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MAA > SEC Filings for MAA > Form 10-Q on 2-Aug-2013All Recent SEC Filings

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Form 10-Q for MID AMERICA APARTMENT COMMUNITIES INC


2-Aug-2013

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 condensed consolidated financial statements and notes appearing elsewhere in this Quarterly Report. Historical results and trends that might appear in the condensed consolidated financial statements should not be interpreted as being indicative of future operations.

Forward Looking Statements

We consider this and other sections of this Quarterly Report on Form 10-Q to contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, or the Exchange Act, with respect to our expectations for future periods. Forward-looking statements do not discuss historical fact, but instead include statements related to expectations, projections, intentions or other items related to the future. Such forward-looking statements include, without limitation, statements concerning property acquisitions and dispositions, joint venture activity, development and renovation activity as well as other capital expenditures, capital raising activities, rent and expense growth, occupancy, financing activities and interest rate and other economic expectations and statements about the benefit of the business combination transaction involving Colonial Properties Trust. Words such as "expects," "anticipates," "intends," "plans," "believes," "seeks," "estimates," and variations of such words and similar expressions are intended to identify such forward-looking statements. Such statements involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements to be materially different from the results of operations, financial conditions or plans expressed or implied by such forward-looking statements. Such factors include, among other things, unanticipated adverse business developments affecting us, or our properties, adverse changes in the real estate markets and general and local economies and business conditions. Although we believe that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate, and therefore such forward-looking statements included in this report may not prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by us or any other person that the results or conditions described in such statements or our objectives and plans will be achieved.

The following factors, among others, could cause our future results to differ materially from those expressed in the forward-looking statements:

inability to generate sufficient cash flows due to market conditions, changes in supply and/or demand, competition, uninsured losses, changes in tax and housing laws, or other factors;

inability to consummate the merger with Colonial Properties Trust and the timing of the closing of the merger;

failure of new acquisitions to achieve anticipated results or be efficiently integrated;

failure of development communities to be completed, if at all, on a timely basis or to lease-up as anticipated;

inability of a joint venture to perform as expected;

inability to acquire additional or dispose of existing apartment units on favorable economic terms;

unexpected capital needs;

increasing real estate taxes and insurance costs;

losses from catastrophes in excess of our insurance coverage;

inability to acquire funding through the capital markets;

the availability of credit, including mortgage financing, and the liquidity of the debt markets, including a material deterioration of the financial condition of the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation;

inability to replace financing with the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation should their investment in the multifamily industry decrease or cease to exist;

changes in interest rate levels, including that of variable rate debt, which are extensively used by us;

loss of hedge accounting treatment for interest rate swaps or interest rate caps;

the continuation of the good credit of our interest rate swap and cap providers;

inability to meet loan covenants;

significant decline in market value of real estate serving as collateral for mortgage obligations;

inability to pay required distributions to maintain REIT status due to required debt payments;


significant change in the mortgage financing market that would cause single-family housing, either as an owned or rental product, to become a more significant competitive product;

imposition of federal taxes if we fail to qualify as a REIT under the Internal Revenue Code in any taxable year or foregone opportunities to ensure REIT status;

inability to attract and retain qualified personnel;

potential liability for environmental contamination;

adverse legislative or regulatory tax changes; and

litigation and compliance costs associated with laws requiring access for disabled persons.

Critical Accounting Policies and Estimates

The following discussion and analysis of financial condition and results of operations are based upon our condensed consolidated financial statements, and the notes thereto, which have been prepared in accordance with GAAP. The preparation of these condensed consolidated financial statements requires us to make a number of estimates and assumptions that affect the reported amounts and disclosures in the condensed consolidated financial statements. On an ongoing basis, we evaluate our estimates and assumptions based upon historical experience and various other factors and circumstances. We believe that our estimates and assumptions are reasonable under the circumstances; however, actual results may differ from these estimates and assumptions.

We believe that the estimates and assumptions listed below are most important to the portrayal of our financial condition and results of operations because they require the greatest subjective determinations and form the basis of accounting policies deemed to be most critical. These critical accounting policies include revenue recognition, capitalization of expenditures and depreciation and amortization of assets, impairment of long-lived assets, including goodwill, acquisition of real estate assets and fair value of derivative financial instruments.

Revenue Recognition and Real Estate Sales

We lease multifamily residential apartments under operating leases primarily with terms of one year or less. Rental revenues are recognized using a method that represents a straight-line basis over the term of the lease and other revenues are recorded when earned.

We record gains and losses on real estate sales in accordance with accounting standards governing the sale of real estate. For sale transactions meeting the requirements for the full accrual method, we remove the assets and liabilities from our Consolidated Balance Sheets and record the gain or loss in the period the transaction closes. For properties contributed to our joint ventures, we record gains on the partial sale in proportion to the outside partners' interest in the joint venture.

Capitalization of expenditures and depreciation and amortization of assets

We carry real estate assets at depreciated cost. Depreciation and amortization is computed on a straight-line basis over the estimated useful lives of the related assets, which range from 8 to 40 years for land improvements and buildings, 5 years for furniture, fixtures, and equipment, 3 to 5 years for computers and software, and 6 months amortization for acquired leases, all of which are subjective determinations. Repairs and maintenance costs are expensed as incurred while significant improvements, renovations and replacements are capitalized.

Development costs are capitalized in accordance with accounting standards for costs and initial rental operations of real estate projects and standards for the capitalization of interest cost, real estate taxes and personnel expense.

Impairment of long-lived assets, including goodwill

We account for long-lived assets in accordance with the provisions of accounting standards for the impairment or disposal on long-lived assets and evaluate our goodwill for impairment under accounting standards for goodwill and other intangible assets. We evaluate goodwill for impairment on at least an annual basis, or more frequently if a goodwill impairment indicator is identified. We periodically evaluate long-lived assets, including investments in real estate and goodwill, for indicators that would suggest that the carrying amount of the assets may not be recoverable. The judgments regarding the existence of such indicators are based on factors such as operating performance, market conditions and legal factors.

Long-lived assets, such as real estate assets, equipment and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated


undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of are separately presented on the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. The assets and liabilities of a disposed group classified as held for sale are presented separately in the appropriate asset and liability sections of the balance sheet.

Goodwill is tested annually for impairment and is tested for impairment more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss for goodwill is recognized to the extent that the carrying amount exceeds the implied fair value of goodwill. This determination is made at the reporting unit level and consists of two steps. First, we determine the fair value of a reporting unit and compare it to its carrying amount. In the apartment industry, the primary method used for determining fair value is to divide annual operating cash flows by an appropriate capitalization rate. We determine the appropriate capitalization rate by reviewing the prevailing rates in a property's market or submarket. Second, if the carrying amount of a reporting unit exceeds its fair value, an impairment loss is recognized for any excess of the carrying amount of the reporting unit's goodwill over the implied fair value of that goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation in accordance with accounting standards for business combinations. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill.

Acquisition of real estate assets

We account for our acquisitions of investments in real estate in accordance with ASC 805-10, Business Combinations, which requires the fair value of the real estate acquired to be allocated to the acquired tangible assets, consisting of land, building and furniture, fixtures and equipment, and identified intangible assets, consisting of the value of in-place leases.

We allocate the purchase price to the fair value of the tangible assets of an acquired property determined by valuing the property as if it were vacant, based on management's determination of the relative fair values of these assets. Management determines the as-if-vacant fair value of a property using methods similar to those used by independent appraisers. These methods include using stabilized NOI and market specific capitalization and discount rates.

In allocating the fair value of identified intangible assets of an acquired property, the in-place leases are valued based on current rent rates and time and cost to lease a unit. Management concluded that the residential leases acquired on each of its property acquisitions are approximately at market rates since the residential lease terms generally do not extend beyond one year.

Our policy is to expense the costs incurred to acquire properties in the period these costs occur. Acquisition costs include appraisal fees, title fees, broker fees, and other legal costs to acquire the property. These costs are recorded in our Statement of Operations under the line Acquisition expenses.

Fair value of derivative financial instruments

We utilize certain derivative financial instruments, primarily interest rate swaps and interest rate caps, during the normal course of business to manage, or hedge, the interest rate risk associated with our variable rate debt or as hedges in anticipation of future debt transactions to manage well-defined interest rate risk associated with the transaction.

In order for a derivative contract to be designated as a hedging instrument, changes in the hedging instrument must be highly effective at offsetting changes in the hedged item. The historical correlation of the hedging instruments and the underlying hedged items are assessed before entering into the hedging relationship and on a quarterly basis thereafter, and have been found to be highly effective.

We measure ineffectiveness using the change in the variable cash flows method or the hypothetical derivative method for interest rate swaps and the hypothetical derivative method for interest rate caps for each reporting period through the term of the hedging instruments. Any amounts determined to be ineffective are recorded in earnings. The change in fair value of the interest rate swaps and the intrinsic value or fair value of interest rate caps designated as cash flow hedges are recorded to accumulated other comprehensive income in the Condensed Consolidated Balance Sheets.

The valuation of our derivative financial instruments is determined using widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of each derivative. The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash payments and the discounted expected variable cash receipts. The variable cash receipts are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. The fair values of interest rate caps are determined using the market


standard methodology of discounting the future expected cash receipts that would occur if variable interest rates rise above the strike rate of the interest rate caps. The variable interest rates used in the calculation of projected receipts on the interest rate cap are based on an expectation of future interest rates derived from observable market interest rate curves and volatilities. Additionally, we incorporate credit valuation adjustments to appropriately reflect both our own nonperformance risk and the respective counterparty's nonperformance risk in the fair value measurements. Changes in the fair values of our derivatives are primarily the result of fluctuations in interest rates. See Notes 8 and 9 of the accompanying Condensed Consolidated Financial Statements.

Overview of the Three Months Ended June 30, 2013

We experienced an increase in income from continuing operations for the three months ended June 30, 2013 over the three months ended June 30, 2012 as increases in revenues outpaced increases in property operating expenses. The increases in revenues came from a 5.3% increase in our large market same store segment, a 3.3% increase in our secondary market same store segment and a 128.7% increase in our non-same store and other segment, which was primarily a result of acquisitions. Our same store portfolio represents those communities that have been held and have been stabilized for at least 12 months. Communities excluded from the same store portfolio would include recent acquisitions, communities being developed or in lease-up, communities undergoing extensive renovations, and communities identified as discontinued operations or classified as held for sale.

As of June 30, 2013, our wholly-owned portfolio consisted of 47,957 apartment units in 160 communities, compared to 47,220 apartment units in 162 communities at June 30, 2012. For these communities, the average effective rent per apartment unit, excluding units in lease-up, increased to $876 per unit at June 30, 2013 from $828 per unit at June 30, 2012. For these same communities, overall occupancy at June 30, 2013 and 2012 was 96.0%. Average effective rent per unit is equal to the average of gross rent amounts after the effect of leasing concessions for occupied units plus prevalent market rates asked for unoccupied units, divided by the total number of units. Leasing concessions represent discounts to the current market rate. We believe average effective rent is a helpful measurement in evaluating average pricing. It does not represent actual rental revenue collected per unit.

On June 3, 2013, we entered into an agreement and plan of merger with Colonial Properties Trust, or Colonial, a Birmingham, Alabama-based REIT operating primarily in the multifamily apartment sector, in which we will merge with Colonial in a stock-for-stock transaction. We expect the merger to be completed during the third quarter of 2013. The combined company will operate under the name "MAA" and will be run by our existing management team.

The following is a discussion of our consolidated financial condition and results of operations for the three- and six-month periods ended June 30, 2013 and 2012. This discussion should be read in conjunction with all of the consolidated financial statements included in this Quarterly Report on Form 10-Q.

Results of Operations

Comparison of the Three-Month Period Ended June 30, 2013 to the Three-Month Period Ended June 30, 2012

Property revenues for the three months ended June 30, 2013 were approximately $134.0 million, an increase of approximately $15.2 million from the three months ended June 30, 2012 due to (i) a $3.2 million increase in property revenues from our large market same store group primarily as a result of an increase in average rent per unit, (ii) a $1.7 million increase in property revenues from our secondary market same store group primarily as a result of an increase in average rent per unit, and (iii) a $10.3 million increase in property revenues from our non-same store and other group, primarily as a result of acquisitions. See further discussion on revenue growth in the Trends section below.

Property operating expenses include costs for property personnel, property personnel bonuses, building repairs and maintenance, real estate taxes and insurance, utilities, landscaping and depreciation and amortization. Property operating expenses, excluding depreciation and amortization, for the three months ended June 30, 2013 were approximately $53.8 million an increase of approximately $5.0 million from the three months ended June 30, 2012 due primarily to (i) an increase in property operating expenses of $0.8 million from our large market same store group, (ii) an increase of $0.5 million from our secondary market same store group, and (iii) an increase of $3.7 million from our non-same store and other group, primarily as a result of acquisitions. The increases in the large market same store and secondary market same store groups are mainly the result of increases in real estate taxes. Other increases are the result of normal operating costs.

Depreciation and amortization expense for the three months ended June 30, 2013 was approximately $32.7 million, an increase of approximately $2.5 million from the three months ended June 30, 2012 primarily due to (i) an increase in depreciation and


amortization expense of $0.2 million from our large market same store group,
(ii) an increase of $0.1 million from our secondary market same store group, and
(iii) an increase of $2.2 million from our non-same store and other group, mainly as a result of acquisitions.

Interest expense increased by approximately $1.2 million during the three months ended June 30, 2013 compared to the three months ended June 30, 2012 primarily as a result of an increase in our average debt outstanding of approximately $126.7 million. This increase was partially offset by a decrease in the average interest rate from 3.8% to 3.5%.

For the three months ended June 30, 2013, we recorded total gain on sale of four properties presented in discontinued operations of approximately $43.1 million compared to $13.0 million for the sale of one property during the three months ended June 30, 2012.

We also incurred merger related expenses for the pending acquisition of Colonial of $5.7 million for the three months ended June 30, 2013. There were no merger related expenses for the three months ended June 30, 2012.

Primarily as a result of the foregoing, net income attributable to MAA increased by approximately $30.9 million in the three months ended June 30, 2013 from the three months ended June 30, 2012.

Comparison of the Six-Month Period Ended June 30, 2013 to the Six-Month Period Ended June 30, 2012

Property revenues for the six months ended June 30, 2013 were approximately $264.0 million, an increase of approximately $32.2 million from the six months ended June 30, 2012 due to (i) a $6.7 million increase in property revenues from our large market same store group primarily as a result of an increase in average rent per unit, (ii) a $3.3 million increase in property revenues from our secondary market same store group primarily as a result of an increase in average rent per unit, and (iii) a $22.2 million increase in property revenues from our non-same store and other group, primarily as a result of acquisitions. See further discussion on revenue growth in the Trends section below.

Property operating expenses include costs for property personnel, property personnel bonuses, building repairs and maintenance, real estate taxes and insurance, utilities, landscaping and depreciation and amortization. Property operating expenses, excluding depreciation and amortization, for the six months ended June 30, 2013 were approximately $105.1 million, an increase of approximately $9.4 million from the six months ended June 30, 2012 due primarily to (i) an increase in property operating expenses of $1.1 million from our large market same store group, (ii) an increase of $0.4 million from our secondary market same store group, and (iii) an increase of $7.9 million from our non-same store and other group, primarily as a result of acquisitions. The increases in the large market same store and secondary market same store groups are mainly the result of increases in real estate taxes. Other increases are the result of normal operating costs.

Depreciation and amortization expense for the six months ended June 30, 2013 was approximately $65.4 million, an increase of approximately $6.2 million from the six months ended June 30, 2012 primarily due to (i) an increase in depreciation and amortization expense of $0.1 million from our large market same store group and (ii) an increase of $6.1 million from our non-same store and other group, mainly as a result of acquisitions. Depreciation and amortization from our secondary market same store group remained consistent period over period.

Interest expense increased by approximately $2.8 million during the six months ended June 30, 2013 compared to the six months ended June 30, 2012 primarily as a result of an increase in our average debt outstanding of approximately $105.6 million. This increase was partially offset by a decrease in the average interest rate from 3.8% to 3.5%.

For the six months ended June 30, 2013, we recorded total gain on sale of four properties presented in discontinued operations of approximately $43.1 million compared to $22.4 million for the sale of three properties during the six months ended June 30, 2012.

We also incurred merger related expenses for the pending acquisition of Colonial of $5.7 million for the six months ended June 30, 2013. There were no merger related expenses for the six months ended June 30, 2012.

Primarily as a result of the foregoing, net income attributable to MAA increased by approximately $28.2 million in the six months ended June 30, 2013 from the six months ended June 30, 2012.


Funds From Operations and Net Income

Funds from operations, or FFO, represents net income (computed in accordance with GAAP) excluding extraordinary items, net income attributable to noncontrolling interest, asset impairment, gains or losses on disposition of real estate assets, plus depreciation and amortization of real estate, and adjustments for joint ventures to reflect FFO on the same basis. This definition of FFO is in accordance with the National Association of Real Estate Investment Trusts, or NAREIT, definition. Disposition of real estate assets includes sales of discontinued operations.

FFO should not be considered as an alternative to net income or any other GAAP measurement of performance, as an indicator of operating performance or as an alternative to cash flow from operating, investing, and financing activities as a measure of liquidity. We believe that FFO is helpful to investors in understanding our operating performance in that such calculation excludes depreciation and amortization expense on real estate assets. We believe that GAAP historical cost depreciation of real estate assets is generally not correlated with changes in the value of those assets, whose value does not diminish predictably over time, as historical cost depreciation implies. Our calculation of FFO may differ from the methodology for calculating FFO utilized by other REITs and, accordingly, may not be comparable to such other REITs.

The following table is a reconciliation of FFO to net income available for MAA common shareholders for the three- and six-month periods ended June 30, 2013, and 2012 (dollars in thousands):

                                                       Three months ended June 30,          Six months ended June 30,
                                                         2013               2012               2013             2012
Net income available for MAA common shareholders   $      59,089       $      28,160     $      80,269       $  52,050
Depreciation and amortization of real estate
assets                                                    32,181              29,647            64,258          58,047
Depreciation and amortization of real estate
assets of discontinued operations                            466               1,679             1,223           3,529
Gain on sales of discontinued operations                 (43,121 )           (12,953 )         (43,121 )       (22,382 )
Depreciation and amortization of real estate
assets of real estate joint ventures                         281                 438               661             995
Net income attributable to noncontrolling
interests                                                  1,939               1,312             2,764           2,490
Funds from operations                              $      50,835       $      48,283     $     106,054       $  94,729

FFO for the three- and six-month periods ended June 30, 2013 increased by . . .

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