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, 2004

 

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

 

Part III incorporates by reference certain information to be contained in Equity Residential’s definitive proxy statement, which Equity Residential anticipates will be filed no later than April 15, 2005.  Equity Residential is the general partner and 93.3% owner of ERP Operating Limited Partnership.

 

2

 

ERP OPERATING LIMITED PARTNERSHIP

 

TABLE OF CONTENTS

 

 

PART I.
	Item 1.	Business	4
	Item 2.	The Properties	17
	Item 3.	Legal Proceedings	21
	Item 4.	Submission of Matters to a Vote of Security Holders	21
PART II.
	Item 5.	Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities	22
	Item 6.	Selected Financial Data	22
	Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	24
	Item 7A.	Quantitative and Qualitative Disclosure about Market Risk	41
	Item 8.	Financial Statements and Supplementary Data	42
	Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	42
	Item 9A.	Controls and Procedures	42
	Item 9B.	Other Information	43
PART III.
	Item 10.	Trustees and Executive Officers of the Registrant	43
	Item 11.	Executive Compensation	43
	Item 12.	Security Ownership of Certain Beneficial Owners and Management	43
	Item 13.	Certain Relationships and Related Transactions	43
	Item 14.	Principal Accountant Fees and Services	43
PART IV.
	Item 15.	Exhibits and Financial Statement Schedules	44

 

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 real estate companies and is the largest publicly traded owner of multifamily properties (based on the aggregate market value of its 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, 2004 owned an approximate 93.3% ownership interest in ERPOP.  EQR is structured as an umbrella partnership REIT (“UPREIT”), under which all property ownership and business operations are conducted through ERPOP and its various subsidiaries.  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, 2004, the Operating Partnership, directly or indirectly through investments in title holding entities, owned all or a portion of 939 properties in 32 states and the District of Columbia consisting of 200,149 units.  The ownership breakdown includes:

 

 

As of March 1, 2005, the Company has approximately 6,000 employees who provide real estate operations, leasing, legal, financial, accounting, acquisition, disposition, development and other support functions.

 

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

 

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.equityresidential.com.  These reports are made available at our website as soon as reasonably practicable after we file them with the SEC.

 

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 strategy for accomplishing these objectives include:

 

•                  Leveraging our size and scale in four critical ways:

 

•                  Investing or “recycling” capital investments in apartment communities located in strategically targeted markets, to maximize our total return on an enterprise level;

•                  Meeting the needs of our customers by offering a wide array of product choices and a commitment to service;

•                  Engaging, retaining, and attracting the best people by providing them with the education, resources and opportunities to succeed; and

•                  Sharing resources, customers and best practices in property management and across the enterprise.

 

•                  Owning a highly diversified portfolio by investing in target markets defined by a combination of the following criteria:

 

•                  High barrier-to-entry (low supply);

•                  Strong economic predictors (high demand); and

•                  Attractive quality of life (high demand and retention).

 

•                  Giving customers reasons to stay with Equity by providing a range of product options available in our diversified portfolio and by enhancing their experience through our employees and our services.

 

•                  Being open and responsive to market realities to take advantage of investment opportunities that align with our long-term vision.

 

Acquisition and Development Strategies

 

The Operating Partnership anticipates that future property acquisitions and developments will occur within the United States.  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 generally considers the following factors:

 

•                  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;

 

5

 

•                  the benefits of integration into existing operations;

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

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

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

 

Disposition Strategies

 

When evaluating potential dispositions, the Operating Partnership generally considers the following factors:

 

•                  low barrier-to-entry (high supply);

•                  weak economic predictors (low demand);

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

•                  age or location of a particular property; and

•                  opportunistic selling based on demand and price of high quality assets, including condominium conversions.

 

The Operating Partnership generally reinvests the proceeds received from property dispositions primarily to achieve its acquisition and development strategies.  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, 2004 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.

 

6

 

 

 

 

The Operating Partnership’s policy is 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, 2004, 2003 and 2002

 

During 2004, EQR contributed all of the net proceeds, as discussed below, to the Operating Partnership in exchange for OP Units:

 

•                  EQR issued 3,350,759 Common Shares pursuant to its Share Incentive Plans and received net proceeds of approximately $79.0 million.

•                  EQR issued 275,616 Common Shares pursuant to its Employee Share Purchase Plan and received net proceeds of approximately $6.9 million.

 

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

 

7

 

$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.

 

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 2, 2005, $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, 2004, a subsidiary of ERPOP issued and has outstanding various series of Preference Interests (the “Preference Interests”) with an equity value of $206.0 million receiving net proceeds of $200.9 million.

 

Debt Offerings For the Years Ended December 31, 2004, 2003 and 2002

 

During 2004:

 

•                  The Operating Partnership issued $300.0 million of five-year 4.75% redeemable unsecured fixed rate notes (the “June 2009 Notes”) in a public debt offering in June 2004.  The June 2009 Notes were issued at a discount, which is being amortized over the life of the notes on a straight-line basis.  The June 2009 Notes are due June 15, 2009 with interest payable semiannually in arrears on June 1 and December 1, commencing December 1, 2004.  The Operating Partnership received net proceeds of approximately $296.8 million in connection with this issuance.

•                  The Operating Partnership issued $500.0 million of ten-year 5.25% redeemable unsecured fixed rate notes (the “September 2014 Notes”) in a public debt offering in September 2004.  The September 2014 Notes were issued at a discount, which is being amortized over the life of the notes on a straight-line basis.  The September 2014 Notes are due September 15, 2014 with interest payable semiannually in arrears on September 1 and March 1, commencing March 1, 2005.  The Operating Partnership received net proceeds of approximately $496.1 million in connection with this issuance.

•                  The Operating Partnership received $100.0 million as an initial draw on a $300.0 million floating rate loan in July 2004.  The loan was paid off in full and terminated in September 2004.

 

8

 

During 2003:

 

•                  The Operating Partnership issued $400.0 million of ten-year 5.20% 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 with interest 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 ten-year 6.625% 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 with interest 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 five-year 4.861% 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 with interest 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.

 

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 2, 2005, $1.48 billion in debt securities remained available for issuance under this registration statement.

 

Credit Facilities

 

In May 2002, the Operating Partnership obtained a three-year $700.0 million unsecured revolving credit facility maturing May 29, 2005.  Advances under the 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, 2004, $150.0 million was outstanding and $65.4 million was restricted (dedicated to support letters of credit and not available for borrowing) on the credit facility.  During the year ended December 31, 2004, the weighted average interest rate on borrowings under the line of credit was 1.73%.

 

The Operating Partnership is currently negotiating a new credit facility to replace or expand its existing facility and fully expects to obtain this at current or improved terms in March or April 2005.

 

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 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

 

9

 

sheets as a reduction in goodwill, net.

 

Competition

 

All of the Operating Partnership’s 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 2003 and 2004, 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.

 

10

 

New Acquisitions, Developments and/or Condominium Conversion Projects May Fail to Perform as Expected and Competition for Acquisitions May Result in Increased Prices for Properties

 

We intend to actively acquire and develop multifamily properties for rental operations and/or specifically to convert directly into condominiums as well as upgrade and sell existing properties as individual condominiums.  We may underestimate the costs necessary to bring an acquired or condominium conversion property up to standards established for its intended market position or to develop a property.  Additionally, we expect that other major real estate investors with significant capital will compete with us for attractive investment opportunities or may also develop properties in markets where we focus our development efforts.  This competition may increase prices for multifamily properties or decrease the price we expect to sell individual condominiums.  We may not be in a position or have the opportunity in the future to make suitable property acquisitions on favorable terms.   We also plan to develop more properties ourselves over the next few years in addition to co-investing with our development partners for either the rental or condominium market, depending on opportunities in each sub-market.  This may increase the overall level of risk associated with developments.  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 and Litigation Risk 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.

 

As the largest owner of multifamily properties, we may become involved in legal proceedings, including but not limited to, consumer, employment, tort and commercial, that if decided adversely to or settled by us, could result in liability material to our financial condition or results of operations.

 

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 four 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

 

11

 

the presence of mold in residential real estate.  Some of these lawsuits have resulted in substantial monetary judgments or settlements.  Insurance carriers have reacted to these liability awards by excluding mold related claims from standard policies and pricing mold endorsements at prohibitively high rates.  We have adopted programs designed to minimize the existence of mold in any of our properties as well as guidelines for promptly addressing and resolving reports of mold to minimize any impact mold might have on residents or the property.

 

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

 

Insurance Policy Deductibles and Exclusions

 

In order to partially mitigate the substantial increase in insurance costs in recent years, management has determined to gradually increase deductible and self-insured retention amounts.  As of December 31, 2004, 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, 2004, provide for a $1.0 million per occurrence deductible.  These higher deductible and self-insured retention amounts do expose the Operating Partnership to greater potential uninsured losses, such as the property damage caused by Hurricanes Charley, Frances, Ivan and Jeanne, but management believes the savings in insurance premium expense justifies this increased exposure over the long-term.

 

As a result of the terrorist attacks of September 11, 2001, property 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 and deductibles are very high.  Additionally, the terrorism insurance coverage that is available typically excludes coverage for losses from nuclear, biological and chemical attacks.  At the present time, the Operating Partnership has determined that it is not economically prudent to obtain property terrorism insurance for its entire portfolio to the extent otherwise available, especially given the significant risks that are not covered by such insurance.  As of December 31, 2004, the Operating Partnership’s high-rise properties were insured for $125 million in terrorism insurance coverage, with a $5 million deductible.  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 and its high-rise terrorism insurance coverage help to mitigate its exposure to the risks associated with potential terrorist attacks.

 

12

 

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, 2004, included:

 

 

 

In addition to debt, we have $842.4 million of combined liquidation value of outstanding preference interests and units, with a weighted average dividend preference of 8.23% per annum, as of December 31, 2004.  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, 2004 is as follows:

 

13

 

 

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.

 

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, 2004 and 2003, respectively, are (terms are defined in the indentures):

 

14

 

 

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, 2004.  We have a policy of incurring indebtedness for borrowed money only through the Operating Partnership 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 the Operating Partnership’s 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.

 

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 affected.  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.

 

In the event EQR's Chairman of the Board and/or CEO are unable to serve, (i) the Lead Trustee shall automatically be appointed to serve as the interim successor to the Chairman, (ii) the Chairman shall automatically be appointed to serve as the interim successor to the CEO and (iii) the Chair of the Compensation Committee of the Board will immediately call a meeting of the Committee to recommend to the full Board the selection of a permanent replacement for either or both positions, as necessary.

 

15

 

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, the Zell affiliates may have 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.  For additional information regarding the security ownership of Mr. Zell and EQR’s executive officers and trustees, see EQR’s definitive proxy statement.

 

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.

 

16

 

Item 2.  The Properties

 

As of December 31, 2004, the Operating Partnership, directly or indirectly through investments in title holding entities, owned all or a portion of 939 properties in 32 states and the District of Columbia consisting of 200,149 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 (includes development and condominium conversion properties) at December 31, 2004:

 

17

 

GARDEN-STYLE PROPERTIES

 

 

18

 

MID-RISE/HIGH RISE PROPERTIES

 

 

 

RANCH-STYLE PROPERTIES

 

 

 

MILITARY HOUSING PROPERTIES

 

 

19

 

The properties currently in various stages of development at December 31, 2004 are included in the following table.

 

CONSOLIDATED DEVELOPMENT PROJECTS as of December 31, 2004

(Amounts in thousands except for project and unit amounts)

 

 

(1) Total capital cost represents estimated development cost for projects under development and all capitalized costs incurred to date plus any estimates of costs remaining to be funded for all completed projects. Total capital cost and total book value to date exclude purchase consideration paid to the development partner of $1.8 million and $1.0 million on Water Terrace I and Bella Vista I & II, respectively.

 

(2) Of the total book value to date, $516.0 million has been transferred to land and depreciable property and $169.2 million is currently reflected as construction in progress (“CIP”). The remaining $148.7 million of CIP represents land held for future development and related costs. Of the $162.6 million remaining to be invested, $107.6 million will be funded through third party construction mortgages.

 

(3) Project will be converted to condominiums.

 

(4) Projects are wholly owned. All others are partially owned.

 

(5) Project sold on January 31, 2005.

 

(6) Projects and units excluded from total Operating Partnership property and unit count.

 

20

 

Item 3.  Legal Proceedings

 

In August 2004, the Operating Partnership tried a class action lawsuit in Palm Beach County, Florida regarding certain charges made to residents who terminated their leases early or failed to provide sufficient notice of intent to vacate.  In December 2004, the Court issued a Findings of Fact and Conclusions of Law holding those fees legally uncollectible under Florida law. In recognition of the Findings of Fact and Conclusions of Law, which awarded damages and interest to the class in the amount of approximately $1.6 million, the Operating Partnership established a reserve of approximately $1.6 million and correspondingly recorded this as a general and administrative expense. Due to pending appeals, the award is neither final nor enforceable.  Accordingly, it is not possible to determine or predict the ultimate outcome of the case.  While no assurances can be given, the Operating Partnership does not believe that this lawsuit, if the ultimate outcome is unfavorable, 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.

 

21

 

PART II

 

Item 5.           Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities

 

There is no established public 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 February 3, 2005, were 543 and 1, respectively.  The number of outstanding OP Units and Junior Convertible Preference Units as of February 3, 2005 were 306,965,461 and 7,367 respectively.

 

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.

 

22

 

CONSOLIDATED HISTORICAL FINANCIAL INFORMATION

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

 

 

(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 (“GAAP”)), excluding gains (or losses) from sales of depreciable 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.  See Item 7 for a reconciliation of net income to 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 is a recognized measure of performance by the real estate industry and by excluding gains or losses related to dispositions of depreciable property and excluding real estate depreciation (which can vary among owners of identical assets in similar condition based on historical cost accounting and useful life estimates), FFO can help compare the operating performance of a company’s real estate between periods or as compared to different companies.  FFO in and of itself

 

23