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BRE > SEC Filings for BRE > Form 10-K on 18-Feb-2014All Recent SEC Filings

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Form 10-K for BRE PROPERTIES INC /MD/


18-Feb-2014

Annual Report


Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Executive Summary

We are a self-administered equity real estate investment trust, or REIT, focused on the ownership, development, acquisition, and management of multifamily apartment communities. Our operating and investment activities are primarily focused on the major metropolitan markets within the state of California, and in the metropolitan area of Seattle, Washington. At December 31, 2013 our portfolio had real estate assets with a net book value of approximately $3.5 billion that include 73 wholly or majority owned stabilized multifamily communities, aggregating 20,724 homes primarily located in California and Washington; one multifamily community owned in a joint venture and comprised of 252 homes; one land asset held for sale; and six development communities in various stages of construction and development. We earn revenue and generate operating cash flow primarily by collecting monthly rent from our community residents.

Our 2013 results, when compared to 2012 and 2011 annual results reflect the impact of improving fundamentals for the multifamily industry. We experienced same-store revenue growth in 2013 of 4.8% as compared to 5.5% growth in 2012 and 3.4% growth in 2011. Operating fundamentals, driven by low levels of new supply and an increase in propensity to rent, began to improve in 2011 and continued to strengthen throughout 2012 and 2013. Although unemployment levels following the severe recession that started in late 2007 remain elevated at 8.3% in California and 6.6% in Washington, we did experience job growth in our core markets in 2013 with the San Francisco Bay Area and Seattle markets benefiting the most from increased employment levels.

We continue to make progress on building out our development pipeline with properties that are in some of the country's premier locations. As of December 31, 2013, our active development pipeline had a total estimated cost of $724,200,000 of which approximately $181,000,000 remains to be funded. Our active pipeline consists of Solstice, Wilshire La Brea, Radius and MB 360 projects.

We expect that strategic draws on our unsecured revolving credit facility and asset sales will be the primary funding source for our remaining current construction funding commitments. During 2013, we disposed of three communities with 872 homes (located in Southern California) for combined net proceeds of $162,357,000. The dispositions produced net gains on sales totaling $57,324,000. In addition, during 2013 we sold our joint venture interests in seven communities that generated $53,408,000 in net proceeds and net gains totaling $18,633,000. We believe that a combination of a targeted development program focused on our core markets along with the disposition of slower revenue growth communities will over the time result in a higher quality portfolio with a stronger revenue growth profile.

We also remain committed to maintaining a strong financial position and balance sheet flexibility. Our leverage measured as debt as a percentage of gross assets was 39% as of December 31, 2013.

We believe our communities are well-positioned to take advantage of the favorable demographic factors that are expected to produce continued revenue growth for apartment owners in the coming years. These factors include: (1) increases in overall population levels among the age demographic with the greatest tendency to rent (age 20 to 34 years old); (2) a greater propensity to rent among all age groups as a result of the psychology and financial impact on homeownership rates coming out of this past recession; and (3) low levels of new supply of apartment communities from development activities in the majority of our core markets.

To better understand our overall results, our 73 wholly or majority owned apartment communities can be characterized as follows:

19,952 homes in 70 communities were owned, completed and stabilized for all of 2012 and 2011 ("same-store") communities;

502 homes in two development communities were experiencing lease up and stabilization during 2012 and 2013 and as a result did not have comparable year-over-year operating results ("non same-store"); and

270 homes in one community was acquired during 2013, and as a result did not have comparable annual year-over-year operating results ("non same-store").

In addition to year-over-year economic operating performance, our results of operations for the three years ended December 31, 2013 were affected by income derived from communities acquired and completions of apartment communities, offset by the cost of capital associated with financing these transactions.

Proposed Merger Transaction with Essex Property Trust, Inc.

On December 19, 2013, we entered into the Merger Agreement with Essex and Merger Sub. The Board of Directors of the Company has unanimously (i) determined and declared that the Merger, the Merger Agreement and the other transactions contemplated by the Merger Agreement are advisable and in the best interests of the Company and its shareholders and (ii) approved the Merger Agreement.

Pursuant to the terms and subject to the conditions set forth in the Merger Agreement, at the effective time of the Merger (the "Effective Time"), each outstanding share of common stock, par value $0.01 per share, of the Company
(the "Company Common Stock"), will be converted into the right to receive (i)
0.2971 shares of common stock, par value $0.0001 per share, of Essex ("Essex Common Stock") and (ii) $12.33 in cash, without interest, each subject to certain adjustments provided for in the Merger Agreement and subject to any applicable withholding tax (collectively, the "Merger Consideration").

Under the Merger Agreement, at the Effective Time each BRE stock option that is outstanding and unexercised immediately prior to the Effective Time, whether or not then vested or exercisable, will be assumed by Essex and converted into a stock option to acquire the number of whole shares of Essex Common Stock equal to the product of (i) the number of shares of Company Common Stock subject to the BRE stock option and (ii) the sum of 0.2971 and the quotient obtained by dividing (x) the per share cash consideration portion of the Merger Consideration by (y) the volume weighted average of Essex Common Stock over a ten-day trading period starting with the opening of trading on the first trading day to the closing of the second to last trading day prior to the closing date of the transactions contemplated by the Merger Agreement (such sum, the "Stock Award Exchange Ratio"). The exercise price per share of Essex Common Stock subject to each such assumed option will be equal to the quotient obtained by dividing (a) the exercise price per share of Company Common Stock of such BRE stock option by (b) the Stock Award Exchange Ratio. Except as described above, each such assumed stock option will continue to have, and will be subject to, the same terms and conditions as applied to the BRE stock option immediately prior to the Effective Time (but taking into account any changes provided for in the applicable Company Equity Plan (as defined in the Merger Agreement), in any award agreement, or in such BRE stock option by reason of the Merger or the Merger Agreement).

Additionally, at the Effective Time, each outstanding and unvested share of BRE restricted stock (including any associated right to the issuance of additional shares of Company Common Stock upon the achievement of BRE performance goals) will be assumed by Essex and will be converted into an award of Essex restricted stock for that number of shares of Essex Common Stock equal to product of (i) the number of shares of Company Common Stock underlying the BRE restricted stock award, and (ii) the Stock Award Exchange Ratio. To the extent any such BRE restricted stock is subject to performance vesting and, following the Effective Time, the performance metrics applicable to such BRE restricted stock otherwise cease to be measurable on substantially similar terms as immediately prior to the Effective Time, then the Essex restricted stock will vest based on target performance at the time and, subject to any applicable payment conditions, prescribed by the terms in effect for such BRE restricted stock immediately prior to the Effective Time. Except as described above, each such assumed award of restricted stock will continue to have, and will be subject to, the same terms and conditions as applied to the BRE restricted stock immediately prior to the Effective Time (but taking into account any changes provided for in the applicable Company Equity Plan or in any award agreement by reason of the Merger or the Merger Agreement).

The Company and Essex have made certain customary representations and warranties to each other in the Merger Agreement. The Company has agreed, among other things, not to solicit, initiate, knowingly encourage or facilitate any inquiry, discussion, offer or request from third parties regarding other proposals to acquire the Company and not to engage in any discussions or negotiations regarding any such proposal, or furnish to any third party non-public information regarding the Company. The Company has also agreed to certain other restrictions on its ability to respond to any such proposals. The Merger Agreement also includes certain termination rights for both the Company and Essex and provides that, in connection with the termination of the Merger Agreement, under specified circumstances, (i) the Company may be required to pay to Essex a termination fee of $170.0 million and/or reimburse Essex's transaction expenses in an amount equal to $10,000,000 and (ii) Essex may be required to reimburse the Company's transaction expenses in an amount equal to $10,000,000.

The completion of the Merger is subject to various conditions, including, among other things, the approval by the Company's shareholders of the Merger and the other transactions contemplated by the Merger Agreement, the approval by Essex's shareholders of the issuance of Essex Common Stock in connection with the Merger and certain consents having been obtained. Essex and the Company filed preliminary joint proxy materials (Form S-4) with the Securities and Exchange Commission on January 29, 2014. Complete information on the Merger, including the Merger background, reasons for the Merger, who may vote, how to vote and the time and place of the Company shareholder meeting are included in the definitive proxy statement filed on February 14, 2014. As of December 31, 2013, the Company has incurred $3,400,000 for legal, consulting and other expenses related to the Merger. If the Merger process proceeds without delay, we currently expect the transaction to close by the second quarter of 2014.

RESULTS OF OPERATIONS

Comparison of the Years ended December 31, 2013, 2012 and 2011

Revenues

Total revenues include revenues from discontinued operations in an effort to provide information regarding the amount of total revenues the portfolio generated each year. The increase in rental income in 2013 was primarily derived from a 4.8% increase in same-store property revenue. A summary of revenues is as follows:

Composite of Change in year over year revenues

                                                      % of                             % of                             % of
                                                     Total                            Total                            Total
                                  2013 Total        Revenues       2012 Total        Revenues       2011 Total        Revenues
Rental income                    $ 388,300,000           88.8 %   $ 361,116,000           92.0 %   $ 336,014,000           90.0 %
Ancillary income                    15,728,000            3.6 %      14,441,000            4.0 %      12,789,000            4.0 %
Total revenue from continuing
operations                         404,028,000                      375,557,000                      348,803,000
Revenues from discontinued
operations                          11,851,000            2.7 %      21,880,000            2.0 %      28,817,000            4.0 %
Total rental and ancillary
income                             415,879,000                      397,437,000                      377,620,000
Income from unconsolidated
entities                               625,000            0.2 %       2,644,000            1.0 %       2,888,000            1.0 %
Other income                        20,614,000            4.7 %       2,530,000            1.0 %       2,536,000            1.0 %
Total revenues                   $ 437,118,000          100.0 %   $ 402,611,000          100.0 %   $ 383,044,000          100.0 %

                                                                 2013             2012
                                                                Change           Change
Same-store communities                                       $ 17,973,000     $ 18,834,000
Non same-store communities                                     10,498,000        8,245,000
Total change in rental and ancillary revenues from
continuing operations                                        $ 28,471,000     $ 27,079,000

Rental and Ancillary Income

Same-store revenues increased by $17,973,000 or 4.8% and by $18,834,000 or 5.5% for the years ended for the years ended December 31, 2013 and 2012, respectively. The 2013 same-store increase was primarily due to a 5.3% increase in average revenue earned per occupied home. Revenue per home is comprised of rental and ancillary income earned on occupied homes during the period and net of concessions of $1 per month per occupied home during 2013 and concessions of $3 per month per home during 2012. Physical occupancy levels averaged 95%, 94%, and 95% during the years ended 2013, 2012, and 2011, respectively. The $10,498,000 increase in revenue from non same-store communities represents the increase in the year-over-year size of the portfolio from recently completed development communities and communities acquired in 2013.

As described above, the increase in non same-store rental and ancillary revenues relates to acquired and developed communities. The following table summarizes our multifamily development, acquisition and disposition activities:

                                                               Year Ended December 31,
                                                      2013              2012              2011
Total cost of development communities completed   $  42,900,000     $ 104,400,000     $           -
# of homes completed                                        166               336                 -
Total cost of communities acquired                $ 120,515,000     $           -     $ 170,127,000
# of homes acquired                                         270                 -               652
Approximate net sales proceeds of dispositions    $ 162,357,000     $  88,236,000     $  63,486,000
# of homes sold                                             872               512               634




                                                            Year Ended December 31,
                                                     2013              2012           2011
Number of wholly or majority owned operating
communities                                                73               74             76
Physical occupancy rates for operating

communities(1) 95.0 % 94.0 % 95.0 %

(1)Physical occupancy is calculated by dividing the total occupied homes by the total homes in stabilized communities in the portfolio.

Other income

Other income is detailed below and is comprised of the following:

                                         For the years ended December 31,
                                      2013              2012            2011
Legal and insurance settlements   $ 19,750,000 (1)   $   133,000     $    40,000
JV management fees (2)                 384,000         1,637,000       1,843,000
Interest income                        219,000           377,000         369,000
Disposition fees                       128,000           243,000         144,000
Other                                  133,000           140,000         140,000
Total other income                $ 20,614,000       $ 2,530,000     $ 2,536,000

(1) Related to $19,750,000 legal settlement for construction defects.

(2) Decrease in management fees due to decrease in the number of joint venture interests from 11 interests at December 31, 2011 to 8 interests at December 31, 2012 to 1 interest at December 31, 2013.

Expenses

Real estate expenses

The summary of real estate expenses, excluding discontinued operations is as follows:

                                                               Year Ended December 31,
                                                      2013              2012              2011
Real estate expenses                              $ 124,304,000     $ 118,143,000     $ 112,497,000
Real estate expenses as a percent of rental and
ancillary income from continuing operations                30.8 %            31.5 %            32.3 %
Same-store expense % change                                 1.9 %             3.6 %             1.5 %

Real estate expenses for multifamily rental communities (which include repairs and maintenance, utilities, on-site staff payroll, property taxes, insurance, advertising and other direct operating expenses) increased $6,161,000, or 5.2% and $5,646,000 or 5.0%, for the years ended December 31, 2013 and 2012, respectively. Also, same-store expenses increased $2,252,000, $3,920,000, and $1,520,000 in 2013, 2012 and 2011, respectively.

Property taxes comprised 30% of real estate expenses during the years ended December 31, 2013, 2012 and 2011, respectively. Across the same-store portfolio, property taxes increased $2,236,000 or 6.4% in 2013 from 2012. In our Seattle market on a same-store basis, property taxes increased $876,000 or 17% for the year e ended December 31, 2013.

Real estate expenses shown in the table above exclude real estate expense from discontinued operations which totaled $4,077,000, $7,139,000 and $9,177,000 for 2013, 2012 and 2011, respectively.

Provision for depreciation

The provision for depreciation totaled $105,371,000, $96,736,000 and $97,139,000 for the years ending 2013, 2012 and 2011, respectively. The provision for depreciation increased $8,635,000, or 8.9%, for the year ended December 31, 2013 compared to 2012, and decreased $403,000, or 0.4%, for the year ended December 31, 2012 compared to 2011. The increases in 2013 resulted from higher depreciable bases on newly delivered developments and acquisitions.

Interest expense

                                                  Year ended December 31,
                                         2013              2012              2011
Interest on unsecured senior notes   $  46,048,000     $  42,103,000     $  38,518,000
Interest on convertible debt                     -           274,000         1,870,000
Interest on mortgage loans payable      40,513,000        40,953,000        43,898,000
Interest on line of credit               3,777,000         5,101,000         3,396,000
Total interest incurred              $  90,338,000     $  88,431,000     $  87,682,000
Capitalized interest(1)                (24,471,000 )     (21,633,000 )     (14,431,000 )
Total interest expense               $  65,867,000     $  66,798,000     $  73,251,000

(1) The increase in capitalized interest is related to the increase in our average investment in land and construction in progress. Our monthly average investment balance in land and construction in progress was $468,363,000, $406,619,000 and $280,698,000 for the years ended December 31, 2013, 2012 and 2011, respectively.

Year-end debt balances were as follows:

                                                                  Year ended December 31,
                                                       2013                2012                2011
Unsecured senior notes                            $   950,000,000     $   990,018,000     $   690,018,000
Convertible unsecured senior notes(1)                           -                   -          34,939,000
Mortgage loans payable                                711,428,000         741,942,000         808,714,000
Unsecured line of credit                               98,000,000                   -         129,000,000
Total debt                                        $ 1,759,428,000       1,731,960,000       1,662,671,000
Weighted average interest rate for all debt at
end of period                                                 5.1 %               5.4 %               5.3 %

(1) During 2012, we exercised the right to redeem for cash all of the remaining 4.125% convertible unsecured notes outstanding, at a redemption price equal to 100% of the principal amount of the notes outstanding, plus accrued and unpaid interest up to, but excluding, February 21, 2012 (the "Redemption Date").

General and administrative expenses

General and administrative expenses for the three years ended December 31, were as follows:

                                                         For the years ended December 31,
                                                      2013             2012             2011
General and administrative expenses               $ 23,037,000     $ 22,848,000     $ 21,768,000
Annual change as a percentage                              0.8 %            5.0 %            5.8 %
As a percentage of rental and ancillary
revenues (including revenues from discontinued
operations)                                                5.5 %            5.7 %            5.8 %

General and administrative expenses increased 0.8% in 2013, increased 5.0% in 2012 and increased 5.8% in 2011. The increase during 2013 was primarily due to legal costs.

Other expenses

Other expenses are comprised of the following:

                                     For the years ended December 31,
                                   2013             2012           2011
Merger costs(1)                 $ 3,401,000     $          -     $       -
Acquisition fees                    585,000                -       402,000
Non cash impairment charge(2)             -       15,000,000             -
Total other expenses            $ 3,986,000     $ 15,000,000     $ 402,000

(1) Represents merger related legal and professional fees incurred as of December 31, 2013.

(2) Represents a $15,000,000 non cash impairment charge to write down a land site to its estimated fair value less cost of disposal, as a result of changes in the future plans to develop the project.

Redeemable noncontrolling interest in income

Redeemable noncontrolling interest in income represent the earnings attributable to the noncontrolling members of our consolidated subsidiaries and totaled $190,000, $413,000 and $1,168,000 for the years ended December 31, 2013, 2012 and 2011, respectively.

Discontinued operations

Accounting guidance requires the results of operations for communities sold during the period or designated as held for sale at the end of the period to be classified as discontinued operations. The property-specific components of net earnings that are classified as discontinued operations include all property-related revenues and operating expenses, depreciation expense recognized prior to the classification as held for sale, and property-specific interest expense to the extent there is secured debt on the property. In addition, the net gain or loss on the eventual disposal of communities held for sale is reported as discontinued operations.

During 2013 we sold three communities in Southern California: Summerwind Townhomes, with 200 homes; Mission Grove Park with 432 homes; and Villa Santana, with 240 homes. The net proceeds from the three sales were $162,357,000 resulting in a net gain of $57,324,000.

During 2012, we sold three communities located in San Diego, California:
Countryside Village, with 96 homes in El Cajon submarket; Terra Nova Villas, with 233 homes in Chula Vista; and Canyon Villa, with 183 homes in Chula Vista. The approximate net proceeds from the three sales were $88,236,000 resulting in a combined net gain of $62,136,000. The sale of these assets reduced our exposure in the San Diego multi-family market to 18% of total net operating income from 21% at year-end 2011.

During 2011, we sold two communities in the eastern half of the Inland Empire totaling 634 homes: Galleria at Towngate, with 268 homes located in Moreno Valley, California; and Windrush Village, a 366 unit property located in Colton, California. The net proceeds from sales of the two communities were $63,486,000, resulting in a combined net gain of $14,489,000. The sale of these assets reduced our concentration of net operating income from the Inland Empire.

The net gain on sale and the combined results of operations for these eight communities for each year presented are included in discontinued operations on the consolidated statements of income. These amounts totaled $61,631,000, $70,326,000 and $25,615,000 for the years ended December 31, 2013, 2012 and 2011, respectively. There were no operating communities held for sale as of December 31, 2013.

As of December 31, 2013, there was land with a net carrying value of $23,481,000 classified as held for sale on the consolidated balance sheet. As of December 31, 2012, there was land with a net carrying value of $23,065,000 classified as held for sale on the consolidated balance sheet.

Income from unconsolidated entities

Income from unconsolidated entities totaled $625,000, $2,644,000 and $2,888,000 for the years ended December 31, 2013, 2012 and 2011, respectively. The totals for each year include our share of net income from the joint ventures we own.

During 2013, six joint venture interests were sold to our joint venture partner. The sale consisted of four joint venture communities located in Denver, Colorado and two joint venture communities located in Phoenix, Arizona totaling 2,180 homes. We had a 15% equity ownership in all six joint venture interests sold. The net proceeds from the sale was $47,408,000 and net gain of $15,025,000. We also sold to an unrelated third party one joint venture community located in Phoenix, Arizona with 432 homes. We had a 15% interest in the joint venture and the net proceed from the sale was $6,000,000 with a net gain of $3,608,000.

Dividends attributable to preferred stock

Dividends totaled $3,645,000, $3,645,000 and $7,655,000 for the years ended December 31, 2013, 2012, and 2011, respectively. Dividends for the year ended December 31, 2013 and 2012 are attributable to the dividends on our 6.75% Series D Cumulative Redeemable Preferred Stocks. Dividends for the year ended December 31, 2011 are attributable to the dividends on our 6.75% Series C and 6.75% Series D Cumulative Redeemable Preferred Stock. Our Series D Cumulative Redeemable Preferred Stock has a $25.00 per share liquidation preference and became callable at our election in December of 2009.

Net income available to common shareholders

As a result of the various factors mentioned above, net income available to common shareholders for the year ended December 31, 2013 was $179,131,000 or $2.32 per diluted share, for the year ended December 31, 2012 was $133,499,000 or $1.74 per diluted share, and $66,461,000, or $0.93 per diluted share for the year ended December 31, 2011.

Non-GAAP financial measure reconciliations and definitions

The following is our reconciliation of net income to funds from operations (FFO) and core funds from operations (Core FFO) for each of the five years ended December 31, 2013:

. . .

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