

 

 

 

 

 

Discontinued operations, net

 

$

9,494

 

$

42,252

 

$

(7

)

$

11,137

 

 


(1)             Includes expenses paid in the current period for Wholly Owned Properties sold in prior periods related to the Operating Partnership’s period of ownership.

 

15.                               Commitments and Contingencies

 

The Operating Partnership, as an owner of real estate, is subject to various Federal, state and local environmental laws.  Compliance by the Operating Partnership with existing laws has not had a material adverse effect on the Operating Partnership.  However, the Operating Partnership cannot predict the impact of new or changed laws or regulations on its current properties or on properties that it may acquire in the future.

 

The Operating Partnership is a party to a class action lawsuit in Florida state court alleging that several of the types of fees that the Operating Partnership charged when residents breached their leases were illegal, as are all efforts to collect them. We are vigorously contesting the plaintiffs’ claims and will seek immediate appellate review of the recent class action certification decision. Due to the preliminary nature of the litigation, it is not possible to determine or predict the outcome. While no assurances can be given, we do not believe that this lawsuit, if adversely determined, will have a material adverse effect on the Operating Partnership.

 

The Operating Partnership does not believe there is any other litigation pending or threatened against the Operating Partnership which, individually or in the aggregate, reasonably may be expected to

 

21



 

have a material adverse effect on the Operating Partnership.

 

As of September 30, 2003, the Operating Partnership has 16 projects in various stages of development with estimated completion dates ranging through December 31, 2004.  The three development agreements currently in place have the following key terms:

 

                        The first development partner has the right, at any time following completion of a project, to stipulate a value for such project and offer to sell its interest in the project to the Operating Partnership based on such value.  If the Operating Partnership chooses not to purchase the interest, it must agree to a sale of the project to an unrelated third party at such value.  The Operating Partnership’s partner must exercise this right as to all projects within five years after the receipt of the final certificate of occupancy on the last developed property.   In connection with this development partner, the Operating Partnership has an obligation to provide up to $40.0 million in credit enhancements to guarantee a portion of the third party construction financing.  As of November 4, 2003, the Operating Partnership had set-aside $20.0 million towards this credit enhancement.  The Operating Partnership would be required to perform under this agreement only if there was a material default under a third party construction mortgage agreement.  This agreement expires no later than December 31, 2018.  Notwithstanding the termination of the agreement, the Operating Partnership shall have recourse against its development partner for any losses incurred.

 

                        The second development partner has the right, at any time following completion of a project, to require the Operating Partnership to purchase the partners’ interest in that project at a mutually agreeable price.  If the Operating Partnership and the partner are unable to agree on a price, both parties will obtain appraisals.  If the appraised values vary by more than 10%, both the Operating Partnership and its partner will agree on a third appraiser to determine which original appraisal is closest to its determination of value.  The Operating Partnership may elect at that time not to purchase the property and instead, authorize its partner to sell the project at or above the agreed-upon value to an unrelated third party.  Five years following the receipt of the final certificate of occupancy on the last developed property, the Operating Partnership must purchase, at the agreed-upon price, any projects remaining unsold.

 

                  The third development partner has the exclusive right for six months following stabilization (generally defined as having achieved 90% occupancy for three consecutive months following the substantial completion of a project) to market a project for sale.  Thereafter, either the Operating Partnership or its development partner may market a project for sale.  If the Operating Partnership’s development partner proposes the sale, the Operating Partnership may elect to purchase the project at the price proposed by its partner or defer the sale until two independent appraisers appraise the project.  If the two appraised values vary by more than 5%, a third appraiser will be chosen to determine the fair market value of the property.  Once a value has been determined, the Operating Partnership may elect to purchase the property or authorize its development partner to sell the project at the agreed-upon value.

 

In connection with one of its mergers, the Operating Partnership executed a credit enhancement agreement with respect to certain tax-exempt bonds issued to finance certain public improvements at a multifamily development project.  The Operating Partnership has the obligation to facilitate credit under this agreement for a period of eight years from the consummation of the merger or through May 2005.  The Operating Partnership would be required to perform under this agreement only if there was a material default with respect to the tax-exempt bonds.  If there should be any default in connection with this agreement, the Operating Partnership has the right, among other remedies, to select an alternate interest rate on the bonds.  As of September 30, 2003, this enhancement was still in effect at a commitment amount of $12.7 million and no outstanding liability.

 

22



 

16.                               Asset Impairment

 

For both the nine months ended September 30, 2003 and 2002, the Operating Partnership recorded $0.9 million of asset impairment charges related to its technology investments.  These charges were the result of a review of the existing investments reflected on the consolidated balance sheet.  These impairment losses are reflected on the consolidated statements of operations in total expenses and include the write-down of assets classified as other assets.

 

For the nine months ended September 30, 2002, the Operating Partnership recorded approximately $17.1 million of asset impairment charges related to its corporate housing business.  Following the guidance in SFAS No. 142, these charges were the result of the Operating Partnership’s decision to reduce the carrying value of its corporate housing business to $30.0 million, given the continued weakness in the economy and management’s expectations for near-term performance.  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.

 

17.                               Reportable Segments

 

Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by senior management.  Senior management decides how resources are allocated and assesses performance on a monthly basis.

 

The Operating Partnership’s primary business is owning, managing, and operating multifamily residential properties, which includes the generation of rental and other related income through the leasing of apartment units to residents and includes Equity Corporate Housing (“ECH”).  Senior management evaluates the performance of each of our apartment communities on an individual basis; however, each of our apartment communities has similar economic characteristics, residents, and products and services so they have been aggregated into one reportable segment.  The Operating Partnership’s rental real estate segment comprises approximately 99.2% and 99.5% of total revenues for the nine months ended September 30, 2003 and 2002, respectively, and approximately 99.3% and 99.4% of total revenues for the quarters ended September 30, 2003 and 2002, respectively.  The Operating Partnership’s rental real estate segment comprises approximately 99.7% of total assets at both September 30, 2003 and December 31, 2002.

 

The primary financial measure for the Operating Partnership’s rental real estate segment is net operating income (“NOI”), which represents rental income less: 1) property and maintenance expense; 2) real estate taxes and insurance expense; and 3) property management expense (all as reflected in the accompanying statements of operations).  The Operating Partnership believes that NOI is helpful to investors as a supplemental measure of the operating performance of a real estate Operating Partnership because it is a direct measure of the actual operating results of the Operating Partnership’s apartment communities.  Current year NOI is compared to prior year NOI and current year budgeted NOI as a measure of financial performance.  NOI from our rental real estate totaled approximately $810.5 million and $840.1 million for the nine months ended September 30, 2003 and 2002, respectively, and approximately $270.8 million and $277.0 million for the quarters ended September 30, 2003 and 2002, respectively.

 

During the acquisition, development and/or disposition of real estate, the Operating Partnership considers its NOI return on total investment as the primary measure of financial performance.

 

The Operating Partnership’s fee and asset management activity is immaterial and does not meet the threshold requirements of a reportable segment as provided for in SFAS No. 131.

 

All revenues are from external customers and there is no customer who contributed 10% or more of the Operating Partnership’s total revenues during the nine months ended September 30, 2003 or 2002.

 

23



 

18.                               Subsequent Events/Other

 

Subsequent to September 30, 2003 and through November 4, 2003, the Operating Partnership:

 

                  Acquired two properties consisting of 432 units for approximately $79.2 million;

                  Assumed $9.6 million of mortgage debt on certain properties in connection with their acquisitions and/or consolidation;

                  Disposed of four properties and various individual condominium units consisting of 561 units for approximately $28.4 million;

                  Repaid $23.5 million of mortgage debt;

                  Relinquished $7.0 million of mortgage debt assumed by the purchaser on disposed properties;

                  Repaid $40.0 million of 6.875% fixed rate public notes at maturity; and

                  Purchased a third party’s $20.0 million participation interest in a floating rate construction loan secured by one of the Operating Partnership’s unconsolidated development properties.

 

24



 

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

 

Overview

 

For further information including definitions for capitalized terms not defined herein, refer to the consolidated financial statements and footnotes thereto included in the Operating Partnership’s annual report on Form 10-K for the year ended December 31, 2002.

 

Forward-looking statements in this report are intended to be made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.  The words “believes”, “estimates”, “expects” and “anticipates” and other similar expressions that are predictions of or indicate future events and trends and which do not relate solely to historical matters identify forward-looking statements.  Such forward-looking statements are subject to risks and uncertainties, which could cause actual results, performance, or achievements of the Operating Partnership to differ materially from anticipated future results, performance or achievements expressed or implied by such forward-looking statements.  Factors that might cause such differences include, but are not limited to, the following:

 

                  The total number of development units, cost of development and completion dates as well as anticipated capital expenditures for replacements and building improvements all reflect the Operating Partnership’s best estimates and are subject to uncertainties arising from changing economic conditions (such as the cost of labor and construction materials), competition and local government regulation;

                  Alternative sources of capital to the Operating Partnership or labor and materials required for maintenance, repair, capital expenditure or development are more expensive than anticipated;

                  Occupancy levels and market rents may be adversely affected by national and local economic and market conditions including, without limitation, new construction of multifamily housing, continuing decline in employment, availability of low interest mortgages for single-family home buyers and the potential for geopolitical instability, all of which are beyond the Operating Partnership’s control; and

                  Additional factors as discussed in Part I of the Annual Report on Form 10-K, particularly those under “Risk Factors”.

 

Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof.  The Operating Partnership undertakes no obligation to publicly release any revisions to these forward-looking statements, which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.  Forward-looking statements and related uncertainties are also included in Notes 6 and 12 to the Notes to Consolidated Financial Statements in this report.

 

25



 

Results of Operations

 

The following table summarizes the number of properties and related units for the periods presented:

 

 

 

Properties

 

Units

 

Purchase /
Sale Price
$ Millions

 

At December 31, 2001

 

1,076

 

224,801

 

 

 

Q1/Q2/Q3 2002 Acquisitions

 

10

 

3,053

 

$

245.4

 

Ft. Lewis Military Housing

 

1

 

3,652

 

 

 

Q1/Q2/Q3 2002 Dispositions

 

(35

)

(6,046

)

$

338.9

 

Q1/Q2/Q3 2002 Completed Developments

 

7

 

1,966

 

 

 

At September 30, 2002

 

1,059

 

227,426

 

 

 

Q4 2002 Acquisitions

 

2

 

581

 

$

44.5

 

Q4 2002 Dispositions

 

(23

)

(4,667

)

$

207.3

 

Q4 2002 Completed Developments

 

1

 

235

 

 

 

Q4 2002 Unit Configuration Changes

 

 

16

 

 

 

At December 31, 2002

 

1,039

 

223,591

 

 

 

Q1/Q2/Q3 2003 Acquisitions

 

8

 

2,678

 

$

389.7

 

Q1/Q2/Q3 2003 Dispositions

 

(63

)

(15,996

)

$

803.2

 

Q1/Q2/Q3 2003 Completed Developments

 

6

 

1,745

 

 

 

Q1/Q2/Q3 2003 Unit Configuration Changes

 

 

129

 

 

 

At September 30, 2003

 

990

 

212,147

 

 

 

 

Significant changes in revenues between the nine months and quarters presented have resulted primarily from reduced rental income through increased concessions or reduced apartment rents and occupancy at many of our properties.  Significant changes in expenses have resulted from increases in property and maintenance expenses including payroll, maintenance, building, utilities and leasing and advertising as well as real estate taxes, partially offset by decreases in property management expenses.  In addition, the Operating Partnership’s acquisition, disposition and completed development activity has impacted overall results of operations for the nine months and quarters ended September 30, 2003 and 2002.  These changes are discussed in greater detail in the following paragraphs.

 

Properties that the Operating Partnership owned for the entire nine month periods ended September 30, 2003 as well as September 30, 2002 (the “Nine-Month 2003 Same Store Properties”), which represented 179,233 units and properties that the Operating Partnership owned for all of both the quarters ended September 30, 2003 and September 30, 2002 (the “Third Quarter 2003 Same Store Properties”), which represented 181,656 units, also impacted the Operating Partnership’s results of operations.  Both the Nine-Month 2003 Same Store Properties and Third Quarter 2003 Same Store Properties are discussed in the following paragraphs.

 

Comparison of the nine months ended September 30, 2003 to the nine months ended September 30, 2002

 

For the nine months ended September 30, 2003, income before allocation to Minority Interests, loss from investments in unconsolidated entities, net gain (loss) on sales of unconsolidated entities and discontinued operations decreased by approximately $15.4 million when compared to the nine months ended September 30, 2002.

 

Revenues from the Nine-Month 2003 Same Store Properties decreased primarily as a result of lower overall physical occupancy, increased concessions and lower rental rates charged to both new and renewal residents.  Property operating expenses from the Nine-Month 2003 Same Store Properties increased

 

26



 

primarily due to higher payroll, maintenance, utility, real estate taxes, leasing and advertising and building costs.  The following tables provide comparative revenue, expense, net operating income (“NOI”) and weighted average occupancy for the Nine-Month 2003 Same Store Properties (NOI represents rental income less: 1) property and maintenance expense; 2) real estate taxes and insurance expense; and 3) property management expense):

 

September YTD 2003 vs. September YTD 2002
For Nine-Month Same Store Properties

 

$ in Millions – 179,233 Same-Store Units

 

Description

 

Revenues

 

Expenses

 

NOI

 

 

 

 

 

 

 

 

 

YTD 2003

 

 

$

1,279.4

 

$

508.7

 

$

770.7

 

YTD 2002

 

 

$

1,316.2

 

$

482.6

 

$

833.6

 

Change

 

 

$

(36.8

)

$

26.1

 

$

(62.9

)

Change

 

 

(2.8

)%

5.4

%

(7.5

)%

 

Same Store Occupancy Statistics

 

YTD 2003

 

 

93.0

%

YTD 2002

 

 

94.0

%

Change

 

 

(1.0

)%

 

The Operating Partnership’s primary financial measure for evaluating each of its apartment communities is NOI.  The Operating Partnership believes that NOI is helpful to investors as a supplemental measure of the operating performance of a real estate company because it is a direct measure of the actual operating results of the Operating Partnership’s apartment communities.

 

For properties that the Operating Partnership acquired prior to January 1, 2002 and expects to continue to own through December 31, 2003, the Operating Partnership anticipates the following same store results for the full year ending December 31, 2003:

 

2003 Same Store Assumptions

 

Physical Occupancy

 

93.0%

 

Revenue Change

 

(2.3%)

 

Expense Change

 

5.2%

 

NOI Change

 

(6.7%)

 

Dispositions

 

$1.0 to $1.2 billion

 

 

For properties that the Operating Partnership acquired prior to January 1, 2003 and expects to continue to own through December 31, 2004, the Operating Partnership anticipates the following same store results for the full year ending December 31, 2004:

 

2004 Same Store Assumptions

 

Physical Occupancy

 

93.0%

 

Revenue Change

 

(0.75%) to 1.50%

 

Expense Change

 

3.0% to 4.0%

 

NOI Change

 

(4.0%) to 0.5%

 

Dispositions

 

$800.0 million

 

 

These 2003 and 2004 assumptions are based on current expectations and are forward-looking.

 

Rental income from properties other than Nine-Month 2003 Same Store Properties increased by

 

27



 

approximately $34.0 million primarily as a result of revenue from properties acquired in 2002 and 2003 and additional Partially Owned Properties consolidated in the fourth quarter of 2002 and the first nine months of 2003.

 

Fee and asset management revenues, net of fee and asset management expenses, increased by $3.9 million primarily as a result of additional income allocated from Ft. Lewis Military Housing.  As of September 30, 2003 and 2002, the Operating Partnership managed 18,897 units and 20,142 units, respectively, for third parties and unconsolidated entities.

 

Property management expenses include off-site expenses associated with the self-management of the Operating Partnership’s properties as well as management fees paid to third party management companies.  These expenses decreased by approximately $7.3 million or 13.0%.  This decrease is primarily attributable to a reversal of a profit sharing accrual in the first quarter of 2003 related to the 2002 calendar year as the Operating Partnership didn’t achieve its stated goals and management elected not to make a discretionary contribution to the plan.  In addition, the Company recorded lower expense in connection with granting less restricted shares and reducing the expense associated with the Company’s matched funding of its 401(k) plan during the first nine months of 2003 and not incurring an expense for any 2003 profit sharing.

 

Depreciation expense, which includes depreciation on non-real estate assets, increased $19.1 million primarily as a result of properties acquired after September 30, 2002 and additional depreciation on capital expenditures for all properties owned.

 

General and administrative expenses, which include corporate operating expenses, decreased approximately $4.1 million between the periods under comparison.  This decrease was primarily due to lower expenses recorded in connection with granting less restricted shares to employees during the first nine months of 2003 offset by approximately a $3.4 million increase related to the Operating Partnership’s decision to expense its stock based compensation in accordance with SFAS No. 123 and its amendment (SFAS No. 148).  In addition, lower state income and franchise taxes also contributed to this decrease.

 

The Operating Partnership recorded impairment charges on its technology investments and its corporate housing business of approximately $0.9 million and $18.0 million for the nine months ended September 30, 2003 and 2002, respectively.  See Note 16 in the Notes to Consolidated Financial Statements for further discussion.

 

Interest and other income increased by approximately $2.2 million, primarily as a result of higher cash balances available for short-term investments throughout 2003.

 

Interest expense, including amortization of deferred financing costs, decreased approximately $6.0 million primarily due to lower variable interest rates.  During the nine months ended September 30, 2003, the Operating Partnership capitalized interest costs of approximately $16.0 million as compared to $19.4 million for the nine months ended September 30, 2002.  This capitalization of interest primarily related to equity investments in unconsolidated entities engaged in development activities.  The effective interest cost on all indebtedness for the nine months ended September 30, 2003 was 6.37% as compared to 6.60% for the nine months ended September 30, 2002.

 

Loss from investments in unconsolidated entities increased approximately $1.8 million between the periods under comparison.  This increase is primarily the result of increased operating losses from equity investments partially offset by unrealized gains on derivative instruments.

 

Net gain on sales of discontinued operations increased approximately $157.8 million between the periods under comparison.  This increase is primarily the result of a greater number of properties sold during the nine months ended September 30, 2003, as well as the fact that several properties were more fully

 

28



 

depreciated.

 

Discontinued operations, net, decreased approximately $32.8 million between the periods under comparison.  See Note 14 in the Notes to Consolidated Financial Statements for further discussion.

 

Comparison of the quarter ended September 30, 2003 to the quarter ended September 30, 2002

 

For the quarter ended September 30, 2003, income before allocation to Minority Interests, loss from investments in unconsolidated entities, net gain (loss) on sales of unconsolidated entities and discontinued operations increased by approximately $12.0 million when compared to the quarter ended September 30, 2002.

 

Revenues from the Third Quarter 2003 Same Store Properties decreased primarily as a result of lower overall physical occupancy, increased concessions and lower rental rates charged to both new and renewal residents.  Property operating expenses from the Third Quarter 2003 Same Store Properties increased mainly due to higher payroll, maintenance, utility, real estate taxes, building and leasing and advertising costs.  The following tables provide comparative revenue, expense, NOI and weighted average occupancy for the Third Quarter 2003 Same Store Properties:

 

Third Quarter 2003 vs. Third Quarter 2002
For Third Quarter 2003 Same Store Properties

 

$ in Millions – 181,656 Same-Store Units

 

Description

 

Revenues

 

Expenses

 

NOI

 

 

 

 

 

 

 

 

 

Q3 2003

 

 

$

433.8

 

$

176.3

 

$

257.5

 

Q3 2002

 

 

$

442.2

 

$

169.1

 

$

273.1

 

Change

 

 

$

(8.4

)

$

7.2

 

$

(15.6

)

Change

 

 

(1.9

)%

4.3

%

(5.7

)%

 

Same Store Occupancy Statistics

 

Q3 2003

 

 

93.5

%

Q3 2002

 

 

93.9

%

Change

 

 

(0.4

)%

 

Rental income from properties other than Third Quarter 2003 Same Store Properties increased by approximately $11.9 million primarily as a result of revenue from properties acquired in the fourth quarter of 2002 and throughout 2003.

 

Fee and asset management revenues, net of fee and asset management expenses, increased by $0.3 million primarily as a result of income from Ft. Lewis Military Housing.  As of September 30, 2003 and 2002, the Operating Partnership managed 18,897 units and 20,142 units, respectively, for third parties and unconsolidated entities.

 

Property management expenses include off-site expenses associated with the self-management of the Operating Partnership’s properties as well as management fees paid to third party management companies.  These expenses decreased by approximately $1.8 million or 9.8%.  The Company recorded lower expense in connection with granting less restricted shares and reducing the expense associated with the Company’s matched funding of its 401(k) plan during the first nine months of 2003 and not incurring an expense for any 2003 profit sharing.

 

Depreciation expense, which includes depreciation on non-real estate assets, increased $6.0 million

 

29



 

primarily as a result of properties acquired after September 30, 2002 and additional depreciation on capital expenditures for all properties owned.

 

General and administrative expenses, which include corporate operating expenses, decreased approximately $2.0 million between the periods under comparison.  This decrease was primarily due to lower expenses recorded in connection with granting less restricted shares to employees and lower accrued expenses related to deferred compensation during the quarter ended September 30, 2003 offset by a $0.6 million increase related to the Operating Partnership’s decision to expense its stock based compensation.

 

The Operating Partnership recorded impairment charges on its technology investments and corporate housing business of approximately $0.3 million and $17.4 million for the quarters ended September 30, 2003 and 2002, respectively.  See Note 16 in the Notes to Consolidated Financial Statements for further discussion.

 

Interest and other income increased by approximately $4.4 million, primarily as a result of higher cash balances available for short-term investments.

 

Interest expense, including amortization of deferred financing costs, decreased approximately $0.4 million primarily due to lower variable interest rates.  During the quarter ended September 30, 2003, the Operating Partnership capitalized interest costs of approximately $5.1 million as compared to $7.1 million for the quarter ended September 30, 2002.  This capitalization of interest primarily related to equity investments in unconsolidated entities engaged in development activities.  The effective interest cost on all indebtedness for the quarter ended September 30, 2003 was 6.32% as compared to 6.52% for the quarter ended September 30, 2002.

 

Loss from investments in unconsolidated entities decreased approximately $0.1 million between the periods under comparison.  This decrease is primarily the result of unrealized gains on derivative instruments.

 

Net gain on sales of discontinued operations increased approximately $45.2 million between the periods under comparison.  This increase is primarily the result of a greater number of properties sold during the quarter ended September 30, 2003, as well as the fact that several properties were more fully depreciated.

 

Discontinued operations, net, decreased approximately $11.1 million between the periods under comparison.  See Note 14 in the Notes to Consolidated Financial Statements for further discussion.

 

Liquidity and Capital Resources

 

As of January 1, 2003, the Operating Partnership had approximately $29.9 million of cash and cash equivalents and $499.2 million available under its line of credit (net of $60.8 million which was restricted/dedicated to support letters of credit and not available for borrowing).  After taking into effect the various transactions discussed in the following paragraphs and the net cash provided by operating activities, the Operating Partnership’s cash and cash equivalents balance at September 30, 2003 was approximately $372.6 million and the amount available on the Operating Partnership’s line of credit was $643.0 million (net of $57.0 million which was restricted/dedicated to support letters of credit and not available for borrowing).

 

During the nine months ended September 30, 2003, the Operating Partnership generated proceeds from various transactions, which included the following:

 

                  Disposed of sixty-three properties (including two Unconsolidated Properties) and received net proceeds of approximately $759.0 million;

 

30



 

                  Issued $400.0 million of 5.20% fixed rate unsecured debt receiving net proceeds of $397.5 million;

                  Issued $150.0 million of 6.48% Series N Cumulative Redeemable Preference Units and received net proceeds of $145.3 million;

                  Obtained $48.7 million in new mortgage financing; and

                  Issued approximately 2.7 million OP Units and received net proceeds of $56.2 million.

 

All of these proceeds were primarily utilized to:

 

                  Purchase additional properties;

                  Repay mortgage indebtedness on selected properties;

                  Repay the line of credit;

                  Repay public unsecured debt; and

                  Redeem the Series L Preference Units.

 

During the nine months ended September 30, 2003, the Operating Partnership:

 

                  Acquired eight properties, and two additional units at an existing property, utilizing cash of $308.7 million;

                  Repaid $235.2 million of mortgage loans;

                  Repaid $140.0 million on its line of credit;

                  Repaid $100.0 million of floating rate public notes at maturity;

                  Repaid $4.5 million of other unsecured notes; and

                  Redeemed $100.0 million of 7.625% Series L Cumulative Redeemable Preference Units at liquidation value.

 

Depending on its analysis of market prices, economic conditions, and other opportunities for the investment of available capital, the Company may repurchase up to an additional $85.0 million of its Common Shares pursuant to its existing share buyback program authorized by the Board of Trustees.  The Operating Partnership in turn, would repurchase $85.0 million of its OP Units held by EQR.  The Company did not repurchase any of its Common Shares during the nine months ended September 30, 2003.

 

The Operating Partnership’s total debt summary and debt maturity schedule as of September 30, 2003, are as follows:

 

31



 

Debt Summary

 

 

 

As of 9/30/03
$ Millions (1)

 

For the Nine Months
Ended 9/30/03
Weighted
Average Rate (1)

 

Secured

 

$

2,819

 

5.84

%

Unsecured

 

2,748

 

6.39

%

Total

 

$

5,567

 

6.11

%

 

 

 

 

 

 

Fixed Rate

 

$

4,835

 

6.64

%

Floating Rate

 

732

 

2.25

%

Total

 

$

5,567

 

6.11

%

 

 

 

 

 

 

Above Totals Include:

 

 

 

 

 

Tax Exempt:

 

 

 

 

 

Fixed

 

$

383

 

4.31

%

Floating

 

568

 

1.83

%

Total

 

$

951

 

3.02

%

 

 

 

 

 

 

Unsecured Revolving Credit Facility

 

$

 

1.85

%

 


(1) Net of the effect of any derivative instruments.

 

Debt Maturity Schedule as of September 30, 2003

 

Year

 

$ Millions

 

% of Total

 

2003

 

$

121

 

2.2

%

2004

 

600

 

10.8

%

2005 (2)

 

594

 

10.7

%

2006 (3)

 

490

 

8.8

%

2007

 

297

 

5.3

%

2008

 

488

 

8.8

%

2009

 

247

 

4.4

%

2010

 

197

 

3.5

%

2011

 

689

 

12.4

%

2012+

 

1,844

 

33.1

%

Total

 

$

5,567

 

100.0

%

 


(2) Includes $300 million of unsecured debt with a final maturity of 2015 that is putable/callable in 2005.

 

(3) Includes $150 million of unsecured debt with a final maturity of 2026 that is putable in 2006.

 

On June 5, 2003, the Operating Partnership filed a Form S-3 registration statement with the SEC to register $2.0 billion of debt securities.  The SEC declared this registration statement effective on June 11, 2003.  In addition, the Operating Partnership carried over $280.0 million related to the registration statement effective on September 8, 2000.  As of September 30, 2003, $2.28 billion remained available for issuance under this registration statement.

 

The Operating Partnership’s “Consolidated Debt-to-Total Market Capitalization Ratio” as of September 30, 2003 is presented in the following table.  The Operating Partnership calculates the equity

 

32



 

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 September 30, 2003

 

Total Debt

 

 

 

$

5,566,665,932

 

 

 

 

 

 

 

OP Units

 

297,291,121

 

 

 

OP Unit Equivalents (see below)

 

14,881,326

 

 

 

Total Outstanding at quarter-end

 

312,172,447

 

 

 

EQR Common Share Price at September 30, 2003

 

$

29.28

 

 

 

 

 

 

 

9,140,409,248

 

Perpetual Preference Units Liquidation Value

 

 

 

615,000,000

 

Perpetual Preference Interests Liquidation Value

 

 

 

211,500,000

 

Total Market Capitalization

 

 

 

$

15,533,575,180

 

 

 

 

 

 

 

Debt/Total Market Capitalization

 

 

 

36

%

 

Convertible Preference Units, Preference Interests
and Junior Preference Units
as of September 30, 2003

 

 

 

Units

 

Conversion
Ratio

 

OP Unit
Equivalents

 

Preference Units:

 

 

 

 

 

 

 

Series E

 

2,488,290

 

1.1128

 

2,768,969

 

Series G

 

1,264,692

 

8.5360

 

10,795,408

 

Series H

 

51,228

 

1.4480

 

74,178

 

Preference Interests:

 

 

 

 

 

 

 

Series H

 

190,000

 

1.5108

 

287,052

 

Series I

 

270,000

 

1.4542

 

392,634

 

Series J

 

230,000

 

1.4108

 

324,484

 

Junior Preference Units:

 

 

 

 

 

 

 

Series A

 

56,616

 

4.081600

 

231,084

 

Series B

 

7,367

 

1.020408

 

7,517

 

 

 

 

 

 

 

 

 

Total

 

 

 

 

 

14,881,326

 

 

The Operating Partnership’s policy is to maintain a ratio of consolidated debt-to-total market capitalization of less than 50%.

 

From October 1, 2003 through November 4, 2003, the Operating Partnership:

 

                  Acquired two properties consisting of 432 units for approximately $79.2 million;

                  Assumed $9.6 million of mortgage debt on certain properties in connection with their acquisitions and/or consolidation;

                  Disposed of four properties and various individual condominium units consisting of 561 units for approximately $28.4 million;

                  Repaid $23.5 million of mortgage debt;

                  Relinquished $7.0 million of mortgage debt assumed by the purchaser on disposed properties;

                  Repaid $40.0 million of 6.875% fixed rate public notes at maturity; and

                  Purchased a third party’s $20.0 million participation interest in a floating rate construction loan secured by one of the Operating Partnership’s unconsolidated development properties.

 

33



 

Off-Balance Sheet Arrangements and Contractual Obligations

 

As of September 30, 2003, the Operating Partnership has 16 projects in various stages of development with estimated completion dates ranging through December 31, 2004.  The three development agreements currently in place have the following key terms:

 

                  The first development partner has the right, at any time following completion of a project, to stipulate a value for such project and offer to sell its interest in the project to the Operating Partnership based on such value.  If the Operating Partnership chooses not to purchase the interest, it must agree to a sale of the project to an unrelated third party at such value.  The Operating Partnership’s partner must exercise this right as to all projects within five years after the receipt of the final certificate of occupancy on the last developed property.   In connection with this development partner, the Operating Partnership has an obligation to provide up to $40.0 million in credit enhancements to guarantee a portion of the third party construction financing.  As of November 4, 2003, the Operating Partnership had set-aside $20.0 million towards this credit enhancement.  The Operating Partnership would be required to perform under this agreement only if there was a material default under a third party construction mortgage agreement.  This agreement expires no later than December 31, 2018.  Notwithstanding the termination of the agreement, the Operating Partnership shall have recourse against its development partner for any losses incurred.

 

                        The second development partner has the right, at any time following completion of a project, to require the Operating Partnership to purchase the partners’ interest in that project at a mutually agreeable price.  If the Operating Partnership and the partner are unable to agree on a price, both parties will obtain appraisals.  If the appraised values vary by more than 10%, both the Operating Partnership and its partner will agree on a third appraiser to determine which original appraisal is closest to its determination of value.  The Operating Partnership may elect at that time not to purchase the property and instead, authorize its partner to sell the project at or above the agreed-upon value to an unrelated third party.  Five years following the receipt of the final certificate of occupancy on the last developed property, the Operating Partnership must purchase, at the agreed-upon price, any projects remaining unsold.

 

                        The third development partner has the exclusive right for six months following stabilization (generally defined as having achieved 90% occupancy for three consecutive months following the substantial completion of a project) to market a project for sale.  Thereafter, either the Operating Partnership or its development partner may market a project for sale.  If the Operating Partnership’s development partner proposes the sale, the Operating Partnership may elect to purchase the project at the price proposed by its partner or defer the sale until two independent appraisers appraise the project.  If the two appraised values vary by more than 5%, a third appraiser will be chosen to determine the fair market value of the property.  Once a value has been determined, the Operating Partnership may elect to purchase the property or authorize its development partner to sell the project at the agreed-upon value.

 

In connection with one of its mergers, the Operating Partnership executed a credit enhancement agreement with respect to certain tax-exempt bonds issued to finance certain public improvements at a multifamily development project.  The Operating Partnership has the obligation to facilitate credit under this agreement for a period of eight years from the consummation of the merger or through May 2005.  The Operating Partnership would be required to perform under this agreement only if there was a material default with respect to the tax-exempt bonds.  If there should be any default in connection with this agreement, the Operating Partnership has the right, among other remedies, to select an alternate interest rate on the bonds.  As of November 4, 2003, this enhancement was still in effect at a commitment amount of $12.7 million and no outstanding liability.

 

See also Note 2 and Note 7 and the third paragraph of Note 15 in the Notes to Consolidated

 

34



 

Financial Statements for additional discussion regarding the Operating Partnership’s investments in unconsolidated entities.

 

Capitalization of Fixed Assets and Improvements to Real Estate

 

Our policy with respect to capital expenditures is generally to capitalize expenditures that improve the value of the property or extend the useful life of the component asset of the property.  We track improvements to real estate in two major categories and several subcategories:

 

             Replacements (inside the unit).  These include:

                  carpets and hardwood floors;

                  appliances;

                  mechanical equipment such as individual furnace/air units, hot water heaters, etc;

                  furniture and fixtures such as kitchen/bath cabinets, light fixtures, ceiling fans, sinks, tubs, toilets, mirrors, countertops, etc;

                  flooring such as vinyl, linoleum or tile; and

                  blinds/shades.

 

All replacements are depreciated over a five-year estimated useful life.  We expense as incurred all maintenance and turnover costs such as cleaning, interior painting of individual units and the repair of any replacement item noted above.

 

             Building improvements (outside the unit).  These include:

                  roof replacement and major repairs;

                  paving or major resurfacing of parking lots, curbs and sidewalks;

                  amenities and common areas such as pools, exterior sports and playground equipment, lobbies, clubhouses, laundry rooms, alarm and security systems and offices;

                  major building mechanical equipment systems;

                  interior and exterior structural repair and exterior painting and siding;

                  major landscaping and grounds improvement; and

                  vehicles and office and maintenance equipment.

 

All building improvements are depreciated over a five to ten-year estimated useful life.  We expense as incurred all recurring expenditures that do not improve the value of the asset or extend its useful life.

 

For the nine months ended September 30, 2003, our actual improvements to real estate totaled approximately $128.5 million.  This includes the following detail (amounts in thousands except for unit and per unit amounts):

 

Capitalized Improvements to Real Estate
For the Nine Months Ended September 30, 2003

 

 

 

Total Units
(1)

 

Replacements

 

Avg.
Per
Unit

 

Building
Improvements

 

Avg.
Per
Unit

 

Total

 

Avg.
Per
Unit

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Established Properties (2)

 

169,402

 

$

44,960

 

$

265

 

$

53,768

 

$

317

 

$

98,728

 

$

582

 

New Acquisition Properties (3)

 

11,447

 

1,786

 

180

 

3,520

 

354

 

5,306

 

534

 

Other (4)

 

8,245

 

8,833

 

 

 

15,612

 

 

 

24,445

 

 

 

Total

 

189,094

 

$

55,579

 

 

 

$

72,900

 

 

 

$

128,479

 

 

 

 


(1)          Total units exclude 23,053 unconsolidated units.

 

35



 

(2)          Wholly Owned Properties acquired prior to January 1, 2001.

(3)          Wholly Owned Properties acquired during 2001, 2002 and 2003.  Per unit amounts are based on a weighted average of 9,931 units.

(4)          Includes properties either Partially Owned or sold during the period, commercial space, condominium conversions and $3.6 million included in building improvements spent on five specific assets related to major renovations and repositioning of these assets.

 

The Operating Partnership expects to fund approximately $30.0 million for capital expenditures for replacements and building improvements for all consolidated properties for the remainder of 2003.

 

During the nine months ended September 30, 2003, the Operating Partnership’s total non-real estate capital additions, such as computer software, computer equipment, and furniture and fixtures and leasehold improvements to the Operating Partnership’s property management offices and its corporate offices, was approximately $2.3 million.  The Operating Partnership expects to fund approximately $1.6 million in total additions to non-real estate property for the remainder of 2003.

 

Improvements to real estate and additions to non-real estate property were funded from net cash provided by operating activities.

 

Derivative Instruments

 

In the normal course of business, the Operating Partnership is exposed to the effect of interest rate changes.  The Operating Partnership limits these risks by following established risk management policies and procedures including the use of derivatives to hedge interest rate risk on debt instruments.

 

The Operating Partnership has a policy of only entering into contracts with major financial institutions based upon their credit ratings and other factors.  When viewed in conjunction with the underlying and offsetting exposure that the derivatives are designed to hedge, the Operating Partnership has not sustained a material loss from those instruments nor does it anticipate any material adverse effect on its net income or financial position in the future from the use of derivatives.

 

See Note 12 in the Notes to Consolidated Financial Statements for additional discussion of derivative instruments at September 30, 2003.

 

Other

 

Total distributions paid in October 2003 amounted to $147.8 million (excluding distributions on Partially Owned Properties), which included certain distributions declared during the third quarter ended September 30, 2003.

 

The Operating Partnership expects to meet its short-term liquidity requirements, including capital expenditures related to maintaining its existing properties and certain scheduled unsecured note and mortgage note repayments, generally through its working capital, net cash provided by operating activities and borrowings under its line of credit.  The Operating Partnership considers its cash provided by operating activities to be adequate to meet operating requirements and payments of distributions.  The Operating Partnership also expects to meet its long-term liquidity requirements, such as scheduled unsecured note and mortgage debt maturities, property acquisitions, financing of construction and development activities and capital improvements through the issuance of unsecured notes and equity securities, including additional OP Units, and proceeds received from the disposition of certain properties.  In addition, the Operating Partnership has certain unencumbered properties available to secure additional mortgage borrowings in the event that the public capital markets are unavailable or the cost of alternative sources of capital is too high.  The fair value of and cash flow from these unencumbered properties are in excess of the requirements the Operating Partnership must maintain in order to comply with covenants under its unsecured notes and line of credit.

 

36



 

The Operating Partnership has a revolving credit facility with potential borrowings of up to $700.0 million.  This facility matures in May 2005 and may, among other potential uses, be used to fund property acquisitions, costs for certain properties under development and short term liquidity requirements.  As of November 4, 2003, no amounts were outstanding under this facility.

 

Critical Accounting Policies and Estimates

 

The Operating Partnership has identified six significant accounting policies as critical accounting policies.  These critical accounting policies are those that have the most impact on the reporting of our financial condition and those requiring significant judgments and estimates.  With respect to these critical accounting policies, management believes that the application of judgments and assessments is consistently applied and produces financial information that fairly presents the results of operations for all periods presented.  The six critical accounting policies are:

 

Impairment of Long-Lived Assets, Including Goodwill

 

The Operating Partnership periodically evaluates its long-lived assets, including its investments in real estate and goodwill, for impairment indicators.  The judgments regarding the existence of impairment indicators are based on factors such as operational performance, market conditions, expected holding period of each asset and legal and environmental concerns.  Future events could occur which would cause the Operating Partnership to conclude that impairment indicators exist and an impairment loss is warranted.

 

Depreciation of Investment in Real Estate

 

The Operating Partnership depreciates the building component of its investment in real estate over a 30-year estimated useful life, building improvements over a 5-year to 10-year estimated useful life and both the furniture, fixtures and equipment and replacements components over a 5-year estimated useful life, all of which are judgmental determinations.

 

Cost Capitalization

 

See the Capitalization of Fixed Assets and Improvements to Real Estate section for discussion of the policy with respect to capitalization vs. expensing of fixed asset/repair and maintenance costs.  In addition, the Operating Partnership capitalizes the payroll and associated costs of employees directly responsible for and who spend all of their time on the supervision of major capital projects.  These costs are reflected on the balance sheet as an increase to depreciable property.

 

The Operating Partnership follows the guidance in SFAS No. 67, Accounting for Costs and Initial Rental Operations of Real Estate Projects, for all development projects and uses its professional judgment in determining whether such costs meet the criteria for capitalization or must be expensed as incurred.  The Operating Partnership capitalizes interest, real estate taxes and insurance and payroll and associated costs for those individuals directly responsible for and who spend all of their time on development activities.  The Operating Partnership expenses as incurred all payroll costs of employees working directly at our properties, except for costs that are incurred during the initial lease-up phase on a development project.  An allocated portion of payroll costs is capitalized based upon the occupancy of the project until stabilized occupancy is achieved.  Stabilized occupancy is always deemed to have occurred no later than one year from cessation of major development activities.  The incremental payroll and associated costs are capitalized to the projects under development based upon the effort directly identifiable with such projects.  These costs are reflected on the balance sheet as either construction in progress or a separate component of investments in unconsolidated entities.  The Operating Partnership ceases the capitalization of such costs as the property becomes substantially complete and ready for its intended use.

 

37



 

Fair Value of Financial Instruments, Including Derivative Instruments

 

The valuation of financial instruments under SFAS No. 107 and SFAS No. 133 and its amendments (SFAS Nos. 137/138/149) requires the Operating Partnership to make estimates and judgments that affect the fair value of the instruments.  The Operating Partnership, where possible, bases the fair values of its financial instruments, including its derivative instruments, on listed market prices and third party quotes. Where these are not available, the Operating Partnership bases its estimates on other factors relevant to the financial instruments.

 

Revenue Recognition

 

Rental income attributable to leases is recorded when due from residents and is recognized monthly as it is earned, which is not materially different than on a straight-line basis.  Leases entered into between a resident and a property for the rental of an apartment unit are generally year-to-year, renewable upon consent of both parties on an annual or monthly basis.  Interest income is recorded on an accrual basis.

 

Stock-Based Compensation

 

Prior to 2003, the Company had chosen to account for its stock-based compensation in accordance with APB No. 25, Accounting for Stock Issued to Employees, which resulted in no compensation expense for options issued with an exercise price equal to or exceeding the market value of EQR’s Common Shares on the date of grant (intrinsic method).  The Company has elected to expense its stock-based compensation in accordance with SFAS No. 123 and its amendment (SFAS No. 148), Accounting for Stock Based Compensation, effective in the first quarter of 2003, which resulted in compensation expense being recorded based on the fair value of the stock compensation granted or modified.  Any Common Shares issued pursuant to EQR’s incentive equity compensation and employee share purchase plans will result in the Operating Partnership issuing OP Units to EQR on a one-for-one basis, with the Operating Partnership receiving the net cash proceeds of such issuances.

 

SFAS No. 148 provides three transition methods for entities that adopt the fair value recognition provisions of SFAS No. 123.  The Company has chosen to use the “Prospective Method”.  This method requires that companies apply the recognition provisions of SFAS No. 123 to only employee awards granted or modified after the beginning of the fiscal year in which the recognition provisions are first applied, or January 1, 2003.  Compensation expense under all of the Company’s plans is generally recognized over periods ranging from three months to five years.  Therefore, the cost related to stock-based employee compensation included in the determination of net income for the nine months and quarter 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.  See Note 2 in the Notes to Consolidated Financial Statements for further discussion and comparative information regarding application of the fair value method to all outstanding employee awards.

 

Funds From Operations

 

For the nine months ended September 30, 2003, Funds From Operations (“FFO”) available to OP Units decreased $39.8 million, or 7.3%, as compared to the nine months ended September 30, 2002.

 

For the quarter ended September 30, 2003, FFO available to OP Units increased $4.4 million, or 2.7%, as compared to the quarter ended September 30, 2002.

 

The following is a reconciliation of net income to FFO available to OP Units for the nine months and quarters ended September 30, 2003 and 2002:

 

38



 

Funds From Operations
(Amounts in thousands)
(Unaudited)

 

 

 

Nine Months Ended
September 30,

 

Quarter Ended
September 30,

 

 

 

2003

 

2002

 

2003

 

2002

 

Net income

 

$

436,445

 

$

321,903

 

$

146,426

 

$

93,944

 

Adjustments:

 

 

 

 

 

 

 

 

 

Depreciation

 

341,723

 

322,615

 

115,346

 

109,331

 

Depreciation – Non-real estate additions

 

(6,524

)

(6,823

)

(1,926

)

(2,250

)

Depreciation – Partially Owned Properties

 

(6,240

)

(5,710

)

(2,124

)

(1,959

)

Depreciation – Unconsolidated Properties

 

15,618

 

14,468

 

5,468

 

5,563

 

Net (gain) loss on sales of unconsolidated entities

 

(4,673

)

626

 

2

 

5,872

 

Discontinued Operations:

 

 

 

 

 

 

 

 

 

Depreciation

 

13,175

 

30,591

 

2,160

 

9,029

 

Net gain on sales of depreciable property

 

(211,488

)

(60,011

)

(73,383

)

(32,435

)

 

 

 

 

 

 

 

 

 

 

FFO (1)(2)

 

578,036

 

617,659

 

191,969

 

187,095

 

 

 

 

 

 

 

 

 

 

 

Preferred distributions

 

(73,115

)

(72,969

)

(24,698

)

(24,188

)

 

 

 

 

 

 

 

 

 

 

FFO available to OP Units

 

$

504,921

 

$

544,690

 

$

167,271

 

$

162,907

 

 


(1)       The National Association of Real Estate Investment Trusts (“NAREIT”) defines funds from operations (“FFO”) (April 2002 White Paper) as net income (computed in accordance with accounting principles generally accepted in the United States), excluding gains (or losses) from sales of property, plus depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures.  Adjustments for unconsolidated partnerships and joint ventures will be calculated to reflect funds from operations on the same basis.  The April 2002 White Paper states that gain or loss on sales of property is excluded from FFO for previously depreciated operating properties only.  Once the Operating Partnership commences the conversion of units to condominiums, it simultaneously discontinues depreciation of such property.  Accordingly, the Operating Partnership included in FFO its incremental gains or losses from the sale of condominium units to third parties, which represented net gains of $7,487 and $1,198 for the nine months ended September 30, 2003 and 2002, respectively, and $4,600 and $328 for the quarters ended September 30, 2003 and 2002, respectively.  Effective January 1, 2003, the Operating Partnership no longer adds back impairment losses when computing FFO in accordance with NAREIT’s definition.  As a result, FFO for the nine months and quarter ended September 30, 2002 have been reduced by $17,994 and $17,413, respectively, to conform to the current year presentation.

 

(2)       The Operating Partnership believes that FFO is helpful to investors as a supplemental measure of the operating performance of a real estate company because it provides investors an understanding of the ability of the Operating Partnership to incur and service debt and to make capital expenditures.  FFO in and of itself does not represent net income or net cash flows from operating activities in accordance with GAAP.  Therefore, FFO should not be exclusively considered as an alternative to net income or to net cash flows from operating activities as determined by GAAP or as a measure of liquidity.  The Operating Partnership’s calculation of FFO may differ from other real estate companies due to variations in cost capitalization policies for capital expenditures and, accordingly, may not be comparable to such other real estate companies.

 

Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

The Operating Partnership’s market risk has not changed materially from the amounts and information reported in Item 7A, Quantitative and Qualitative Disclosures About Market Risk, to the Operating Partnership’s Form 10-K for the year ended December 31, 2002.  See also Note 12 to the Notes to Consolidated Financial Statements for additional discussion of derivative instruments.

 

39



 

Item 4. Disclosure Controls and Procedures

 

Effective as of September 30, 2003, the Operating Partnership carried out an evaluation, under the supervision and with the participation of the Operating Partnership’s management, including the Chief Executive Officer and Chief Financial Officer of EQR, of the effectiveness of the design and operation of the Operating Partnership’s disclosure controls and procedures pursuant to Exchange Act Rules 13a-15 and 15d-15.  Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures are effective in timely alerting them to material information.  During the fiscal quarter ended September 30, 2003, there were no changes to the internal controls over financial reporting of the Operating Partnership identified in connection with the Operating Partnership’s evaluation or otherwise that has materially affected, or is reasonably likely to materially affect, the Operating Partnership’s internal controls over financial reporting.

 

PART II.    OTHER INFORMATION

 

Item 1.  Legal Proceedings

 

The Operating Partnership is a party to a class action lawsuit in Florida state court alleging that several of the types of fees that the Operating Partnership charged when residents breached their leases were illegal, as are all efforts to collect them. We are vigorously contesting the plaintiffs’ claims and will seek immediate appellate review of the recent class action certification decision. Due to the preliminary nature of the litigation, it is not possible to determine or predict the outcome. While no assurances can be given, we do not believe that this lawsuit, if adversely determined, will have a material adverse effect on the Operating Partnership.

 

Except as disclosed above, there have been no new or significant developments related to the legal proceedings that were discussed in Part I, Item III of the Operating Partnership’s Form 10-K for the year ended December 31, 2002.

 

40



 

Item 6.  Exhibits and Reports on Form 8-K

 

(A)                              Exhibits:

 

12                                    Computation of Ratio of Earnings to Combined Fixed Charges.

 

31.1                           Certification of Bruce W. Duncan, Chief Executive Officer of EQR.

 

31.2                           Certification of David J. Neithercut, Chief Financial Officer of EQR.

 

32.1                           Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, of Bruce W. Duncan, Chief Executive Officer of Registrant’s General Partner.

 

32.2                           Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, of David J. Neithercut, Chief Financial Officer of Registrant’s General Partner.

 

(B)                                Reports Filed on Form 8-K:

 

None.

 

41



 

SIGNATURES

 

 

Pursuant to the requirements of the Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on behalf by the undersigned thereunto duly authorized.

 

 

 

ERP OPERATING LIMITED PARTNERSHIP

 

By:

EQUITY RESIDENTIAL

 

 

ITS GENERAL PARTNER

Date:

November 13, 2003

 

By:

/s/

 

David J. Neithercut

 

 

 

 

David J. Neithercut

 

 

 

Executive Vice President and
Chief Financial Officer

 

 

 

 

 

 

Date:

November 13, 2003

 

By:

/s/

 

Michael J. McHugh

 

 

 

 

Michael J. McHugh

 

 

 

Executive Vice President,

 

 

 

Chief Accounting Officer
and Treasurer

 

 

42



 

EXHIBIT INDEX

 

Exhibit

 

Document

 

 

 

12

 

Computation of Ratio of Earnings to Combined Fixed Charges.

 

 

 

31.1

 

Certification of Bruce W. Duncan, Chief Executive Officer of EQR.

 

 

 

31.2

 

Certification of David J. Neithercut, Chief Financial Officer of EQR.

 

 

 

32.1

 

Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, of Bruce W. Duncan, Chief Executive Officer of Registrant’s General Partner.

 

 

 

32.2

 

Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, of David J. Neithercut, Chief Financial Officer of Registrant’s General Partner.

 

43