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AEC > SEC Filings for AEC > Form 10-Q on 2-Nov-2012All Recent SEC Filings

Show all filings for ASSOCIATED ESTATES REALTY CORP

Form 10-Q for ASSOCIATED ESTATES REALTY CORP


2-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the consolidated financial statements and notes thereto included in Part I, Item 1 of this report on Form 10-Q. This discussion may contain forward-looking statements based on current judgments and current knowledge of management, which are subject to certain risks, trends and uncertainties that could cause actual results to vary from those projected, including but not limited to, expectations regarding our 2012 performance that are based on certain assumptions. Accordingly, readers are cautioned not to place undue reliance on forward-looking statements that speak only as of the date of this report. These forward-looking statements are intended to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The words "expects," "projects," "believes," "plans," "anticipates" and similar expressions are intended to identify forward-looking statements. Investors are cautioned that these forward-looking statements involve risks and uncertainty that could cause actual results to differ from estimates or projections contained in these forward-looking statements, including without limitation the following:
changes in the economic climate in the markets in which we own and manage properties, including interest rates, the overall level of economic activity, the availability of consumer credit and mortgage financing, unemployment rates and other factors;

elimination of, or limitations on, federal government support for Fannie Mae and/or Freddie Mac that might result in significantly reduced availability of mortgage financing sources, as well as increases in interest rates for mortgage financing;

construction and construction business risks, including, without limitation, rapid and unanticipated increases in prices of building materials and commodities;

our ability to refinance debt on favorable terms at maturity;

risks of a lessening of demand for the multifamily units that we own;

competition from other available multifamily units and changes in market rental rates;

the failure of development projects to perform in accordance with our expectations;

increases in property and liability insurance costs;

unanticipated increases in real estate taxes and other operating expenses;

weather conditions that adversely affect operating expenses;

expenditures that cannot be anticipated such as utility rate and usage increases and unanticipated repairs;

our inability to control operating expenses or achieve increases in revenue;

shareholder ownership limitations that may discourage a takeover otherwise considered favorable by shareholders;

the results of litigation filed or to be filed against us;

changes in tax legislation;

risks of personal injury claims and property damage related to mold claims that are not covered by our insurance;

catastrophic property damage losses that are not covered by our insurance;

our ability to acquire properties at prices consistent with our investment criteria;

risks associated with property acquisitions such as failure to achieve expected results or matters not discovered in due diligence; and

risks related to the perception of residents and prospective residents as to the attractiveness, convenience and safety of our properties or the neighborhoods in which they are located.


Overview.
We are engaged primarily in the ownership and operation of multifamily apartment units. Our subsidiary, Merit, is a general contractor and construction manager that acts as our in-house construction division. Our primary source of cash and revenue from operations is rental payments from the leasing of apartment units, which represents substantially all of our consolidated revenue for the nine months ended September 30, 2012.
The operating performance of our properties is affected by general economic trends including, but not limited to, factors such as household formation, job growth, unemployment rates, population growth, immigration, the supply of new multifamily rental communities and, in certain markets, the supply of other housing alternatives, such as condominiums, single and multifamily rental homes and owner occupied single and multifamily homes. Additionally, our performance may be affected by access to, and cost of, debt and equity.
Rental revenue collections are impacted by net rental rates and occupancy levels. We have recently implemented LROTM, a rental revenue software product that optimizes rents by leveraging the statistical data provided by LROTM. We combine this data with our proprietary market knowledge and experience in our efforts to maximize rental revenues and maintain high occupancy levels. LROTM is expected to generate long term rent growth and asset stability with daily, incremental rent changes. We continuously monitor physical occupancy and net collected rent per unit to track our success in maximizing rental revenue. These indicators are more fully described in the Results of Operations comparison. Additionally, we consider property net operating income ("NOI"), Funds from Operations ("FFO") and FFO as adjusted to be important indicators of our overall performance. Property NOI (property operating revenue less property operating and maintenance expenses) is a measure of the profitability of our properties and has the largest impact on our financial condition and operating results. FFO is used in the real estate industry as a supplemental measure of the operating performance of real estate companies because it excludes charges such as real estate depreciation and amortization on intangible assets that are generally considered not to be reflective of the actual value of real estate assets over time. Additionally, gains and losses from the sale of most real estate assets and certain other items are also excluded from FFO. We calculate FFO as adjusted as FFO, defined above, excluding $1.7 million of prepayment penalties associated with debt repayments and $279,000 of refunds for a previously defeased loan. In accordance with GAAP, these prepayment penalties and refunds on the previously defeased loan are included in interest expense in the Company's Consolidated Statements of Operations and Comprehensive Income. We are providing this calculation as an alternative FFO calculation as we consider it a more appropriate measure of comparing the operating performance of a company's real estate between periods or as compared to different REITs. A reconciliation of property NOI to consolidated net income attributable to AERC and a reconciliation of net income attributable to AERC to FFO and FFO as adjusted are included in the Results of Operations comparison. Updated 2012 Expectations.
Portfolio performance - Our full-year 2012 guidance reflects Same Community NOI increasing in the range of 6.7% to 6.9% as compared to 2011.

Property acquisitions, sales and development - During 2012, we anticipate acquisitions of $183 million and dispositions of $67 million. We also anticipate that development expenditures will be between $50 million and $55 million during 2012. Through September 30, 2012, we have completed $182.6 million of acquisitions, disposed of $60.0 million of properties and spent $45.2 million on development, including land acquisitions.

Debt repayment - We have repaid seven mortgage loans totaling $123.4 million as of September 30, 2012, and have no remaining mortgage loan maturities in 2012.

Forecast Qualification. The foregoing updated expectations are forward looking statements expressly subject to the discussion in the first paragraph of this Item 2. Uncertainties relating to the broader domestic economic and financial conditions impact our ability to forecast future performance. We believe that the apartment industry is better situated to weather a delayed recovery than other real estate sectors. Nevertheless, unless and until meaningful job and wage growth occurs in our markets, continued rent increases may be limited.


LIQUIDITY AND CAPITAL RESOURCES
Cash Flows and Liquidity. Significant sources and uses of cash during the nine
months ended September 30, 2012 and 2011 are summarized as follows:
                                                                   Nine Months Ended
                                                                     September 30,
(In thousands)                                                    2012           2011
Net cash provided by operations                               $   51,617     $   43,265
Fixed assets:
Acquisition expenditures                                        (158,925 )     (116,018 )
Development expenditures                                         (44,485 )      (15,034 )
Net property disposition proceeds                                 57,523         28,967
Recurring, revenue enhancing and non-recurring capital
expenditures                                                      (8,005 )       (8,477 )
Debt:
(Decrease) increase in mortgage notes                            (77,058 )        2,701
Increase (decrease) in revolving credit facility borrowings      109,000        (50,500 )
Increase in term loan borrowings                                       -        125,000
Common share issuance proceeds                                    98,355         13,330
Cash dividends and operating partnership distributions paid      (23,589 )      (20,993 )

Our primary sources of liquidity are cash flows provided by operations, short-term borrowings on the unsecured revolver, project specific loans and the sale of debt or equity securities. Our scheduled debt maturities for 2012 consisted of five mortgage loans totaling approximately $79.8 million. We have repaid all of these loans with proceeds from borrowings on our unsecured revolver. Additionally, we prepaid two FHA loans totaling $43.6 million and incurred a prepayment penalty of $1.7 million. In January 2012, we increased our $250.0 million unsecured revolving credit facility, or revolver, to $350.0 million and, among other modifications, reduced the credit spread used to determine the interest rate applied to our borrowings and extended the maturity to January 2016. This facility provides financial flexibility and the opportunity to capitalize on strategic acquisitions without the delays associated with financing contingencies. On October 26, 2012, we had $192.0 million of availability under this facility. On October 19, 2012, we completed modifications to our unsecured term loan which increased the outstanding principal amount to $150.0 million from $125.0 million. The additional proceeds were used to repay a project specific construction loan.
During the second quarter of 2012, we sold 681,178 shares under our $25.0 million at-the-market ("ATM") program for total gross proceeds of $11.3 million, or $11.1 million net of sales and commissions and other costs. The proceeds were used to reduce borrowings on our unsecured revolver and for general corporate purposes. At June 30, 2012, all $25.0 million of common shares available for issuance under the ATM have been sold and the program has been completed. In August 2012, we registered an ATM program allowing us to sell up to $75.0 million of our common shares in open market transactions at-the-then market price per share. There were no shares sold during the three months ended September 30, 2012, under this program. Our ability to access the capital market affords us additional liquidity as demonstrated by our sale of 6,325,000 of our common shares, during 2012, in an underwritten public offering. The net proceeds from this offering, which totaled approximately $87.2 million, were used to fund property acquisitions and development and for general corporate purposes. As of October 26, 2012, equity and/or debt securities of up to $258.8 million issue price remain available for public offerings under our current shelf registration statement.
We anticipate that cash flow provided by operations for the remainder of the year will be sufficient to meet normal business operations and liquidity requirements. We believe that if net cash provided by operations is below projections, other sources such as the unsecured revolver, secured and unsecured borrowings are, or can be made available, and should be sufficient to meet our normal business operations and liquidity requirements. We anticipate that we will continue to pay our regular quarterly dividends in cash. Funds to be used for property acquisitions, development or other capital expenditures are expected to be provided by proceeds from our unsecured revolver, property sales, unsecured bond issuances, property specific secured financings and possibly the sale of common shares in a follow on offering, private placement or under our ATM.


Cash flow provided by operations increased 19.3% during the nine months ended September 30, 2012, compared to the nine months ended September 30, 2011, as a result of a 6.7% increase in Same Community Property NOI and the contribution from the four properties acquired during the nine months of 2012 and three properties acquired during the year ended 2011. See the discussion under Results of Operations for further information concerning the property NOI contribution from the Same Community Properties and Acquired Properties.
During the remainder of 2012, we anticipate incurring an additional $3.0 million in capital expenditures for replacements and improvements at our operating properties. This includes replacement of worn carpet and appliances, improvements to parking lots and similar items in accordance with our current property expenditure plan, as well as commitments for revenue enhancing and non-recurring expenditures. These capital expenditures are expected to be funded with cash provided by operating activities.
RESULTS OF OPERATIONS
Comparison of the three and nine months ended September 30, 2012 to the three and nine months ended September 30, 2011:
Our Same Community portfolio represents operating properties that we have owned for all of the comparison periods. For the three month comparison periods ended September 30, 2012 and 2011, the Same Community portfolio consisted of 45 owned properties containing 12,078 units. For the nine month comparison periods ended September 30, 2012 and 2011, the Same Community portfolio consisted of 44 owned properties containing 11,856 units. Acquired Properties for the three month comparison period ended September 30, 2012 and 2011, include four properties acquired in 2012 and two properties that we acquired during the year ended 2011. Acquired properties for the nine month comparison periods ended September 30, 2012 and 2011, include four properties acquired in 2012 and three properties that we acquired during the year ended 2011. Beginning in the first quarter of 2012, our consolidated results of operations also includes one development property consisting of 242 units located in Nashville, Tennessee.
Net income from continuing operations for the Company for the three months ended September 30, 2012, increased $4.9 million to $2.0 million when compared to the $2.9 million loss from continuing operations recognized for the three months ended September 30, 2011. Net loss from continuing operations recognized for the nine months ended September 30, 2012, decreased $8.5 million. Our positive performance was primarily due to increases in property revenues, net of increases in property operating and maintenance expenses, depreciation and amortization expense, and general and administrative expense. Additionally, interest expense increased for the nine month comparison period primarily due to the net of the following: $1.7 million in prepayment costs in 2012, a defeasance refund of $279,000, interest incurred on the $125.0 million term loan that closed in June 2011, and a reduction of mortgage loan interest expense resulting from the payoff of seven mortgages during the quarter ended March 31, 2012. The following table reflects the amount and percentage change in line items that are relevant to the changes in overall operating performance, which includes income from discontinued operations as well as income (loss) from continuing operations:

                                          Increase (decrease) when                Increase when
                                         comparing the three months         comparing the nine months
                                          ended September 30, 2012          ended September 30, 2012
(Dollar amounts in thousands)               to September 30, 2011             to September 30, 2011

Property revenue                      $       7,261            19.0  %   $        18,144          16.6 %
Property operating and maintenance
expense                                       2,937            19.2  %             6,928          15.8 %
Depreciation and amortization                 1,159             8.9  %             2,325           6.2 %
General and administrative expense              335             9.3  %               839           7.2 %
Interest expense                               (905 )         (11.5 )%               365           1.6 %
Income from discontinued operations         (15,032 )         (99.4 )%             7,554          46.6 %


We use property NOI as a measure of the results of our properties' activities. We believe that the changes in property NOI can help to explain how the properties' activities influenced our results of operations. Property NOI is determined by deducting property operating and maintenance expenses from property revenue (excluding revenue and expense amounts classified as discontinued operations). We consider property NOI to be an appropriate supplemental measure of our performance because it reflects the operating performance of our real estate portfolio and is used to assess regional property level performance. Property NOI should not be considered (i) as an alternative to net income (determined in accordance with GAAP), (ii) as an indicator of financial performance, (iii) as an alternative to cash flow from operating activities (determined in accordance with GAAP), or (iv) as a measure of liquidity; nor is it necessarily indicative of sufficient cash flow to fund all of our needs. Other real estate companies may define property NOI in a different manner.
A reconciliation of property NOI to total consolidated net income attributable to AERC is as follows:

                                                   Three Months Ended         Nine Months Ended
                                                     September 30,              September 30,
(In thousands)                                     2012          2011         2012         2011

Property NOI                                    $  27,221     $ 22,897     $ 76,330     $ 65,114
Office NOI                                            350            -          663            -
Construction and other services net loss              (28 )     (1,080 )       (181 )     (1,385 )
Depreciation and amortization                     (14,150 )    (12,991 )    (39,674 )    (37,349 )
General and administrative expense                 (3,936 )     (3,601 )    (12,569 )    (11,730 )
Development costs                                    (193 )        (81 )       (800 )       (257 )
Costs associated with acquisitions                   (282 )       (182 )       (766 )       (303 )
Interest expense                                   (6,978 )     (7,883 )    (23,083 )    (22,718 )
Income (loss) from continuing operations            2,004       (2,921 )        (80 )     (8,628 )
Income from discontinued operations:
Operating income, net of interest expense              97          532          941        1,609
Gain on disposition of properties                       -       14,597       22,819       14,597
Income from discontinued operations                    97       15,129       23,760       16,206
Net income                                          2,101       12,208       23,680        7,578
Net (income) loss attributable to
noncontrolling redeemable interest                     (8 )        (12 )          1          (37 )
Consolidated net income attributable to AERC    $   2,093     $ 12,196     $ 23,681     $  7,541

Property NOI increased as a result of revenue and occupancy increases across the Same Community portfolio and the contributions of the Acquired Properties, partially offset by increased property operating expenses. The following table presents property NOI results by region:

                              Three Months Ended                                 Nine Months Ended
                                 September 30,                                     September 30,
                             2012              2011                            2012              2011
(In thousands)           Property NOI      Property NOI      Increase      Property NOI      Property NOI     Increase
Same Community
Properties:
Midwest                $       10,640     $      9,917     $      723     $      31,220     $     28,578     $   2,642
Mid-Atlantic                    7,960            7,614            346            23,369           22,273         1,096
Southeast                       4,692            4,478            214            12,749           12,359           390
Southwest                         345              292             53             1,029              864           165
Total Same Community           23,637           22,301          1,336            68,367           64,074         4,293
Acquired Properties             3,027              601          2,426             7,103            1,045         6,058
Development Property              557               (5 )          562               860               (5 )         865
Total Property NOI     $       27,221     $     22,897     $    4,324     $      76,330     $     65,114     $  11,216


Property revenue. Property revenue is impacted by a combination of net rental rates and occupancy levels, i.e., net collected rent per unit. Physical occupancy at the end of each period and net collected rent per unit are presented in the following tables:

                                   Physical Occupancy for the            Physical Occupancy for the
                                Three Month Comparison Period at      Nine Month Comparison Period at
                                         September 30,                         September 30,
                                   2012                 2011              2012                2011
Same Community Properties:
Midwest                            97.6%                96.7%            97.6%               96.7%
Mid-Atlantic                       97.2%                94.4%            97.2%               94.4%
Southeast                          96.5%                90.5%            96.5%               91.0%
Southwest                          96.8%                98.6%            96.8%               98.6%
Total Same Community               97.3%                94.8%            97.3%               95.0%
Acquired Properties                95.8%                92.4%            95.9%               89.0%


                                            Average Monthly Net Collected Rent Per Unit
                                     Three Months Ended                    Nine Months Ended
                                       September 30,                         September 30,
(In thousands)                     2012              2011               2012                2011
Same Community Properties:
Midwest                       $         918     $        857     $          899        $         839
Mid-Atlantic                  $       1,369     $      1,305     $        1,343        $       1,281
Southeast                     $       1,054     $      1,004     $        1,017        $         976
Southwest                     $         925     $        884     $          919        $         870
Total Same Community          $       1,053     $        994     $        1,029        $         973
Acquired Properties           $       1,218     $      2,005     $        1,208        $       1,590

The following table presents property revenue results:

                                   Three Months Ended                             Nine Months Ended
                                     September 30,                                  September 30,
                                  2012            2011                           2012           2011
                                Property        Property                       Property       Property
(In thousands)                  Revenue          Revenue        Increase       Revenue        Revenue        Increase
Same Community Properties:
Midwest                      $     18,257     $    17,054     $    1,203     $   53,511     $   49,915     $    3,596
Mid-Atlantic                       11,864          11,328            536         34,809         33,246          1,563
Southeast                           8,806           8,364            442         23,336         22,360            976
Southwest                             635             600             35          1,885          1,768            117
Total Same Community               39,562          37,346          2,216        113,541        107,289          6,252
Acquired Properties                 5,041             884          4,157         12,194          1,808         10,386
Development Property                  888               -            888          1,506              -          1,506
Total Property Revenue       $     45,491     $    38,230     $    7,261     $  127,241     $  109,097     $   18,144

The increase in Same Community property revenue was a result of increases in net rents and occupancy across substantially all of the portfolio. Property operating and maintenance expenses. The property operating and maintenance expenses increase was primarily due to the acquisition and development properties and the increases in real estate taxes across the Mid-Atlantic and Southeast portfolio in Same Community Properties and personnel expense across substantially all of the portfolio.


Depreciation and amortization. The depreciation and amortization expense increase was primarily due to the acquisition and development properties. General and administrative expense. General and administrative expenses increased primarily due to increases in payroll expense associated with performance bonus award accruals.
Construction and other services. In 2011, we decided to exit the third party construction services business and at December 31, 2011, we had substantially completed our work under all third party construction contracts. We continue to provide general contracting and construction management services for our own account in connection with the development of multifamily properties we will own and operate.
Interest expense. Interest expense increased during the nine month comparison primarily due to the net of the following: $1.7 million in prepayment costs in 2012, the defeasance refund of $279,000, interest incurred on the $125.0 million term loan that closed in June 2011, and a reduction of mortgage loan interest expense resulting from the payoff of seven mortgages during the quarter ended March 31, 2012. Interest expense decreased during the three month comparison due . . .

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