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HME > SEC Filings for HME > Form 10-K on 21-Feb-2014All Recent SEC Filings

Show all filings for HOME PROPERTIES INC

Form 10-K for HOME PROPERTIES INC


21-Feb-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

Overview

Management's Discussion and Analysis of Financial Condition and Results of Operations is intended to facilitate an understanding of the Company's business and results of operations. It should be read in conjunction with the Consolidated Financial Statements, the accompanying Notes to Consolidated Financial Statements and the selected financial data included in this Form 10-K. This Form 10-K, including the following discussion, contains forward-looking statements regarding future events or trends as described more fully under "Forward-Looking Statements" on page 58. Actual results could differ materially from those projected in such statements as a result of the risk factors described in Item 1A, "Risk Factors," of this Form 10-K.

The Company is engaged in the ownership, management, acquisition, rehabilitation and development of residential apartment communities primarily in selected Northeast and Mid-Atlantic markets of the United States. As of December 31, 2013, the Company owned and operated 120 apartment communities with 42,170 apartments.

Executive Summary

The Company operated during 2013 in a stable economic environment, where the Company's markets and the country as a whole experienced job growth of 1.2% and 1.6%, respectively. This is slightly more than the job growth in the Company's markets of 1.1% in 2012. An increase in job growth leads to household formations, which creates an increase in demand for rental housing. In addition, the credit crisis of the past recession has made it more difficult for apartment residents who may have considered purchasing a home to qualify for a mortgage. After years of home ownership being the number one reason our residents gave for moving out of our apartment communities, it dropped starting in 2007, such that it was the number five and number three reason in 2012 and 2013, respectively. The combination of steady job growth and reduced flexibility for residents to purchase homes has created an environment supporting higher rental income growth and occupancy rates.

The Company owned 112 communities with 38,440 apartment units throughout 2012 and 2013 where comparable operating results are available for the years presented (the "2013 Core Properties"). Physical occupancies at the 2013 Core Properties decreased slightly, by 10 basis points, from 95.4% to 95.3%. Including bad debt in the calculation to arrive at "economic occupancy", this metric remained the same at 94.4%. The level of bad debt remained at 97 basis points for 2013 and 2012. For 2014, we are projecting bad debt to be approximately 90 basis points of rental income plus utility recovery.

The Company uses a measurement referred to as Available to Rent, or "ATR". This is a leading indicator of future occupancy rates and refers to units which will be available for rent, based upon leases signed or termination notices received relating to future move in/move out dates. As of the end of the first week of February, 2014 and 2013, our ATR was 6.6%. Average physical occupancy for the quarter ended December 31, 2013 was at a level of occupancy at 94.9%, with a continuation of low resident turnover for 2013 of 40.5%, up slightly from the 39.0% experienced in 2012. For 2014, we are projecting physical occupancy to be 10 basis points higher than 2013, as a result of a slightly less aggressive approach to rent increases combined with the continuation of limited alternatives for our residents.

Total 2013 Core Properties rental revenue growth for 2013 was projected to be 4.3%, consisting of an increase of 3.8% in rental rate growth with economic occupancy to increase 0.4%. Actual results were positive 3.2% in rental rate growth and a 0.1% decrease in economic occupancy resulting in 3.1% total rental revenue growth.


Table of Contents

Executive Summary (continued)

The guidance for 2014 Core Properties (apartment units owned throughout 2013 and 2014, the "2014 Core Properties") total revenue growth is 3.1% at the midpoint of guidance. Rental rates are projected to increase 3.0%, including above-average rental increases at certain communities resulting from continued efforts to upgrade the properties. Economic occupancies are expected to increase 0.2% for the year, such that rental revenues are projected to increase 3.2%. Property other income growth is expected to be less than 3.0%, resulting in 3.1% total revenue growth. Expenses for 2014 Core Properties are projected to increase 3.5% at the midpoint of guidance. After four consecutive years of expense decreases (2009-2012), in 2013 the Company experienced only a slight increase of 1.8%. In 2014, some of the line items where the Company expects above average increases include: repairs and maintenance costs up 4.0%; personnel costs (specifically from health care and the effects of new regulations) up 5.2%; real estate taxes up 5.6%; and property insurance up 7.0%.

These revenue and expense projections result in 2014 Core Properties NOI growth of 3.0% at the midpoint of 2014 guidance. Markets where the Company expects NOI results above the average include: Boston 3.9%, North Lauderdale 3.8%, Philadelphia 3.8% and Washington, D.C. 3.2%. Markets with below average expectations include: Baltimore 2.7%, Chicago 2.5% and Long Island, New Jersey 1.7%. Certain historical demographic information for these markets may be found in the tables on pages 10 and 11 of this report.

Of the two items comprising NOI, revenue and operating expenses, the operating expense component is likely to be more volatile. It is difficult to predict the weather, which can have a significant effect, and there continues to be growing concern about real estate tax rate reassessments.

The Company has anticipated acquisitions in the range of $150 million to $250 million in its budget for 2014. The Company is committed to a disciplined approach to acquisitions. If cap rates stabilize, interest rates continue to be historically low, and NOI growth rates improve, the Company may take a more aggressive approach. The Company expects to dispose of between $160 million and $260 million of properties for 2014. After many years of being a net acquirer, and a net seller in 2013, the Company is looking to create a better balance, with an equal range targeted of acquisitions and dispositions in 2014. Property sale proceeds add another significant source of capital, reducing reliance on debt and equity sources.

During 2014, the Company will target leverage in a range from 38.0% to 38.5% of debt-to-total value (value as calculated under the terms of the line of credit facility) in order to meet the goals described above. This level is the same to slightly less than at the end of 2013.


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Results of Operations (dollars in thousands, except unit and per unit data)

Comparison of year ended December 31, 2013 to year ended December 31, 2012.

The Company owned 112 communities with 38,440 apartment units throughout 2012 and 2013 where comparable operating results are available for the years presented (the "2013 Core Properties"). For the year ended December 31, 2013, the 2013 Core Properties showed an increase in total revenues of 3.2% and a net operating income increase of 4.0% over the 2012 period. Property level operating expenses increased 1.8%. Average physical occupancy for the 2013 Core Properties was 95.3%, down from 95.4% in 2012, with average monthly rental rates of $1,294 per apartment unit, an increase of 3.2% over the 2012 period.

A summary of the 2013 Core Properties NOI is as follows:

                              2013         2012       $ Variance     % Variance
Rent                        $563,457     $546,292        $17,165           3.1%
Utility recovery revenue      22,968       22,379            589           2.6%
Rent including recoveries    586,425      568,671         17,754           3.1%
Other income                  27,178       26,013          1,165           4.5%
Total revenue                613,603      594,684         18,919           3.2%
Operating and maintenance   (221,537 )   (217,682 )       (3,855 )        (1.8% )
Net operating income        $392,066     $377,002        $15,064           4.0%

NOI falls within the definition of "non-GAAP financial measure" set forth in Item 10(e) of Regulation S-K and, as a result, the Company is required to include in this report a statement disclosing the reasons why management believes that presentation of this measure provides useful information to investors. The Company believes that NOI is helpful to investors as a supplemental measure of the operating performance of a real estate company because it is a direct measure of the actual operating results of the Company's apartment communities. In addition, the apartment communities are valued and sold in the market by using a multiple of NOI. The Company also uses this measure to compare its performance to that of its peer group. For a reconciliation of NOI to income from continuing operations, please refer to Note 14 to Consolidated Financial Statements, under Part IV, Item 15 of this Form 10-K.

During 2013, the Company acquired two apartment communities with 457 units and placed into service another 90 units at one development community (the "2013 Acquisition Communities"). In addition, the Company experienced full year results for the three apartment communities with 2,018 units acquired and 314 units placed into service at two development communities during 2012 (the "2012 Acquisition Communities"). The Company has one community with 851 units undergoing significant renovations beginning in 2011 such that the operating results are not comparable to 2013 due to units being taken out of service during the redevelopment period (the "Redevelopment Community"). The inclusion of these acquired and developed communities generally accounted for the significant changes in operating results for the year ended December 31, 2013.


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Results of Operations (continued)



A summary of the NOI from continuing operations for the Company as a whole is as
follows:



                              2013         2012      $Variance     % Variance
Rent                        $608,994     $575,969      $33,025           5.7%
Utility recovery revenue      24,550       23,374        1,176           5.0%
Rent including recoveries    633,544      599,343       34,201           5.7%
Other income                  28,876       27,335        1,541           5.6%
Total revenue                662,420      626,678       35,742           5.7%
Operating and maintenance   (238,510 )   (229,290 )     (9,220 )        (4.0% )
Net operating income        $423,910     $397,388      $26,522           6.7%

During 2013, the Company disposed of four properties in four transactions with a total of 1,013 units, which had partial results for 2013 and full year results for 2012. During 2012, the Company disposed of six properties in six transactions with a total of 1,596 units, which had partial results for 2012. The results of these disposed properties have been reflected in discontinued operations and are not included in the tables above.

For the year ended December 31, 2013, income from continuing operations increased by $33,594 when compared to the year ended December 31, 2012. The increase was primarily attributable to the following factors: an increase in rental income of $33,025, an increase in property other income of $2,717, a decrease in general and administrative expense of $5,667, a decrease in interest expense of $9,963, and a decrease in other expenses of $2,429. These changes were partially offset by increases in operating and maintenance expense of $9,220, and depreciation and amortization of $11,856. Each of the items are described in more detail below.

Of the $33,025 increase in rental income, $14,606 is attributable to the 2012 Acquisition Communities, $97 is attributable to the 2013 Acquisition Communities and $1,157 is attributable to the Redevelopment Community. The balance, an increase of $17,165, relates to a 3.1% increase from the 2013 Core Properties as the result of economic occupancy decreasing 0.1% to 94.4% and a 3.2% increase in weighted average rental rates to $1,294 from $1,254 per apartment unit.

Of the $1,176 increase in utility recovery revenue, $558 is attributable to the 2012 Acquisition Communities and $29 is attributable to the Redevelopment Community. The balance, an increase of $589, relates to a 2.6% increase from the 2013 Core Properties, primarily due to a new trash recovery program in 2013 and an increase in water & sewer costs which is billed to residents.

The remaining property other income, which consists primarily of income from operation of laundry facilities, late charges, administrative fees, garage and carport rentals, revenue from corporate apartments, cable revenue, pet charges, and miscellaneous charges to residents, increased by $1,541. Of this increase, $491 is attributable to the 2012 and 2013 Acquisition Communities and $1,165 is attributable to the 2013 Core Properties resulting primarily from an increase of $827 in damages and other charges due to increased resident turnover. The remaining Core Properties increase of $338 primarily relates to increases in renters insurance door fees, pet fee income, corporate apartment revenue, late fees and incentive rebates, partially offset by lower cable revenue due to the 2012 period including nonrecurring income as a result of signing new contracts with cable providers which offer enhanced services in addition to basic cable. These increases were partially offset by a $115 reduction for the Redevelopment Community.

Of the $9,220 increase in operating and maintenance expenses, $5,092 is attributable to the 2012 Acquisition Communities, $159 is attributable to the 2013 Acquisition Communities and $114 is attributable to the Redevelopment Community. The balance, an increase of $3,855, relates to a 1.8% increase from the 2013 Core Properties primarily as a result of increases in personnel expense, real estate taxes and snow removal costs. These increases were partially offset by decreases in property insurance and property management G&A.


Table of Contents

Results of Operations (continued)



The breakdown of operating and maintenance costs for the 2013 Core Properties by
line item is listed below:



                            2013          2012        $ Variance     % Variance
Electricity               $   8,042     $   8,031      $     (11 )        (0.1% )
Gas                          13,742        13,695            (47 )        (0.3% )
Water & sewer                18,407        18,264           (143 )        (0.8% )
Repairs & maintenance        31,583        31,824            241           0.8%
Personnel expense            51,158        49,328         (1,830 )        (3.7% )
Advertising                   4,780         4,823             43           0.9%
Legal & professional          1,941         1,945              4           0.2%
Office & telephone            6,292         6,469            177           2.7%
Property insurance            6,116         6,939            823          11.9%
Real estate taxes            58,959        56,372         (2,587 )        (4.6% )
Snow                          1,306           425           (881 )      (207.3% )
Trash                         3,343         3,386             43           1.3%
Property management G&A      15,868        16,181            313           1.9%
Total                     $ 221,537     $ 217,682      $  (3,855 )        (1.8% )

Natural gas heating costs were up $47, or 0.3%, from a year ago due to increased consumption resulting from a colder heating season in 2013 as compared to 2012 partially offset by lower commodity rates. For 2013, the Company's natural gas weighted average cost, including transportation of $3.00 per decatherm, was $7.78 per decatherm, compared to $8.32 per decatherm for the 2012 period, a 6.5% decrease.

In January, 2014, the Company has fixed-price contracts covering 98.5% of its natural gas exposure for the balance of the 2013-14 heating season. Risk is further diversified by staggering contract term expirations. For the balance of the 2013-14 heating season, the Company estimates the average price per decatherm will be approximately $4.70, excluding transportation, which has historically approximated $3.00 per decatherm. For the 2014-15 heating season, the Company has fixed-priced contracts covering approximately 89.9% of its natural gas exposure for an estimated weighted average cost for fixed and floating rate contracts of $4.42 per decatherm, excluding transportation.

Water & sewer costs were up $143, or 0.8%, from a year ago and are attributable to general rate increases being assessed by local municipalities. The water & sewer recovery program enabled the Company to recapture much of these rate increases from our residents.

Repairs & maintenance expenses were down $241, or 0.8%, primarily due to accounting for involuntary conversions related to fires and floods and the associated insurance claims at certain properties. Without the impact of these recoveries, the recurring repairs & maintenance expenses increased $710, or 2.2%, as a result of higher resident turnover of 40.5% in 2013 as compared to 39.0% in 2012, which leads to higher spending on apartment turnover costs.

Personnel expenses were up $1,830, or 3.7%, primarily due to a significant increase of $1,829, or 89.3%, in health insurance, which was driven by higher self-insured claims in 2013, coupled with the annual wage increase of 2.6%, or $1,100. These increases were partially offset by $822, or 52.8%, lower workers compensation insurance costs driven by favorable claims experience and $390, or 14.1%, lower incentive compensation for property management personnel.

Advertising expenses were down $43, or 0.9%, in 2013 and is reflective of the resident marketing program which placed less emphasis and spending on print media than in 2012 and more focus on internet-based methods and resident programs which helped result in a 2.5% increase in signed leases in 2013 as compared to 2012.


Table of Contents

Results of Operations (continued)

Office & telephone expenses were down $177, or 2.7%, primarily due to $249 non-recurring refunds of certain resident fees from prior years in 2012. Without the impact of this non-recurring expense, office & telephone expense increased $72, or 1.2%.

Property insurance costs decreased by $823, or 11.9%, primarily due to continued favorable close-outs of prior year self insured general liability claims which yielded $1,378 in savings in 2013 compared to $338 in 2012 and favorable close-outs of prior year property claims of $505 in 2013. These savings were offset by property losses in 2013 of $2,644 compared to $1,421 in 2012, with the 2013 increase attributable to a significant fire at one of the Company's communities. Without the impact of the major items above, recurring property and general liability insurance costs were down $501, or 8.5%.

Real estate taxes were up $2,587, or 4.6%, primarily due to typical rate increases and annual tax assessment increases in our markets, some of which are triggered by our investments in apartment upgrades and repositioning. If not for successful tax assessment challenges and tax incentive programs which resulted in savings of $2,098 and $1,306 in 2013 and 2012, respectively, property taxes increased $3,379, or 5.9%. The Company continues to challenge tax assessments on existing properties and apply for tax incentive programs for newly developed properties where appropriate.

Snow removal costs were up $881, or 207.3%, primarily due to 2013 experiencing a more normal winter season compared to 2012 where most of our Northeast and Mid-Atlantic properties experienced the mildest winter on record.

Property management general & administrative costs decreased $313, or 1.9%. Despite increases in the number of apartment communities and units, the Company has been able to offset costs of growth due to its scalable operating platform, including efficiencies enabled by key application software investments.

The operating expense ratio (the ratio of operating and maintenance expense compared to rental and property other income) for the 2013 Core Properties was 36.1% and 36.6% for 2013 and 2012, respectively. The 0.5% favorable improvement in 2013 is due in part to deliberate cost savings and safety initiatives implemented at the communities and rental income growth. In general, the Company's operating expense ratio is higher than that experienced by apartment owners in other parts of the country due to relatively high real estate taxes and heating costs in its markets.

General and administrative expenses ("G&A") decreased in 2013 by $5,667, or 16.6%, from $34,174 in 2012 to $28,507 in 2013. G&A as a percentage of total revenues (including discontinued operations) was 4.2% for 2013 as compared to 5.2% for 2012. The 2012 costs included $1,580 in connection with the departure of an executive and represent acceleration of previously granted stock-based compensation as well as future payments for salary continuation. Employee stock-based compensation expenses were down $3,391, or 28.4%, in 2013, of which $3,910 was due to a final grant of arrears-based restricted stock and stock options in the 2012 period to executives, which did not occur in 2013 as the executive equity compensation switched primarily to a new three year performance restricted stock unit program in 2012. The cost of the performance based equity program was $519 higher in 2013 due to the impact of executives at, or near retirement age, being expensed immediately or over a one year shorter period in 2013. In addition, the 2013 corporate bonus costs were $922 less than the 2012 period.

Interest expense decreased by $9,963, or 8.0%, in 2013 primarily as a result of paying off $250,000 in maturing loans on several Core Properties over the past year. In addition, both 2013 Acquisition Communities were acquired without secured mortgage debt and only one 2012 Acquisition Community was acquired with assumed secured mortgage debt of $7,284. Refer to the information under the heading "Liquidity and Capital Resources" below for specific discussion of debt transactions impacting the average rate and overall interest expense.


Table of Contents

Results of Operations (continued)

Depreciation and amortization expense increased $11,856, or 7.4%, due to a full year of depreciation expense for the 2012 Acquisition Communities, incremental depreciation on the capital expenditures for additions and improvements to the Core Properties of $121,144 and $140,735 in 2013 and 2012, respectively, as well as a partial year of depreciation expense for the 2013 Acquisition Communities.

Other expenses of $312 in 2013 and $2,741 in 2012 are property acquisition costs, primarily transfer taxes and title fees, which represent 0.56% and 0.92% of the total purchase price of the 2013 and 2012 Acquisition Communities, respectively.

Net income increased $27,957 in 2013 primarily due to an increase in income from continuing operations of $33,594 due to improved operating results from the 2013 Core Properties, the full year results of the 2012 Acquisition Communities plus a partial year impact of the operating results of the 2013 Acquisition Communities. This is partially offset by $6,310 lower income from discontinued operations in 2013 compared to 2012.

Comparison of year ended December 31, 2012 to year ended December 31, 2011.

The Company owned 103 communities with 35,202 apartment units throughout 2011 and 2012 where comparable operating results are available for the years presented (the "2012 Core Properties"). For the year ended December 31, 2012, the 2012 Core Properties showed an increase in total revenues of 4.6% and a net operating income increase of 8.3% over the 2011 period. Property level operating expenses decreased 1.2%. Average physical occupancy for the 2012 Core Properties was 95.6%, up from 95.4% in 2011, with average monthly rental rates of $1,235 per apartment unit, an increase of 4.2% over the 2011 period.

A summary of the 2012 Core Properties NOI is as follows:

                              2012         2011       $ Variance     % Variance
Rent                        $493,512     $471,761        $21,751           4.6%
Utility recovery revenue      19,862       20,021           (159 )        (0.8% )
Rent including recoveries    513,374      491,782         21,592           4.4%
Other income                  23,695       21,571          2,124           9.8%
Total revenue                537,069      513,353         23,716           4.6%
Operating and maintenance   (197,001 )   (199,332 )        2,331           1.2%
Net operating income        $340,068     $314,021        $26,047           8.3%

During 2011, the Company acquired eight apartment communities with 2,817 units and placed into service another 270 units at two development communities (the "2011 Acquisition Communities"). The inclusion of the 2012 Acquisition Communities and 2011 Acquisition Communities generally accounted for the significant changes in operating results for the year ended December 31, 2012.

A summary of the NOI from continuing operations for the Company as a whole is as follows:

                              2012         2011      $Variance     % Variance
Rent                        $575,969     $500,328      $75,641          15.1%
Utility recovery revenue      23,374       21,132        2,242          10.6%
Rent including recoveries    599,343      521,460       77,883          14.9%
Other income                  27,335       22,973        4,362          19.0%
Total revenue                626,678      544,433       82,245          15.1%
Operating and maintenance   (229,290 )   (211,307 )    (17,983 )        (8.5% )
Net operating income        $397,388     $333,126      $64,262          19.3%


Table of Contents

Results of Operations (continued)

During 2013, the Company disposed of four properties in four transactions with a total of 1,013 units, which had full year results for 2012 and 2011. During 2012, the Company disposed of six properties in six transactions with a total of 1,596 units, which had partial results for 2012 and full year results for 2011. The results of these disposed properties have been reflected in discontinued operations and are not included in the tables above.

For the year ended December 31, 2012, income from continuing operations increased by $36,711 when compared to the year ended December 31, 2011. The increase was primarily attributable to the following factors: an increase in rental income of $75,641, an increase in property other income of $6,604, a decrease in interest expense of $1,381, and a decrease in other expenses of . . .

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