FORM 10-K

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

 

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

 

For the Fiscal Year Ended DECEMBER 31, 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)

 

 

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

 

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

 

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

 

 

DOCUMENTS INCORPORATED BY REFERENCE

 

None.

 

2

 

ERP OPERATING LIMITED PARTNERSHIP

 

TABLE OF CONTENTS

 

			PAGE
PART I.
	Item 1.	Business	4
	Item 2.	The Properties	16
	Item 3.	Legal Proceedings	19
	Item 4.	Submission of Matters to a Vote of Security Holders	19
PART II.
	Item 5.	Market for Registrant’s Common Equity and Related Shareholder Matters	20
	Item 6.	Selected Financial Data	20
	Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	22
	Item 7A.	Quantitative and Qualitative Disclosure about Market Risk	38
	Item 8.	Financial Statements and Supplementary Data	39
	Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	39
	Item 9A.	Disclosure Controls and Procedures	39
PART III.
	Item 10.	Trustees and Executive Officers of the Registrant	40
	Item 11.	Executive Compensation	43
	Item 12.	Security Ownership of Certain Beneficial Owners and Management	50
	Item 13.	Certain Relationships and Related Transactions	53
	Item 14.	Principal Accountant Fees and Services	53
PART IV.
	Item 15.	Exhibits, Financial Statement Schedules and Reports on Form 8-K	55

 

3

 

Item 1.  Business

 

General

 

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

 

EQR is one of the largest publicly traded REIT’s and is the largest publicly traded REIT owner of multifamily properties (based on the aggregate market value of EQR’s outstanding Common Shares, the number of apartment units wholly owned and total revenues earned).  The Operating Partnership’s corporate headquarters are located in Chicago, Illinois and the Operating Partnership also leases (under operating leases) approximately thirty-five divisional, regional and area property management offices throughout the United States.

 

EQR is the general partner of, and as of December 31, 2003, owned an approximate 92.7% ownership interest in ERPOP. ERPOP is, directly or indirectly, a partner, member or shareholder of numerous partnerships, limited liability companies and corporations which have been established primarily to own fee simple title to multifamily properties or to conduct property management activities and other businesses related to the ownership and operation of multifamily residential real estate.  As used herein, the term “Operating Partnership” includes ERPOP and those entities owned or controlled by it.  As used herein, the term “Company” means EQR and the Operating Partnership.

 

As of December 31, 2003, the Operating Partnership owned or had investments in 968 properties in 34 states consisting of 207,506 units.  The ownership breakdown includes:

 

 

The Operating Partnership has approximately 6,000 employees as of March 1, 2004.  An on-site manager, who supervises the on-site employees and is responsible for the day-to-day operations of the property, directs each of the Operating Partnership’s properties.  An assistant manager and/or leasing staff generally assist the manager.  In addition, a maintenance director at each property supervises a maintenance staff and/or contractors whose responsibilities include a variety of tasks, including responding to service requests, preparing vacant apartments for the next resident and performing preventive maintenance procedures year-round.

 

Certain capitalized terms as used herein are defined in the Notes to Consolidated Financial Statements.

 

Business Objectives and Operating Strategies

 

The Operating Partnership seeks to maximize both current income and long-term growth in income, thereby increasing:

 

•                  the value of the properties;

•                  distributions on a per limited partnership interest (“OP Unit”) basis; and

•                  partners’ value.

 

4

 

The Operating Partnership’s strategies for accomplishing these objectives are:

 

•                  maintaining and increasing property occupancy while increasing rental rates;

•                  controlling expenses, providing regular preventive maintenance, making periodic renovations and enhancing amenities;

•                  maintaining a ratio of consolidated debt-to-total market capitalization of less than 50%;

•                  strategically acquiring and disposing of properties, with an emphasis on acquiring attractive properties in high barrier to entry markets and on selling properties in low barrier to entry markets;

•                  purchasing newly developed, as well as co-investing in the development of, multifamily communities;

•                  entering into joint ventures related to the ownership of established properties; and

•                  strategically investing in various businesses that will enhance services for the properties.

 

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

 

Acquisition and Development Strategies

 

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

 

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

 

•                  the geographic area and type of community;

•                  the location, construction quality, condition and design of the property;

•                  the current and projected cash flow of the property and the ability to increase cash flow;

•                  the potential for capital appreciation of the property;

•                  the terms of resident leases, including the potential for rent increases;

•                  income levels and employment growth trends in the relevant market;

•                  employment and household growth and net migration of the relevant market’s population;

•                  the potential for economic growth and the tax and regulatory environment of the community in which the property is located;

•                  the occupancy and demand by residents for properties of a similar type in the vicinity (the overall market and submarket);

•                  the prospects for liquidity through sale, financing or refinancing of the property;

•                  the benefits of integration into existing operations;

•                  barriers to entry that would limit competition (zoning laws, building permit availability, supply of undeveloped or developable real estate, local building costs and construction labor costs among other factors);

 

5

 

•                  purchase prices and yields of available existing stabilized communities, if any; and

•                  competition from existing multifamily properties, residential properties under development and the potential for the construction of new multifamily properties in the area.

 

Disposition Strategies

 

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

 

•                  potential increases in new construction;

•                  submarkets that will underperform the average performance of the portfolio in the mid and long-term;

•                  markets where the Operating Partnership does not intend to establish long-term concentrations; and

•                  age or location of a particular property.

 

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

 

Financing Strategies

 

The Operating Partnership’s “Consolidated Debt-to-Total Market Capitalization Ratio” as of December 31, 2003 is presented in the following table.  The Operating Partnership calculates the equity component of its market capitalization as the sum of (i) the total outstanding OP Units at the equivalent market value of the closing price of EQR’s Common Shares on the New York Stock Exchange; (ii) the “OP Unit Equivalent” of all convertible preference interests/units; and (iii) the liquidation value of all perpetual preference interests/units outstanding.

 

Capitalization as of December 31, 2003

 

 

6

 

Convertible Preference Units, Preference Interests
and Junior Preference Units
as of December 31, 2003

 

 

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

 

Equity Offerings For the Years Ended December 31, 2003, 2002 and 2001

 

During 2003, EQR contributed all of the net proceeds, as discussed below, to the Operating Partnership in exchange for OP Units or preference units:

 

•                  EQR issued 600,000 Series N Cumulative Redeemable Preferred Shares with a liquidation value of $150.0 million and received net proceeds of approximately $145.3 million.

•                  EQR issued 3,249,555 Common Shares pursuant to its Share Incentive Plans and received net proceeds of approximately $68.4 million.

•                  EQR issued 289,274 Common Shares pursuant to its Employee Share Purchase Plan and received net proceeds of approximately $6.3 million.

 

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

 

•                  EQR issued 1,435,115 Common Shares pursuant to its Share Incentive Plans and received net proceeds of approximately $29.6 million.

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

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

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

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

 

7

 

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

 

•                  EQR issued 3,187,217 Common Shares pursuant to its Share Incentive Plans and received net proceeds of approximately $65.4 million.

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

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

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

 

In February 1998, EQR filed and the SEC declared effective a Form S-3 Registration Statement to register $1.0 billion of equity securities.  In addition, EQR carried over $272.4 million related to a prior registration statement.  As of February 4, 2004, $956.5 million in equity securities remained available for issuance under this registration statement.  Per the terms of ERPOP’s partnership agreement, EQR contributes the net proceeds of all equity offerings to the capital of the Operating Partnership in exchange for additional OP Units (on a one-for-one Common Share per OP Unit basis) or preference units (on a one-for-one preferred share per preference unit basis).

 

Cumulative through December 31, 2003, a subsidiary of ERPOP issued various series of Preference Interests (the “Preference Interests”) with an equity value of $246.0 million receiving net proceeds of $239.9 million.

 

Debt Offerings For the Years Ended December 31, 2003, 2002 and 2001

 

During 2003:

 

•                  The Operating Partnership issued $400.0 million of redeemable unsecured fixed rate notes (the “April  2013 Notes”) in a public debt offering in March 2003.  The April 2013 Notes were issued at a discount, which is being amortized over the life of the notes on a straight-line basis.  The April 2013 Notes are due April 1, 2013.  The annual interest rate on the April 2013 Notes is 5.20%, which is payable semiannually in arrears on April 1 and October 1, commencing October 1, 2003.  The Operating Partnership received net proceeds of approximately $397.5 million in connection with this issuance.

 

During 2002:

 

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

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

 

8

 

During 2001:

 

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

 

In June 2003, the Operating Partnership filed and the SEC declared effective a Form S-3 registration statement to register $2.0 billion of debt securities.  In addition, the Operating Partnership carried over $280.0 million related to a prior registration statement.  As of February 4, 2004, $2.28 billion in debt securities remained available for issuance under this registration statement.

 

Credit Facilities

 

In May 2002, the Operating Partnership obtained a new three-year $700.0 million unsecured revolving credit facility maturing May 29, 2005.  The new line of credit replaced the $700.0 million unsecured revolving credit facility that was scheduled to expire in August 2002.  The prior existing revolving credit facility was terminated upon the closing of the new facility.  Advances under the new credit facility bear interest at variable rates based upon LIBOR at various interest periods, plus a spread dependent upon the Operating Partnership’s credit rating, or based upon bids received from the lending group.  As of December 31, 2003, $10.0 million was outstanding and $56.7 million was restricted (dedicated to support letters of credit and not available for borrowing) on the line of credit.  During the year ended December 31, 2003, the weighted average interest rate on borrowings under the line of credit was 1.85%.

 

Business Combinations

 

In January 2002, the Company sold the former Globe Business Resources, Inc. (“Globe”) furniture rental business it acquired in July 2000 for approximately $30.0 million in cash, which approximated the net book value at the sale date.  The Company has retained ownership of the former Globe short-term furnished housing business, which is now known as Equity Corporate Housing (“ECH”).

 

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

 

Competition

 

All of the properties are located in developed areas that include other multifamily properties.  The number of competitive multifamily properties in a particular area could have a material effect on the Operating Partnership’s ability to lease units at the properties or at any newly acquired properties and on the rents charged.  The Operating Partnership may be competing with other entities that have greater resources than the Operating Partnership and whose managers have more experience than the Operating Partnership’s managers.  In addition, other forms of rental properties and single-family housing provide housing alternatives to potential residents of multifamily properties.  Throughout 2002 and 2003,

 

9

 

historically low mortgage interest rates coupled with increased residential construction and single-family home sales have had an adverse competitive effect on the Operating Partnership.

 

Risk Factors

 

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

 

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

 

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

 

General

 

Real property investments are subject to varying degrees of risk and are relatively illiquid. Several factors may adversely affect the economic performance and value of our properties.  These factors include changes in the national, regional and local economic climate, local conditions such as an oversupply of multifamily properties or a reduction in demand for our multifamily properties, the attractiveness of our properties to residents, competition from other available multifamily property owners and changes in market rental rates.  Our performance also depends on our ability to collect rent from residents and to pay for adequate maintenance, insurance and other operating costs, including real estate taxes, which could increase over time.  Also, the expenses of owning and operating a property are not necessarily reduced when circumstances such as market factors and competition cause a reduction in income from the property.

 

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

 

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

 

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

 

We intend to continue to actively acquire and develop multifamily properties.  Newly acquired or developed properties may fail to perform as expected.  We may underestimate the costs necessary to bring an acquired property up to standards established for its intended market position or to develop a property.  Additionally, we expect that other major real estate investors with significant capital will compete with us for attractive investment opportunities or may also develop properties in markets

 

10

 

where we focus our development efforts.  This competition may increase prices for multifamily properties.  We may not be in a position or have the opportunity in the future to make suitable property acquisitions on favorable terms.  The total number of development units, cost of development and estimated completion dates are subject to uncertainties arising from changing economic conditions (such as the cost of labor and construction materials), competition and local government regulation.

 

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

 

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

 

Changes in Laws Could Affect Our Business

 

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

 

Environmental Problems are Possible and can be Costly

 

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

 

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

 

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

 

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

 

11

 

otherwise exist as to any one or more of our properties.

 

Insurance Policy Deductibles and Exclusions

 

In order to partially mitigate the substantial increase in insurance costs in recent years, management has determined to gradually increase deductible and self-insured retention amounts.  As of December 31, 2003, the Operating Partnership’s property insurance policy (for Wholly Owned Properties) provides for a per occurrence deductible of $250,000 and self insured retention of $5.0 million per occurrence, subject to a maximum annual aggregate self insured retention of $7.5 million.  The Operating Partnership’s liability and worker’s compensation policies at December 31, 2003, provide for a $1.0 million per occurrence deductible.  While higher deductible and self-insured retention amounts expose the Operating Partnership to greater potential uninsured losses, management believes that the savings in insurance premium expense justifies this increased exposure.

 

As a result of the terrorist attacks of September 11, 2001, insurance carriers have created exclusions for losses from terrorism from our “all risk” insurance policies.  While separate terrorism insurance coverage is available in certain instances, premiums for such coverage are generally very expensive, with very high deductibles.  Moreover, the terrorism insurance coverage that are available typically excludes coverage for losses from acts of foreign governments as well as nuclear, biological and chemical attacks.  At the present time, the Operating Partnership has determined that it is not economically prudent to obtain terrorism insurance for its portfolio to the extent otherwise available, especially given the significant risks that are not covered by such insurance.  In the event of a terrorist attack impacting one or more of the properties, we could lose the revenues from the property, our capital investment in the property and possibly face liability claims from residents or others suffering injuries or losses. The Operating Partnership believes, however, that the number and geographic diversity of its portfolio helps to mitigate its exposure to the risks associated with potential terrorist attacks.

 

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

 

General

 

The Operating Partnership’s total debt summary, as of December 31, 2003, included:

 

Debt Summary

 

 

 

12

 

In addition to debt, the Operating Partnership has issued $919.1 million of combined liquidation value of outstanding preference interests and units, with a weighted average dividend preference of 8.17% per annum, as of December 31, 2003.  Our use of debt and preferred equity financing creates certain risks, including the following:

 

Scheduled Debt Payments Could Adversely Affect Our Financial Condition

 

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

 

We may not be able to refinance existing debt (which in virtually all cases requires substantial principal payments at maturity) and, if we can, the terms of such refinancing might not be as favorable as the terms of existing indebtedness.  If principal payments due at maturity cannot be refinanced, extended or paid with proceeds of other capital transactions, such as new equity capital, our cash flow will not be sufficient in all years to repay all maturing debt.  As a result, we may be forced to postpone capital expenditures necessary for the maintenance of our properties and may have to dispose of one or more properties on terms that would otherwise be unacceptable to us.  The Operating Partnership’s debt maturity schedule as of December 31, 2003 is as follows:

 

Debt Maturity Schedule

 

 

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

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

 

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

 

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

 

13

 

The mortgages on our properties may contain customary negative covenants that, among other things, limit our ability, without the prior consent of the lender, to further mortgage the property and to reduce or change insurance coverage.  In addition, our unsecured credit facilities contain certain customary restrictions, requirements and other limitations on our ability to incur indebtedness.  The indentures under which a substantial portion of our debt was issued also contain certain financial and operating covenants including, among other things, maintenance of certain financial ratios, as well as limitations on our ability to incur secured and unsecured indebtedness (including acquisition financing), and to sell all or substantially all of our assets.  Our credit facility and indentures are cross-defaulted and also contain cross default provisions with other material indebtedness.  Our unsecured public debt covenants as of December 31, 2003 and 2002, respectively, are (terms are defined in the indentures):

 

Unsecured Public Debt Covenants

 

 

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

 

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

 

Our Consolidated Debt-to-Total Market Capitalization Ratio was 35% as of December 31, 2003.  We have a policy of incurring indebtedness for borrowed money only through ERPOP and its subsidiaries and only if upon such incurrence our debt to market capitalization ratio would be approximately 50% or less.  Our degree of leverage could have important consequences to security holders.  For example, the degree of leverage could affect our ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions, development or other general corporate purposes, making us more vulnerable to a downturn in business or the economy in general.

 

Rising Interest Rates Could Adversely Affect Cash Flow

 

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

 

14

 

We Depend on Our Key Personnel

 

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

 

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

 

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

 

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

 

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

 

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

 

Distribution Requirements May Increase the Indebtedness of the Operating Partnership

 

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

 

Available Information

 

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

 

15

 

Item 2.  The Properties

 

As of December 31, 2003, the Operating Partnership owned or had investments in 968 properties in 34 states consisting of 207,506 units.  The Operating Partnership’s properties are more fully described as follows:

 

 

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

 

It is management’s role to monitor compliance with property policies and to provide preventive maintenance of the properties including common areas, facilities and amenities.  The Operating Partnership has a dedicated training and education department that creates and coordinates training and strategic implementation for the Operating Partnership’s property management personnel.  The Operating Partnership believes that, due in part to its emphasis on training and employee quality, the properties historically have had high occupancy rates.

 

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

 

The following tables set forth certain information by type and state relating to the Operating Partnership’s properties at December 31, 2003:

 

16

 

GARDEN-STYLE PROPERTIES

 

State		Properties		Units		Percentage of Total Units		December 31, 2003 Occupancy
Alabama		5		896		0.43	%	94.2	%
Arizona		45		12,735		6.14		88.7
California		91		23,025		11.10		93.9
Colorado		29		8,175		3.94		91.1
Connecticut		22		2,633		1.27		94.4
Florida		75		22,158		10.68		93.7
Georgia		36		11,277		5.43		92.7
Illinois		7		2,360		1.14		93.2
Kansas		3		1,130		0.54		90.4
Maine		5		672		0.32		95.9
Maryland		23		5,419		2.61		93.7
Massachusetts		35		4,829		2.33		94.7
Michigan		8		2,388		1.15		90.9
Minnesota		17		3,819		1.84		90.9
Missouri		9		1,878		0.91		91.2
Nevada		3		1,220		0.59		90.1
New Hampshire		1		390		0.19		89.9
New Jersey		2		980		0.47		95.2
New Mexico		2		369		0.18		90.1
New York		1		300		0.14		91.9
North Carolina		31		8,299		4.00		92.9
Oklahoma		8		2,036		0.98		92.1
Oregon		10		3,604		1.74		92.5
Rhode Island		5		778		0.37		95.5
Tennessee		10		3,171		1.53		91.6
Texas		73		22,816		11.00		91.3
Virginia		14		4,696		2.26		93.3
Washington		41		10,089		4.86		90.4
Wisconsin		3		686		0.33		87.6
Total Garden-Style		614		162,828		78.47	%
Average Garden-Style				265				92.4	%

 

17

 

MID-RISE/HIGH-RISE PROPERTIES

 

State		Properties		Units		Percentage of Total Units		December 31, 2003 Occupancy
California		3		873		0.42	%	55.5	%
Colorado		1		355		0.17		65.2
Connecticut		2		407		0.20		93.7
Florida		3		653		0.31		95.4
Georgia		1		322		0.16		91.0
Illinois		1		1,083		0.52		89.3
Massachusetts		12		3,253		1.57		93.4
Minnesota		1		163		0.08		94.5
New Jersey		5		1,365		0.66		87.2
Ohio		1		747		0.36		70.2
Oregon		1		525		0.25		88.5
Texas		3		596		0.29		90.7
Virginia		5		1,660		0.80		92.4
Washington		5		800		0.39		93.5
Total Mid-Rise/High-Rise		44		12,802		6.17	%
Average Mid-Rise/High-Rise				291				86.4	%

 

RANCH-STYLE PROPERTIES

 

Alabama		1		69		0.03	%	100.0	%
Florida		87		8,176		3.94		91.0
Georgia		53		4,428		2.13		89.6
Indiana		44		4,059		1.96		90.6
Kentucky		19		1,533		0.74		90.4
Maryland		4		414		0.20		96.2
Michigan		17		1,536		0.74		91.7
Ohio		75		7,102		3.42		92.2
Pennsylvania		5		469		0.23		88.3
South Carolina		2		187		0.09		93.0
Tennessee		2		146		0.07		93.2
Total Ranch-Style		309		28,119		13.55	%
Average Ranch-Style				91				91.1	%

 

MILITARY HOUSING PROPERTIES

 

Washington (Ft. Lewis)		1		3,757		1.81	%	95.4	%
Total Military Housing		1		3,757		1.81	%
Average Military Housing				3,757				95.4	%
Total Residential Portfolio		968		207,506		100	%

 

18

 

The properties currently in various stages of development at December 31, 2003 are included in the following table.

 

DEVELOPMENT PROJECTS as of December 31, 2003

(Amounts in millions except for project and unit amounts)

 

		Location		Units		Estimated Development Cost			Funded as of 12/31/2003			Estimated Future Fundings			Total Fundings (1)			Estimated Completion Date
Unconsolidated Projects
Water Terrace I (Regatta I) (2)		Marina Del Rey, CA		450		$	235.3		$	73.0		—			$	73.0		Completed
Watermarke		Irvine, CA		535		120.6			35.2			—			35.2			1Q 2004
Bella Vista I&II (Warner Ridge I&II)		Woodland Hills, CA		315		80.9			24.5			—			24.5			1Q 2004
Concord Center (2)		Concord, CA		259		52.3			13.1			—			13.1			Completed
2400 M Street		Washington, DC		333		104.2			37.2			—			37.2			2Q 2005
1111 25th Street (2440 M St.)		Washington, DC		140		37.5			11.3			—			11.3			4Q 2004
1210 Massachusetts Ave.		Washington, DC		142		36.3			9.1			—			9.1			2Q 2004
13th & N Street		Washington, DC		170		35.4			12.4			—			12.4			1Q 2004
North Pier at Harborside (2)		Jersey City, NJ		297		94.2			24.0			—			24.0			Completed
City View at the Highlands (Lombard)		Lombard, IL		403		67.1			16.8			—			16.8			1Q 2004
Ball Park Lofts (2)		Denver, CO		355		56.4			14.1			—			14.1			Completed
City Place (Westport) (2)		Kansas City, MO		288		34.7			8.7			—			8.7			Completed
Marina Bay II (2)		Quincy, MA		108		22.8			5.7			—			5.7			Completed
Total Projects		13		3,795		$	977.7		$	285.1		$	0.0		$	285.1

 

(1)                   The Operating Partnership generally funds between 25% and 35% of the estimated development cost for the unconsolidated projects (constituting 100% of the equity), with the remaining cost financed through third-party construction mortgages.

(2)                   Properties were substantially complete as of December 31, 2003.  As such, these properties are also included in the outstanding property and unit counts.

 

Item 3.  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 were all efforts to collect them.  The Operating Partnership is vigorously contesting the plaintiffs’ claims and has sought immediate appellate review of the 2003 class action certification decision.  Due to the uncertainty of many critical factual and legal issues, including the viability of the case as a class action, it is not possible to determine or predict the outcome.  While no assurances can be given, the Operating Partnership does 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 have a material adverse effect on the Company.

 

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

 

None.

 

19

 

PART II

 

Item 5.  Market for Registrant’s Common Equity and Related Shareholder Matters

 

There is no established public trading market for the OP Units.

 

The following table sets forth, for the years indicated, the distributions paid on the Operating Partnership’s OP Units:

 

 

The number of holders of record of OP Units and Junior Convertible Preference Units in the Operating Partnership at January 31, 2004, were 434 and 26, respectively.  The number of outstanding OP Units and Junior Convertible Preference Units as of January 31, 2004 were 300,201,002 and 27,700 respectively.

 

OP Units Issued in 2003

 

During 2003, the Operating Partnership directly issued 165,628 OP Units having a value of $4.6 million in exchange for direct or indirect interests in multifamily properties in private placement transactions under section 4(2) of the Securities Act of 1933, as amended (the “Securities Act”).  OP Units are generally exchangeable into Common Shares of EQR on a one-for-one basis or, at the option of EQR, the cash equivalent thereof at any time one year after the date of issuance.

 

On October 31, 2003, the Operating Partnership issued 6,201 OP Units to former partners of Glen Meadow Associates, L.P.  This issuance was made in connection with certain contingent “earnout” rights granted to such former partners upon Grove Property Trust’s (“Grove”) acquisition of the Glen Meadow property in 1998.  The Operating Partnership succeeded to Grove’s earnout obligations as a result of the Grove merger in 2000.  No separate consideration was payable upon issuance of these OP Units.  The Operating Partnership relied upon certifications from each such former partner as to his or her status as an “accredited investor” within the meaning of SEC rule 501 to claim an exemption from registration under Securities Act section 4(2).

 

On December 22, 2003, the Operating Partnership issued 148,092 OP Units as a result of the automatic conversion of 36,283 Series A Junior Convertible Preference Units.

 

Item 6.  Selected Financial Data

 

The following table sets forth selected financial and operating information on a historical basis for the Operating Partnership.  The following information should be read in conjunction with all of the financial statements and notes thereto included elsewhere in this Form 10-K.  The historical operating and balance sheet data have been derived from the historical Financial Statements of the Operating Partnership.  All amounts have also been restated in accordance with the discontinued operations provisions of SFAS No. 144.  Certain capitalized terms as used herein are defined in the Notes to Consolidated Financial Statements.

 

20

 

CONSOLIDATED HISTORICAL FINANCIAL INFORMATION

(Financial information in thousands except for per share and property data)

 

		Year Ended December 31,
		2003			2002			2001			2000			1999
OPERATING DATA:
Total revenues from continuing operations		$	1,823,298		$	1,809,163		$	1,844,003		$	1,733,026		$	1,508,648
Income from continuing operations		$	246,216		$	273,702		$	337,074		$	302,428		$	254,025
Net income		$	578,505		$	448,175		$	506,414		$	591,212		$	423,417
Net income available to OP Units		$	461,297		$	351,024		$	394,971		$	479,271		$	310,221
Earnings per OP Unit – basic:
Income from continuing operations available to OP Units		$	0.44		$	0.60		$	0.77		$	0.67		$	0.52
Net income available to OP Units		$	1.57		$	1.19		$	1.36		$	1.69		$	1.15
Weighted average OP Units outstanding		294,523			294,637			291,362			283,921			270,002
Earnings per share – diluted:
Income from continuing operations available to OP Units		$	0.43		$	0.59		$	0.76		$	0.67		$	0.52
Net income available to OP Units		$	1.55		$	1.18		$	1.34		$	1.67		$	1.14
Weighted average OP Units outstanding		297,041			297,969			295,213			291,266			271,310
Distributions declared per OP Unit outstanding		$	1.73		$	1.73		$	1.68		$	1.575		$	1.47
BALANCE SHEET DATA (at end of period):
Real estate, before accumulated depreciation		$	12,874,379		$	13,046,263		$	13,016,183		$	12,591,539		$	12,238,963
Real estate, after accumulated depreciation		$	10,578,366		$	10,934,246		$	11,297,338		$	11,239,303		$	11,168,476
Total assets		$	11,466,893		$	11,810,917		$	12,235,625		$	12,263,966		$	11,715,689
Total debt		$	5,360,489		$	5,523,699		$	5,742,758		$	5,706,152		$	5,473,868
Minority Interests		$	9,903		$	9,811		$	4,078		$	2,884		$	—
Partners’ capital		$	5,606,467		$	5,798,615		$	6,045,694		$	6,229,281		$	5,961,913
OTHER DATA:
Total properties (at end of period)		968			1,039			1,076			1,104			1,064
Total apartment units (at end of period)		207,506			223,591			224,801			227,704			226,317
Funds from operations available to OP Units (1)(2)		$	640,390		$	719,265		$	706,294		$	719,580		$	619,152
Cash flow provided by (used for):
Operating activities		$	747,981		$	888,938		$	889,668		$	841,826		$	788,970
Investing activities		$	330,366		$	(49,297	)	$	57,429		$	(563,175	)	$	(526,851	)
Financing activities		$	(1,058,643	)	$	(861,369	)	$	(919,266	)	$	(283,996	)	$	(236,967	)

 

(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.  FFO has also been adjusted by preferred distributions and premium on redemption of preference units to arrive at FFO available to OP Units.  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 $10,280, $1,682 and $0 for the years ended December 31, 2003,  2002 and 2001, respectively.  Effective January 1, 2003, the Operating Partnerhsip no longer adds back

 

21

 

impairment losses when computing FFO in accordance with NAREIT’s definition.  As a result, FFO for the years ended December 31, 2002, 2001 and 2000 have been reduced by $18,284, $71,766 and $1,000, respectively, to conform to the current year presentation.  For the year ended December 31, 2001, FFO has been reduced by $5,324 to reflect the SEC’s clarification of EITF Topic D-42 regarding premiums on redemption of preference units.  See Item 7 for a reconciliation between net income and FFO.

 

(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, among other items, variations in cost capitalization policies for capital expenditures and, accordingly, may not be comparable to such other real estate companies.

 

Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

Overview

 

The following discussion and analysis of the results of operations and financial condition of the Operating Partnership should be read in connection with the Consolidated Financial Statements and Notes thereto. Due to the Operating Partnership’s ability to control its subsidiaries (other than entities owning interests in the Unconsolidated Properties and certain other entities in which it has investments), each such subsidiary entity has been consolidated for financial reporting purposes.  Capitalized terms used herein and not defined are as defined elsewhere in this Annual Report on Form 10-K for the year ended December 31, 2003.

 

Forward-looking statements in this Item 7 as well as Item 1 of this Annual Report on Form 10-K 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;

•                  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, slow employment growth, 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 this Annual Report on Form 10-K, particularly those under “Risk Factors”.

 

22

 

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 Note 7 and 14 to the Notes to Consolidated Financial Statements in this report.

 

Results of Operations

 

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

 

 

Properties that the Operating Partnership owned for all of both 2003 and 2002 (the “2003 Same Store Properties”), which represented 171,841 units, impacted the Operating Partnership’s results of operations.  Properties that the Operating Partnership owned for all of both 2002 and 2001 (the “2002 Same Store Properties”), which represented 188,027 units, also impacted the Operating Partnership’s results of operations.  Both the 2003 Same Store Properties and 2002 Same Store Properties are discussed in the following paragraphs.

 

The Operating Partnership’s acquisition, disposition and completed development activities also impacted overall results of operations for the years ended December 31, 2003 and 2002.  The impacts of these activities are also discussed in greater detail in the following paragraphs.

 

Comparison of the year ended December 31, 2003 to the year ended December 31, 2002

 

For the year ended December 31, 2003, income before allocation to Minority Interests, income (loss) from investments in unconsolidated entities, net gain on sales of unconsolidated entities, discontinued operations and cumulative effect of change in accounting principle decreased by approximately $23.1 million when compared to the year ended December 31, 2002.

 

Revenues from the 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 2003 Same Store Properties increased primarily due to higher payroll, maintenance, utility, real estate taxes, insurance, leasing and advertising and building costs.  The following tables provide comparative revenue, expense, net operating income (“NOI”) and

 

23

 

weighted average occupancy for the 2003 Same Store Properties (NOI represents rental income less:  property and maintenance expense; real estate taxes and insurance expense; and property management expense):

 

2003 vs. 2002

Year over Year Same-Store Results

$in Millions – 171,841 Same-Store Units

 

 

Same-Store Occupancy Statistics

 

 

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, 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

 

 

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

 

Rental income from properties other than 2003 Same Store Properties increased by approximately $47.5 million primarily as a result of revenue from newly acquired properties not yet included as 2003 Same Store Properties and additional Partially Owned Properties consolidated in the fourth quarter of 2002 and during the year ended December 31, 2003.

 

Fee and asset management revenues, net of fee and asset management expenses, increased by $4.9 million primarily as a result of additional income allocated from Ft. Lewis. As of December 31, 2003 and 2002, the Operating Partnership managed 18,475 units and 18,965 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 any third party management companies.  These expenses decreased by approximately $4.4 million or 6.0%.  This decrease is primarily

 

24

 

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 Operating Partnership recorded lower expense in connection with granting less EQR restricted shares and reducing the expense associated with the Operating Partnership’s matched funding of its 401(k) plan during 2003 and not incurring an expense for 2003 discretionary profit sharing contributions.

 

Depreciation expense, which includes depreciation on non-real estate assets, increased $25.3 million primarily as a result of properties acquired after December 31, 2002, many of which had significantly higher per unit acquisition costs than properties previously acquired, and additional depreciation on capital expenditures for all properties owned.

 

General and administrative expenses, which include corporate operating expenses, decreased approximately $7.7 million between the periods under comparison.  This decrease was primarily due to lower expenses recorded in connection with granting less EQR restricted shares to employees during 2003, partially offset by approximately a $2.6 million increase related to EQR’s decision to begin 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 $1.2 million and $18.3 million for the years ended December 31, 2003 and 2002, respectively.  See Note 22 in the Notes to Consolidated Financial Statements for further discussion.

 

Interest and other income increased by approximately $1.4 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 $6.1 million primarily due to lower variable interest rates and lower overall levels of debt.  During the year ended December 31, 2003, the Operating Partnership capitalized interest costs of approximately $20.6 million as compared to $27.2 million for the year ended December 31, 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 year ended December 31, 2003 was 6.36% as compared to 6.54% for the year ended December 31, 2002.

 

Loss from investments in unconsolidated entities increased approximately $6.4 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 $206.4 million between the periods under comparison.  This increase is primarily the result of a greater number of properties sold during the year ended December 31, 2003, as well as the fact that several properties had lower net carrying values at sale.

 

Discontinued operations, net, decreased approximately $48.6 million between the periods under comparison.  See Note 16 in the Notes to Consolidated Financial Statements for further discussion.

 

Comparison of the year ended December 31, 2002 to the year ended December 31, 2001

 

For the year ended December 31, 2002, income before allocation to Minority Interests, income (loss) from investments in unconsolidated entities, net gain on sales of unconsolidated entities, discontinued operations and cumulative effect of change in accounting principle decreased by approximately $61.0 million when compared to the year ended December 31, 2001.

 

25

 

Revenues from the 2002 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 2002 Same Store Properties, which include property and maintenance, real estate taxes and insurance and an allocation of property management expenses, remained relatively stable with increases in real estate taxes and insurance costs offset by a decrease in utility costs.  The following tables provide comparative revenue, expense, NOI and weighted average occupancy for the 2002 Same Store Properties:

 

2002 vs. 2001

Year over Year Same-Store Results

 

$in Millions – 188,027 Same Store Units

 

 

Same-Store Occupancy Statistics

 

 

Rental income from properties other than 2002 Same Store Properties increased by approximately $19.8 million primarily as a result of revenue from newly acquired properties not yet included as 2002 Same Store Properties.

 

Fee and asset management revenues, net of fee and asset management expenses, increased by $1.5 million as a result of managing additional units at Fort Lewis, Washington starting in April 2002.  As of December 31, 2002 and 2001, the Operating Partnership managed 18,965 units and 16,539 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.  These expenses decreased by approximately $4.6 million or 5.9%.  This decrease is primarily attributable to lower amounts accrued for employee bonuses and profit sharing for 2002 and lower headcount in 2002.

 

Depreciation expense, which includes depreciation on non-real estate assets, increased $22.3 million primarily as a result of properties acquired after December 31, 2001, many of which had significantly higher per unit acquisition costs than properties previously acquired, and additional depreciation on capital expenditures for all properties owned.

 

General and administrative expenses, which include corporate operating expenses, increased approximately $11.1 million between the years under comparison.  This increase was primarily due to retirement plan expenses for certain key executives, EQR restricted shares/awards granted to key employees, additional compensation charges and costs associated with EQR’s new President, higher state income taxes in Michigan and New Jersey and income taxes incurred by one of the Company’s taxable REIT subsidiaries which has an ownership interest in properties that in prior periods were classified as Unconsolidated Properties.

 

26

 

The Operating Partnership recorded impairment charges on its technology investments and its corporate housing business of approximately $18.3 million and $11.8 million for the years ended December 31, 2002 and 2001, respectively.  See Note 22 in the Notes to Consolidated Financial Statements for further discussion.

 

Interest and other income decreased by approximately $6.7 million, primarily as a result of lower balances available for investment and related interest rates being earned on short-term investment accounts along with lower balances on deposit in tax-deferred exchange accounts.

 

Interest income – investment in mortgage notes decreased by $8.8 million as a result of the consolidation of previously Unconsolidated Properties in July 2001.  No additional interest income will be recognized on such mortgage notes in future years as the Operating Partnership now consolidates the results related to these previously Unconsolidated Properties.

 

Interest expense, including amortization of deferred financing costs, decreased approximately $11.0 million primarily due to lower variable interest rates and lower overall levels of debt.  During the year ended December 31, 2002, the Operating Partnership capitalized interest costs of approximately $27.2 million as compared to $28.2 million for the year ended December 31, 2001.  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 year ended December 31, 2002 was 6.54% as compared to 6.89% for the year ended December 31, 2001.

 

Income (loss) from investments in unconsolidated entities decreased approximately $7.5 million between the periods under comparison.  This decrease is primarily the result of increased equity losses and unrealized losses on derivative instruments.

 

Net gain on sales of discontinued operations decreased approximately $44.6 million between the periods under comparison.  This decrease is primarily the result of the properties sold in 2001 having a lower net carrying value at sale, which resulted in higher gain recognition for financial reporting purposes.

 

Discontinued operations, net, increased approximately $48.5 million between the periods under comparison.  This increase is primarily attributable to a one-time $60.0 million impairment on the furniture rental business in 2001, which was subsequently sold in January 2002.  See Note 16 in the Notes to Consolidated Financial Statements for further discussion.

 

Liquidity and Capital Resources

 

For the Year Ended December 31, 2003

 

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 December 31, 2003 was approximately $49.6 million and the amount available on the Operating Partnership’s line of credit was $633.3 million (net of $56.7 million which was restricted/dedicated to support letters of credit and not available for borrowing).

 

During the year ended December 31, 2003, the Operating Partnership generated proceeds from various transactions, which included the following:

 

•                  Disposed of ninety-six properties (including two Unconsolidated Properties) and received net proceeds of approximately $1.1 billion;

 

27

 

•                  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 $111.2 million in new mortgage financing; and

•                  Issued approximately 3.5 million OP Units and received net proceeds of $74.7 million.

 

During the year ended December 31, 2003, the above proceeds were primarily utilized to:

 

•                  Acquire seventeen properties, and two additional units at an existing property, utilizing cash of $595.1 million;

•                  Pay OP Unit dividends of $510.7 million ($1.73 per share);

•                  Pay preference interest/unit dividends of $99.9 million;

•                  Repay $432.9 million of mortgage loans;

•                  Repay $130.0 million on its line of credit;

•                  Repay $100.0 million of floating rate public notes at maturity;

•                  Repay $50.0 million and $40.0 million of 6.65% and 6.875%, respectively, fixed rate public notes at maturity;

•                  Repay $4.5 million of other unsecured notes;

•                  Redeem $295.3 million of 7.25% Series G Convertible Cumulative Preference Units which included a cash redemption premium of $8.3 million; and

•                  Redeem $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 Operating Partnership did not repurchase any of EQR’s Common Shares during the year ended December 31, 2003.

 

The Operating Partnership’s total debt summary and debt maturity schedule as of December 31, 2003, are as follows:

 

Debt Summary

 

 

 

28

 

Debt Maturity Schedule

 

Year		$ Millions			% of Total
2004		$	515		9.6	%
2005 (1)		605			11.3	%
2006 (2)		490			9.1	%
2007		333			6.2	%
2008		495			9.2	%
2009		246			4.6	%
2010		196			3.7	%
2011		688			12.8	%
2012		424			7.9	%
2013+		1,368			25.6	%
Total		$	5,360		100.0	%

 

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

 

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

 

In June 2003, the Operating Partnership filed and the SEC declared effective a Form S-3 registration statement to register $2.0 billion of debt securities.  In addition, the Operating Partnership carried over $280.0 million related to a prior registration statement.  As of February 4, 2004, $2.28 billion in debt securities remained available for issuance under this registration statement.

 

The Operating Partnership’s “Consolidated Debt-to-Total Market Capitalization Ratio” as of December 31, 2003 is presented in the following table.  The Operating Partnership calculates the equity component of its market capitalization as the sum of (i) the total outstanding OP Units at the equivalent market value of the closing price of EQR’s Common Shares on the New York Stock Exchange; (ii) the “OP Unit Equivalent” of all convertible preference interests/units; and (iii) the liquidation value of all perpetual preference interests/units outstanding.

 

Capitalization as of December 31, 2003

 

 

29

 

Convertible Preference Units, Preference Interests

and Junior Preference Units

as of December 31, 2003

 

 

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

 

From January 1, 2004 through February 4, 2004, the Operating Partnership:

 

•                  Acquired four properties (including two additional units at an existing property) consisting of 1,130 units for approximately $151.3 million;

•                  Assumed $36.9 million of mortgage debt on one property in connection with its acquisition;

•                  Disposed of twelve properties (including one Unconsolidated Property) and various individual condominium units consisting of 2,972 units for approximately $140.9 million;

•                  Obtained $16.5 million in new mortgage financing; and

•                  Repaid $50.0 million of mortgage loans.

 

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;

 

30

 

•                  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 year ended December 31, 2003, our actual improvements to real estate totaled approximately $181.9 million.  This includes the following detail (amounts in thousands except for unit and per unit amounts):

 

Capitalized Improvements to Real Estate

For the Year Ended December 31, 2003

 

		Total Units (1)		Replacements			Avg. Per Unit			Building Improvements			Avg. Per Unit			Total			Avg. Per Unit
Established Properties (2)		162,477		$	57,931		$	356		$	77,607		$	478		$	135,538		$	834
New Acquisition Properties (3)		14,457		2,653			252			5,250			498			7,903			750
Other (4)		7,994		13,417						25,090						38,507
Total		184,928		$	74,001					$	107,947					$	181,948

 

(1)          Total units exclude 22,578 unconsolidated units.

(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 10,533 units.

(4)          Includes properties either Partially Owned or sold during the period, commercial space, condominium conversions and $6.5 million included in building improvements spent on seven specific assets related to major renovations and repositioning of these assets.

 

For the year ended December 31, 2002, our actual improvements to real estate totaled approximately $156.8 million.  This includes the following detail (amounts in thousands except for unit and per unit amounts):

 

Capitalized Improvements to Real Estate

For the Year Ended December 31, 2002

 

		Total Units (1)		Replacements			Avg. Per Unit			Building Improvements			Avg. Per Unit			Total			Avg. Per Unit
Established Properties (2)		171,913		$	49,903		$	290		$	65,985		$	384		$	115,888		$	674
New Acquisition Properties (3)		22,146		5,542			285			8,691			446			14,233			731
Other (4)		7,758		5,787						20,868						26,655
Total		201,817		$	61,232					$	95,544					$	156,776

 

31

 

(1)                Total units exclude 21,774 unconsolidated units.

(2)                Wholly Owned Properties acquired prior to January 1, 2000.

(3)                Wholly Owned Properties acquired during 2000, 2001 and 2002.  Per unit amounts are based on a weighted average of 19,478 units.

(4)                Includes properties either Partially Owned or sold during the period, commercial space, condominium conversions and $9.1 million included in building improvements spent on six specific assets related to major renovations and repositioning of these assets.

 

The Operating Partnership expects to fund approximately $160.0 million for capital expenditures for replacements and building improvements for all consolidated properties in 2004.

 

During the year ended December 31, 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 $2.9 million.  The Operating Partnership expects to fund approximately $6.5 million in total additions to non-real estate property in 2004.

 

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 14 in the Notes to Consolidated Financial Statements for additional discussion of derivative instruments at December 31, 2003.

 

Other

 

Total distributions paid in January 2004 amounted to $141.9 million (excluding distributions on Partially Owned Properties), which included certain distributions declared during the fourth quarter ended December 31, 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 significant 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

 

32

 

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.

 

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 March 1, 2004, $255.0 million was outstanding under this facility (and $56.7 was restricted and dedicated to support letters of credit).

 

Off-Balance Sheet Arrangements and Contractual Obligations

 

The Operating Partnership has co-invested in various properties with unrelated third parties that are unconsolidated and accounted for under the equity method of accounting.  Management does not believe these investments have a materially different impact upon the Operating Partnership’s liquidity, capital resources, credit or market risk than its property management and ownership activities generally, except to the extent the development ventures mitigate risk by deploying the skill and expertise of locally based real estate developers.  The nature and business purpose of these ventures are as follows:

 

•                  Institutional Ventures - During 2000 and 2001, the Operating Partnership entered into ventures with an unaffiliated partner.  At the respective closing dates, the Operating Partnership sold and/or contributed 45 properties containing 10,846 units to these ventures and retained a 25% ownership interest in the ventures.  The Operating Partnership’s joint venture partner contributed cash equal to 75% of the agreed-upon equity value of the properties comprising the ventures, which was then distributed to the Operating Partnership.  The Operating Partnership’s strategy with respect to these ventures was to reduce its concentration of properties in a variety of markets.

•                  Development Ventures - Since 1998, the Operating Partnership has generally engaged in development activities through various joint ventures with third party developers.  The Operating Partnership uses the local expertise of these developers and lowers the overall risks associated with development by grouping various development properties into aggregated pools.  The Operating Partnership generally contributes between 25% and 35% of these projects with the remaining cost financed through third-party construction mortgages.  Voting rights are shared equally between the Operating Partnership and its respective development partners.

 

As of December 31, 2003, the Operating Partnership has 13 projects in various stages of development with estimated completion dates ranging through June 30, 2005.  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 agreement, 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 February 4, 2004, 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.

 

33

 

•                  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.

 

See Note 9 in the Notes to Consolidated Financial Statements for additional discussion regarding the Operating Partnership’s investments in unconsolidated entities.

 

In connection with one of its mergers, the Operating Partnership provided a guaranty of 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 provide this guaranty 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 guaranty only if there was a draw on the letter of credit issued by the credit enhancement party.  The counterparty has also indemnified the Operating Partnership for any losses suffered.  As of February 4, 2004, this guaranty was still in effect at a commitment amount of $12.7 million and no current outstanding liability.

 

The following table summarizes the Operating Partnership’s contractual obligations for the next five years and thereafter as of December 31, 2003:

 

Payments Due by Year (in thousands)

 

Contractual Obligations		2004				2005			2006			2007			2008			Thereafter			Total
Debt (a)		$		514,591		$	605,438		$	489,961		$	332,583		$	494,727		$	2,923,189		$	5,360,489
Operating Leases:
Minimum Rent Payments (b)		4,835				3,915			2,852			2,376			2,243			8,365			24,586
Other Long-Term Liabilities:
Deferred Compensation (c)		831				1,376			1,411			2,215			2,270			20,972			29,075
Other (d)		1,000				—			—			—			—			—			1,000
Total		$	521,257			$	610,729		$	494,224		$	337,174		$	499,240		$	2,952,526		$	5,415,150

 

34

 

(a)          Amounts include aggregate principal payments only.  The Operating Partnership paid $352,391, $365,782 and $380,745 for interest on debt, inclusive of derivate instruments, for the years ended December 31, 2003, 2002 and 2001, respectively.

(b)         Minimum basic rent due for various office space the Operating Partnership leases and fixed base rent due on a ground lease for one property.

(c)          Estimated payments to EQR’s Chairman, former CEO and two other executive officers based on planned retirement dates.

(d)         Promissory note due on one property.

 

Critical Accounting Policies and Estimates

 

The Operating Partnership’s significant accounting policies are described in Note 2 in the Notes to Consolidated Financial Statements.  These policies were followed in preparing the consolidated financial statements at and for the year ended December 31, 2003.

 

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 indicators of permanent impairment.  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

 

35

 

a development project.  An allocated portion of payroll costs is capitalized based upon the occupancy of the project until stabilized occupancy is achieved.  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.

 

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 account for 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.  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 year ended December 31, 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 year ended December 31, 2003, Funds From Operations (“FFO”) available to OP Units decreased $78.9 million, or 11.0%, as compared to the year ended December 31, 2002. For the year

 

36

 

ended December 31, 2002, FFO available to OP Units increased $13.0 million, or 1.8%, as compared to the year ended December 31, 2001.

 

The following is a reconciliation of net income to FFO available to OP Units for the years ended December 31, 2003, 2002 and 2001:

 

Funds From Operations

(Amounts in thousands)

 

		Year Ended December 31,
		2003			2002			2001
Net income		$	578,505		$	448,175		$	506,414
Adjustments:
Depreciation		444,339			419,039			396,737
Depreciation – Non-real estate additions		(7,019		)	(9,213		)	(6,555		)
Depreciation – Partially Owned Properties		(8,390		)	(7,706		)	(4,353		)
Depreciation – Unconsolidated Properties		28,301			19,872			13,022
Net (gain) on sales of unconsolidated entities		(4,942		)	(5,054		)	(387		)
Cumulative effect of change in accounting principle		—			—			1,270
Discontinued Operations:
Depreciation		27,230			53,917			60,495
Net gain on sales of depreciable property		(300,426		)	(102,614		)	(148,906		)
FFO (1)(2)		757,598			816,416			817,737
Preferred distributions		(96,971		)	(97,151		)	(106,119		)
Premium on redemption of preference units		(20,237		)	—			(5,324		)
FFO available to OP Units		$	640,390		$	719,265		$	706,294

 

(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 $10,280, $1,682 and $0 for the years ended December 31, 2003, 2002 and 2001, 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 years ended December 31, 2002, 2001 and 2000 have been reduced by $18,284, $71,766 and $1,000, respectively, to conform to the current year presentation.  For the year ended December 31, 2001, FFO has been reduced by $5,324 to reflect the SEC’s clarification of EITF Topic D-42 regarding premiums on redemption of preference units.

 

37

 

(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, among other items, variations in cost capitalization policies for capital expenditures and, accordingly, may not be comparable to such other real estate companies.

 

Item 7A.  Quantitative and Qualitative Disclosure about Market Risk

 

Market risks relating to the Operating Partnership’s operations result primarily from changes in short-term LIBOR interest rates.  The Operating Partnership does not have any direct foreign exchange or other significant market risk.

 

The Operating Partnership’s exposure to market risk for changes in interest rates relates primarily to the unsecured line of credit.  The Operating Partnership typically incurs fixed rate debt obligations to finance acquisitions and capital expenditures, while it typically incurs floating rate debt obligations to finance working capital needs and as a temporary measure in advance of securing long-term fixed rate financing.  The Operating Partnership continuously evaluates its level of floating rate debt with respect to total debt and other factors, including its assessment of the current and future economic environment.

 

The Operating Partnership also utilizes certain derivative financial instruments to limit market risk.  Interest rate protection agreements are used to convert floating rate debt to a fixed rate basis or vice versa.  Derivatives are used for hedging purposes rather than speculation.  The Operating Partnership does not enter into financial instruments for trading purposes.                               See also Note 14 to the Notes to Consolidated Financial Statements for additional discussion of derivative instruments.

 

The fair values of the Operating Partnership’s financial instruments (including such items in the financial statement captions as cash and cash equivalents, other assets, lines of credit, accounts payable and accrued expenses, rents received in advance and other liabilities) approximate their carrying or contract values based on their nature, terms and interest rates that approximate current market rates.  The fair value of the Operating Partnership’s mortgage notes payable and unsecured notes approximates their carrying value at December 31, 2003.

 

The Operating Partnership had total outstanding floating rate debt of approximately $750.0 million, or 14.0% of total debt at December 31, 2003, net of the effects of any derivative instruments.  If market rates of interest on all of the floating rate debt permanently increased by 22 basis points (a 10% increase from the Operating Partnership’s existing weighted average interest rates), the increase in interest expense on the floating rate debt would decrease future earnings and cash flows by approximately $1.7 million.  If market rates of interest on all of the floating rate debt permanently decreased by 22 basis points (a 10% decrease from the Operating Partnership’s existing weighted average interest rates), the decrease in interest expense on the floating rate debt would increase future earnings and cash flows by approximately $1.7 million.

 

At December 31, 2003, the Operating Partnership had total outstanding fixed rate debt of approximately $4.6 billion, net of the effects of any derivative instruments.  If market rates of interest permanently increased by 67 basis points (a 10% increase from the Operating Partnership’s existing weighted average interest rates), the estimated fair value of the Operating Partnership’s fixed rate debt would be approximately $4.2 billion.  If market rates of interest permanently decreased by 67 basis points (a 10% decrease from the Operating Partnership’s existing weighted average interest rates), the estimated fair value of the Operating Partnership’s fixed rate debt would be approximately $5.1 billion.

 

At December 31, 2003, the Operating Partnership’s consolidated derivative instruments had a net asset fair value of approximately $3.9 million.  If market rates of interest permanently increased by 25 basis points (a 10% increase from the Operating Partnership’s existing weighted average interest rates), the net asset fair value of the Operating Partnership’s consolidated derivative instruments would be approximately $8.0 million.  If market rates of interest permanently decreased by 25 basis points (a 10% decrease from the Operating Partnership’s existing weighted average interest rates), the net liability fair value of the Operating Partnership’s consolidated derivative instruments would be approximately $0.1 million.

 

38

 

At December 31, 2003, the Operating Partnership’s unconsolidated derivative instruments had a net liability fair value of approximately $5.2 million.  If market rates of interest permanently increased by 11 basis points (a 10% increase from the Operating Partnership’s existing weighted average interest rates), the net liability fair value of the Operating Partnership’s unconsolidated derivative instruments would be approximately $5.1 million.  If market rates of interest permanently decreased by 11 basis points (a 10% decrease from the Operating Partnership’s existing weighted average interest rates), the net liability fair value of the Operating Partnership’s unconsolidated derivative instruments would be approximately $5.3 million.

 

These amounts were determined by considering the impact of hypothetical interest rates on the Operating Partnership’s financial instruments.  The foregoing assumptions apply to the entire amount of the Operating Partnership’s debt and derivative instruments and do not differentiate among maturities.  These analyses do not consider the effects of the changes in overall economic activity that could exist in such an environment.  Further, in the event of changes of such magnitude, management would likely take actions to further mitigate its exposure to the changes.  However, due to the uncertainty of the specific actions that would be taken and their possible effects, this analysis assumes no changes in the Operating Partnership’s financial structure or results.

 

The Operating Partnership cannot predict the effect of adverse changes in interest rates on its debt and derivative instruments and, therefore, its exposure to market risk, nor can there be any assurance that long term debt will be available at advantageous pricing.  Consequently, future results may differ materially from the estimated adverse changes discussed above.

 

Item 8.  Financial Statements and Supplementary Data

 

See Index to Consolidated Financial Statements on page F-1 of this Form 10-K.

 

Item 9.  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

None.

 

Item 9A.  Disclosure Controls and Procedures

 

Effective as of December 31, 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 year ended December 31, 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.

 

39

 

PART III

 

Items 10,11,12, 13 and 14 of this Form 10-K may omit the use of certain defined terms used elsewhere herein and may contain certain defined terms that are different from those used in the other sections of this report.

 

Item 10.                       TRUSTEES AND EXECUTIVE OFFICERS OF THE REGISTRANT

 

The Operating Partnership does not have any trustees or executive officers.  The following is a biographical summary, as of March 1, 2004, of the age, experience and position and offices of the trustees and executive officers of EQR, ERPOP’s General Partner.  Officers serve at the pleasure of the Board of Trustees (the “Board”).

 

Trustees

 

All trustees are elected at each annual meeting of EQR’s shareholders.  EQR’s Board of Trustees may appoint trustees to fill vacancies (including vacancies resulting from an increase in the number of trustees) arising between shareholders meetings.

 

John W. Alexander, 56, has been a Trustee of EQR since May 1993 and is the President of Mallard Creek Capital Partners, Inc., an investment company with interests in real estate, development entities and operating companies.  He is also a partner of Meringoff Equities, a real estate investment and development company, and is a member of the International Council of Shopping Centers and the Urban Land Institute.

 

Charles L. Atwood, 55, has been a Trustee of EQR since July 2003.  Mr. Atwood is Senior Vice President and Chief Financial Officer of Harrah’s Entertainment, Inc. (“Harrah’s”), a public owner and operator of gaming facilities.  Mr. Atwood has been with Harrah’s and its predecessor companies since 1979.  He received an M.B.A. in finance from Tulane University and is a member of the American Institute of Certified Public Accountants.

 

Bruce W. Duncan, 52, has been President and a Trustee of EQR since March 2002 and was appointed Chief Executive Officer of EQR in January 2003.  He was a private investor from April 2000 until joining EQR.  Mr. Duncan served as Chairman, President and Chief Executive Officer of The Cadillac Fairview Corporation Limited, a real estate operating company, from December 1995 until its sale in March 2000.  Mr. Duncan is a director of The Rouse Company, a public real estate management and development company, a director of Starwood Hotels & Resorts Worldwide, Inc. (“Starwood”) and a trustee of Starwood Hotels & Resorts, a real estate investment trust and a subsidiary of Starwood.  In addition, Mr. Duncan is on the Executive Committee of the National Multi-Housing Council and the Executive Committee of NAREIT Board of Governors, a member of the Urban Land Institute, and a past trustee of the International Council of Shopping Centers.

 

Stephen O. Evans, 59, has been a Trustee of EQR since December 23, 1997, the date of the merger of Evans Withycombe Residential, Inc. (“Evans”), a public multifamily property company founded by Mr. Evans, into EQR (the “Evans Merger”).  Mr. Evans is President of Evans Realty Associates, a real estate investment company and serves as a director of Biltmore Bank of Arizona.  Mr. Evans also served as an Executive Vice President of Equity Residential from December 1997 to December 1999 and as the Chairman of the Board and Chief Executive Officer of Evans from its formation in May 1994 until the Evans Merger.  Mr. Evans is a member of Lambda Alpha, a national land economics fraternity, and the Urban Land Institute.

 

40

 

James D. Harper, Jr., 70, has been a Trustee of EQR since May 1993.  Mr. Harper is the President of JDH Realty Co., a real estate development and investment company, and is the principal partner in AH Development, S.E., a special limited partnership formed to develop over 400 acres of land in Puerto Rico.  He is a trustee of Equity Office Properties Trust (“EOP”), a public office building company.

 

Boone A. Knox, 67, has been a Trustee of EQR since October 19, 1998, the date of the merger of Merry Land & Investment Company, Inc. (“Merry Land”), a public multifamily property company, into EQR (the “Merry Land Merger”).  Mr. Knox had been a director of Merry Land Properties, Inc. (“MRYP”), a publicly traded diversified real estate company, from its formation as part of the Merry Land Merger through February 2001.  Mr. Knox had been Chairman of the Board of Directors of Merry Land from December 1996 until the Merry Land Merger.  Mr. Knox has served as Chairman of the Board of Directors of Regions Bank, Central Georgia since January 1997, and is a director of Cousins Properties, Incorporated, a public retail and office building company.

 

Desiree G. Rogers, 44, has been a Trustee of the Company since October 2003.  Ms. Rogers joined Peoples Energy Corporation in 1977 and currently serves as Senior Vice President of Peoples Energy Corporation, a publicly diversified energy company.  She received an M.B.A from Harvard Business School.

 

Sheli Z. Rosenberg, 62, has been a Trustee of EQR since March 1993, and Lead Trustee since 2002.  Ms. Rosenberg was Vice Chairman of Equity Group Investments, LLC (“EGI LLC”), an investment company, from January 1, 2000 to March 2003, at which time she retired, and Chief Executive Officer and President of EGI LLC from January 1, 1999 to January 1, 2000.  Ms. Rosenberg is a trustee of EOP and is a director of Capital Trust, Inc. (“Capital Trust”), a specialized finance company, Manufactured Home Communities, Inc. (“MHC”), a public manufactured home community company, Ventas, Inc., a public real estate company focusing on the ownership and acquisition of health care properties, CVS Corporation, a drugstore chain and Cendant Corporation, a provider of business and consumer services primarily within the real estate and travel sectors.

 

Gerald A. Spector, 57, has been a Trustee and Executive Vice President of EQR since March 1993 and Chief Operating Officer of EQR since February 1995.

 

Michael N. Thompson, 55, has been a Trustee of EQR since October 19, 1998, the date of the Merry Land Merger.  Mr. Thompson has been a principal of Merry Land Properties, L.L.C., a private entity performing development activities in the Southeast, since May 2003. Mr. Thompson had been President, Chief Operating Officer and a director of MRYP since its formation as part of the Merry Land Merger until May 2003.  Mr. Thompson served as Executive Vice President and Chief Operating Officer of Merry Land from December 1996 until the Merry Land Merger.

 

B. Joseph White, 56, has been a Trustee of EQR since May 1993.  Mr. White is the Wilbur K. Pierpont Collegiate Professor at the University of Michigan Business School.  In 2003, he served as Managing Director of Fred Alger Management Company, an Asset Management firm.  In 2002, he served as Interim President of the University of Michigan.  From 1991 to 2001 he was dean of the University of Michigan Business School.  Mr. White is a director of Kelly Services, Inc., a temporary services firm, and Kaydon Corporation, a manufacturer of precision engineered metal products.

 

Samuel Zell, 62, has been Chairman of the Board of EQR since March 1993.  Since January 1999, Mr. Zell has been Chairman of EGI LLC.  He is also Chairman of the Board of EOP, MHC, Capital Trust, Anixter International Inc., a provider of integrated network and cabling systems, Angelo & Maxie’s, Inc., an owner and operator of restaurants, Danielson Holding Corporation, a holding company with separate subsidiaries in the insurance and marine transportation industries, and Rewards Network Inc., an administrator of loyalty based consumer rewards programs.

 

41

 

Executive Officers

 

Bruce W. Duncan, Chief Executive Officer, President and a Trustee of EQR.  See biographical information above.

 

Gerald A. Spector, Chief Operating Officer, Executive Vice President and a Trustee of EQR.  See biographical information above.

 

David J. Neithercut, 48, has been Executive Vice President – Corporate Strategy since January 1, 2004, and Executive Vice President and Chief Financial Officer of EQR since February 1995.

 

J. Donald Couvillion, 49, has been Executive Vice President – Development since December 2001.  From December 1997 to November 2001, he was Senior Vice President – Development of EQR. Mr. Couvillion will leave the employ of EQR on or about May 1, 2004, depending upon EQR’s transitional needs.

 

Alan W. George, 46, has been Executive Vice President – Chief Investment Officer of EQR since January 2002.  Mr. George was Executive Vice President – Acquisitions/Dispositions of EQR from February 1997 to January 2002.

 

Edward J. Geraghty, 54, has been Executive Vice President of EQR since March 1998 and President – Eastern Division since April 1999.

 

Michael J. McHugh, 48, has been Executive Vice President of EQR since January 1998 and Chief Accounting Officer and Treasurer of EQR since February 1995.

 

Gregory H. Smith, 52, has been Executive Vice President – Portfolio Investment of EQR since January 1, 2004, and Executive Vice President since December 1994.  Mr. Smith was also President – Central Division from April 1999 to December 2003.

 

Bruce C. Strohm, 49, has been Executive Vice President and General Counsel of EQR since March 1995 and Secretary of EQR since November 1995.

 

Mark N. Tennison, 43, has been Executive Vice President – Development of EQR since March 2004.  Mr. Tennison served as Senior Vice President and Chief Operating Officer of Pritzker Residential from 1997 through 2003.

 

Frederick C. Tuomi, 49, has been Executive Vice President of EQR since January 1994 and President – Western Division since April 1999.

 

Audit Committee

 

The current members of the Audit Committee of EQR’s Board of Trustees are B. Joseph White (Chair), John W. Alexander, Boone A. Knox, James D. Harper, Jr., and Charles L. Atwood.  The Audit Committee is comprised entirely of trustees who meet the independence and financial literacy requirements of NYSE listing standards.  In addition, the Board has determined that Mr. Atwood qualifies as an “audit committee financial expert” as defined in SEC rules.

 

Code of Ethics and Business Conduct

 

EQR’s Board has adopted a Code of Ethics and Business Conduct that applies to all trustees, officers and employees, including EQR’s principal executive officer, principal financial officers and principal accounting officers.  The purpose of the Code of Ethics and Business Conduct is to promote honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest

 

42

 

between personal and professional relationships to promote full, fair, accurate, timely and understandable disclosure in periodic reports required to be filed by EQR; and to promote compliance with all applicable rules and regulations that apply to EQR and its officers and Trustees.  If the Board amends any provisions of the Code of Ethics and Business Conduct that apply to EQR’s chief executive officer or senior financial officers or grants a waiver in favor of any such persons, it will promptly publish the text of the amendment or the specifics of the waiver on its website.  EQR’s Code of Ethics and Business Conduct may be viewed on EQR’s website at www.equityapartments.com under the Investor Relations section.

 

Section 16(a) Beneficial Ownership Reporting Compliance

 

Section 16(a) of the Exchange Act requires the Operating Partnership to report whether or not, based on its review of reports to the SEC filed by its more than 10% beneficial owners, about transactions in its OP Units furnished to the Operating Partnership, and the written representation of its more than 10% beneficial owners that any such required reports were not filed or were filed untimely.  There were no such failures to report or late reports during 2003.

 

Item 11.  EXECUTIVE COMPENSATION

 

Compensation Of Trustees

 

The following information is provided for the Board of Trustees of EQR.

 

To link trustee compensation to performance and to more effectively align the Board’s interests with the interests of the shareholders, the Board believes that over 50% of the trustees’ base annual fee (excluding committee or other Board service fees) should be payable in some form of Company equity.  Each of EQR’s trustees, excluding EQR’s Chairman, Mr. Zell, and the employee trustees, Mr. Duncan and Mr. Spector, is entitled to receive an annual cash fee of $45,000 for serving on the Board.  In addition, trustees who serve on the Audit, Compensation, Nominating, Corporate Governance or Executive Committee receive an additional $4,000 per year for each committee on which they serve.  The chair of the Audit Committee receives an additional $11,000 per year and the chairs of the Compensation, Nominating and Corporate Governance Committees each receive an additional $6,000 per year.  Mr. Zell does not receive a fee for acting as Chair of the Executive Committee.  The Lead Trustee receives an additional annual fee of $10,000 for such service. EQR also reimburses the trustees for travel expenses incurred in connection with their activities on behalf of EQR.  As of January 1, 2003, EQR’s Chairman, Mr. Zell, and the employee trustees no longer receive any such annual trustee’s fee and/or long-term incentive grant for their service on the Board.

 

Each trustee of EQR, excluding EQR’s Chairman, Mr. Zell, and the employee trustees, Mr. Duncan and Mr. Spector, is entitled to receive an annual long-term incentive grant of $50,000 of options and restricted shares.  This grant will be allocated between options and restricted shares in the same ratio and utilizing the same valuation criteria as approved by the Board for the annual long-term incentive grants to EQR’s executive officers.  The 2003 and 2004 grants were allocated 25% to options and 75% to restricted shares.  The options granted vest in approximately equal installments of six months, one year and two years from the date of grant.  The restricted shares vest in full on the third anniversary of the grant date.  Distributions are paid on these restricted shares at the same rate as on unrestricted common shares.

 

Trustees who are first appointed or elected to the Board after the beginning of a fiscal year receive prorated cash fees and long-term incentive grants for their first year of service.

 

Because EQR’s financial results were impacted during 2002, the trustees voluntarily agreed to reduce their base annual trustee compensation by approximately ten percent during 2003.  Accordingly, each non-employee trustee’s annual fee for 2003 was reduced from $45,000 to $40,000, and the annual

 

43

 

long-term incentive grant of $50,000 was reduced to $45,000.

 

For trustees retiring from the Board or completing a scheduled term on the Board without re-nomination, vesting of all outstanding options and restricted shares granted as compensation for serving as a trustee is accelerated, and options may be exercised through the expiration of the exercise period (i.e., ten years from the grant date).  Options and restricted share awards issued to Mr. Zell as Chairman are subject to the same vesting restriction upon retirement as other employees of EQR.

 

Mr. Zell receives restricted shares and options for his services as Chairman as described in “Employment Contracts and Change in Control Arrangements” below.

 

EQR has an optional deferred compensation plan in which trustees may participate.  The trustees may defer receipt of any percentage of their annual cash compensation, which amount is then deposited in a supplemental executive retirement savings plan (the “SERP”) on a tax-deferred basis. These deferred funds (as well as any cash trustee fees which are not deferred) may be used to purchase EQR Common Shares under the EQR Employee Share Purchase Plan (the “ESPP”) at the discounted purchase price under the plan.  Each trustee is immediately 100% vested in his or her purchased ESPP shares held in the SERP and is allowed to begin withdrawals over a one to ten year period following termination of his or her trusteeship.  The majority of the trustees have elected to join the deferred compensation plan and defer the taxation of all cash trustee fees.  The trustees may also elect to defer receipt of their restricted shares to the SERP prior to the vesting of the shares.  Non-employee trustees do not participate in EQR’s profit sharing plan or receive any matching contributions on any fees or restricted shares so deferred.

 

Executive Compensation

 

The following tables show the compensation for Bruce W. Duncan, the Chief Executive Officer and President, and the other four most highly compensated executive officers of Equity Residential, the general partner of the Operating Partnership.

 

										Long-Term Compensation
		Annual Compensation								Awards					Payouts
Name and Principal Position		Year		Salary(1)			Cash Bonus(1)			Restricted Share Awards(3)			Number of Options Granted(4)		Long-Term Incentive Payouts(5)			All Other Compensation(6)
Bruce W. Duncan		2003		$	750,000		$	760,000		$	839,416		168,820		$	0		$	0
Chief Executive Officer &		2002		388,309		(2)	550,000		(2)	262,907			45,361		0			0
President		2001		—			—			—			—		—			—
Gerald A. Spector		2003		$	550,000		$	500,000		$	2,043,580		228,947		$	738,580		$	8,000
Executive Vice President &		2002		550,000			200,000			1,960,974			170,444		1,022,040			10,200
Chief Operating Officer		2001		550,000			500,000			1,594,588			364,742		716,199			11,900
David J. Neithercut		2003		$	350,000		$	400,000		$	785,472		100,987		$	209,839		$	8,000
Executive Vice President –		2002		350,000			300,000			869,007			79,965		428,400			20,200
Corporate Strategy and Chief Financial Officer		2001		350,000			375,000			674,299			132,704		429,740			65,900
Alan W. George		2003		$	350,000		$	275,000		$	616,458		71,711		$	207,726		$	8,000
Executive Vice President		2002		350,000			250,000			731,852			66,176		367,200			20,200
& Chief Investment Officer		2001		350,000			325,000			640,953			123,030		480,271			65,900
Frederick C. Tuomi		2003		$	350,000		$	275,000		$	532,264		69,079		$	138,508		$	8,000
Executive Vice President &		2002		350,000			250,000			668,542			54,687		367,200			20,200
President – Western Division		2001		350,000			325,000			664,377			147,536		480,271			65,900

 

44

 

(1)                 Includes any compensation deferred under EQR’s deferred compensation plan.  Cash bonuses are reported in the year earned, even if paid in a subsequent year.

 

(2)                 Mr. Duncan’s 2002 salary of $388,309 represents time worked from April 8, 2002, his first day of employment, through December 31, 2002.  His annualized base salary for 2002 was $550,000.  Mr. Duncan voluntarily reduced his 2002 bonus from $750,000 to $550,000, with $100,000 of the reduction used to fund employee recognition cash grants.  Mr. Duncan also voluntary reduced his 2003 bonus by $100,000, to be used to fund employee recognition cash grants.

 

(3)                 The dollar amount shown equals the number of restricted shares granted in each year on account of the prior year’s service, multiplied by the fair market value of the common shares on the grant date.  These shares vest upon completion of three years of continuous employment following the grant date, with the exception of restricted shares issued in connection with the termination of the 2000 performance share grants, which vest in equal installments over three years.  The valuations do not take into account the diminution in value attributable to the restrictions applicable to the common shares.  Distributions are paid on restricted shares at the same rate as on unrestricted common shares. The total number of restricted common shares awarded to each named executive officer for 2003, 2002 and 2001, respectively, were: Mr. Duncan 35,644, 9,072 and 0; Mr. Spector 85,462, 71,663 and 60,262; Mr. Neithercut 32,980, 31,743 and 25,626; Mr. George 25,807, 26,736 and 24,350; and Mr. Tuomi 22,355, 24,438 and 25,252.

 

The number and value ($29.51 per share) of the restricted share holdings of each executive officer listed above at December 31, 2003 were as follows:

 

 

(4)                Shares underlying options are reported in the year granted.

 

(5)                 The dollar amount shown reflects the fair market value of vested shares issued in each year, multiplied by the fair market value of the common shares on the grant date.  These vested shares represent shares issued under EQR’s performance share grants, as further described in “Long-Term Incentive Plan Awards” below, based on EQR’s financial performance during the three calendar years following the date of grant.  Fifty percent of the shares were vested upon issuance with the balance issued as restricted shares vesting equally over two years from the grant date.  These restricted shares are reflected in the Restricted Share Awards column.  The total number of vested shares awarded to each named executive for 2003, 2002 and 2001, respectively, were Mr. Duncan 0, 0 and 0; Mr. Spector 30,048, 37,575 and 27,922; Mr. Neithercut 8,537, 15,750 and 16,754; Mr. George 8,451, 13,500 and 18,724; and Mr. Tuomi 5,635, 13,500 and 18,724.

 

(6)                 Principally includes employer matching and profit-sharing contributions to EQR’s 401(k) Plan.  This column also reflects the dollar value of premiums paid for the purchase of split-dollar life insurance policies for the following executives:  Mr. Neithercut:  2003 - $-0-, 2002 - $10,000 and 2001 - $54,000; Mr. George:  2003 - $-0-, 2002 - $10,000 and 2001 - $54,000; and Mr. Tuomi:  2003 - $-0-, 2002 - $10,000 and 2001 - $54,000.  While the executive is the owner of such policy, upon the executive’s death, EQR will receive from the death benefits all premiums paid by it on the executive’s behalf, plus 10% interest per annum on such premium payments for up to the first 10

 

45

 

years of such payments (collectively, “Company Premiums”), and the executive’s beneficiary will receive the balance of the death benefits.  In addition, the executive is entitled to 50% of the cash surrender value of the policy at age 62, and 50% at age 65.  Upon termination of employment prior to age 62, the executive must borrow against the policy or partially surrender the policy in an amount sufficient to repay the Company Premiums to EQR.  EQR ceased making payment of premiums on these policies in 2003.

 

OPTION GRANTS IN 2003

 

Name		Number of Options Granted (1)		% of Total Options Granted to Employees		Exercise Price Per Share			Expiration Date		Grant Date Present Value(2)
Bruce W. Duncan		168,820		6.97	%	$	23.55		2/7/2013		$	320,758
Gerald A. Spector		228,947		9.45	%	23.55			2/7/2013		434,999
David J. Neithercut		100,987		4.17	%	23.55			2/7/2013		191,875
Alan W. George		71,711		2.96	%	23.55			2/7/2013		136,251
Frederick C. Tuomi		69,079		2.85	%	23.55			2/7/2013		131,250

 

(1)                       All options are granted at the fair market value of the common shares at the grant date.  Options granted have a term of not more than ten years from the grant date and vest in equal installments over three years.

 

(2)                       The estimated present value at grant date of option grants in 2003 has been calculated using the Black-Scholes option pricing model based on the following assumptions:  an estimated time until exercise of 5 years, a volatility of 20.8%, a risk-free interest rate of 3.02% and a dividend yield of 6.46%.  The real value of these options depends on the actual performance of EQR’s common shares during the applicable period and on the date or dates when options are exercised.  No gain to the optionee is possible without an increase in common share price, which would benefit all shareholders as well.

 

OPTION EXERCISES IN 2003

AND YEAR-END OPTION VALUES

 

		Number of Shares Acquired Upon Exercise		Value Realized Upon Exercise(1)			Number of Unexercised Options at Dec. 31, 2003				Value of Unexercised Options at Dec. 31, 2003(2)
Name							Exercisable		Unexercisable		Exercisable			Unexercisable
Bruce W. Duncan		0		$	0		16,454		197,727		$	8,721		$	1,021,488
Gerald A. Spector		275,000		1,572,306			661,148		459,157		3,046,278			1,939,586
David J. Neithercut		20,000		338,750			584,652		198,532		4,796,966			849,147
Alan W. George		120,000		1,089,239			261,049		156,840		1,173,434			641,609
Frederick C. Tuomi		0		0			338,560		154,716		1,908,744			638,172

 

(1)                       Represents the market value of a common share on the exercise date less the exercise price of the option.

 

(2)                       Represents the market value of a common share at December 31, 2003 ($29.51) less the exercise price of in-the-money options.

 

46

 

LONG-TERM INCENTIVE PLAN AWARDS

 

The table set forth below identifies the target number of performance units awarded in early 2004 for services rendered during 2003.  The executive officers have the opportunity to earn in common shares an amount as little as 0% to as much as 225% of the target number of performance units.  The owners of performance units have no right to vote, receive dividends or transfer the units until common shares are issued in exchange for the units.  The number of common shares the executive actually receives on the third anniversary of the grant date will depend on the excess, if any, by which EQR’s Average Annual Return (i.e., the average of the common share dividends declared during each year as a percentage of the common share price as of the first business day of January 2004 ($29.53), and the average percentage increase in funds from operations (“FFO”) for each calendar year on a per share basis over the prior year) for the three performance years exceeds the average of the 10-year Treasury Note interest rate as of the first business day in January of each performance year (the “T-Note Rate”).

 

If EQR’s Average Annual Return exceeds the T-Note Rate by:		less than 0.99%		1-1.99%		2%		3%		4%		5%		6%		greater than 7%
Then the executive will receive common shares equal to the target number of units times the following%:		0%		50%		100%		115%		135%		165%		190%		225%

 

Fifty percent of the common shares to which an executive may be entitled under the performance share grants will vest, subject to the executive’s continued employment with EQR, on the third anniversary of the award (which will be the date the common shares are issued); twenty-five percent will vest on the fourth anniversary and the remaining twenty-five percent will vest on the fifth anniversary.  The common shares will also fully vest upon the executive’s death, retirement at or after age 62, disability or upon a change in control of EQR.

 

LONG-TERM INCENTIVE PLAN AWARDS  FOR 2003

 

Name		Number of Target Units		Performance Period
Bruce W. Duncan		15,470		1-01-2004 – 12-31-2006
Gerald A. Spector		11,750		1-01-2004 – 12-31-2006
David J. Neithercut		6,837		1-01-2004 – 12-31-2006
Alan W. George		5,213		1-01-2004 – 12-31-2006
Frederick C. Tuomi		4,615		1-01-2004 – 12-31-2006

 

Employment Contracts And Change In Control Arrangements

 

Employment Contracts.  EQR entered into an Employment Agreement with Mr. Duncan in January 2003 reflecting Mr. Duncan’s appointment as President and Chief Executive Officer as of January 1, 2003.  The term of the agreement is four years from January 1, 2003 until December 31, 2006, with annual one-year extensions thereafter unless terminated by either party upon 90 days notice.  Mr. Duncan’s base annual salary is $750,000, subject to periodic increases in the Board’s discretion.  His target cash bonus is 144% of base salary, or $1,080,000.  His target long-term incentive annual grant of options, restricted shares and performance shares is 246% of annual cash compensation, or $4,500,000.  The “target” criteria for achievement of Mr. Duncan’s bonus and long-term incentive awards will be determined using the same criteria utilized by the Compensation Committee of EQR’s Board for achievement of target bonuses and long-term incentive awards for EQR’s other senior executives.

 

47

 

Mr. Duncan’s employment agreement provides that upon his termination of employment for any reason (other than having left EQR voluntarily without good reason or as a result of termination for cause or a Change in Control (as defined below)), he would receive the following benefits:

 

•                  All his options, restricted shares and performance share units would vest in full, with the performance share units vesting at the greater of the 100% level or the performance level achieved through the date of termination.  He would have the balance of the 10-year option period to exercise any vested options.

 

•                  He would receive a severance payment equal to two and one-half times his current base annual salary and two and one-half times the average of the prior two years’ cash bonuses (or two and one-half times the 2004 target bonus if termination occurs prior to the payment of the 2004 calendar year bonus), unless his employment is terminated due to his death or disability, in which case he would receive only the proceeds payable under EQR’s standard employee life insurance and disability programs.

 

•                  He would receive a prorated cash bonus (based on the number of days in the calendar year worked) equal to the prior year’s bonus, as well as any accrued unpaid base salary, accrued unreimbursed expenses and benefits, and his accrued unpaid bonus, if any, for the prior year.

 

Upon Mr. Duncan’s continuous employment with EQR through December 31, 2006, he will be deemed to have sufficient years of service for retiree eligibility under all EQR incentive and benefit plans (specifically excluding Mr. Duncan’s Deferred Compensation Agreement and his Retirement Benefits Agreement, which will remain in effect thereafter in accordance with their terms), including continued exercisability of share options at the most senior tier upon a termination of employment, but not less than the lesser of five years or the remaining term of the grant.  Mr. Duncan also receives five weeks of vacation and an EQR paid non-golf club membership and may maintain two additional for-profit directorships.  EQR also has agreed to renominate Mr. Duncan for reelection to its Board as long as he is the Chief Executive Officer of EQR.  In accordance with EQR’s policy, Mr. Duncan has agreed to submit his resignation as trustee upon the termination of his employment with EQR for any reason.

 

EQR entered into a Compensation Agreement with Mr. Zell in October 2001 (as amended in March 2003) for services provided by Mr. Zell as Chairman of the Board for the calendar years 2001, 2002 and 2003, which entitles Mr. Zell to an annual long-term incentive grant of $3,250,000 of options and restricted shares.  Mr. Zell is also responsible for his own business related expenses. Subject to Mr. Zell’s continuing service as EQR’s Chairman, his annual long-term incentive grant of $3,250,000 shall be allocated between options and restricted shares in the same ratio as approved by the Board for the annual long-term incentive grants to EQR’s executive officers, utilizing the same valuation criteria described below.  For the 2003 and 2004 grants, the $3,250,000 was allocated 25% to options and 75% to restricted shares.  In January 2004, Mr. Zell was granted 359,518 options at an exercise price of $29.25 per share and 83,333 restricted shares for his contribution during 2003 in his capacity as Chairman of the Board.

 

The number of options granted is determined by dividing the dollar amount allocated to options by the fair market value of each option using the same valuation criteria utilized by EQR’s Compensation Committee in its annual employee option grants made as of the same date.  The options are granted at the fair market value of EQR’s common shares at the date of grant, are granted for a period of ten years and vest over a period of three years at a rate of one third of such grant each year.  The number of restricted shares granted is determined by dividing the dollar amount allocated to restricted shares by the closing price of common shares of EQR on the grant date.  The restricted shares vest in full on the third anniversary of the grant date.  Distributions are paid on these restricted shares at the same rate as on unrestricted common shares.

 

48

 

EQR also entered into a Retirement Benefits Agreement with Mr. Zell in October 2001.  The Retirement Benefits Agreement provides Mr. Zell with a cash retirements benefit after the termination of his service as Chairman of the Board.  If Mr. Zell’s employment as Chairman is terminated for any reason, other than by EQR for cause, he (or his estate in the event of his death) will be entitled to an annual retirement benefit of $500,000 (as increased by a CPI index from January 2002 through the termination date) over a ten year period commencing on the termination date.  Should Mr. Zell be terminated for cause, he would not be entitled to any such retirement benefit.

 

Deferred Compensation Agreements.  EQR has entered into Deferred Compensation Agreements with Messrs. Duncan and Spector.

 

Mr. Duncan’s Deferred Compensation Agreement, entered into in January 2003, provides Mr. Duncan with a salary benefit after the termination of his employment with EQR.  If Mr. Duncan’s employment is terminated by EQR without cause, Mr. Duncan resigns for good reason, or Mr. Duncan resigns for any reason on or after December 31, 2006, he would be entitled to annual deferred compensation for a ten-year period commencing on the termination date (or age 62 if Mr. Duncan resigns without good reason between December 31, 2006 and December 31, 2011) in an amount equal to $750,000 (increased by a CPI Index from January 2003 through the termination date), multiplied by a percentage equal to 10% for each year Mr. Duncan was employed by EQR since March 15, 2002, but not to exceed 100%.  In the event Mr. Duncan’s employment is terminated as a result of his death, permanent disability or incapacity, he would be entitled to a similar amount except that the annual percentage would be 15%, not 10%.  Should Mr. Duncan be terminated for cause or should he choose to leave voluntarily, without good reason, prior to December 31, 2006, he would not be entitled to any deferred compensation.

 

Mr. Spector’s Deferred Compensation Agreement, entered into in 1996, as most recently amended in January 2002, provides Mr. Spector with a salary benefit after the termination of his employment with EQR.  If Mr. Spector’s employment is terminated by EQR without cause, Mr. Spector resigns for good reason, or Mr. Spector resigns for any reason on or after January 1, 2009, he would be entitled to annual deferred compensation for a ten-year period commencing on the termination date in an amount equal to $550,000 (increased by a CPI Index from January 2002 through the termination date), multiplied by a percentage equal to 6.67% for each year Mr. Spector was employed by EQR since December 31, 1993, but not to exceed 100%.  In the event Mr. Spector’s employment is terminated as a result of his death, permanent disability or incapacity, he would be entitled to a similar amount except that the annual percentage would be 10%, not 6.67%.  Should Mr. Spector be terminated for cause or should he choose to leave voluntarily, without good reason, prior to January 1, 2009, he would not be entitled to any deferred compensation.

 

Change in Control Agreements.  EQR has Change in Control/Severance Agreements (the “Agreements”) with the persons named in the Summary Compensation Table and other key employees of EQR that become effective upon either a “Change in Control” or termination of employment within three years following the hiring of a new Chief Executive Officer.  A Change in Control will generally be deemed to have occurred upon a third party’s acquisition of 30% or more of EQR’s common shares, whether through purchase, merger or consolidation or a sale of all or substantially all of the assets of EQR.  In the event that an employee is dismissed without Cause or resigns for Good Reason (as such terms are defined in the Agreements) during the three-year period following either the effective date of the Change in Control or, for all executives other than the Chief Executive Officer, the hiring of a new Chief Executive Officer, he or she will be entitled to all accrued but unpaid compensation and benefits in a lump sum cash payment consisting of the employee’s base salary through the date of termination, and a severance payment equal to a multiple (ranging from 3.0 for the CEO to 2.0 for other executive officers) of the employee’s annual base salary plus the average of the employee’s annual bonus for the last three fiscal years.  The employee is also entitled to continued employee welfare benefits for the remainder of the applicable time period.  Several of EQR’s employment benefit plans also provide for enhanced employee benefits upon a “Change in Control” of EQR.  In general, upon a Change in

 

49

 

Control, all options, restricted shares and performance shares immediately vest.

 

Retirement Benefits Agreements.  EQR has entered into Executive Retirement Benefits Agreements with the persons named in the Summary Compensation Table and other Executive Vice Presidents of EQR.  These agreements provide that, if after reaching age 62 or older, either the executive retires from EQR or is terminated as a result of a Change in Control, the executive will be eligible to receive health and life benefits for the remainder of his or her life as any regular active employee.  These benefits will be offered at the same rates as would be paid by an active employee for like coverage and subject to increase as any other active employee.

 

Compensation Committee Interlocks And Insider Participation

 

The members of the Compensation Committee of EQR’s Board are John W. Alexander (Chair), James D. Harper, Jr. and Sheli Z. Rosenberg.  No member of the Compensation Committee is a past or present officer or employee of EQR.

 

Item 12.  SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT

 

The following table sets forth information, as of January 31, 2004, regarding the beneficial ownership of the OP Units by each person known by the Operating Partnership to be the beneficial owner of more than five percent of the Operating Partnership’s outstanding OP Units, and in addition, each trustee of EQR, EQR’s five most highly compensated executive officers at year end, and by all trustees and executive officers of EQR as a group.  Each person named in the table has sole voting and investment power with respect to all OP Units shown as beneficially owned by such person, except as otherwise set forth in the notes to the table.  In addition, the table also sets forth information, as of January 31, 2004, regarding each such person’s (other than EQR) beneficial ownership of EQR Common Shares and Common Shares that may be acquired within 60 days through the exercise of options.

 

Name		Number of EQR Common Shares(1)		EQR Shares Upon Exercise of Options(2)		Percent of EQR Common Shares(1)		Number of OP Units		Percent of OP Units
Equity Residential (2 N. RiversidePlaza, Chicago, IL  60606)		—		—		—		278,543,863		92.79	%
Samuel Zell		6,796,077	(3)	2,243,708		3.16	%	4,863,502		1.62	%
Bruce W. Duncan		164,677	(4)	87,847			*	44,794			*
John W. Alexander		62,437		75,786			*	—		—
Charles L. Atwood		2,905		1,809			*	—		—
Stephen O. Evans		1,294,712	(5)	22,283			*	1,168,778			*
James D. Harper, Jr.		32,418		88,951			*	—		—
Boone A. Knox		3,388,575	(6)	38,948		1.23	%	—		—
Desiree G. Rogers		1,992		—			*	—		—
Sheli Z. Rosenberg		290,455	(7)	326,432			*	3,056			*
Gerald A. Spector		789,183	(8)	845,858			*	218			*
Michael N. Thompson		213,762	(9)	38,948			*	—		—
B. Joseph White		28,638		70,948			*	—		—
Alan W. George		176,362		326,355			*	—		—
David J. Neithercut		212,799	(10)	667,537			*	—		—
Frederick C. Tuomi		148,166		407,327			*	—		—
Trustees and Executive Officers as a Group (20 persons)		14,237,365		6,122,961		7.00	%	6,080,348		2.03	%

 

*                      Less than 1%.

 

50

 

(1)               The number of common shares beneficially owned is based on SEC regulations regarding the beneficial ownership of securities.  On January 31, 2004, a total of 278,543,863 common shares and 21,657,139 OP units were outstanding, including both vested and unvested restricted share awards.  OP Units are exchangeable on a one-for-one basis into common shares.  Percentage ownership amounts are calculated by treating the holders’ options and, in the case of EQR, OP Units, as outstanding EQR Common Shares.  Except as otherwise noted, the persons named in the table have sole voting and investment power over the shares listed.

 

(2)     Reflects EQR Common Shares which may be acquired within 60 days after January 31, 2004.

 

(3)               Includes 4,863,502 OP Units.  Mr. Zell does not have a pecuniary interest in 600 common shares reported above held by the Helen Zell Revocable Trust (“HZRT”), the trustee of which is Helen Zell, Mr. Zell’s spouse.  Mr. Zell also does not have a pecuniary interest in 60,000 common shares held by the Zell Family Foundation, of which Mr. Zell is a director.  The number in the table includes 1,206,968 common shares and 4,462,828 OP Units in which Mr. Zell has a pecuniary interest but does not have voting or dispositive power.  1,206,968 common shares and 3,388,316 OP Units are indirectly held by trusts established for the benefit of Mr. Zell and his family, the trustee of which is Chai Trust Company, L.L.C. (“Chai Trust”).  Mr. Zell is not an officer or director of Chai Trust and does not have voting or dispositive power over such common shares or OP Units.  Additionally, 1,074,512 OP Units are held by EGIL Investments, Inc.  Under a shareholders’ agreement dated December 31, 1999, trusts established for the benefit of the family of Ann and Robert Lurie have the power to vote and to dispose of the common shares and OP Units beneficially owned by EGIL Investments, Inc.  Mr. Zell disclaims beneficial ownership of such 1,206,968 common shares and 4,462,828 OP Units except to the extent of his pecuniary interest therein.

 

(4)               Includes 44,794 OP Units.

 

(5)               Includes 100,000 common shares and 35,550 OP Units beneficially owned by The Evans Family Limited Liability Company, of which Mr. Evans serves as the manager.  Also includes four OP Units beneficially owned by The Evans Family Revocable Trust, of which Mr. Evans serves as the trustee.  As such, Mr. Evans may be deemed the beneficial owner of all the foregoing common shares and OP Units.  Also includes 1,133,224 OP Units beneficially owned by limited partnerships (collectively, the “EW LPs”), of which Mr. Evans serves as a general partner and has a 50% ownership interest.  As such, Mr. Evans may be deemed the beneficial owner of approximately 50% of the common shares and OP Units beneficially owned by the EW LPs.  Mr. Evans disclaims beneficial ownership of the other 50% interest in such common shares and OP Units, which are beneficially owned by other persons.

 

(6)               Includes 2,347,898 common shares beneficially owned by Knox, Ltd., of which Mr. Knox is the general partner, and includes 6,774 common shares beneficially owned by BT Investments, of which Mr. Knox is the managing partner.  Mr. Knox disclaims beneficial ownership of the common shares owned by Knox, Ltd. and BT Investments, except to the extent of his pecuniary interest in 230,232 common shares.  Also includes 6,228 common shares beneficially owned by Mr. Knox’s spouse and 848 common shares beneficially owned by Mr. Knox, not individually, but as custodian for his niece and nephew, as to all of which Mr. Knox disclaims beneficial ownership.  Also includes 359,678 common shares beneficially owned by the Knox Foundation, of which Mr. Knox is the trustee.  Mr. Knox disclaims beneficial ownership of the common shares owned by the Knox Foundation.  Also includes 335,892 common shares beneficially owned by Folkstone Limited Partnership (“FLP”), of which Mr. Knox is a general partner.  Mr. Knox disclaims beneficial ownership of the common shares owned by FLP, except to the extent of his pecuniary interest therein.  Also includes 144,298 common shares, over which Mr. Knox has investment authority, beneficially owned by his sister-in-law.  Mr. Knox disclaims beneficial ownership of these common shares.

 

(7)               Includes 59,342 common shares beneficially owned by Ms. Rosenberg’s spouse, as to which Ms. Rosenberg disclaims beneficial ownership.  Also includes 3,056 OP Units.

 

51

 

(8)               Includes 239,919 common shares beneficially owned by Mr. Spector’s spouse, and 6,328 common shares beneficially owned by Mr. Spector as custodian for his minor children, as to all of which Mr. Spector disclaims beneficial ownership.  Also includes 218 OP Units.

 

(9)               Includes 173,290 common shares beneficially owned by Deep South Investments, Ltd., of which Mr. Thompson is general partner.  Mr. Thompson disclaims beneficial ownership of the shares, except to the extent of his pecuniary interest therein.

 

(10)         Includes 9,974 common shares beneficially owned by Benemi Partners, L.P., of which Mr. Neithercut is general partner.

 

Equity Compensation Plan Information

 

The following table provides information as of December 31, 2003 with respect to EQR’s Common Shares that may be issued under existing equity compensation plans.  Any Common Shares issued pursuant to EQR’s equity compensation plans will result in the Operating Partnership issuing OP Units to EQR on a one-for-one basis.

 

Plan Category		Number of securities to be issued upon exercise of outstanding options, warrants and rights		Weighted-average exercise price of outstanding options, warrants and rights			Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))
		(a)(1)(2)		(b)(2)			(c)(3)
Equity compensation plans approved by shareholders		12,079,908		$	24.27		25,474,544
Equity compensation plans not approved by shareholders		n/a		n/a			n/a

 

(1)                                  Amount shown includes 21,970 shares reserved for issuance upon exercise of outstanding options assumed by EQR as a result of mergers.

 

(2)                                  The amounts shown in columns (a) and (b) of the above table do not include 1,362,733 outstanding common shares (all of which are restricted and subject to vesting requirements) that were granted under EQR’s Fifth Amended and Restated 1993 Share Option and Share Award Plan (the “1993 Plan”) and EQR’s 2002 Share Incentive Plan (the “2002 Plan”) and outstanding common shares that have been purchased by employees and trustees under EQR’s ESPP.

 

(3)                                  Includes 20,488,513 common shares that may be granted under the 2002 Plan, of which only 25% may be in the form of restricted shares, and 5,046,553 common shares that may be sold to employees and trustees under the ESPP.

 

The aggregate number of securities available for issuance (inclusive of restricted shares previously granted and outstanding and shares underlying outstanding options) under the 2002 Plan equals 7.5% of EQR’s outstanding common shares, calculated on a fully diluted basis, determined annually on the first day of each calendar year.  On January 1, 2004, this amount equaled 22,736,239.

 

52

 

Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

 

(a) Transactions with Management and Others

 

Pursuant to the terms of the partnership agreement for the Operating Partnership, the Operating Partnership is required to reimburse EQR for all expenses incurred by EQR in excess of income earned by EQR through its indirect 1% ownership of various entities.  Amounts paid on behalf of EQR are reflected in the Consolidated Statements of Operations as general and administrative expenses.

 

(b) Certain Business Relationships

 

•                  EQR’s management company managed a multifamily residential community owned by an affiliate of Mr. Zell on terms equivalent to a third-party transaction.  The property management fees received from such affiliate were $250,854 for 2003.

 

•                  During 2003, the Operating Partnership reimbursed Mr. Spector in the amount of $224,943 for the actual operating costs (excluding acquisition costs) of operating his personal aircraft for himself and other employees on business.

 

•                  The Operating Partnership leases its corporate headquarters from an entity controlled by Mr. Zell.  Amounts incurred for such office space and related office facility services in 2003 were $1,733,486.

 

•                  Since the Merry Land Merger, the Operating Partnership has leased space in an office building in Augusta, Georgia indirectly owned by Mr. Thompson since May 2003 and directly owned by MRYP from 1998 to 2003.  The Operating Partnership paid $168,822 in annual rent in 2003 for this space.

 

(c) Indebtedness of Management – None

 

(d) Transactions with Promoters – None

 

Item 14.  PRINCIPAL ACCOUNTANT FEES AND SERVICES

 

Fees billed to EQR and the Operating Partnership by Ernst & Young for the years ended December 31, 2003 and 2002 were as follows:

 

 

(1)               Audit fees are incurred for the review and audit of EQR’s and the Operating Partnership’s annual financial statements included in their respective Annual Reports on Form 10-K, the review of EQR’s and the Operating Partnership’s interim financial statements included in their Quarterly Reports on Form 10-Q, and for comfort and consent letters related to SEC registration statements and public offerings of registered securities.

 

53

 

(2)               Fees for audit-related services include consultations regarding EQR’s and the Operating Partnership’s internal control documentation, lender required partnership audits and legally required employee benefit plan audits.

 

(3)               Tax compliance/preparation fees are incurred for the preparation of original and amended tax returns for EQR, the Operating Partnership and numerous subsidiaries, claims for refunds and tax payment compliance.

 

(4)               Tax consulting fees relate primarily to tax planning advice incident to acquisitions, dispositions, financings and taxable REIT subsidiaries.

 

(5)               All other fees relate to real estate tax appeal consulting services.

 

Pre-Approval Policies

 

EQR’s Audit Committee, pursuant to its exclusive authority, has reviewed and approved EQR’s engagement of Ernst & Young as the Operating Partnership’s independent auditors, and the incurrence of all of the fees described above, for 2003 and 2002 and has selected Ernst & Young as independent auditor for 2004, subject to review and approval of the final terms of its engagement as such and its audit fees.  The Audit Committee has also adopted Pre-Approval Policies for all other services Ernst & Young may perform for EQR and the Operating Partnership in 2004.  The Pre-Approval Policies detail with specificity the services that are authorized within each of the above-described categories of services and provide for aggregate maximum dollar amounts for such pre-approved services.  Any additional services not described or otherwise exceeding the maximum dollar amounts prescribed by the Pre-Approval Policies for 2004 will require the further advance review and approval of the Audit Committee.  The Audit Committee has delegated the authority to grant any such additional required approval to its Chairman between meetings of the Committee, provided that the Chairman report the details of the exercise of any such delegated authority at the next meeting of the Audit Committee.

 

54

 

PART IV

 

Item 15.  Exhibits, Financial Statements, Schedules and Reports on Form 8-K

 

(a)

(1 & 2) See Index to Financial Statements and Schedules on page F-1 of this Form 10-K.

(3) Exhibits:

 

2.1^		Agreement and Plan of Merger among Grove Property Trust, Grove Operating, L.P. and  ERP Operating Limited Partnership dated as of July 17, 2000.
3.1*		Fifth Amended and Restated Agreement of Limited Partnership of ERP Operating Limited Partnership.
4.1**		Indenture, dated October 1, 1994, between the Operating Partnership, as obligor and The First National Bank of Chicago, as trustee.
10.1+		Amended and Restated Master Reimbursement Agreement dated as of November 1, 1996 by and between Federal National Mortgage Association and EQR-Bond Partnership.
10.2		Master Amendment to Other Securities Term Sheets and Joinders to Operating Partnership Agreement of ERP Operating Limited Partnership dated December 19, 2003.
10.3		Assignment and Assumption Agreement between Equity Residential and ERP Operating Limited Partnership dated December 19, 2003.
10.4++		Amended and Restated Limited Partnership Agreement of Lexford Properties, L.P.
10.5+++		Revolving Credit Agreement dated as of May 29, 2002 among the Operating Partnership, Bank of America, National Association, as administrative agent, JP Morgan Chase Bank, as syndication agent, and the banks named therein.
10.6+++		Guaranty of Payment dated as of May 29, 2002 between Equity Residential and Bank of America, N.A., as administrative agent.
12		Computation of Ratio of Earnings to Combined Fixed Charges.
21		List of Subsidiaries of ERP Operating Limited Partnership.
23.1		Consent of Ernst & Young LLP.
24.1		Power of Attorney for John W. Alexander dated March 3, 2004.
24.2		Power of Attorney for Stephen O. Evans dated March 5, 2004.
24.3		Power of Attorney for Charles L. Atwood dated March 8, 2004.
24.4		Power of Attorney for Desiree G. Rogers dated March 9, 2004.
24.5		Power of Attorney for B. Joseph White dated March 3, 2004.
24.6		Power of Attorney for Sheli Z. Rosenberg dated March 5, 2004.
24.7		Power of Attorney for James D. Harper, Jr. dated March 4, 2004.
24.8		Power of Attorney for Boone A. Knox dated March 3, 2004.
24.9		Power of Attorney for Michael N. Thompson dated March 5, 2004.
24.10		Power of Attorney for Samuel Zell dated March 2, 2004.
24.11		Power of Attorney for Gerald A. Spector dated March 2, 2004.
31.1		Certification of Bruce W. Duncan, Chief Executive Officer of Registrant’s General Partner.
31.2		Certification of David J. Neithercut, Chief Financial Officer of Registrant’s General Partner.
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.

 

55

 

^                                          Included as Appendix A to Equity Residential’s Form S-4 filed on July 23, 2000.

*                                         Included as an exhibit to the Operating Partnership’s Form 8-K/A dated July 23, 1998, filed on August 18, 1998.

**                                  Included as an exhibit to the Operating Partnership’s Form 10/A dated December 12, 1994, File No. 0-24920, and incorporated herein by reference.

+                                         Included as an exhibit to the Operating Partnership’s Form 10-K for the year ended December 31, 1996.

++                                  Included as an exhibit to Equity Residential’s Form 10-K for the year ended December 31, 1999 and incorporated herein by reference.

+++                           Included as an exhibit to the Operating Partnership’s Form 10-Q for the quarterly period ended June 30, 2002 and incorporated herein by reference.

 

(b)  Reports on Form 8-K:  None.

 

(c)  Exhibits:  See Item 15(a)(3) above.

 

(d)  Financial Statement Schedules:  See Index to Financial Statements attached hereto on page F-1 of this Form 10-K.

 

56

 

SIGNATURES

 

Pursuant to the requirements of 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:	March 12, 2004			By:		/s/	Bruce W. Duncan
							Bruce W. Duncan
						President, Chief Executive Officer, and Trustee
Date:	March 12, 2004			By:		/s/	David J. Neithercut
							David J. Neithercut
						Executive Vice President, Corporate Strategy and Chief Financial Officer
Date:	March 12, 2004			By:		/s/	Michael J. McHugh
							Michael J. McHugh
						Executive Vice President, Chief Accounting Officer, Treasurer and *Attorney-in-fact

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the following persons on behalf of the registrant and in the capacities and on the dates indicated have signed this report below.

 

Date:	March 12, 2004		By:	/s/	Samuel Zell*
					Samuel Zell
				Chairman of the Board of Trustees
Date:	March 12, 2004		By:	/s/	Gerald A. Spector*
					Gerald A. Spector
				Executive Vice President, Chief Operating Officer and Trustee
Date:	March 12, 2004		By:	/s/	Sheli Z. Rosenberg*
					Sheli Z. Rosenberg
					Trustee
Date:	March 12, 2004		By:	/s/	James D. Harper*
					James D. Harper
					Trustee
Date:	March 12, 2004		By:	/s/	John W. Alexander*
					John W. Alexander
					Trustee

 

57

 

SIGNATURES-CONTINUED

Date:

March 12, 2004

By:

/s/

B. Joseph White*

B. Joseph White

Trustee

Date:

March 12, 2004

By:

/s/

Charles L. Atwood*

Charles L Atwood

Trustee

Date:

March 12, 2004

By:

/s/

Desiree G. Rogers*

Desiree G. Rogers

Trustee

Date:

March 12, 2004

By:

/s/

Stephen O. Evans*

Stephen O. Evans

Trustee

Date:

March 12, 2004

By:

/s/

Boone A. Knox*

Boone A. Knox

Trustee

Date:

March 12, 2004

By:

/s/

Michael N. Thompson*

Michael N. Thompson

Trustee

* By:

/s/  Michael J. McHugh

Michael J. McHugh as Attorney-in-fact

 

58