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

Show all filings for HOME PROPERTIES INC

Form 10-Q for HOME PROPERTIES INC


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 accompanying consolidated financial statements and notes thereto.

Forward-Looking Statements

This discussion contains forward-looking statements. Historical results and percentage relationships set forth in the consolidated financial statements, including trends which might appear, should not be taken as indicative of future operations. The Company considers portions of the information to be "forward-looking statements" within the meaning of Section 27A of the Securities Exchange Act of 1933 and Section 21E of the Securities Exchange Act of 1934, both as amended, with respect to the Company's expectations for future periods. Some examples of forward-looking statements include statements related to acquisitions (including any related pro forma financial information), future capital expenditures, potential development and redevelopment opportunities, projected costs and rental rates for development and redevelopment projects, financing sources and availability, and the effects of environmental and other regulations. Although the Company believes that the expectations reflected in those forward-looking statements are based upon reasonable assumptions, it can give no assurance that its expectations will be achieved. Factors that may cause actual results to differ include general economic and local real estate conditions, the weather and other conditions that might affect operating expenses, the timely completion of repositioning activities and development within anticipated budgets, the actual pace of future development, acquisitions and sales, and continued access to capital to fund growth. For this purpose, any statements contained in this Form 10-Q that are not statements of historical fact should be considered to be forward-looking statements. Some of the words used to identify forward-looking statements include "believes", "anticipates", "plans", "expects", "seeks", "estimates", "intends", and any other similar expressions. Readers should exercise caution in interpreting and relying on forward-looking statements since they involve known and unknown risks, uncertainties and other factors which are, in some cases, beyond the Company's control and could materially affect the Company's actual results, performance or achievements.

Liquidity and Capital Resources

General

The Company's principal liquidity demands are expected to be distributions to the common stockholders and holders of UPREIT Units, capital improvements and repairs and maintenance for its properties, acquisition and development of additional properties and debt repayments. The Company may also acquire equity ownership in other public or private companies that own and manage portfolios of apartment communities.

The Company intends to meet its short-term liquidity requirements through net cash flows provided by operating activities and its existing bank line of credit, described below. The Company considers its ability to generate cash to be adequate to meet all operating requirements, including availability to pay dividends to its stockholders and make distributions to its Unit holders in accordance with the provisions of the Internal Revenue Code, as amended, applicable to REITs.

To the extent that the Company does not satisfy its short-term liquidity requirements through net cash flows provided by operating activities and its existing bank line of credit, it intends to satisfy such requirements through proceeds from the sale of properties, from the issuance of unsecured senior notes and from the issuance of its common stock through its equity offering programs, described below.

In 2000, the Company obtained an investment grade rating from Fitch, Inc. The rating in effect at September 30, 2012 is a corporate credit rating of "BBB" (Triple B), which was reaffirmed on June 27, 2012.


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Liquidity and Capital Resources (continued)

Cash Flow Summary

The Company's net cash flow from operating activities was $198 million in the first nine months of 2012 compared to $146 million in the first nine months of 2011. The $52 million increase was primarily due to more profitable operations and the full period impact of properties acquired during 2011, as more fully described under the heading "Results of Operations" below.

Cash used in investing activities was $450 million during 2012 compared to $278 million in 2011. Cash outflows for the purchase of properties were $290 million in 2012 and $174 million in 2011. Current year acquisitions are further described under the heading "Acquisitions and Dispositions - Property Acquisitions" below. Cash outflows for capital improvements were $121 million in 2012 compared to $84 million in 2011. The increased investment in 2012 reflects management's strategy to continually reposition and perform selective rehabilitation in markets that are able to support rent increases. Cash outflows for additions to construction in progress were $39 million in 2012 as compared to $24 million in 2011. The increased spending on development in 2012 reflects the active construction of three communities in 2012 compared to one major project and the commencement of one new development during 2011. Proceeds for the disposition of properties during the third quarter 2012 are held in escrow as of September 30, 2012 pending the completion of a tax-free exchange.

Net cash provided by financing activities totaled $252 million in 2012. Cash flows from the sale of common stock under the ATM offerings of $144 million and proceeds from stock option exercises of $16 million combined with line of credit proceeds of $126 million and proceeds from unsecured notes payable of $150 million during the period were used for net paydown of mortgages of $60 million, and distributions paid to stockholders and UPREIT unitholders of $118 million.

Net cash provided by financing activities totaled $325 million in 2011. Cash flows from the sale of common stock under the public equity offering of $337 million plus the ATM offering of $190 million and proceeds from stock option exercises of $26 million during the period were used for net paydown of mortgages of $71 million, net paydown on the line of credit of $57 million and distributions paid to stockholders and UPREIT unitholders of $94 million.

Unsecured Line of Credit

As of September 30, 2012, the Company had a $275 million unsecured line of credit agreement with M&T Bank and U.S. Bank National Association, as joint lead banks, and nine other participating commercial banks, with an initial maturity date of December 8, 2015 and a one-year extension at the Company's option. The Company had $128 million outstanding under the credit facility as of September 30, 2012. The line of credit agreement provides the ability to issue up to $20 million in letters of credit. While the issuance of letters of credit does not increase the borrowings outstanding under the line of credit, it does reduce the amount available. At September 30, 2012, the Company had outstanding letters of credit of $13.2 million resulting in the amount available on the credit facility of $133.8 million. Borrowings under the line of credit bear interest at a variable rate based on LIBOR, plus a spread from 1.00% to 2.00% based on the Company's leverage ratio. As of September 30, 2012, based on the Company's leverage ratio, the spread was 1.30%, and the one-month LIBOR was 0.25%; resulting in an effective rate of 1.55% for the Company.

The unsecured line of credit has not been used for long-term financing but adds a certain amount of flexibility, especially in meeting the Company's acquisition goals. Many times it is easier to temporarily finance an acquisition, development or stock repurchases by short-term use of the line of credit, with long-term secured and unsecured financing or other sources of capital replenishing the line of credit availability.


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Liquidity and Capital Resources (continued)

Unsecured Term Loan

On December 9, 2011, the Company entered into a $250 million five-year unsecured term loan with M&T Bank as lead bank, and ten other participating lenders. The term loan generated net proceeds of $248 million, after fees and closing costs, which were used to pay off $135 million principal amount of exchangeable senior notes, purchase an unencumbered property and acquire land for future development. The loan bears monthly interest at a variable rate based on LIBOR, plus a spread from 1.00% to 2.00% based on the Company's leverage ratio. On July 19, 2012, the Company entered into interest rate swap agreements with major financial institutions that effectively convert the variable LIBOR portion of this loan to a fixed rate of 0.685%. As of September 30, 2012, based on the Company's leverage ratio, the spread was 1.30%, and the swapped one-month LIBOR was 0.685%; resulting in an effective rate of 1.99% for the Company. The loan has covenants that align with the unsecured line of credit facility.

Unsecured Demand Note

On June 27, 2012, the Company entered into a loan agreement with M&T Bank. The note has a maximum principal amount of $100 million with monthly interest at a variable rate based on LIBOR, plus a spread from 1.00% to 2.00% based on the Company's leverage ratio. As of September 30, 2012, based on the Company's leverage ratio, the spread was 1.30%, and the one-month LIBOR was 0.25%; resulting in an effective rate of 1.55% for the Company. Proceeds from this demand note were utilized to partially fund the purchase of a 1,350 unit apartment community on June 28, 2012. The Company had $100 million outstanding on the note as of September 30, 2012.

Unsecured Senior Notes

On December 19, 2011, the Company issued $150 million of unsecured senior notes. The notes were offered in a private placement in two series: Series A:
$90 million with a seven-year term due December 19, 2018 at a fixed interest rate of 4.46% ("Series A"); and, Series B: $60 million with a ten-year term due December 19, 2021 at a fixed interest rate of 5.00% ("Series B"). The net proceeds of $89 million and $60 million for Series A and Series B, respectively, after fees and closing costs, were used to purchase an unencumbered property and pay off a maturing mortgage note. The notes require semiannual interest payments on June 19 and December 19 of each year until maturity and are subject to various covenants and maintenance of certain financial ratios. Although the covenants of the notes do not duplicate all the covenants of the unsecured line of credit facility, any covenants applicable to both the notes and the line are identical.

On June 27, 2012, the Company issued another private placement note in the amount of $50 million with a seven-year term, a fixed rate of 4.16% and a June 27, 2019 due date. The proceeds from this note were used to partially fund the purchase of a 1,350 unit apartment community on June 28, 2012. The note requires semiannual interest payments on June 27 and December 27 of each year until maturity and is subject to various covenants and maintenance of certain financial ratios. Although the covenants of the note do not duplicate all the covenants of the unsecured line of credit facility, any covenants applicable to both the note and the line are identical.

Exchangeable Senior Notes

On November 1, 2011, the Company repurchased at face value $135 million principal amount of exchangeable senior notes ("Senior Notes"), plus accrued interest of $2.8 million, that were presented by the holders for repurchase in accordance with the October 2006 Senior Notes Indenture Agreement (the "Indenture"). On December 21, 2011 the remaining outstanding balance of $5 million principal amount of the Senior Notes was repurchased by the Company at face value plus accrued interest at the Company's option in accordance with the Indenture. There were no outstanding Senior Notes as of December 31, 2011.

Indebtedness

As of September 30, 2012, the weighted average interest rate on the Company's total indebtedness of $2.9 billion was 4.50% with staggered maturities averaging approximately five years. Approximately 85% of total indebtedness is at fixed rates, including the $250 million unsecured term loan subject to interest rate swap agreements. This limits the exposure to changes in interest rates, minimizing the effect of interest rate fluctuations on the Company's results of operations and cash flows.


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Liquidity and Capital Resources (continued)

Unencumbered Assets

The Company increased the percentage of unencumbered assets of the total property pool from 33% at the end of 2011, to 38% as of September 30, 2012. Higher levels of unsecured assets add borrowing flexibility because more capacity is available for unsecured debt under the terms of the Company's unsecured line of credit agreement, and for the issuance of additional unsecured senior notes. It also permits the Company to place secured financing on unencumbered assets if desired.

UPREIT Units

The Company believes that the issuance of UPREIT Units for property acquisitions will continue to be a potential source of capital for the Company. During 2011 and continuing through September 30, 2012, there were no UPREIT Units issued for property acquisitions.

Universal Shelf Registration

On March 3, 2010, the Company filed a Form S-3 universal shelf registration statement with the SEC that registers the issuance, from time to time, of common stock, preferred stock or debt securities. The Company may offer and sell securities issued pursuant to the universal shelf registration statement after a prospectus supplement, describing the type of security and amount being offered, is filed with the SEC. Sales of common stock under the Company's ATM equity offering programs, as described below, were made under this registration statement.

At-the-Market Equity Offering Programs

On September 17, 2010, the Company initiated an "At-the-Market" ("ATM") equity offering program through which it was authorized to sell up to 3.6 million shares of common stock from time to time in ATM offerings or negotiated transactions. From September 2010 through completion of the offering in May 2012, the Company issued 3.6 million shares of common stock at an average price per share of $60.71, for aggregate gross proceeds of $218.5 million and aggregate net proceeds of $214.0 million after deducting commissions and other transaction costs of approximately $4.5 million. The Company used the net proceeds from the offering primarily for acquisitions, development and redevelopment of apartment communities.

On May 14, 2012, the Company filed a prospectus supplement with respect to another ATM equity offering program, with similar terms and conditions as the September 2010 program, through which it is authorized to sell up to 4.4 million shares of common stock, from time to time in ATM offerings or negotiated transactions. As of September 30, 2012, the Company issued 1,960,724 shares of common stock at an average price per share of $62.65, for aggregate gross proceeds of $122.8 million and aggregate net proceeds of $120.3 million after deducting commissions and other transaction costs of approximately $2.5 million. In addition, the Company issued an additional 10,100 shares of common stock at an average price per share of $62.19, for aggregate gross and net proceeds of $0.6 million with a trade date in September 2012 and a settlement date in October 2012. The Company used the net proceeds from the offering primarily for acquisitions, development and redevelopment of apartment communities.

Dividend Reinvestment and Direct Stock Purchase Plan ("DRIP")

The Company's DRIP provides the stockholders of the Company an opportunity to automatically invest their cash dividends in additional shares of common stock. In addition, eligible participants may make monthly payments or other voluntary cash investments in shares of common stock. The maximum monthly investment permitted without prior Company approval is currently $10,000. The Company can issue waivers to DRIP participants to provide for investments in excess of the $10,000 maximum monthly investment. No such waivers were granted during 2011 or 2012. The Company meets share demand under the DRIP through stock repurchases by the transfer agent in the open market on the Company's behalf or new stock issuances. Management monitors the relationship between the Company's stock price and its estimated net asset value ("NAV"). During times when the difference between these two values is small, resulting in little dilution of NAV by common stock issuances, the Company can choose to issue new shares. At times when the gap between NAV and stock price is greater, the Company has the flexibility to satisfy the demand for DRIP shares with stock repurchased by the transfer agent in the open market.


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Liquidity and Capital Resources (continued)

Stock Repurchase Program

The Company has a stock repurchase program, approved by its Board of Directors (the "Board"), under which it may repurchase shares of its common stock or UPREIT Units (the "Company Program"). The shares and units may be repurchased through open market or privately negotiated transactions at the discretion of Company management. The Board's action did not establish a target stock price or a specific timetable for repurchase. There were no repurchases under the Company Program during 2011 and through September 30, 2012. The remaining authorization level as of September 30, 2012 is 2,291,160 shares and UPREIT Units, collectively. The Company will continue to monitor stock prices relative to the NAV to determine the current best use of capital among our major uses of capital: stock buybacks, debt paydown to increase the pool of unencumbered properties, acquisitions, rehabilitation and redevelopment of owned properties and development of new properties.

Acquisitions and Dispositions

Property Acquisitions

On May 11, 2012, the Company acquired The Manor East, a 164 unit apartment community located in Leesburg, Virginia. The total purchase price of $16.2 million included the assumption of an existing $6.7 million fixed rate mortgage at an interest rate of 5.69% and an April 1, 2016 maturity date (fair market value of $7.3 million) with the balance paid in cash. In connection with this acquisition, closing costs of approximately $0.1 million were incurred and were included in other expenses for the second quarter of 2012. The property was built in 1964 and consists of 15 three-story brick garden apartment buildings.

On May 17, 2012, the Company acquired Woodway at Trinity Centre, a 504 unit apartment community located in Centreville, Virginia for a total purchase price of $96.0 million. In connection with this acquisition, closing costs of approximately $0.4 million were incurred and were included in other expenses for the second quarter of 2012. The property was built in 1997 and consists of 18 three-story wood frame buildings.

On June 28, 2012, the Company acquired Howard Crossing, a 1,350 unit apartment community located in Ellicott City, Maryland for a total purchase price of $186.0 million. In connection with this acquisition, closing costs of approximately $2.2 million were incurred and were included in other expenses for the second quarter of 2012. The property was constructed in phases from 1968 through 1975 and consists of 42 three-story brick garden apartment buildings.

Property Dispositions

On September 13, 2012, the Company sold an apartment community located in the Philadelphia region with a total of 247 units for $25.1 million. A gain on sale of approximately $12.2 million was recorded in the third quarter related to this sale.

On September 20, 2012, the Company sold an apartment community located in the Baltimore region with a total of 177 units for $16.0 million. A gain on sale of approximately $7.5 million was recorded in the third quarter related to this sale.

On October 11, 2012, the Company sold a property located in the Philadelphia region with a total of 318 units for $29.7 million. A gain on sale of approximately $15.9 million will be recorded in the fourth quarter of 2012 related to these sales.


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Development

Current Development Projects

During the third quarter 2012, the Company finished construction of The Apartments at Cobblestone Square, a project located in Fredericksburg, Virginia, consisting of eight four-story buildings and a refurbished rail depot, for a total of 314 apartment units. Initial occupancy commenced in the fourth quarter of 2011 and as of September 30, 2012 the community had reached stabilization (greater than 95% physical occupancy) with 301 of the 314 units occupied. The entire project was completed for a total cost of $48 million.

Eleven55 Ripley, a 379 unit high rise development consisting of two buildings, a 21 story high-rise and a 5 story mid-rise, is located in Silver Spring, Maryland. Construction commenced in the fourth quarter of 2011, and is expected to continue through 2014 with initial occupancy in the third quarter of 2013 for a total projected cost of $111 million.

The Courts at Spring Mill Station, a 385 unit development consisting of two buildings, being built in a combination donut/podium style, is located in Conshohocken, Pennsylvania. Construction commenced in the second quarter of 2012, and is expected to continue through the second half of 2014 with initial occupancy in the first quarter of 2014 for a total projected cost of $89 million.

Redevelopment

Arbor Park, located in Alexandria, Virginia, currently has 851 garden apartments in fifty-two buildings built in 1967. The Company is one year into a four-year project to extensively renovate all of the apartment units on a building by building basis. As of September 30, 2012, there were five buildings with 118 units under renovation and twenty-one buildings with 273 units completed and 266 units occupied. As of September 30, 2012, rents in the renovated units are averaging $1,739 compared to $1,399 for the existing non-renovated units. As of September 30, 2012, the Company has incurred costs of $10.9 million for the renovation. The entire project is expected to be completed in 2014 for an estimated cost of $30 million.

Pre-redevelopment

Falkland Chase, located in Silver Spring, Maryland, currently has 450 garden apartments constructed between 1936 and 1939. The Company has obtained the necessary approvals to redevelop the North parcel consisting of 182 units, which will be renamed Falkland North. The Company is making progress on the design of Falkland North, which will contain approximately 1,100 units for a total projected cost in excess of $300 million.

Land Under Contract

The Company has land under contract in Fairfax County, Virginia within a development known as Westpark Tysons. This project involves an entitled land parcel on which the Company is working with the seller to process a rezoning application for development of a podium style project with a total of approximately 600 wood-framed mid-rise and concrete high-rise units. Closing will occur after the seller obtains final zoning approval for the project. Construction may begin as early as the first half of 2014 with a total projected cost of $205 million.


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Contractual Obligations and Other Commitments

The primary obligations of the Company relate to its borrowings under the unsecured line of credit, unsecured notes and mortgage notes. The Company's line of credit matures in December 2015 (not including a one-year extension at the option of the Company), and had $128 million in loans and letters of credit totaling $13.2 million outstanding at September 30, 2012. Of the $550 million in unsecured notes, $450 million have maturities ranging from approximately four to nine years. The remaining $100 million is a bank demand note. The $2.2 billion in mortgage notes payable have varying maturities ranging from 1 month to 22 years. The weighted average interest rate of the Company's secured debt was 5.09% at September 30, 2012. The weighted average rate of interest on the Company's total indebtedness of $2.9 billion at September 30, 2012 was 4.50%.

The Company leases its corporate office space from an affiliate and the office space for its regional offices from non-affiliated third parties. The rent for the corporate office space is a gross rent that includes real estate taxes and common area maintenance. The regional office leases are net leases which require an annual base rent plus a pro-rata portion of real estate taxes.

The Company, through its former general partnership interest in an affordable property limited partnership, has a secondary guarantee through 2015 on certain low income housing tax credits to limited partners in this partnership totaling approximately $3 million. With respect to the guarantee of the low income housing tax credits, the new unrelated general partner assumed operating deficit guarantee and primary tax credit guarantee positions. The Company believes the property's operations conform to the applicable requirements and does not anticipate any payment on the guarantee; therefore, no liability has been recorded in the financial statements.


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Capital Improvements (dollars in thousands, except unit and per unit data)

The Company's policy is to capitalize costs related to the acquisition, development, rehabilitation, construction and improvement of properties. Capital improvements are costs that increase the value and extend the useful life of an asset. Ordinary repair and maintenance costs that do not extend the useful life of the asset are expensed as incurred. Costs incurred on a lease turnover due to normal wear and tear by the resident are expensed on the turn. Recurring capital improvements typically include appliances, carpeting and flooring, HVAC equipment, kitchen and bath cabinets, new roofs, site improvements and various exterior building improvements. Non-recurring revenue generating upgrades include community centers, new windows, and kitchen and bath apartment upgrades. Revenue generating capital improvements are expected to directly result in increased rental earnings or expense savings. The Company capitalizes interest and certain internal personnel costs related to the communities under rehabilitation and construction.

The Company estimates, that on an annual basis, $848 and $800 per unit is spent on recurring capital expenditures in 2012 and 2011, respectively. During the three months ended September 30, 2012 and 2011, approximately $212 and $200 per unit, respectively, was estimated to be spent on recurring capital expenditures. For the nine months ended September 30, 2012 and 2011, approximately $636 and $600 per unit, respectively, was estimated to be spent on recurring capital expenditures.

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