Item 1. BUSINESS
The Company General
United Dominion Realty Trust, Inc., a Virginia corporation, (collectively with its subsidiaries, the "Company"), is a self-administered equity real estate investment trust ("REIT"), engaged in the ownership, acquisition and development of apartment communities primarily across the Sunbelt region of the United States.
Formed in 1972, the Company is headquartered in Richmond, Virginia with regional offices in Richmond, Dallas, Atlanta, Orlando and Houston, and area offices in the previously mentioned cities plus Columbia, Raleigh, Charlotte, Tampa, Nashville, San Antonio and Phoenix. The regional offices are responsible for the operation, acquisition, construction and asset management activities in their respective geographic regions. The Company had approximately 2,100 employees as of March 13, 1998.
The Company manages its properties directly, rather than through outside property management firms. During 1997, the cost of internal property management of the Company's apartment communities totaled approximately 3.2% of rental revenue. In determining its cost of self management, the Company considers all direct and indirect costs associated with the internal property management function.
The Company operates as a real estate investment trust under the applicable provisions of the Internal Revenue Code of 1986, as amended (the "Code"). To qualify, the Company must meet certain tests which, among other things, require that its assets consist primarily of real estate, its income be derived primarily from real estate and at least 95% of its taxable income be distributed to its common shareholders. Because the Company qualifies as a REIT, it is generally not subject to federal income taxes.
Apartments and Markets
At December 31 1997, the Company's apartment portfolio included 225 apartment communities having a total of 62,789 completed apartment homes and 1,064 apartment homes under development (See Item 2, "Properties."). The apartment community is the Company's basic business unit and is staffed with well trained property management personnel. The communities have a community director, leasing assistants and a maintenance staff who oversee the daily operation of the communities. Other than Dallas, Texas where 14% of the Company's apartment homes are located, no other market has more than 6% of the Company's communities. The Company's apartment communities consist primarily of upper middle to moderate income garden and townhouse communities which make up the broadest segment of the apartment market. Most of the communities are considered to be "B" grade quality although the Company does own class A properties that compete at or near the top of their respective markets. "B" grade communities are generally either of 1980's construction, located in good neighborhoods or 1970's construction in good neighborhoods where the apartments have been, or can be, significantly upgraded and repositioned. Management believes that these well located apartments offer the Company a good combination of current income and longer-term income growth.
The Company's apartment operations are divided into four geographic regions, each of which constitutes a core operating unit . The Northern Region includes Delaware, Maryland, Virginia and northern North Carolina. The Southern Region includes Charlotte, North Carolina, South Carolina, Georgia, Tennessee and Alabama. The Florida Region consists of the entire state of Florida, while the Western Region includes Texas, Arkansas, Oklahoma, Nevada, New Mexico and Arizona.
In 1997, the Company designated 23 markets throughout the Sunbelt in which it wanted to own and operate a significant number of apartment communities. Geographic market diversification is important as it balances the portfolio performance and makes the Company less susceptible to cyclical real estate cycles and economies in a specific market. In a given year, the Company will have some markets that are strong, many that are balanced and some that are oversupplied. However, with its market diversification, the Company's aggregate results of operations are anticipated to be balanced year to year. By the end of 1998, the Company plans to be an owner and operator in 30 major markets.
Although there is no known move toward rent control in any of the markets in which the Company currently owns apartments, the Company's ability to raise rents to cover increases in operating expenses might be impaired should rent control legislation be enacted. As the Company has expanded, attempts have been made to avoid markets where the exposure to reduced defense spending is believed to be high. Size and geographical diversification can smooth the overall performance of the Company during natural real estate cycles.
In the beginning of 1996, most of the southeast apartment markets were in equilibrium with supply and demand balanced, however, occupancy began to fall during the second half of the year which was primarily due to a combination of factors which included: (i) slower job growth, (ii) an increase in the home ownership rate and (iii) an increase in the supply of new apartments. Physical occupancy at the Company's apartment communities averaged 91.9% for December 1996 and bottomed out in January 1997 at 91.6%. Occupancy grew steadily throughout 1997 as these markets began to recover, and by December 1997, physical occupancy had increased to 92.6%, one full basis point above the beginning of the year. In 1997, the increased supply led to softness in certain of the Company's southeastern markets, however, supply and demand in the Company's markets are generally in equilibrium.
Business and Operating Strategies
The Company seeks to increase shareholder value by (i) generating growth in the operating results of its existing apartment communities, (ii) acquiring apartment communities that will provide a good long-term investment, (iii) developing communities in its existing markets which provide above market yields, (iii) selling communities that no longer meet the its investment criteria and (iv) financing its activities at the lowest possible cost of capital.
The Company's current strategy includes three major elements designed to position the Company for the future which includes the following: (i) to establish the Company as a national owner of apartment communities by entering new markets, (ii) to achieve sufficient size in designated major markets by continuing to grow in existing markets and (iii) to upgrade the portfolio by selling 20% of the Company's apartment portfolio, in terms of asset quality and location, in order to upgrade the overall quality of the portfolio to "B" grade. The Company believes that being a dominant owner in a market has the following advantages:
o Being a local market leader. o Improving operating margins as operating costs are driven down through economies of scale and efficiencies in operations. o Efficiently market services to residents. o Benefit from utility deregulation by purchasing utilities in bulk and remarketing them to residents. o Building stronger local and regional teams of associates. o Increase acquisition and development opportunities. o Spread the risk of economic downturns by operating in numerous markets. o Create name recognition and loyalty.
To fully execute this strategy, the Company will focus some of its acquisition efforts on new markets in different parts of the country, concentrating on opportunities that will create value for the Company. However, because of the increase in prices for acquisition properties, the Company is placing additional emphasis on development, as it provides added flexibility to grow in its existing markets.
Acquisitions
The Company seeks to acquire apartment communities that can provide returns on investment in excess of the Company's cost of capital and that are projected to provide first year weighted average returns on investment of at least 9-9 1/2%. While the Company seeks positive spreads on its nominal cost of capital, the ability to add value by repositioning the community, adding features that provide higher returns on incremental investment and growing non-rental income, can be more important than the current yield. The Company's goal is to achieve a 10 1/2% rate of return by the third year of ownership. During 1997, the Company acquired 28 apartment communities containing 8,524 apartment homes, net of one resold, at a total cost (including closing costs) of approximately $342 million. Of the 28 apartment communities purchased, 27 were located in the Company's major markets. All of the communities acquired offered an opportunity for the Company to add features that would be revenue enhancing and, therefore, add value. The Company expects to acquire approximately 8,000 to 10,000 apartment homes for an aggregate purchase price ranging from $350 million to $450 million during 1998, excluding the merger with ASR Investment Corporation. The 1998 acquisition activity will be focused primarily in Florida, the Southwest and Northwest.
The following table summarizes the Company's growth during the last five years (dollars in thousands)
(a) Includes 14,320 completed apartment homes and 675 homes under development acquired in connection with the South West Property Trust Inc. merger on December 31, 1996.
Mergers
Prior to 1990, the Company was the only major publicly held REIT focusing predominantly on apartment investments. Since then, a number of new multifamily REITs have been formed. Some of these REITs may seek to be acquired by larger, more strongly capitalized REITs that have superior access to the capital markets. The Company has been a major participant in this real estate consolidation process, having acquired apartment portfolios in each of the last three years. The Company completed the South West Property Trust Inc. Merger ("South West Merger") on December 31, 1996 which contained 14,320 apartment homes located throughout the Sunbelt. The South West Merger provided the Company with significant diversification beyond its traditional Southeast and Mid-Atlantic markets, expanding the Company into Southwestern markets. The Company intends to participate in the real estate consolidation process by acquiring private and public real estate companies in strategic mergers and portfolio transactions that meet the Company's objective to increase size in existing markets or to expand geographically.
Effective at the close of business on March 27, 1998, ASR Investment Corporation ("ASR") was merged with and into a wholly owned subsidiary of the Company. ASR owns approximately 7,500 apartment homes in the Southwest and Northwest which satisfies the Company's objective of obtaining greater size in its Southwest markets and gaining entry into new markets. The merger was treated as a purchase for accounting purposes and had an aggregate purchase price estimated at approximately $330 million, including closing costs.
Real estate under development
Development activity is focused in certain of the Company's major markets. With acquisition costs approaching replacement cost and the spreads over the Company's cost of capital narrowing, building in selected markets enables the Company to increase its return on investment. During 1997, the Company increased its level of development activity, completing the development of 1,067 apartment homes in five additional phases to existing communities and one new apartment community. During 1997, the Company invested $52.2 million in eleven properties under development, which includes four new apartment communities and seven additional phases to existing
apartment communities. The Company plans to invest approximately $100 million on the development of new apartment communities and additional phases to existing apartment communities during 1998 which are anticipated to provide stabilized returns on investment in the 10% to 10 1/2% range. At December 31, 1997, the Company had three new apartment communities and two additional phases to existing communities under development containing a total of 1,276 apartment homes (212 of which were completed).
Existing Communities
The Company's net income is primarily generated from the operations of its apartment communities. During 1997, the Company's mature apartment communities (those communities acquired, developed and stabilized prior to January 1, 1996 and held throughout the annual reporting period) consisted of 127 apartment communities containing 31,519 apartment homes. These mature communities provided strong rental growth of 3.8% which was coupled with only a 2.2% increase in rental expenses. Average economic occupancy and rental rates at the Company's mature apartment communities (those acquired, developed and stabilized prior to January 1, 1996) during the comparable periods are set forth below:
1997 1996 1995 ---- ---- ---- Economic occupancy 92.6% 92.8% 94.8% Average monthly rental rates $572 $540 $516
The Company's strategic objectives include upgrading the apartment portfolio through the addition of features and initiatives to the communities that are appropriate for the market and which will support higher rents.
Value enhancing improvements plus improvements that substantially extend the useful life of an existing asset are capitalized. A significant portion of the Company's capital expenditures relates to an upgrade program that began in 1996 to modernize certain older apartment communities. This program, which primarily involves updating kitchens and bathrooms, contributed to the rent growth at the mature apartment communities during 1997 and will continue to give these communities a competitive advantage in their respective markets. In addition, several initiatives which are considered revenue enhancing are under way that either allow the Company to increase rents by more than the inflationary rate or allow the Company to pass expenses to residents including: (i) sub-metering of water and sewer to residents where local and state regulations allow, (ii) gating and fencing of apartment communities, (iii) installing monitoring devices such as intrusion alarms or controlled access devices, (iv) enlarging fitness centers, (v) adding business centers and (vi) constructing carports, garages and self storage units.
Sales
The Company continually undertakes portfolio review analysis with the objective of identifying communities that do not meet long-term investment objectives due to size, location, age, quality and/or performance. In 1997, the Company implemented a plan to sell 20% of its apartment portfolio which did not meet the Company's long-term investment objectives. During 1997, the Company sold twelve apartment communities and one shopping center for an aggregate sales price of $68.4 million and received net proceeds of approximately $64.0 million. The average age of communities sold was 24 years, which was 13 years older than the average age of the Company's 1997 acquisitions. At December 31, 1997, the Company had 25 apartment communities containing 6,907 apartment homes included in real estate held for disposition.
Management has determined that by grouping communities and offering them for sale as a portfolio is more efficient and provides greater opportunities for disposition. As a result, the Company plans to sell approximately $75 million of assets each quarter in 1998 and expects to complete the disposition program by the end of 1998.
In January 1998, the company sold a 2,406 home portfolio of five Texas communities for approximately $65.6 million and has a second portfolio under contract for sale. The proceeds from the property sales will be used to acquire apartment communities and fund the development program.
Financing Strategies
As a qualified REIT, the Company distributes a substantial portion of its cash flow to its shareholders in the form of distributions. The Company seeks to retain sufficient cash to cover normal operating needs, including routine
replacements and to help fund additional acquisitions and development activity. The Company utilizes a variety of primarily external financing sources to fund portfolio growth, major capital improvement programs and balloon debt payments. Bank lines of credit generally have been used to temporarily finance these expenditures, and subsequently this short-term bank debt has been replaced with longer-term debt or equity. The Company may also fund its capital requirements through (i) the assumption of mortgage indebtedness, (ii) property sales, (iii) common shares sold through the Company's Dividend Reinvestment and Stock Purchase Plan, (iv) retained operating cash flow, (v) the issuance of operating partnership units and (vi) the use of unused credit facilities. At December 31, 1997, the Company had the following credit facilities outstanding: (i) $200 million three year unsecured revolving credit facility (which includes a $100 million competitive bid option which allows the Company to solicit bids from participating banks at rates below the contractual rate), (ii) a $50 million one year unsecured line of credit and (iii) a $15 million uncommitted line of credit with a major U.S. financial institution. At December 31, 1997, the Company had $135.6 million of borrowings outstanding under these credit facilities.
During 1997, the Company completed the following financing activities: (i) issued 4 million shares of common stock at $15.75 per share, netting proceeds of $59.4 million, (ii) issued $125 million of 7.25% Notes, (iii) sold 6 million shares of 8.60% Series B Redeemable Preferred Stock at $25 per share, for net proceeds of $145.1 million, (iv) raised $39.7 million under the Dividend Reinvestment and Stock Purchase Plan, (v) assumed debt of $60 million in connection with the acquisition of apartment communities and (vi) issued 849,000 Operating Partnership Units valued at $13 million.
Depending on the volume and timing of acquisition activity, the Company anticipates raising additional debt and equity capital during the next twelve months to finance capital requirements while striving to minimize the overall cost of capital, however, the 1998 acquisition and development activity is expected to be funded primarily with the proceeds from the planned sales of communities.
Competition
In most of the Company's markets, the competition for residents among communities is extremely intense as some competing communities offer features that Company's properties do not have. Also, some competing communities are larger and/or newer than the Company's communities. The competitive situation of each community varies and intensifies as additional properties are constructed.
When in the market for new acquisitions, the Company competes with numerous other investors, including other REITs, individuals, partnerships, corporations, pension funds, insurance companies, foreign investors and other real estate entities. Although the Company has certain advantages because of its substantial presence in its markets and its access to capital, some competing investors are larger than and may have a competitive advantage over the Company in terms of assets and other investment resources. During 1997, the competition for both single property and portfolio acquisitions intensified which resulted in lower acquisition capitalization rates. Management believes that the Company, in general, is well positioned in terms of economic and other resources to compete effectively and intends to maintain its pricing discipline while continuing to pursue acquisitions that meet the Company's long-term investment objectives.
Environmental Regulations
To date, compliance with federal, state, and local environmental protection regulations has not had a material effect on the capital expenditures, earnings or competitive position of the Company. However, over the past few years, concerns have been raised regarding the presence of asbestos and other hazardous materials in existing real estate properties. In response to this, on March 1, 1991, the Company adopted a property management plan for hazardous materials. As part of the plan, Phase I environmental site investigation and reports have been completed for each property owned by the Company and not previously inspected. In addition, all proposed acquisitions are inspected prior to acquisition. The inspections are conducted by qualified environmental consultants, and the report issued is reviewed by the Company prior to the purchase or development of any property. Nevertheless, it is possible that the Company's environmental assessments will not reveal all environmental liabilities, or that some material environmental liabilities exist in which the Company is unaware. In some cases, the Company has abandoned otherwise economically attractive acquisitions because the costs of removal or control have been prohibitive and/or the Company has been unwilling to accept the potential risks involved. The Company does not believe it will be required to remediate any asbestos
materials at any of its properties as asbestos is managed in place in accordance with current environmental laws and regulations. Management believes that through professional environmental inspections and testing for asbestos and other hazardous materials, coupled with a conservative posture toward accepting known risk, the Company can minimize its exposure to potential liability associated with environmental hazards.
The Company is unaware of any environmental hazards at any of its properties which individually or in the aggregate may have a material adverse impact on its operations or financial position. The Company has not been notified by any governmental authority, and is not otherwise aware, of any material non-compliance, liability or claim relating to environmental liabilities in connection with any of its properties. The Company does not believe that the cost of continued compliance with applicable environmental laws and regulations will have a material adverse effect on the Company or its financial condition or results of operations. There can be no assurance, however, that future environmental laws, regulations or ordinances will not require additional remediation of existing conditions that are not currently actionable. Also, if more stringent requirements are imposed on the Company in the future, the costs of compliance could have a material adverse effect on the Company or its financial condition. To the best of its knowledge, the Company is in compliance with all applicable environmental rules and regulations.
Operating Partnership - United Dominion Realty Trust, L.P.
On October 23, 1995, the Company organized United Dominion Realty, L.P. (the "Partnership") under the Virginia Revised Uniform Limited Partnership Act, as amended (the "Partnership Act"). The Company is the sole General Partner of the Partnership and currently holds an 89.4% interest. The Partnership is intended to assist the Company in competing for the acquisition of properties that meet the Company's investment strategies from seller partnerships, some or all of whose partners may wish to defer taxation of gain realized on sale through an exchange of partnership interests.
The Partnership was organized under a First Amended and Restated Agreement of Limited Partnership dated as of December 31, 1995 which was subsequently amended in the Second Amended and Restated Agreement of Limited Partnership dated as of August 30, 1997 (the "Partnership Agreement"). A summary of certain provisions of the Partnership Agreement is set forth below. The summary does not purport to be complete and is subject to and qualified in its entirety by reference to applicable provisions of the Partnership Act and the complete Partnership Agreement. The Partnership Agreement is filed as an exhibit to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997.
Admission of Limited Partners; Investment Agreements
The Company presently intends to limit admission to the Partnership to Limited Partners who are "accredited investors," as defined in Rule 501(a) under the Securities Act of 1933, as amended (the "Securities Act"). Limited Partners will be admitted upon executing and delivering to the Company an Investment Agreement (the "Investment Agreement") and delivering to the Partnership the consideration prescribed therein. In the Investment Agreement, the prospective Limited Partner makes both representations as to his status as an accredited investor and other representations and agreements regarding the Units (defined below) to be issued to him, thus, assuring compliance with the Securities Act. Any rights to Securities Act registration of the Common Stock of the Company issued to such Limited Partner upon redemption of his Units (see "Redemption Rights" below), will also be set forth in the Investment Agreement or a separate registration rights agreement.
Units
The interests in the Partnership of the Partnership's limited partners (the "Limited Partners") are represented by units of limited partnership interest (the "Units"). All holders of Units are entitled to share in the cash distributions from, and in the profits and losses of, the Partnership. Distributions by the Partnership are made equally for each Unit outstanding.
As the Partnership's sole General Partner, the Company intends to make distributions per Unit in the same amount as the cash dividends paid by the Company on each share of Common Stock. However, because Partnership properties, which are the primary source of cash available for distribution to Unit holders, are significantly fewer than properties held directly by the Company and may not perform as well, there can be no assurance that distributions per Unit will always equal Common Stock dividends per share. A distribution made to the Company that enables it to maintain its REIT status (see "Management and Operations" below) may deplete cash otherwise available to Unit holders. The Partnership may borrow from the Company for the purpose of equalizing per Unit and per Common share distributions, but neither the Partnership nor the Company is under any obligation regarding Partnership borrowings for this or any other purpose.
The Limited Partners have the rights to which limited partners are entitled under the Partnership Act. The Units are illiquid, they are not registered for secondary sale under any securities are laws, state or federal, and they cannot be transferred by a holder except as provided in the Partnership Agreement and unless they are registered as such or an exemption from such registration is available. Except as provided in any Investment Agreement or other agreement with a partner, neither the Partnership nor the Company is under any obligation to effect any such registration or to establish any such exemption. The Partnership Agreement imposes additional restrictions on the transfer of Units, as described below under "Transferability of Interests."
Management and Operations
The Company, as the sole General Partner of the Partnership, has full, exclusive and complete responsibility and discretion in the management and control of the Partnership. The Limited Partners have no authority to transact business for, or participate in the management activities or decisions of the Partnership.
The Partnership Agreement requires that the Partnership be operated in a manner that will enable the Company to both satisfy the requirements for being classified as a REIT and avoid any federal income tax liability. The General Partner is expressly directed, notwithstanding anything to the contrary in the Partnership Agreement, to cause the Partnership to distribute amounts (including proceeds of Partnership borrowings) that sufficiently enable the Company to pay distributions to its shareholders that are required in order to maintain REIT status and to avoid income tax or excise tax liability.
Ability to Engage in Other Businesses; Conflicts of Interest
The Company and other persons (including officers, directors, employees, agents and other affiliates of the Company) are not prohibited under the Partnership Agreement from engaging in other business activities, including business activities substantially similar or identical to those of the Partnership. The Company will not be required to present any business opportunities to the Partnership or to any Limited Partner.
Borrowing by the Partnership
The General Partner is authorized under the Partnership Agreement to cause the Partnership to borrow money and to issue and guarantee debt as it deems necessary for the conduct of the activities of the Partnership. Such debt may be secured by mortgages, deeds of Company, pledges or other liens on the assets of the Partnership.
Reimbursement of General Partner; Transactions with the General Partner and its Affiliates
The General Partner will receive no compensation for its services as General Partner of the Partnership. However, as a partner in the Partnership, the General Partner has the same right to allocations of profit and loss and distributions as other partners of the Partnership. In addition, the Partnership will reimburse the General Partner for all expenses it incurs relating to the ownership and operation of, or for the benefit of, the Partnership and any offering of Units or other partnership interests, and for the pro rata share of the expenses of any offering of securities of the Company some or all of the proceeds of which are contributed to the Partnership.
Liability of General Partner and Limited Partners
The General Partner is liable for all general obligations of the Partnership to the extent not paid by the
Partnership. The General Partner is not liable for the non-recourse obligations of the Partnership.
The Limited Partners are not required to make further capital contributions to the Partnership after their respective initial contributions are fully paid. Assuming that a Limited Partner acts in conformity with the provisions of the Partnership Agreement, the liability of the Limited Partner for obligations of the Partnership under the Partnership Agreement and Partnership Act will be limited to, subject to certain possible exceptions, the loss of the Limited Partner's investment in the Partnership.
The Partnership is qualified to conduct business in each state in which it owns property and may qualify to conduct business in other jurisdictions. Maintenance of limited liability may require compliance with certain legal requirements of those jurisdictions and certain other jurisdictions. Limitations on the liability of a limited partner for the obligations of a limited partnership have not clearly been established in many states. Accordingly, if it were determined that the right, or exercise of the right by the Limited Partners, to make certain amendments to the Partnership Agreement or to take other action pursuant to the Partnership Agreement constituted "control" of the Partnership's business for the purposes of the statutes of any relevant state, the Limited Partners might be held personally liable for the Partnership's obligations. The Partnership will operate in a manner the General Partner deems reasonable, necessary and appropriate to preserve the limited liability of the Limited Partners.
Exculpation and Indemnification of the General Partner
If acting in good faith, the Partnership Agreement provides that the General Partner will incur no liability for monetary damages to the Partnership or any Limited Partner for losses sustained or liabilities incurred as a result of errors in judgment or of any act or omission. In addition, the General Partner is not responsible for any misconduct or negligence on the part of its agents, provided the General Partner appointed such agents in good faith.
The Partnership Agreement also provides for indemnification of the General Partner, the directors, officers and employees of the General Partner, and such other persons as the General Partner may from time to time designate, against any and all losses, claims, damages, liabilities (joint or several), expenses (including reasonable legal fees and expenses), judgments, fines, settlements and other amounts arising from any and all claims, demands, actions, suits or proceedings, whether civil, criminal, administrative or investigative, that relate to the operations of the Partnership in which any such indemnitee may be involved, or is threatened to be involved, unless it is established that (i) the act or omission of such indemnitee was material to the matter giving rise to the proceeding and either was committed in bad faith or was the result of active and deliberate dishonesty, (ii) such indemnitee actually received an improper personal benefit in money, property or services or (iii) in the case of any criminal proceeding, such indemnitee had reasonable cause to believe that the act or omission was unlawful.
Sale of Assets; Merger
Under the Partnership Agreement, the General Partner generally has the exclusive authority to determine whether, when and on what terms the assets of the Partnership will be sold or on which the Partnership will merge or consolidate with another entity.
Removal of the General Partner; Transfer of General Partner's Interest
The Partnership Agreement does not authorize the Limited Partners to remove the General Partner and the Limited Partners have no right to remove the General Partner under the Partnership Act. The General Partner may not transfer any of its interest as General Partner and withdraw as General Partner, except (a) to a wholly-owned subsidiary of the General Partner or the owner of all the ownership interests in the General Partner, (b) in connection with a merger or sale of all or substantially all of the assets of the General Partner or (c) as a result of the bankruptcy of the General Partner. A substitute or additional General Partner may be admitted upon compliance with the applicable provisions of the Partnership Agreement, including delivery by counsel for the Partnership of an opinion that admission of such General Partner will not cause (i) the Partnership to be classified other than as a partnership for federal income tax purposes or (ii) the loss of any Limited Partner's limited liability. The General Partner may not sell all or substantially all of its assets, or enter into a merger, unless the sale or merger includes the sale of all or substantially all of the assets of, or the merger of, the Partnership and the Limited Partners receive for each Unit substantially the same consideration as the holder of one share of Common Stock.
Transferability of Interests
A Limited Partner generally may not transfer his interest in the Partnership without the consent of the General Partner which may be withheld in its absolute discretion. The General Partner may require, as a condition of any transfer, that the transferring Limited Partner assume all costs incurred by the Partnership in connection with such a transfer.
Redemption Rights
Each Limited Partner has the right (the "Redemption Right"), subject to the purchase right of the General Partner described below, to cause the redemption of such Limited Partner's Units for cash in an amount per Unit equal to the average of the closing sale prices of the Common Stock of the Company on the New York Stock Exchange (the "NYSE") for the ten trading days immediately preceding the date of receipt by the General Partner of notice of such Limited Partner's exercise of the Redemption Right. Subject to certain restrictions intended to prevent undesirable tax consequences and assure compliance with the Securities Act, a Limited Partner may exercise the Redemption Right at any time but not more than twice within the same calendar year and not with respect to less than 1,000 Units (or all Units owned by such Limited Partner, if less than 1,000). A Limited Partner that exercises the Redemption Right shall be deemed to have offered to sell the Units to be redeemed to the General Partner, and the General Partner may elect to purchase such Units by paying to such Limited Partner either the redemption price in cash or by delivering to such Limited Partner a number of shares of Common Stock of the Company equal to the product of the number of such Units, multiplied by the "Conversion Factor," which is 1.0, subject to customary antidilution provisions in the event of stock dividends on or subdivisions or combinations of the Common Stock subsequent to issuance of such Units. Any Common Stock issued to the redeeming Limited Partner will be listed on the NYSE and, if to the extent provided in such Redeeming Partner's Investment Agreement or other agreement, registered under the Securities Act and/or entitled to rights to Securities Act registration.
No Withdrawal of Capital by Limited Partners
No Limited Partner has the right to withdraw any part of his capital contribution to the Partnership or interest thereon or to receive any distribution, except as provided in the Partnership Agreement.
Issuance of Additional Limited Partnership Interests and Other Partnership Securities
The General Partner is authorized, without the consent of the Limited Partners, to cause the Partnership to issue additional Units or other Partnership securities to the partners or to other persons on such terms and conditions and for such consideration, including cash or any property or other assets permitted by the Partnership Act, as the General Partner deems appropriate.
Meetings
The Partnership Agreement does not provide for annual meetings of the Limited Partners, and the General Partner does not anticipate calling such meetings.
Amendment of Partnership Agreement
Amendments to the Partnership Agreement may, with four exceptions, be made by the General Partner without the consent of the Limited Partners. Any amendment to the Partnership Agreement which would (i) affect the Conversion Factor or the Redemption Rights of the Limited Partners, (ii) adversely affect the rights of the Limited Partners to receive distributions payable to them under the Partnership Agreement, or (iii) alter the Partnership's profit and loss allocations shall require the consent of Limited Partners owning more than 50% of the percentage interests in the Partnership. Any amendment that would impose any obligation upon the Limited Partners to make additional capital contributions to the Partnership shall require the consent of each Limited Partners owning more than 50% of the percentage interests in the Partnership.
Books and Reports
The General Partner is required to keep at the specified office of the Partnership the Partnership's books and records, including copies of the Partnership's federal, state and local tax returns, a list of the partners and their last known business addresses, the Partnership Agreement, the Partnership certificate and all amendments thereto and any other documents and information required under Partnership Act. Any partner or his duly authorized representative, upon paying duplicating, collection and mailing costs, is entitled to inspect or copy such records during ordinary business hours.
The General Partner will furnish to each Limited Partner, as soon as practicable after the close of each fiscal year, an annual report containing financial statements of the Partnership (or the Company, if consolidated financial statements including the Partnership are prepared) for such fiscal year. The financial statements will be audited by accountants selected by the General Partner. In addition, as soon as practicable after the close of each fiscal quarter (other than the last quarter of the fiscal year), the General Partner will furnish to each Limited Partner a quarterly report containing unaudited financial statements of the Partnership (or the Company and the Partnership, consolidated).
The General Partner will furnish to each Limited Partner, within 75 days after the close of each fiscal year of the Partnership, the tax information necessary to file such Limited Partner's individual tax returns.
Loans to Partnership
The Partnership Agreement provides that the General Partner may borrow additional Partnership funds for any Partnership purpose from the General Partner or a subsidiary or subsidiaries of the General Partner or otherwise.
Adjustments of Capital Accounts and Percentage Interests
A separate capital account will be established and maintained for each Partner. The General Partner shall revalue the property of the Partnership to its fair market value (as determined by the General Partner, in its sole discretion) in accordance with applicable federal income tax regulations if: (i) a new or existing general or limited partner of the Partnership (a "Partner" or collectively "Partners") acquires an additional interest in the Partnership in exchange for more than a de minimis capital contribution, (ii) the Partnership distributes to a Partner more than a de minimis amount of Partnership property as consideration for a Partnership interest or (iii) the Partnership is liquidated for federal income tax purposes. When the Partnership's property is revalued by the General Partner, the capital accounts of the partners shall be adjusted in accordance with such regulations, which generally requires such capital accounts to be adjusted to reflect the manner in which the unrealized gain or loss inherent in such property (that has not been reflected in the capital accounts previously) would be allocated among the Partners pursuant to the Partnership Agreement if there were a taxable disposition of such property for its fair market value on the date of the revaluation.
If the number of outstanding Units increases or decreases during a taxable year, each Partner's percentage interest in the Partnership shall be adjusted by the General Partner as of the effective date of each such increase or decrease to a percentage equal to the number of Units held by such Partner divided by the aggregate number of Units outstanding, after giving effect to such increase or decrease, and profits and losses for the year will be allocated among the Partners in a manner selected by the General Partner to give appropriate effect to such adjustments.
Registration Rights
Limited Partners have no rights to Securities Act registration of any Common Stock of the Company received in connection with redemption of Units except as provided in their respective Investment Agreements or other agreements with the Company.
Tax Matters; Profit and Loss Allocations
Pursuant to the Partnership Agreement, the General Partner is the "tax matters" partner of the Partnership and, as such, has the authority to handle tax audits and to make tax elections under the Code on behalf of the Partnership.
Profit and loss of the Partnership generally will be allocated among the Partners in accordance with their respective interests in the Partnership based on the number of Units held by the Partners.
Distributions
The Partnership Agreement provides that the General Partner shall distribute cash quarterly, in amounts determined by the General Partner in its sole discretion, to the partners in accordance with their respective percentage interests in the Partnership, except that the amount of cash distributable to a Limited Partner who has not been a Limited Partner for the full quarter for which the distribution is paid is subject to pro rata reduction. Upon liquidation of the Partnership, after payment of, or adequate provision for, debts and obligations of the Partnership, including any Partner loans, any remaining assets of the Partnership will be distributed to all Partners with positive capital accounts in accordance with their respective positive capital account balances. If the General Partner has a negative balance in its capital account following a liquidation of the Partnership, it will be obligated to contribute cash to the Partnership equal to the negative balance in its capital account.
Term
The Partnership will continue until December 31, 2051, or until sooner dissolved upon (i) the bankruptcy, dissolution, death or withdrawal of a General Partner (unless the Limited Partners elect to continue the Partnership by electing by unanimous consent a substitute General Partner within 90 days of such occurrence), (ii) the passage of 90 days after the sale or other disposition of all or substantially all the assets of the Partnership, (iii) the redemption of all Limited Partners' interests in the Partnership or (iv) election by the General Partner. Upon dissolution of the Partnership, the General Partner will proceed to liquidate the assets of the Partnership and distribute the proceeds remaining after payment or adequate provision for payment of all debts and obligations of the Partnership as provided in the Partnership Agreement.
Item 2.
Item 2. Properties
Real Estate Owned
The table below sets forth a summary by major geographic market of the Company's portfolio of apartment rental properties held for investment and held for disposition (excludes real estate under development) at December 31, 1997.
See also Notes 1 and 2 to the Consolidated Financial Statements and Schedule III-Summary of Real Estate Owned.
Included in the table above are 25 apartment properties held for disposition in the amount of $154,162,187, net of accumulated depreciation in the amount of $40,904,918. At December 31, 1997, the Company also has 1 shopping center and 3 other commercial properties in the consolidated balance sheet classified as real estate held for disposition in the amount of $12,338,629, net of accumlated depreciation in the amount of $3,955,900, which are not included in the above schedule.
* Average Monthly Rental Rates for the Year Ended December 31, 1997, represents potential rent collections (gross potential rents less market adjustments), which approximates net effective rents. These amounts exclude the 1997 acquisitions.
(a) In connection with the South West Merger, the Company assumed $88,573,613 of REMIC financing encumbering 25 apartments communities.
(b) Represents a $39,000,000 secured note payable which encumbers 6 apartment communities.
Item 3.
Item 3. LEGAL PROCEEDINGS
Neither the Company nor any of its apartment communities is presently subject to any material litigation nor, to the Company's knowledge, is any litigation threatened against the Company or any of the communities, other than routine actions arising in the ordinary course of business. Some of these routine actions are expected to be covered by liability insurance, and none are expected to have a material adverse effect on the business or financial condition or results of operations of the Company.
Item 4.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Executive Officers of the Registrant
The executive officers of the Company, listed below, serve in their respective capacities for approximate one year terms.
Mr. McCann has been the Company's managing Chief Executive Officer since 1974. Mr. McCann was elected Chairman of the Board in 1996.
Mr. Schneider is the former Chief Executive Officer and Chairman of the Board of South West Property Trust Inc. (South West). Mr. Schneider was employed with the investment banking firm of Donaldson, Lufkin and Jenrette until from 1967 until 1973, when he co-founded a predecessor firm to South West. Mr. Schneider was elected Vice Chairman of the Board and Executive Vice President in 1996 in connection with the merger with South West.
Mr. Dolphin was first employed by the Company in 1979 as Controller. He was elected Vice President of Finance in 1985 and has served as the Company's Chief Financial Officer since that time. He was elected Senior Vice President in 1987 and Executive Vice President in 1996.
Mr. Giannotti joined the Company as Director of Development and Construction in September 1985. He was elected Assistant Vice President in 1988, Vice President in 1989 and Senior Vice President in 1996.
Mr. Sherman is the former President and Chief Operating Officer of South West. Mr. Sherman was in charge of South West's management division from 1973 until 1996. Mr. Sherman was elected Senior Vice President in 1996 in connection with the merger with South West. Effective December 31, 1997, Mr. Sherman was no longer employed by the Company.
Mr. Johnston is the former Executive Vice President-Real Estate Investments of South West, a position he held since joining South West in 1992. From 1989 until 1992, Mr. Johnston was Senior Vice President of Property Company of America. Mr. Johnston was elected Senior Vice President in 1996 in connection with the merger with South West.
Ms. Surface joined the Company in 1992 as Assistant Vice President and Legal Counsel, elected General Counsel, Corporate Secretary and Vice President in 1994 and elected to Senior Vice President in 1997.
Mr. Carter joined the Company in 1991 as an Assistant Vice President of Apartment Operations. In 1992, he was promoted to Vice President of Apartment Operations. In 1995, he was elected Regional Vice President- Northern Region, and in 1997 was promoted to Senior Vice President and Director of Apartment Operations- Northern Region.
Mr. Landis joined the Company in 1996 as Regional Vice President-Florida Region and was promoted in 1997 to Senior Vice President and Director of Apartment Operations-Florida Region. Prior to joining the Company, he was Vice President of Asset Management and Property Management for CRI/CAPREIT, Inc.
Mr. Lamperski joined the Company joined the Company in 1996 as the Regional Vice President-Southern Region and was promoted in 1997 to Senior Vice President and Director of Apartment Operations-Southern Region. From February 1990 to August 1996, he was Vice President and Director of Property Management for Steven D. Bell, a property management company located in Greensboro, North Carolina.
PART II
Item 5.
Item 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is traded on the New York Stock Exchange ("NYSE") under the symbol "UDR". The following tables set forth the quarterly high and low closing sale prices per common share reported on the NYSE for each quarter of the last two years. Distribution information for Common Stock reflects distributions declared per share for each calendar quarter and paid at the end of the following month.
COMMON STOCK Distributions High Low Declared 1st Quarter $ 15 5/8 $ 14 1/8 $ .24 2nd Quarter 15 1/4 14 1/8 .24 3rd Quarter 14 1/2 13 1/8 .24 4th Quarter 15 3/4 13 5/8 .24
1st Quarter $ 16 $ 14 5/8 $ .2525 2nd Quarter 15 1/8 13 3/8 .2525 3rd Quarter 15 3/8 13 7/8 .2525 4th Quarter 15 1/8 13 5/8 .2525
The Company determined that, for federal income tax purposes, approximately 72.7% of the distributions for each of the four quarters of 1997 represented ordinary income to its shareholders, 24.9% represented return of capital to its shareholders and 2.1% represented capital gains to its shareholders.
On March 13, 1998, the closing sale price of the Common Stock was $13.9375 per share on the NYSE, and there were 7,897 holders of record of the 91,886,256 shares of Common Stock.
The Company pays regular quarterly distributions to holders of shares of Common Stock. Future distributions by the Company will be at the discretion of its Board of Directors after considering the Company's actual funds from operations, financial condition and capital requirements, the annual distribution requirements under the REIT provisions of the Internal Revenue Code and other factors. The annual distribution payment for calendar year 1997 necessary for the Company to maintain its status as a REIT was approximately $.71 per share. The Company paid total distributions of $.9975 per share for 1997.
SERIES A PREFERRED STOCK
The Company's Series A Preferred Stock ("Series A Preferred") and Series B Preferred Stock ("Series B Preferred") is traded on the New York Stock Exchange ("NYSE") under the symbol "UDRa" and "UDRb", respectively. The following tables set forth the quarterly high and low closing sale prices per share reported on the NYSE for each quarter of the last two years for the Series A Preferred and Series B Preferred. Distribution information for the Series A Preferred and Series B Preferred reflects distributions declared per share for each calendar quarter and paid at the end of the following month.
Distributions High Low Declared 1st Quarter $ 27 $ 25 3/4 $ .578 2nd Quarter 26 7/8 25 1/8 .578 3rd Quarter 26 3/8 25 1/4 .578 4th Quarter 26 7/8 26 1/8 .578
1st Quarter $ 26 7/8 $ 25 3/4 $ .578 2nd Quarter 26 5/8 25 5/8 .578 3rd Quarter 27 1/8 25 7/8 .578 4th Quarter 26 7/8 25 1/8 .578
On or after April 24, 2000, the Series A Preferred Stock may be redeemed for cash at a redemption price of $25 per share, plus accrued and unpaid dividends from the proceeds from the sale of additional capital stock (common or preferred).
SERIES B PREFERRED STOCK Distributions High Low Declared 1st Quarter -- -- -- 2nd Quarter $ 25 1/2 $ 25 $ .-- 3rd Quarter 26 7/8 25 1/4 .5554 4th Quarter 26 5/8 25 7/8 .5375
On May 29, 1997, the Company sold 6,000,000 shares of 8.60% Series B Cumulative Redeemable Preferred Stock (Series B Preferred Stock). The Series B Preferred Stock may be redeemed beginning May 29, 2007 at the sole option of the Company at a redemption price of $25 per share, plus accrued and unpaid dividends from the proceeds from the sale of additional capital stock (common or preferred).
The Company has a Dividend Reinvestment and Stock Purchase Plan under which holders of Common and Preferred Stock may elect to automatically reinvest their distributions and make additional cash payments to acquire additional shares of the Company's Common Stock at a discount.
Item 6.
Item 6. SELECTED FINANCIAL DATA
The following table sets forth selected consolidated financial and other information for the Company as of and for each of the years in the five year period ended December 31, 1997. The table should be read in conjunction with the Consolidated Financial Statements of United Dominion Realty Trust, Inc. and the Notes thereto included elsewhere herein.
SELECTED FINANCIAL DATA
(a) The earnings per share amounts prior to 1997 have been restated as required to comply with Statement of Financial Accounting Standards No. 128, "Earning per Share". For further discussion of earnings per share and the impact of Statement No. 128, see the notes to the consolidated financial statements. (b) Funds from operations ("FFO") is defined as income before gains (losses) on sales of investments, minority interest of unitholders in operating partnership and extraordinary item (computed in accordance with generally accepted accounting principles) plus real estate depreciation, less preferred dividends and after adjustment for significant non-recurring items, if any. This definition conforms to the recommendations set forth in a White Paper adopted by the National Association of Real Estate Investment Trusts ("NAREIT") in early 1995. FFO for years prior to 1995 have been adjusted to conform to the NAREIT definition. The Company considers FFO in evaluating property acquisitions and its operating performance and believes that FFO should be considered along with, but not as an alternative to, net income and cash flows as a measure of the Company's operating performance and liquidity. FFO does not represent cash generated from operating activities in accordance with generally accepted accounting principles and is not necessarily indicative of cash available to fund cash needs.
PART II
Item 7.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Overview
The following discussion should be read in conjunction with the Consolidated Financial Statements and Notes thereto of United Dominion Realty Trust, Inc. (the "Company") appearing elsewhere in this report. This annual report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1993, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Such forward-looking statements include, without limitation, statements concerning property acquisitions, development activity and capital expenditures, capital raising activities, rent growth, occupancy and rental expense growth expected in 1998. Such statements involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievement of the Company to be materially different from the results of operations or plans expressed or implied by such forward-looking statements. Such factors include, among other things, unanticipated adverse business developments affecting the Company, and/or its properties, adverse changes in the real estate markets and general and local economies and business conditions. Although the Company believes that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate, and therefore there can be no assurance that such statements included in this report will 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 representation by the Company or any other person that the results or conditions described in such statements or the objectives and plans of the Company will be achieved.
The Company is engaged in the ownership, acquisition, development and management of apartment communities across the Sunbelt. The Company's investment strategy has focused on acquiring apartment communities in 23 targeted major markets, however, the Company intends to expand geographically into other regions of the United States and enter into several new markets during 1998, as appropriate opportunities arise. The Company seeks to be a market leader by operating a sufficiently sized portfolio of apartments within each market, and as such, plans to significantly increase the number of apartment homes owned in most of its major markets. The Company believes this market diversification increases investment opportunity and decreases the risk associated with cyclical local real estate markets and economies. At December 31, 1997, the Company owned 225 apartment communities containing 62,789 apartment homes throughout the Sunbelt, including 25 apartment communities containing 6,907 completed apartment homes included in real estate held for disposition. The following table summarizes the Company's apartment information by market:
* Average monthly rental rates represent potential rent collections (gross potential rents less market adjustments), which approximate net effective rents. These figures exclude 1997 acquisitions.
** Economic occupancy is defined as rental income (potential rental collections less vacancy loss, management units, units held out of service, move-in concessions and credit loss) divided by potential collections (gross potential rent less management units, units held out of service and move-in concessions) for the period, expressed as a percentage.
Liquidity and Capital Resources As a qualified real estate investment trust ("REIT"), the Company distributes a substantial portion of its cash flow to its shareholders in the form of quarterly distributions. The Company seeks to retain sufficient cash to cover normal operating needs, including routine replacements and to help fund additional acquisitions and development activity. For the year ended December 31, 1997, the Company's cash flow from operating activities exceeded cash distributions paid to preferred and common shareholders and operating partnership unitholders by $35.7 million. The Company utilizes a variety of primarily external financing sources to fund portfolio growth, major capital improvement programs and balloon debt payments. The Company's bank lines of credit generally have been used to
temporarily finance these expenditures, and subsequently this short-term bank debt has been replaced with longer-term debt or equity.
Operating Activities For the year ended December 31, 1997, the Company's cash flow from operating activities increased $47.8 million over the same period last year. This increase was primarily a result of the significant expansion of the Company's portfolio of apartment communities as discussed below and under "Results of Operations".
The Company considers its cash provided by operating activities adequate to meet its operating requirements and payments of distributions to both common and preferred shareholders and unitholders in the operating partnership.
Investing Activities For the year ended December 31, 1997, net cash used for investing activities was $345.7 million compared to $161.6 million for 1996, an increase of $184.1 million. The level of investing activities primarily reflects the levels of the Company's acquisition activities and, to a lesser extent, capital expenditure and development programs. During 1997, the Company significantly increased both its development activity and upgrade program, which was implemented at its older communities. For the year ended December 31, 1997, in connection with the acquisition of real estate owned (excluding land purchased for development) aggregating $344.4 million, the Company assumed debt and issued both common stock and operating partnership units aggregating $72.6 million, compared to the acquisition of $880.6 million of real estate owned shown net of debt assumed and common stock and operating partnership units issued aggregating $734.8 million in 1996.
Acquisitions The Company seeks to acquire apartment communities that can provide returns on investment in excess of the Company's cost of capital. These acquisitions are typically projected to provide first year weighted average returns on investment of 9-9 1/2% with the prospect for future cash flow growth and appreciation. The Company calculates its investment as the purchase price plus average first year capital improvements. The return on this investment is calculated by dividing the investment by the sum of the rental income less rental expenses during the first year of ownership.
During 1997, the Company acquired 29 apartment communities containing 8,628 apartment homes at a total cost (including closing costs) of $344.4 million or $39,900 per home. The 1997 acquisitions included 16 apartment communities acquired in separate and unrelated transactions and 13 apartment communities acquired in three smaller portfolio transactions. Of the 29 apartment communities acquired, 27 were located in the Company's major markets. The apartment communities acquired by market were as follows:
(a) In connection with the acquisition of seven apartment communities, the Company assumed six mortgage notes payable and one tax-exempt note payable aggregating $60.1 million with a weighted average interest rate of approximately 8.4%. (b) In connection with the acquisition of four apartment communities, the Company issued approximately 849,000 units in the Operating Partnership with an aggregate value of $12.5 million. (c) Community was sold in October 1997.
During 1998, the Company seeks to acquire 8,000-10,000 apartment homes in individual and portfolio transactions at an aggregate cost ranging from $350 million to $450 million. These acquisitions are expected to occur in the Company's existing markets and designated new markets. In addition, the Company plans to participate in the real estate consolidation process by acquiring private and public apartment companies in strategic mergers or portfolio acquisitions that meet the Company's objectives to increase its penetration in its existing markets or to expand geographically.
On December 19, 1997, the Company executed a definitive merger agreement (the "Merger Agreement") pursuant to which ASR Investment Corporation ("ASR") would be merged with and into a wholly-owned subsidiary of the Company. At December 31, 1997, ASR owned and operated 41 apartment communities containing approximately 7,500 apartment homes in the Southwest and Northwest. Pursuant to the Merger Agreement, each share of the ASR's common stock was exchanged for 1.575 shares of the Company's common stock. The merger has been structured as a tax-free transaction and will be treated as a purchase for accounting purposes. The aggregate purchase price is estimated at approximately $330 million, including closing costs. The merger closed on March 27, 1998.
Real estate under development Consistent with the Company's acquisition strategy, development activity is focused in certain of its major markets. During 1997, the Company increased its level of development activity, completing the development of 1,067 apartment homes in six additional phases to existing communities and one new apartment community. During 1997, the Company invested $52.2 million in 11 properties under development, which includes four new apartment communities and seven additional phases to existing apartment communities.
At December 31, 1997, the Company had 1,064 apartment homes under development as outlined below (dollars in thousands, except cost per home):
During 1997, the Company completed the following development projects:
During 1997, full lease-up at Brantley Pines, Oak Park and Paradise Falls was achieved. In late 1997, construction on Providence Court was completed, and it is currently in the lease-up process. These additions did not have a material impact on the Company's financial results for the year ended December 31, 1997.
During 1998, the Company plans to fund approximately $100 million on the development of new apartment communities and additional phases to existing apartment communities which are anticipated to provide stabilized returns on investment in the 10% to 10 1/2% range. The Company currently has three new apartment communities and two additional phases under development and plans to begin development on two new apartment communities in Phoenix, Arizona during 1998.
Capital Expenditures For 1997, capitalized expenditures averaged $1,166 per home for all apartment homes acquired prior to 1995. As it generally takes up to two years to complete the improvement and enhancement process at acquisitions communities, the 1995, 1996 and 1997 acquisitions are excluded from these averages. The Company's capital expenditures include the following: various exterior improvements including roofing, siding, balconies, porches, garages, carports and storage units ($289/home), various interior improvements including the upgrade program and the addition of business and fitness centers ($222/home), carpet and vinyl replacements ($201/home), various land improvements including parking lots, carports and site lighting ($134/home), security alarms, gating and fencing ($133/home), appliances ($78/home), HVAC equipment ($46/home), sub-metering for water and sewer ($34/home) and other improvements ($29/home).
During 1997, the Company invested $99.2 million on capital improvements to its apartment portfolio. The Company capitalizes value enhancing improvements plus improvements that substantially extend the useful life of an existing asset. In addition to the Company's capital expenditures on new acquisitions, a significant portion of capital expenditures relate to an upgrade program that began in 1996 to modernize certain of the Company's older apartment communities. These upgrades primarily involve updating kitchens and bathrooms. In addition, several initiatives which are considered revenue enhancing are underway that either allow the Company to increase rents by more than the inflationary rate or allow the Company to pass expenses to residents including: (i) sub-metering of water and sewer to residents where local and state regulations allow, (ii) gating and fencing apartment communities, (iii) installing monitoring devices such as intrusion alarms or controlled access devices, (iv) enlarging fitness centers, (v) adding business centers and (vi) constructing carports and self storage units. As a result of the continued upgrade program and initiatives discussed above, capital expenditures increased approximately $46.1 million over 1996 when the average capital expenditure per mature apartment home was $832. The Company expects 1998 capital expenditures to be at levels similar to 1997.
Disposition of investments
Real estate held for disposition
The Company continually undertakes portfolio review analyses with the objective of identifying communities that do not meet the Company's long-term investment objectives due to size, location, age, quality and/or performance. The Company intends to sell 20% of its apartment portfolio, although specific properties have not been identified as sales candidates. Generally, this will result in the disposition of many of the Company's older apartment communities. These sales will allow the Company to reduce the age of its existing portfolio, which should result in lower operating expense and capital expenditure growth associated with the older communities. Management has determined that packaging communities in portfolios is more efficient and provides the greatest opportunities for disposition, and as such, the Company intends to sell approximately $75 million of communities each quarter through fiscal 1998 for a total of 7,000 to 8,000 apartment homes. The net proceeds from these sales will be primarily used to acquire and develop newer apartment communities that will provide higher long term returns on investment than the communities that are being sold.
During 1997, the Company sold 12 apartment communities containing 2,570 apartment homes and one shopping center for an aggregate sales price of $68.4 million and received net cash proceeds of approximately $64.0 million. For financial reporting purposes, the Company recognized an aggregate $10.6 million gain on the sales. Nine of these dispositions were structured to qualify as like-kind exchanges under Section 1031 of the Internal Revenue
Code, so the related capital gains totaling $14.2 million will be deferred for federal income tax purposes. The 12 apartment community sales included the August 1997 sale of a portfolio of six apartment communities containing 1,204 apartment homes, which had a weighted average age of 26 years for an aggregate sales price of $34.7 million.
On January 20, 1998, the Company sold a portfolio of five apartment communities containing 2,406 apartment homes, which had a weighted average age of 21 years for an aggregate sales price of $65.6 million. The transaction was structured to qualify as a like-kind exchange under Section 1031 of the Internal Revenue Code, so the related capital gain will be deferred for federal income tax purposes. These five communities, all located in Texas, were acquired on December 31, 1996 in connection with the South West Property Trust Inc. Merger ("South West Merger"), and accordingly, no significant gain or loss was recorded for financial reporting purposes.
Net cash provided by financing activities during 1997 was $194.8 million compared to $82.1 million for 1996. In connection with its 1997 acquisitions of real estate owned, the Company assumed debt and issued operating partnership units aggregating approximately $72.6 million compared to the assumption of $387.9 million of debt and the issuance of common stock and operating partnership units aggregating approximately $346.9 million last year.
Cash provided by financing activities On January 28, 1997, the Company issued 4,000,000 shares of its common stock at $15.75 per share for an aggregate value of approximately $63 million. Net proceeds of $59.4 million were used to repay an unsecured credit facility assumed in connection with the South West Merger.
The Company raised $39.7 million of new equity capital through its Dividend Reinvestment and Stock Purchase Plan (the "Plan") during 1997 which included $29.6 million in optional cash investments and $10.1 million of reinvested dividends.
In anticipation of the issuance of unsecured debt in early 1997, the Company entered into a $100 million (notional amount) Treasury rate lock agreement in November 1996. On January 27, 1997, the Company issued $125 million of 7.25% Notes due January 15, 2007. The Notes were priced to yield 7.31% which was 79 basis points over the 10 year Treasury rate at the time of issuance. The interest rate protection agreement was terminated simultaneously with the $125 million Note issuance, and the Company received $1.5 million in cash. This had the economic effect of lowering the interest rate on the Notes to approximately 7.14%. Net proceeds of approximately $124 million were used to curtail bank debt and purchase apartment communities.
On May 29, 1997, the Company sold 6,000,000 shares of 8.60% Series B Redeemable Preferred Stock at $25 per share. Net proceeds of $145.1 million were primarily used to repay short-term bank debt.
Derivative Instruments The Company, from time to time, uses derivative instruments to synthetically alter on-balance sheet liabilities or to hedge anticipated financing transactions. Derivative contracts did not have a material impact on the results of operations during the twelve months ended December 31, 1997 and 1996.
On May 1, 1997, an interest rate swap agreement with a notional amount of $83 million expired. This interest rate swap agreement effectively changed the Company's interest exposure from a variable rate to a weighted average fixed rate of 6.45% on borrowings outstanding under the Company's credit facilities. No gain or loss was recognized on the expiration of this agreement.
At December 31, 1997, the Company had five interest rate swap agreements outstanding with an aggregate notional amount of $45 million. These five interest rate swap agreements effectively fix $45 million of the Company's variable-rate secured notes payable to a weighted average fixed rate of 7.29%.
In order to reduce the interest rate risk associated with the anticipated issuance of unsecured notes during 1998, the Company entered into a $100 million (notional amount) fixed pay forward starting swap agreement with a major Wall Street investment banking firm in July 1997. The transaction allowed the Company to lock-in a ten year Treasury rate of 6.486% on or before September 9, 1998. The Company anticipates replacing balances currently outstanding under its bank line borrowings with permanent debt during 1998.
Credit facilities On August 4, 1997, the Company closed on a new $200 million three year unsecured revolving credit facility (the "Credit Facility"), a $50 million one year unsecured line of credit (the "Line of Credit") and a $15 million uncommitted line of credit with a major U.S. financial institution. Under the new Credit Facility, pricing is based upon the higher of the Company's senior unsecured debt ratings from S&P and Moody's which are currently BBB+ and Baa1, respectively. At these rating levels, contractual interest under the new Credit Facility is LIBOR plus 42.5 basis points. The Credit Facility also includes a $100 million competitive bid option which allows the Company to solicit bids from participating banks at rates below the contractual rate. The Credit Facility and Line of Credit are subject to customary financial covenants and limitations.
At and for the year ended December 31, 1997, the Company had the following credit facilities (dollars in thousands):
** Represents the Company's unsecured revolving credit facilities with four commercial banks which were terminated on August 4, 1997 upon the execution of the $200 million three year unsecured revolving credit facility, therefore, there was no balance outstanding at December 31, 1997.
The Company's liquidity and capital resources are believed to be more than adequate to meet its cash requirements for the next several years. The Company expects to meet its short and long-term capital requirements, such as balloon debt maturities, property acquisitions, development activity and significant capital improvements, primarily through the public and private sale of capital stock and the issuance of medium and long-term unsecured notes payable. The Company may also fund its capital requirements through (i) the assumption of mortgage indebtedness, (ii) property sales, (iii) common shares sold through the Company's Dividend Reinvestment and Stock Purchase
Plan, (iv) retained operating cash flow, (v) the issuance of operating partnership units and (vi) the use of unused credit facilities. As a result of its investment grade debt ratings, the Company expects to use unsecured debt as its primary debt funding source.
Depending upon the volume and timing of acquisition and sales activity, the Company anticipates raising additional debt and equity capital during the next twelve months to finance capital requirements, while striving to minimize the overall cost of capital. During the second quarter of 1997, the Company filed a shelf registration statement for approximately $675 million of debt and preferred and common equity securities of which $486.7 million was unused at December 31, 1997.
In February 1998, the Company issued 1.7 million shares of its common stock at a gross sales price of $14.3125 per share to a Unit Investment Trust ("UIT"). Net proceeds of $23.8 million were primarily used to curtail bank debt.
Year 2000 Conversion The Company has recognized the need to ensure that its systems, equipment and operations will not be adversely affected by the change to calendar year 2000. As such, the Company has taken steps to identify potential areas of risk and has begun addressing these in its planning, purchasing and daily operations. The total cost of converting all internal information systems, equipment and operations for the year 2000 has not been fully quantified, but it is not expected to be a material cost to the Company. Much of the Company's internal software programs have been purchased from third parties. However, no such estimates can be made as to the potential adverse impact resulting from the failure of third party service providers and vendors to prepare for the year 2000. The Company is attempting to identify those risks as well as to receive compliance certificates from all third parties that have a material impact on the Company's operations.
Funds from operations Funds from operations ("FFO") is defined as income before gains (losses) on sales of investments, minority interest of unitholders in operating partnership and extraordinary items (computed in accordance with generally accepted accounting principles) plus real estate depreciation, less preferred dividends and after adjustment for significant non-recurring items, if any. The Company computes FFO in accordance with the recommendations set forth by the National Association of Real Estate Investment Trusts ("NAREIT"). The Company considers FFO in evaluating property acquisitions and its operating performance, and believes that FFO should be considered along with, but not as an alternative to, net income and cash flows as a measure of the Company's operating performance and liquidity. FFO does not represent cash generated from operating activities in accordance with generally accepted accounting principles and is not necessarily indicative of cash available to fund cash needs.
For 1997, FFO increased 65.3 % to $118.6 million, compared with $71.7 million last year. The increase in FFO was principally due to the increased net rental income from the Company's 31,270 non-mature apartment homes in 98 apartment communities that were acquired and developed subsequent to January 1, 1996. For 1996, FFO increased 14.9 % to $71.7 million, compared with $62.4 million for 1995, principally due to the increased net rental income from the Company's then 12,914 non-mature apartment homes in 52 apartment communities.
Results of Operations
The Company's net income is primarily generated from the operations of its apartment communities. For purposes of evaluating its comparative operating performance, the Company categorizes its apartment communities into two categories mature and non-mature. For the 1997 versus 1996 comparison, these communities are as follows: (i) mature--those communities acquired, developed and stabilized prior to January 1, 1996 and held throughout both 1997 and 1996 and (ii) non-mature--those communities acquired, developed or sold subsequent January 1, 1996. For the 1996 versus 1995 comparison, these communities are as follows: (i) mature--those communities acquired prior to January 1, 1995 and held throughout the annual reporting period and (ii) non-mature--those communities acquired and developed subsequent to December 31, 1995 plus four apartment communities sold during this same period. The Company's apartment operations are divided into four geographic regions, each of which constitutes a core operating unit. Based on the total number apartment homes, the Northern Region constitutes 33% of the Company's apartment portfolio and includes Delaware, Maryland, Virginia and northern North Carolina. The Southern Region constitutes 22% of the Company's apartment portfolio and includes Charlotte, North Carolina, South Carolina, Georgia, Tennessee and Alabama. The Florida Region includes the entire state of Florida or 17% of the Company's apartment portfolio, while the Western Region constitutes 28% of the Company's apartment portfolio and includes Texas, Arkansas, Oklahoma, Nevada, New Mexico and Arizona.
All per share amounts refer to basic earnings per share unless otherwise indicated.
1997-vs-1996 For 1997, the Company reported increases over last year in rental income, income before gains on sales of investments and minority interest of unitholders in operating partnership, net income and net income available to common shareholders. For 1997, net income available to common shareholders increased $24.5 million, with a corresponding increase of $.12 and $.11 for basic and diluted earnings per share, respectively, compared to 1996. The large per share increases over last year are primarily attributed to gains recognized on the sales of investments. Net income available to common shareholders for the year ended December 31, 1997 includes aggregate gains on the sales of investments of $12.7 million ($.15 per share). In addition, since the beginning of 1996, the Company acquired and developed a total of 31,270 apartment homes in 98 apartment communities (including 14,320 completed apartment homes in 44 apartment communities acquired in the South West Merger) and sold 16 apartment communities containing 3,222 apartment homes, representing a net 82% expansion in the number of apartment homes owned during that period. These non-mature apartment homes provided a substantial portion of the aggregate reported increases. However, these increases were moderated in part due to the Company's financing activities during 1997. During 1997, the Company financed its acquisition and development programs primarily with common and preferred equity and the proceeds from property sales rather than debt which was used to finance much of the 1996 acquisition and development programs.
1996-vs-1995 For 1996, the Company reported increases in rental income and income before gains on sales of investments and minority interest of unitholders in operating partnership and net income over 1995. Net income available to common shareholders increased $1.8 million, with a decrease of $.01 per share compared to 1995. Since the beginning of 1995, the Company acquired and developed a total of 12,914 apartment homes in 52 communities (excluding those acquired in the South West Merger) representing a 44.1% expansion in the number of apartment homes owned during that period. These non-mature apartment homes provided a substantial portion of the aggregate reported increases.
Total Apartment Communities The operating performance of the Company's total apartment portfolio is summarized in the chart below:
(1) Net rental income for an apartment community is defined as total rental income, less rental expenses, less real estate depreciation.
(2) Economic occupancy is defined as rental income (potential rental collections less vacancy loss, management units, units held out of service, move-in concessions and credit loss) divided by potential collections (gross potential rent less management units, units held out of service and move-in concessions) for the period, expressed as a percentage.
1997-vs -1996 Due to the acquisition and development of 31,270 apartment homes since January 1, 1996, the weighted average number of apartment homes increased 54.8% to 58,038 for 1997. This includes 14,320 completed apartment homes acquired in the South West Merger on December 31, 1996. As a result of the increase in the number of apartment homes acquired since January 1, 1996, the Company experienced significant increases in rental income, rental expenses and real estate depreciation for 1997.
1996-vs-1995 Due to the acquisition and development of 12,914 apartment homes since January 1, 1995, the weighted average number of apartment homes increased 20% to 37,481 for the year ended December 31, 1996. As a result of the increase in the number of apartment homes acquired since January 1, 1995, the Company experienced significant increases in rental income, rental expenses and real estate depreciation for 1996.
Mature Apartment Communities The operating performance of the Company's mature apartment communities is summarized below. For the 1997 vs. 1996 analysis, there were 127 communities with 31,519 homes that were classified as mature. For the 1996 vs. 1995 analysis, 114 communities with 28,430 homes were classified as mature.
1997-vs-1996
Mature apartment communities were all located in the Northern, Southern and Florida Regions in 1997. The Company did not own any properties in the Western Region until December 31, 1996. For 1997, the Company's mature communities provided approximately 54% of the Company's apartment rental income and 52% of its net rental income. During 1997, the Company's mature apartment communities continued to generate rent growth greater than the pace of inflation and double digit growth of other income. Compared to the same period last year, total rental income from these apartment homes grew 3.8%, or approximately $7.6 million, reflecting an increase in
average monthly rents of 3.9% to $572 per month. Growth in rental income was slightly offset by a .04% decrease in economic occupancy. In addition, other income, primarily fee income, increased approximately $1.2 million or 17.6%. Overall, economic occupancy bottomed out in January 1997 at 90.8% and grew steadily through August before declining slightly to 92.3% for December 1997, an improvement of 1.9% during the year. The economic occupancy declined due to the weakening of certain major southeastern markets during the last half of 1996, however, these markets are recovering. The Company expects to maintain rent growth in the 4% range and economic occupancy in the 92% to 93% range during 1998.
For 1997, rental expenses at these communities increased 2.2%, or $1.9 million, resulting in an improvement in the operating margin of 0.8% to 57.3%. The 2.2% increase in operating expenses was attributable to higher personnel costs, marketing and advertising costs and the Company's cost of self-management. Personnel costs increased approximately $1.8 million, primarily due to understaffing at some of its properties during much of 1996. Marketing and advertising costs increased 33.9% or approximately $845,000 over the same period last year as a direct result of softening in certain major markets as discussed above. The cost of self-management increased $1.7 million as the Company invested heavily in its personnel and technological infrastructure during 1997 in response to growth. Management believes that these additions will allow the Company to compete more effectively and expand the number of properties owned in major markets during 1998 and beyond. However, these expense increases were offset by decreases in repairs and maintenance expense and utility expense. Repairs and maintenance expense decreased 13.1% or approximately $2.0 million primarily as a result of less exterior painting, extraordinary repairs, mechanical repairs and the effect of the upgrade program. In addition, the Company has taken advantage of some economies of scale due to its increased size and some centralized purchasing during the 1997 period. Utility expense decreased primarily as a result of sub-metering water and sewer where local and state regulations allow. The Company's objective is to maintain rental expense growth below 2% during 1998.
The operating performance for the Company's mature apartment communities for 1997 and 1996, summarized by geographic region is outlined below:
For the year ended December 31, 1997, depreciation expense increased partly as a result of the upgrade, improvement and initiative programs in place at the Company's mature apartment communities discussed under "Capital Expenditures" in Liquidity and Capital Resources.
1996-vs-1995 For 1996, the Company's mature communities provided approximately 75% of the Company's apartment rental income and 71% of its net rental income. Compared to 1995, total rental income from these apartment homes grew 4.2%, or $7.1 million, reflecting an increase in average monthly rents of 4.6% to $540 per month. In addition, other income, primarily fee income, increased $1.6 million or 33%. The rental rate increases were offset by a 1.3% decline in economic occupancy to 92.8%, which resulted from a decrease in physical occupancy of 1.0% and an increase in credit loss of .3%. The economic occupancy declined due to the weakening of certain major markets during the last half of 1996 including Richmond, Columbia, Greenville, Washington DC and Hampton Roads. The Company attributed the market softness primarily to increased home buying.
For 1996, rental expenses at these communities increased 8.3%, or $6.0 million, resulting in a decrease in the operating margin of 1.7% to 55.6%. The increase in rental expenses is partly attributable to the severe winter of 1996 compared to the relatively mild winter of 1995. Of the $6.0 million increase, $400,000 was weather related which included increases in gas, snow removal and repair labor expenses. During 1996, the Company's mature apartments experienced increases in most of its operating expense categories compared to 1995. Payroll and
payroll-related expenses increased approximately $1.1 million or 7% due to several factors: (i) increased salaries and wages in 1996 as several positions were re-priced, (ii) tightening in the labor markets and (iii) overtime attributable to the upgrade process discussed below. Exterior painting and other exterior improvements, such as striping and sealcoating parking lots, accounted for almost $1.1 million of the increase. In addition, real estate taxes, security and water and sewer expenses increased $232,000, $427,000 and $416,000, respectively, over 1995. For 1996, casualty insurance expense increased approximately $406,000 over 1995 as the Company experienced several large casualty insurance claims relating to hurricane and storm damage. This resulted in a significant increase in insurance rates beginning with its July 1, 1996 policy year.
In 1996, the Company began the process of upgrading certain of its older apartment communities in order to enhance rent growth over the long term. The upgrades relate primarily to the modernization of the kitchens and bathrooms with new appliances, cabinets, light fixtures, ceiling fans, shelving, countertops, doors and floor coverings. Although certain of these costs were capitalized, a portion were expensed. The process of upgrading contributed to higher turnover costs and increased repair labor costs.
For the year ended December 31, 1996, depreciation expense increased $2.2 million or 6.5%, primarily as a result of capital expenditures. During 1996, the Company had significant capital expenditures on several apartment communities acquired during 1994.
Non-Mature Communities For the 1997 vs. 1996 analysis, the Company's non-mature apartment communities include: (i) 7,590 apartment homes acquired during 1996, net of one resold, and a community acquired in 1995 and not stabilized due to significant rehabilitation, (ii) 13,671 apartment homes acquired on December 31, 1996 in connection with the South West Merger, net of one resold and one under development, (iii) 8,524 apartment homes acquired since January 1, 1997, net of one resold, (iv) 3,222 apartment homes sold since January 1, 1996 and (v) the 1,232 apartment homes developed since January 1, 1996 which is summarized in the chart below (dollars in thousands):
Year Ended December 31, 1997 and 1996:
Year Ended December 31, 1996 and 1995:
1997-vs-1996 For 1997, the Company's non-mature apartment communities provided approximately 46% of the Company's apartment rental income and 48% of its net rental income. Rental income, rental expenses and real estate depreciation increased from 1996 to 1997 directly as a result of the increase in the weighted average number of apartment homes owned during 1997. For the year ended December 31, 1997, average economic occupancy was 90.7%, and the operating margin was 57.9% for the non-mature apartment communities.
1996 Acquisitions (excluding the South West Merger) The 29 apartment communities containing 7,590 apartment homes that were acquired during 1996 (net of one apartment community containing 122 apartment homes resold and a community acquired in 1995 and not stabilized
due to significant rehabilitation) provided a significant increase in rental income, rental expenses and depreciation expense for the Company's apartment portfolio for 1997. For 1997, these apartment communities had economic occupancy of 89.8% and an operating margin of 59.4%. The first year return on investment for these communities in 1997, on an average investment of $319 million, was 9.0% (excluding one community under renovation). This reflects the under-performance of nine apartment communities in the Greensboro/Winston-Salem, North Carolina market that were acquired in August 1996 as part of a portfolio transaction. Occupancy in this region peaked in August 1996 when the Company acquired these properties and subsequently fell, reflecting an oversupply of apartment product in this market. However, the Company believes Greensboro is a good long-term market.
South West Property Trust Inc. (South West) The acquisition of the 43 apartment communities containing 13,671 apartment homes included in the South West Merger on December 31, 1996, net of one apartment community resold and one under development, provided the largest increases in rental income, rental expenses and depreciation expense for the Company's entire apartment portfolio for the year ended December 31, 1997. The return on investment for the South West properties was 9.4% during 1997. For the year ended December 31, 1997, these apartment communities had economic occupancy of 92.7% and an operating margin of 57.5%.
1997 Acquisitions, Development and Sales Included in this category are the following: (i) the 28 apartment communities containing 8,524 apartment homes acquired by the Company during 1997 (net of one resold) which are projected to have a first year return on investment of approximately 9.5%, (ii) the 1,232 apartment homes developed since January 1, 1996 and (iii) the 16 apartment communities containing 3,222 apartment homes sold since January 1, 1996. The return on investment for 1997 acquisitions on an average investment of $345 million was 9.3%.
1996 -vs-1995 For 1996, the Company's non-mature apartment communities provided approximately 25% of the Company's rental income and 29% of its net rental income. Rental income, rental expenses and real estate depreciation increased from 1995 to 1996 directly as a result of the increase in the number of apartment homes acquired during those years. For the 12,914 apartments in the 52 communities acquired and developed since January 1, 1995, average economic occupancy for 1996 was 93.1%, and the operating margin was 59.8%. During 1996, these communities provided increases of $42.3 million, $16.9 million and $17.2 million, respectively, in rental income, rental expenses and net rental income. For 1996, the 30 apartment communities containing 7,712 apartment homes which were acquired during 1996, provided rental income, rental expenses and net rental income of $27.1 million, $10.6 million and $11.6 million, respectively, and the 1995 acquisitions which consisted of 42 apartment communities containing 5,142 apartment homes provided rental income, rental expenses and net rental income of $30.2 million, $12.1 million and $11.5 million, respectively.
Interest Expense During 1997, interest expense increased $28.2 million or $.02 per common share over 1996. The weighted average amount of debt employed during 1997 was higher than it was in 1996 ($1 billion in 1997 versus $647 million in 1996) which accounted for the majority of the increase in interest expense. The weighted average interest rate on this debt was slightly lower than it was last year, decreasing from 7.6% in 1996 to 7.5% in 1997. This slightly lower interest rate during 1997 reflected the fact that the weighted average interest rate on short-term bank borrowings decreased compared to last year and the Company's reliance on these short-term bank borrowings increased in 1997 compared to 1996 ($74.6 million weighted average outstanding in 1997 versus $49.9 million in 1996). For 1997 and 1996, total interest capitalized was $2.6 million and $.5 million, respectively. The increase reflects increased development activity during 1997.
For 1996, interest expense increased $10.2 million or $.10 per common share over 1995. The weighted average amount of debt employed during 1996 was higher than it was in 1995 ($647 million in 1996 versus $512 million in 1995). The weighted average interest rate on this debt was slightly lower in 1996, decreasing from 7.9% in 1995 to 7.6%. The lower interest rate during 1996 reflected the fact that the weighted average interest rate on short-term bank borrowings decreased compared to 1995 and the Company's reliance on these lower rate short-term bank borrowings increased in 1996 compared to 1995 ($49.9 million weighted average outstanding in 1996 versus $8.2
million in 1995). The Company funded its 1996 acquisitions and development activity primarily with debt compared to 1995 when a combination of debt and equity was used.
General and Administrative During 1997, general and administrative expenses increased by $1.7 million over 1996. In 1997, the Company incurred increases in most of its general and administrative expense categories which are directly attributable to the increased size of the Company. The largest increases occurred in payroll and payroll-related expenses and investor relations expense. General and administrative expense as a percentage of rental revenues decreased .4% from 2.2% during 1996 to 1.8% during 1997 primarily due to economies of scale. During 1997, general and administrative expenses grew approximately 31% while rental income grew by 60% over the same period last year.
During 1996, general and administrative expenses increased by $553,000 over the same period in the prior year. In 1996, the Company incurred increases in most of its general and administrative expense categories. The largest increases occurred in payroll expenses, investor relations expenses and office rent which are directly related to the higher administrative costs associated with increasing the size of the Company. However, general and administrative expense, as a percentage of rental revenues, remained relatively flat compared to 1995.
Impairment Loss The Company's long-lived assets held and used are periodically evaluated for impairment and provisions for possible losses are recorded if required. In connection with the Company's evaluation of its apartment portfolio, during the third quarter of 1997, the Company recorded an impairment loss of $1.4 million relating to two apartment communities included in the Company's real estate held for investment. These apartment communities were subsequently moved to real estate held for disposition based upon management's decision to dispose of these properties.
During 1995, the Company recognized a $1.7 million impairment loss associated with management's decision to sell a shopping center at a discount as part of a portfolio transaction.
Gains on Sales of Investments During the year ended December 31, 1997, the Company recognized gains on the sales of investments aggregating $12.7 million as a result of the following transactions: (i) the first quarter sale of the Company's investment in the preferred stock of First Washington Realty Trust, Inc. obtained as partial consideration in the 1995 sale of four commercial properties on which the Company recognized a gain for financial reporting purposes of $2.1 million and (ii) the sale of 12 apartment communities containing 2,570 apartment homes and one shopping center for an aggregate sales price of $68.4 million on which the Company recognized aggregate gains for financial reporting purposes of $10.6 million.
During 1996, the Company recognized gains for financial reporting purposes aggregating $4.3 million on the sale of four apartment communities, four shopping centers, one industrial park and two parcels of undeveloped land. Seven of the sales were structured to qualify as tax deferred exchanges which enabled the Company to defer approximately $7.8 million of capital gains for income tax purposes.
Dividends to Preferred Shareholders Dividends to preferred shareholders totaled $17.3 million for 1997 compared to $9.7 million for 1996. The increase in dividends to preferred shareholders is a result of the issuance of six million shares of Series B 8.60% Cumulative Redeemable Preferred Stock in May 1997.
Dividends to preferred shareholders totaled $9.7 million for 1996 compared to $6.6 million for 1995. The increase in dividends to preferred shareholders was a result of a full year of dividends on the Company's 4.2 million shares of Series A 9.25% Cumulative Redeemable Preferred Stock in 1996 compared to a partial year of dividends in 1995.
Inflation The Company believes that the direct effects of inflation on the Company's operations have been inconsequential.
Item 8.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Index to Consolidated Financial Statements and Schedule on page 44 of this Annual Report on Form 10-K.
Item 9.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
Part III
Item 10.
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Incorporated herein by reference from the Company's definitive proxy statement to be filed with respect to its Annual Meeting of Shareholders to be held on May 12, 1998.
Information required by this item regarding the executive officers of the Company is included in Part I of this Annual Report on Form 10-K in the section entitled "Executive Officers of the Registrant".
Item 11.
Item 11. EXECUTIVE COMPENSATION
Incorporated herein by reference from the Company's definitive proxy statement to be filed with respect to its Annual Meeting of Shareholders to be held on May 12, 1998.
Item 12.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Incorporated herein by reference from the Company's definitive proxy statement to be filed with respect to its Annual Meeting of Shareholders to be held on May 12, 1998.
Item 13.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Incorporated herein by reference from the Company's definitive proxy statement to be filed with respect to its Annual Meeting of Shareholders to be held on May 12, 1998.
PART IV
Item 14.
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1&2) See Index to Consolidated Financial Statements and Schedule on page 44 of this Annual Report on Form 10-K.
(3) Exhibits
The exhibits listed below are filed as part of this annual report. References under the caption "Location" to exhibits, forms, or other filings indicate that the form or other filing has been filed, that the indexed exhibit and the exhibit referred to are the same and that the exhibit referred to is incorporated by reference.
The Company agrees to furnish to the Commission on request a copy of any instrument with respect to long-term debt of the Company or its subsidiaries the total amount of securities authorized under which does not exceed 10% of the total assets of the Company and its subsidiaries on a consolidated basis.
Exhibits 10(i) through 10(viii) inclusive, are management contracts or compensatory plans or arrangements required to be filed as an exhibit to this Form 10-K pursuant to Item 14(c) of this report.
(b)Reports on Form 8-K
See accompanying notes.
UNITED DOMINION REALTY TRUST, INC. CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands, except per share data)
UNITED DOMINION REALTY TRUST, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands)
See accompanying notes.
United Dominion Realty Trust, Inc. Consolidated Statements of Shareholders' Equity (In thousands, except per share amounts)
UNITED DOMINION REALTY TRUST, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Summary of Significant Accounting Policies
Organization United Dominion Realty Trust, Inc., a Virginia corporation, was formed in 1972. The Company is a fully integrated real estate company which owns, operates and develops apartment communities for its own portfolio. At December 31, 1997, the Company owned 225 apartment communities containing 62,789 completed apartment homes located primarily throughout the Sunbelt states.
Basis of presentation The accompanying consolidated financial statements include the accounts of the Company and its subsidiaries, including United Dominion Realty, L.P., its Operating Partnership, (collectively, the "Company"). As of December 31, 1997, United Dominion Realty Trust, Inc. and its wholly-owned subsidiaries had a 89.4% interest in the Operating Partnership. The financial statements of the Company include the minority interest of the unitholders in the operating partnership. All significant inter-company accounts and transactions have been eliminated in consolidation. Certain previously reported amounts have been reclassified to conform with the current financial statement presentation.
Use of estimates The preparation of the financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.
Federal income taxes The Company is operated as and elects to be taxed as a real estate investment trust under the Internal Revenue Code of 1986, as amended (the "Code"). Generally, a real estate investment trust which complies with the provisions of the Code and distributes at least 95% of its taxable income to its shareholders, does not pay federal income taxes on its distributed income. Accordingly, no provision has been made for federal income taxes.
Cash and cash equivalents All highly liquid investments with maturities of three months or less, when purchased, are considered to be cash equivalents.
Real estate assets and depreciation On October 1, 1995, the Company adopted the provisions of SFAS No. 121 AAccounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of@. The statement requires impairment losses to be recognized for long-lived assets used in operations when indicators of impairment are present and the undiscounted future cash flows are not sufficient to recover the asset's carrying value. If such indicators are present, an impairment loss is recognized based on the excess of the carrying amount of the impaired asset over its fair value.
For long-lived assets to be disposed of, impairment losses are recognized when the fair value of the asset less estimated cost to sell is less than the carrying value of the asset. Real estate is classified as real estate held for disposition when management has committed to sell and is actively marketing the property. Real estate held for disposition is carried at the lower of cost, net of accumulated depreciation or fair value less cost to dispose, determined on an asset by asset basis. Depreciation is not recorded on real estate held for disposition and gains (losses) from initial and subsequent adjustments to the carrying value of the assets, if any, are recorded as a separate component of income from continuing operations.
Ordinary repairs and maintenance costs are expensed as incurred. Significant improvements, renovations and replacements related to the acquisition and improvement of real estate assets are capitalized at cost and depreciated over their estimated useful lives.
Depreciation is computed on a straight-line basis over the estimated useful lives of the related assets which is 35 years for buildings, 10 to 35 years for major improvements, and 5 to 20 years for fixtures, equipment and other assets.
All development projects and related carrying costs, principally interest and real estate taxes, are capitalized and reported on the balance sheet as "real estate under development" until such time as the development project is completed. Upon completion, the total cost of the building and associated land is transferred to real estate held for investment and the assets
are depreciated over their estimated useful lives. The cost of development projects includes interest, property taxes, insurance and allocated development overhead during the construction period.
Interest and real estate taxes incurred during the construction period are capitalized as part of the projects under development to the extent that such charges do not cause the carrying value of the asset to exceed its net realizable value. During 1997, 1996 and 1995, total interest capitalized was $2,634,000, $541,000 and $40,000, respectively.
Revenue recognition The Company's apartment homes are leased under operating leases with terms generally of one year or less. Rental income is recognized as it is earned, which is not materially different than on a straight-line basis.
Deferred financing costs Deferred financing costs include fees and other costs incurred to obtain long-term debt obligations and are generally amortized over a period not to exceed the term of the related debt.
Interest rate swap agreements The Company enters into interest rate swap agreements to alter the interest rate characteristics of outstanding debt instruments. Each interest rate swap agreement is designated with all or a portion of the principal balance and term of a specific debt obligation. The interest rate swaps involve the periodic exchange of payments over the life of the related agreements. Amounts received or paid on the interest rate swaps are recorded on an accrual basis as an adjustment to the related interest expense of the outstanding debt based on the accrual method of accounting. The related amounts payable to and receivable from counterparties are included in other liabilities and other assets, respectively. The fair value of and changes in the fair value as a result of changes in market interest rates for the interest rate swap agreements are not reflected in the financial statements.
Gains and losses on terminations of interest rate swap agreements are deferred as an adjustment to the carrying amount of the outstanding debt and amortized into interest expense over the remaining term of the original contract life of the terminated swap agreement. In the event of early extinguishment of a designated debt obligation, any realized or unrealized gain or loss from the swap would be recognized in income coincident with the extinguishment gain or loss. There were no gains or losses on terminations of interest rate swap agreements recognized by the Company for the periods presented.
Any interest rate swap agreements that are not designated with outstanding debt or notional amounts of interest rate swap agreements in excess of the original amounts of the underlying debt obligations are recorded as an asset or liability at fair value, with the changes in the fair value recorded in other income or expense (fair value method).
Interest rate risk management agreements The Company enters into interest rate futures contracts to hedge interest rate risk associated with anticipated debt transactions. The Company follows SFAS No.80 "Accounting for Futures Contracts" which permits hedge accounting for anticipatory transactions meeting certain criteria. Gains and losses, if any, on these transactions are deferred as an adjustment to the carrying amount of the outstanding debt and amortized over the terms of the related debt as an adjustment to interest expense. The fair values of interest rate risk management agreements are not recognized in the financial statements. At the time the anticipated transaction is no longer likely to occur, the Company would mark the derivative instrument to market and would recognize any adjustment in the consolidated statement of operations.
Earnings per share In 1997, the Financial Accounting Standards Board issued Statement No. 128, "Earnings per Share" (Statement 128). Statement 128 replaced the calculation of primary and fully diluted earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effects of options, warrants and convertible securities. Diluted earnings per share is similar to fully diluted earnings per share. All earnings per share amounts for all periods presented, and where appropriate, are restated to conform to the Statement 128 requirements. The early extinguishment of debt does not have an effect on the earnings per share calculation for the periods presented. The affect of the conversion of the operating partnership units is antidilutive and is therefore not included in the following calculations. The weighted average effect of the conversion of the oerating partnership units for the years ended
December 31, 1997, 1996 and 1995 was 317,120, 68,502 and 0, respectively. The following table sets forth the computation of basic and diluted earning per share (dollars in thousands, except per share data):
Investment in marketable equity securities In connection with a shopping center sale in 1995, the Company received marketable preferred stock with a fair value of $7.7 million on the date of receipt. In January 1997, the Company sold the preferred stock and received $9.9 million in cash and recognized a $2.1 million gain on the sale of investment for financial reporting purposes.
Minority interest Capital contributions, distributions and profits and losses are allocated to minority interests in accordance with the terms of the individual partnership agreements. Operating Partnership Units can be exchanged for cash or shares of the Company's common stock on a one-for-one basis, at the option of the Company.
Stock based compensation In October, 1995, the Financial Accounting Standards Board issued SFAS No. 123, "Accounting for Stock-Based Compensation" (Statement 123) which provides an alternative to APB Opinion No.25 in accounting for stock-based compensation plans and is effective for fiscal years beginning after December 31, 1995. The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related Interpretations in accounting for its employee stock options because the alternative fair value accounting provided for under Statement 123 requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation cost has been recognized.
Pending accounting pronouncements In February 1997, the Financial Accounting Standards Board issued SFAS No. 129, "Disclosure of Information about Capital Structure" (Statement 129), which establishes standards for disclosing information about an entity's capital structure. Statement 129 is effective for periods ending after December 15, 1997. The adoption of Statement 129 did not impact the Company's capital structure disclosures as the Company was already in compliance with Statement 129.
In June 1997, the Financial Accounting Standards Board issued SFAS No. 130 "Reporting Comprehensive Income" (Statement 130) and SFAS No. 131 "Disclosure about Segments of an Enterprise and Related Information " (Statement 131) which are effective for fiscal years beginning after December 15, 1997. The Company will adopt Statement 130 and
Statement 131 with the fiscal year beginning January 1, 1998. Statement 130 and Statement 131 do not have a material impact on the financial results or financial condition of the Company, but will result in certain changes in required disclosures. Management is evaluating the additional disclosure requirements for the Company upon the implementation of Statement 130 and Statement 131.
2. Real Estate Owned
The Company operates primarily in 23 separate markets dispersed throughout a 15 state area. At December 31, 1997, the Company's largest apartment market was Dallas, where it owned 14% of its apartment homes. Excluding Dallas, the Company did not own more than 6% of its apartment homes in any one market.
The following table summarizes real estate held for investment at December 31, (dollars in thousands):
The following is a summary of real estate owned by market at December 31, 1997 (dollars in thousands):
Real Estate Held for Investment by Market (Excluding real estate under development)
UNITED DOMINION REALTY TRUST, INC.. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Real Estate Held for Disposition (B)
(A) There are 31 apartment communities encumbered by two REMIC financings and one note payable-secured aggregating $127.6 million.
(B) Real estate held for disposition contributed net rental income (rental income less rental expenses and depreciation expense) in the aggregate amount of approximately $19.5 million for the year ended December 31, 1997. The Company expects to dispose of these properties within the next twelve months.
In connection with the Company's periodic evaluation of its apartment portfolio, during the third quarter of 1997, the Company recorded an impairment loss of $1.4 million relating to two apartment communities included in the Company's real estate held for investment. These apartment communities were subsequently moved to real estate held for disposition based upon management's decision to dispose of these properties.
The following is a reconciliation of the carrying amount of real estate held for investment (dollars in thousands):
The following is a reconciliation of accumulated depreciation for real estate held for investment (dollars in thousands):
* Includes $752,000, $629,000 and $503,000 for 1997, 1996 and 1995, respectively, classified as "Other depreciation and amortization" in the Consolidated Statements of Operations.
3. Acquisitions
During 1997, the Company acquired 29 apartment communities containing 8,628 apartment homes for a total cost of $344 million, including closing costs and three parcels of land for development at an aggregate cost of $4 million. In connection with these acquisitions the Company assumed mortgage debt of $60 million and issued 849,000 Operating Partnership Units valued at $13 million. On December 31, 1996, the Company acquired South West Property Trust Inc. in a statutory merger (the "South West Merger"). South West Property Trust Inc. consisted primarily of real estate assets valued at $560 million which included 14,320 completed apartment homes and 675 apartment homes under development. In connection with the South West Merger, the Company issued 22.8 million shares of its common stock valued at $14.125 per share for total market equity of $322 million, assumed debt and other liabilities of $246 million and incurred transaction costs of $4 million for total consideration of approximately $572 million. No goodwill was recorded in connection with this transaction. In addition to the South West Merger, during 1996 the Company acquired 30 apartment communities containing 7,172 apartment homes in separate transactions at a total cost of approximately $321 million, including closing costs. In connection with these acquisitions, the Company assumed $138 million of secured debt, issued 1.7 million shares of the Company's common stock valued at $24 million, assumed unsecured debt of $25 million and issued 136,000 Operating Partnership Units valued at $2 million.
Information concerning unaudited pro forma results of operations for the years ended December 31, 1997 and 1996 are set forth below. For 1997, such pro forma information assumes the acquisition of 17 apartment communities containing 5,659 homes at a total cost of $219 million, as if the transactions had occurred on January 1, 1996. For 1996, such pro forma information assumes the following transactions occurred on January 1, 1996: (i) the South West Merger, (ii) the acquisition during 1996 of 20 apartment communities containing 5,157 apartment homes at a total cost of approximately $213 million and (iii) the acquisition of 17 apartment communities containing 5,659 apartment homes at a total cost of approximately $219 million.
The unaudited information is not necessarily indicative of what the Company's consolidated results of operations would have been if the acquisitions had occurred at the beginning of each period presented. Additionally, the pro forma information does not purport to be indicative of the Company's results of operations for future periods.
4. Notes Payable-Secured
Notes payable-secured, which encumber $849.3 million or 34% of the Company's real estate owned, ($1.7 billion or 66% of the Company's real estate owned is unencumbered) consist of the following at December 31, 1997 (dollars in thousands):
Fixed-Rate Mortgage Notes Payable Fixed-rate mortgage notes payable are generally due in monthly installments of principal and interest and mature at various dates from June 1998 through November 2008. These notes payable carry interest rates ranging from 7.00% to 9.63%. During 1997, the Company assumed six fixed-rate mortgage notes payable aggregating $48.5 million with a weighted average interest rate of 8.51% in connection with the acquisition of apartment communities.
Tax-Exempt Secured Notes Payable Fixed-rate mortgage notes which secure related tax-exempt housing bond issues mature at various dates through December 2025. Interest on these notes is generally payable in semi-annual installments. During 1997, the Company assumed one tax exempt note payable in the amount of $11.5 million bearing interest of 8.10%.
REMIC Financings In connection with the South West Merger, the Company assumed two fixed-rate REMIC Financings which bear interest of 7.01% and 8.50% and mature on December 10, 2000 and February 10, 2001, respectively. The Company makes monthly installments of principal and interest over the term of the REMIC Financings. Principal balances at maturity are expected to be $36.5 million and $41.7 million, respectively.
Secured Notes Payable Secured notes payable consist of a $39 million variable-rate secured senior credit facility and a $6 million variable-rate construction note payable, both of which mature in August 1999. The variable-rate secured notes payable bear interest at LIBOR + 1% or 6.63% at December 31, 1997. The Company has five interest rate swap agreements aggregating $45 million under which the Company pays a fixed-rate of interest and receives a variable-rate on the notional amounts. The interest rate swap agreements effectively change the Company's interest rate exposure on the $45 million secured notes payable from a variable-rate to a weighted average fixed-rate of 7.29%.
Variable-Rate Secured Notes Payable Two of the variable rate secured notes payable consist of construction notes payable, both of which mature in August 1999 and bear interest at LIBOR + 1% or 6.63% at December 31, 1997. The third variable rate secured
note payable is a mortgage note payable which matures in March 2001 and bears interest of 7.15% at December 31, 1997.
Tax-Exempt-Secured Notes Payable At December 31, 1997, the Company had one variable-rate tax-exempt mortgage note outstanding which matures in December 2002 and carries interest of 5.43%.
The aggregate maturities of secured notes payable for the five years subsequent to December 31, 1997 were as follows (dollars in thousands):
5. Notes Payable-Unsecured
A summary of notes payable-unsecured at December 31, 1997 and 1996 is as follows:
(a) Payable in six equal principal installments of $7.4 million. (b) Payable in annual principal installments of $2 million, of which, the final installment is due November 1998. (c) Includes $6.2 million and $5.6 million at December 31, 1997 and 1996, respectively, of deferred gain from the termination of interest rate hedge transactions. (d) Debentures include an investor put feature which grants the debentureholder a one time option to redeem debentures at the end of 10 years.
In November 1996, the Company entered into an interest rate protection agreement for a notional amount of $100 million in anticipation of issuance of debt early in 1997. The interest rate protection agreement was terminated simultaneously with the issuance of $125 million of 7.25% Notes in January 1997. The Company received $1.5 million in cash on the settlement which had the economic effect of lowering the interest rate on the Notes to approximately 7.14% over their ten year term.
Information concerning short-term bank borrowings is summarized in the table that follows:
The underlying loan agreements contain certain covenants which, among other things, require the Company to maintain minimum consolidated tangible net worth, as defined, and maintain certain financial ratios.
At December 31, 1997, the Company had in place a syndicated three year $200 million unsecured revolving credit facility (the "Credit Facility") of which $136 million was outstanding at December 31,1997. The Credit Facility will expire on August 4, 2000. Borrowings under the Credit Facility generally bear interest at LIBOR plus 42.5 basis points. The Company is also required to pay a fee of .175% of the committed amount. This fee and the interest rate are both subject to change as the Company's credit ratings change.
At December 31, 1997, the Company had a $50 million interim syndicated 364 day credit agreement (the "Credit Agreement') expiring on August 3, 1998. There were no borrowings outstanding under this Credit Agreement at December 31, 1997. Borrowings generally bear interest at the LIBOR plus 47.5 basis points. The Company is required to pay a fee of .125% of the committed amount. This fee and the interest rate are both subject to change as the Company's credit ratings change.
At December 31, 1997, the Company had a $15 million unsecured line of credit with a commercial bank, of which $.6 million was outstanding at December 31, 1997. Currently expiring on June 30, 1998, this credit facility is renewable annually by mutual agreement between the Company and the bank. The line is subject to periodic bank review and requires the Company to maintain a depository relationship with the bank, however, there are no formal compensating balance arrangements. Borrowings bear interest generally at negotiated rates in line with borrowings under the Company's revolving credit facility.
The Credit Facility and Credit Agreement are subject to customary financial covenants and limitations.
6. Financial Instruments
Fair Value of Financial Instruments The following disclosures of estimated fair value of financial instruments were determined by the Company using available market information and appropriate valuation methodologies. The carrying amounts and estimated fair value of the Company's financial instruments at December 31, 1997 and 1996, both on and off-balance sheet, are summarized as follows:
The following methods and assumptions were used by the Company in estimating the fair values set forth above.
Cash and cash equivalents The carrying amount of cash and cash equivalents approximates fair value.
Investment in equity securities At December 31, 1996, securities available-for-sale were carried at fair value based upon market quotations.
Notes payable Estimated fair value is based on mortgage rates and tax-exempt bond rates believed to be available to the Company for issuance of debt with similar terms and remaining lives. The carrying amount of the Company's variable-rate notes payable-secured approximate fair value at December 31, 1997 and 1996. The carrying amounts of the Company's borrowings under short-term revolving credit agreements and lines of credit reasonably approximate their fair values.
Interest rate swap agreements Fair value is based on external market quotations from investment banks.
Interest rate risk management agreements Fair value is based on external market quotations from investment banks.
Derivative Instruments Interest rate swap agreements At December 31, 1997, the Company had five interest rate swap agreements outstanding with an aggregate notional amount of $45 million. These agreements effectively fix the interest rate on certain variable-rate secured notes payable to a weighted average fixed rate of 7.29%. These contracts have a weighted average maturity of 3.6 years and mature at various times from May 2000 to July 2004. On May 1, 1997, an interest rate swap agreement with a commercial lender expired with a notional value of $83 million which effectively changed the Company's interest exposure from a variable rate to a weighted average fixed rate of 6.45% during the first four months of 1997. The Company's credit exposure on swaps is limited to the value of interest rate swaps that are favorable to the Company at December 31, 1997. At December 31, 1997, the market value of interest rate swaps in an unfavorable value position to the Company was $547,000.
At December 31, 1996 the Company had six interest rate swap agreements with an aggregate notional amount of $122.2 million outstanding and had a net fair value which was unfavorable to the Company of $589,000.
For all periods presented, the Company had no deferred gains or losses relating to terminated swap contracts.
Interest rate risk management agreements The Company deferred gains of $3.0 million in 1996 related to the termination of interest rate risk management agreements used to hedge $200 million of medium-term notes issued in 1996. These agreements had the economic impact of reducing the interest rate from 7.95% to 7.61% over the ten year term of the Notes.
The Company deferred gains of $1.5 million in 1997 related to the termination of an interest rate risk management agreement used to hedge the issuance of $125 million of Notes issued in 1997. This agreement had the economic impact of reducing the interest rate from 7.31% to 7.14% over the ten year term of the Notes.
In order to reduce the interest rate risk associated with the anticipated issuance of unsecured notes during 1998, the Company entered into a $100 million (notional amount) fixed pay forward starting swap agreement with a major Wall Street investment banking firm in July 1997. The transaction allowed the Company to lock-in a ten year Treasury rate of 6.486% on or before September 9, 1998. This interest rate risk management agreement had an unfavorable position to the Company of $5.6 million at December 31, 1997.
The Company has not obtained collateral or other security to support financial instruments. In the event of nonperformance by the counterparty, the Company's credit loss on its derivative instruments is limited to the value of the derivative instruments that are favorable to the Company at December 31, 1997. However, such nonperformance is not anticipated as the counterparties are highly rated, credit quality U.S. financial institutions.
7. Income Taxes
The differences between net income available to common shareholders for financial reporting purposes and taxable income before dividend deductions relate primarily to temporary differences, principally real estate depreciation and the tax deferral of certain gains on property sales. The temporary differences in depreciation result from differences in the book and tax basis of certain real estate assets and the differences in the methods of depreciation and lives of the real estate assets.
All realized gains (losses) on sales of investments are distributed to shareholders if and when recognized for income tax purposes. Since 1980, gains aggregating approximately $30.0 million have been deferred for income tax purposes and are undistributed at December 31, 1997.
For income tax purposes, distributions paid to common shareholders consist of ordinary income, capital gains, return of capital or a combination thereof. For the three years ended December 31, 1997, distributions paid per common share were taxable as follows:
8. Employee Benefit Plans
Profit Sharing Plan
The "United Dominion Realty Trust, Inc. Profit Sharing Plan" (the Plan) is a defined contribution plan covering all eligible full-time employees. Under the Plan, the Company makes discretionary profit sharing and matching contributions to the Plan as determined by the Compensation Committee of the Board of Directors. Aggregate contributions, both matching and discretionary, which are included in the Company's consolidated statements of operations for the three years ended December 31, 1997, 1996 and 1995 were $646,000, $600,000 and $536,000, respectively.
Stock Option Plan
The Company's 1985 Share Option Plan, (the "Plan"), authorizes the grant of options, at the discretion of the Board, to certain officers, directors and key employees of the Company, for up to 4,200,000 shares of the Company's common stock. The Plan generally provides, among other things, that options be granted at exercise prices not lower than the market value of the shares on the date of grant. Shares under options which subsequently expire or are canceled are available for subsequent grant. For options granted prior to December 12, 1995, the optionee has up to five years from the date on which the options first become exercisable during which to exercise the options. For all options granted subsequent to December 12, 1995, the options have 10 year terms and typically vest on December 31 of the year subsequent to grant.
Pro forma information regarding net income and earnings per share is required by Statement 123, and has been determined as if the Company had accounted for its employee stock options under the fair value method of accounting as defined in Statement 123. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions for 1997, 1996 and 1995:
For purposes of the pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. Statement 123 is applicable only to options granted subsequent to December 31, 1994, consequently, the pro forma effect is not fully reflected until 1997. The Company's pro forma information is as follows: (in thousands, except per share amounts):
A summary of the Company's stock option activity during the three years ended December 31, 1997 is provided in the following table (in thousand of dollars, except per share amounts).
The weighted average remaining contractual life on all options outstanding is 7.9 years. Approximately 2,586,500 of share options had exercise prices between $14.25 and $15.38, and approximately 812,100 had exercise prices between $11.56 and $13.63.
The weighted-average fair value of options granted during 1997, 1996 and 1995 was $1.35, $1.43 and $1.58, respectively.
9. Shareholders' Equity
Preferred Stock Both Series A and B Preferred Stock have no stated par value, with a liquidation preference of $25 per share. With no voting rights and no stated maturity, the preferred stock in both series is not subject to any sinking fund or mandatory redemption and is not convertible into any other securities of the Company. All dividends due and payable on the Preferred Stock have been accrued or paid as of the end of each fiscal year.
Officers' Stock Purchase and Loan Plan Under the Officer Stock Purchase and Loan Plan, certain officers have purchased common stock at the then current market price with financing provided by the Company at 7.5% interest only. The underlying notes mature beginning in November 1998. A total of 582,500 shares are available for future issuance under this Plan.
Dividend Reinvestment and Stock Purchase Plan The Company's Dividend Reinvestment and Stock Purchase Plan (the "Plan") allows common and preferred shareholders the opportunity to purchase, through reinvestment of cash dividends, additional shares of the Company's common stock at a discount. As of December 31, 1997, 3,915,493 shares of common stock had been issued under the Company's Dividend Reinvestment and Stock Purchase Plan. Shares in the amount of 84,507 were reserved for further issuance under this plan at December 31, 1997, and 10,000,000 additional shares of common stock were registered for sale on January 16, 1998. During 1997, 2,852,231 shares were issued under the Plan for a total market equity value of approximately $39.7 million.
Purchase Rights On January 27, 1998, the Board of Directors authorized a Shareholders Rights Plan (the "Rights Plan") which will become exercisable only if a person or group (the "Acquiring Person") acquires or announces a tender offer for more than 15% of the outstanding common stock of the Company. Upon exercise, the Company may issue one share of common stock in exchange for each Right. Each Right will entitle the holder to purchase for $45 one thousandth of a share of Series C Preferred stock or, at the option of the company, the Company's common stock having a value of $90.
10. Unaudited Summarized Consolidated Quarterly Financial Data Summarized consolidated quarterly financial data for the year ended December 31, 1997 is as follows (In thousands, except per share information):
Summarized consolidated quarterly financial data for the year ended December 31, 1996 is as follows (In thousands, except per share information):
The 1996 and first three quarters of 1997 earnings per share amounts have been restated to comply with Statement of Financial Accounting Standards No. 128, "Earnings per Share".
11. Subsequent Events
On December 19, 1997, the Company executed a definitive merger agreement (the "Merger Agreement") pursuant to which ASR Investment Corporation ("ASR") would be merged with and into a wholly-owned subsidiary of the Company which would continue the geographic expansion of the Company into the Western region of the United States. At December 31, 1997, ASR owned and operated 41 apartment communities containing approximately 7,500 apartment homes in the Southwest and Northwest. Pursuant the Merger Agreement, each share of the ASR's common stock will be exchanged for 1.575 shares of the Company's common stock. The merger has been structured as a tax-free transaction and will be treated as a purchase for accounting purposes. The aggregate purchase price is estimated at approximately $330 million, including closing costs. The merger, expected to close on or about March 27, 1998, is subject to ASR's shareholder approval and customary regulatory and other conditions. There can be no assurances that the transaction will be consummated.
SCHEDULE III. Summary of Real Estate Owned
(a) The aggregate cost for federal income tax purposes was approximately $2.3 billion and $1.9 billion at December 31, 1997 and 1996, respectively.
(b) Represents a $41,494,601 REMIC financing encumbering 12 apartment communities.
(c) Represents a $47,079,012 REMIC financing encumbering 13 apartment communities.
(d) represents a $39,000,000 notes payable-secured which encumbers six apartment communities.
(e) The depreciable life for all buildings is 35 years.
(f) The Company's long-lived assets are periodically evaluated for impairment and provisions for possible investment losses are recorded if required. The following properties have a provision for possible investment loss recorded as follows: (i) The Ledges - $300,000, (ii) Patriot Place - $257,000 (iii) Covington Crossing - $1,100,000, (iv) Gloucester Exchange - $775,000 and (v) Meadowdale Office Park - $300,000.