Organization, Basis of Presentation and Significant Accounting Policies

Organization and Basis of Presentation

AvalonBay Communities, Inc. (the “Company,” which term, unless the context otherwise requires, refers to AvalonBay Communities, Inc. together with its subsidiaries), is a Maryland corporation that has elected to be treated as a real estate investment trust (“REIT”) for federal income tax purposes under the Internal Revenue Code of 1986 (the “Code”). The Company focuses on the development, redevelopment, acquisition, ownership and operation of multifamily communities primarily in New England, the New York/New Jersey metro area, the Mid-Atlantic, the Pacific Northwest, and Northern and Southern California.

At September 30, 2015, the Company owned or held a direct or indirect ownership interest in 255 operating apartment communities containing 74,202 apartment homes in 11 states and the District of Columbia, of which eight communities containing 2,675 apartment homes were under reconstruction. In addition, the Company has 27 communities under construction that are expected to contain an aggregate of 8,649 apartment homes when completed. The Company also owned or held a direct or indirect ownership interest in land or rights to land on which the Company expects to develop an additional 33 communities that, if developed as expected, will contain an estimated 9,752 apartment homes.

The interim unaudited financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and in conjunction with the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements required by GAAP have been condensed or omitted pursuant to such rules and regulations. These unaudited financial statements should be read in conjunction with the financial statements and notes included in the Company’s 2014 Annual Report on Form 10-K. The results of operations for the three and nine months ended September 30, 2015 are not necessarily indicative of the operating results for the full year. Management believes the disclosures are adequate to ensure the information presented is not misleading. In the opinion of management, all adjustments and eliminations, consisting only of normal, recurring adjustments necessary for a fair presentation of the financial statements for the interim periods, have been included.

Capitalized terms used without definition have meanings provided elsewhere in this Form 10-Q.

Earnings per Common Share

Basic earnings per share is computed by dividing net income attributable to common stockholders by the weighted average number of shares outstanding during the period. All outstanding unvested restricted share awards contain rights to non-forfeitable dividends and participate in undistributed earnings with common shareholders and, accordingly, are considered participating securities that are included in the two-class method of computing basic earnings per share (“EPS”). Both the unvested restricted shares and other potentially dilutive common shares, and the related impact to earnings, are considered when calculating earnings per share on a diluted basis. The Company’s earnings per common share are determined as follows (dollars in thousands, except per share data):



	For the three months ended						For the nine months ended
	9/30/2015			9/30/2014			9/30/2015			9/30/2014
Basic and diluted shares outstanding
Weighted average common shares - basic	133,669,584			131,330,078			132,516,847			130,165,873
Weighted average DownREIT units outstanding	7,500			7,500			7,500			7,500
Effect of dilutive securities	1,032,376			568,417			1,139,423			554,627
Weighted average common shares - diluted	134,709,460			131,905,995			133,663,770			130,728,000

Calculation of Earnings per Share - basic
Net income attributable to common stockholders	$	206,142		$	241,100		$	586,610		$	540,929
Net income allocated to unvested restricted shares	(467		)	(366		)	(1,444		)	(858		)
Net income attributable to common stockholders, adjusted	$	205,675		$	240,734		$	585,166		$	540,071

Weighted average common shares - basic	133,669,584			131,330,078			132,516,847			130,165,873

Earnings per common share - basic	$	1.54		$	1.83		$	4.42		$	4.15

Calculation of Earnings per Share - diluted
Net income attributable to common stockholders	$	206,142		$	241,100		$	586,610		$	540,929
Add: noncontrolling interests of DownREIT unitholders in consolidated partnerships, including discontinued operations	9			9			28			26
Adjusted net income available to common stockholders	$	206,151		$	241,109		$	586,638		$	540,955

Weighted average common shares - diluted	134,709,460			131,905,995			133,663,770			130,728,000

Earnings per common share - diluted	$	1.53		$	1.83		$	4.39		$	4.14

All options to purchase shares of common stock outstanding as of September 30, 2015 are included in the computation of diluted earnings per share. Certain options to purchase shares of common stock in the amount of 1,499 were outstanding at September 30, 2014, but were not included in the computation of diluted earnings per share because such options were anti-dilutive for the quarter.

The Company is required to estimate the forfeiture of stock options and recognize compensation cost net of the estimated forfeitures. The estimated forfeitures included in compensation cost are adjusted to reflect actual forfeitures at the end of the vesting period. The forfeiture rate at September 30, 2015 was 1.0% and is based on the average forfeiture activity over a period equal to the estimated life of the stock options. The application of estimated forfeitures did not materially impact compensation expense for the three and nine months ended September 30, 2015 or 2014.

Derivative Instruments and Hedging Activities

The Company enters into interest rate swap and interest rate cap agreements (collectively, “Hedging Derivatives”) for interest rate risk management purposes and in conjunction with certain variable rate secured debt to satisfy lender requirements. The Company does not enter into Hedging Derivatives transactions for trading or other speculative purposes. The Company assesses the effectiveness of qualifying cash flow and fair value hedges, both at inception and on an on-going basis. Hedge ineffectiveness is reported as a component of general and administrative expenses. The fair values of Hedging Derivatives that are in an asset position are recorded in prepaid expenses and other assets. The fair value of Hedging Derivatives that are in a liability position are included in accrued expenses and other liabilities. Fair value changes for derivatives that are not in qualifying hedge relationships are reported as a component of interest expense, net. For the Hedging Derivatives positions that the Company has determined qualify as effective cash flow hedges, the Company has recorded the effective portion of cumulative changes in the fair value of Hedging Derivatives in other comprehensive income. Amounts recorded in other comprehensive income will be reclassified into earnings in the periods in which earnings are affected by the hedged cash flow. The effective portion of the change in fair value of Hedging Derivatives that the Company has determined qualified as effective fair value hedges is reported as an adjustment to the carrying amount of the corresponding debt being hedged. See Note 10, "Fair Value," for further discussion of derivative financial instruments.

Legal and Other Contingencies

In January 2015, a fire occurred at the Company’s Avalon at Edgewater apartment community located in Edgewater, New Jersey ("Edgewater"). Edgewater consisted of two residential buildings. One building, containing 240 apartment homes, was destroyed. The second building, containing 168 apartment homes, suffered minimal damage and has been repaired. The Company is still assessing its losses resulting from the fire, including liability to third parties who incurred damages as a result of the fire. The Company is also evaluating whether to rebuild and replace the building that was destroyed and does not believe that the outcome of this decision will have a material impact on the Company’s financial condition or results of operations.

The Company believes that the fire was caused by sparks from a torch used during repairs being performed by a Company employee who was not a licensed plumber. The Company’s insurers are negotiating and settling claims submitted to the insurers by third parties who incurred property damage and are claiming other losses. Four putative class action lawsuits have been filed against the Company on behalf of Edgewater residents and others who may have been harmed by the fire; these actions have been consolidated by the court into one civil putative class action. In addition, 17 lawsuits representing approximately 133 individual plaintiffs have been filed against the Company. The Company believes that it has meritorious defenses to the extent of damages claimed. Additional lawsuits arising from the fire may be filed.

Following the fire, the Company received a civil citation for “failure to notify Fire Department of an active fire” from Bergen County, New Jersey. The Company has decided not to appeal this citation. The Company has also received two citations that were alleged to be serious by the Occupational Safety and Health Administration ("OSHA"); the Company has appealed these citations. It is possible that additional governmental investigations are or may be ongoing. The Company is unable to evaluate the nature and potential materiality of any such investigations or actions.

Having incurred applicable deductibles and a self-insured amount equal to 12% of the first $50,000,000 of property damage, the Company currently believes that all of its remaining liability to third parties and all of the Company's additional cost for replacement cost coverage for property damage resulting from the fire will be substantially covered by its insurance policies. However, the Company can give no assurances in this regard and continues to evaluate this matter. See Note 5, "Investments in Real Estate Entities," and Part II, Item 1, "Legal Proceedings," for further discussion of the casualty gains and losses and lawsuits associated with the Edgewater fire.

The Company is involved in various other claims and/or administrative proceedings unrelated to the Edgewater fire that arise in the ordinary course of its business. While no assurances can be given, the Company does not currently believe that any of these other outstanding litigation matters, individually or in the aggregate, will have a material adverse effect on its financial condition or results of operations.

Acquisitions of Investments in Real Estate

The Company accounts for acquisitions of investments in real estate in accordance with the authoritative guidance for the initial measurement, which requires the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree to be recognized at fair value. Typical assets and liabilities acquired include land, building, furniture, fixtures, and equipment, and identified intangible assets and liabilities, consisting of the value of above or below market leases and in-place leases. In making estimates of fair values for purposes of allocating purchase price, the Company utilizes various sources, including its own analysis of recently acquired and existing comparable properties in its portfolio and other market data.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make certain estimates and assumptions. These estimates and assumptions affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Actual results could differ from those estimates.

Reclassifications

Certain reclassifications have been made to amounts in prior years’ financial statements to conform to current year presentations as a result of changes in held for sale classification as described in Note 6, “Real Estate Disposition Activities.”

Recently Issued Accounting Standards

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers, a revenue recognition standard that will result in companies recognizing revenue from contracts when control for the service or product that is the subject of the contract is transferred from the seller to the buyer. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers-Deferral of the Effective Date, which defers the effective date of the new revenue recognition standard one year. The guidance is effective in the first quarter of 2018, and the Company is assessing whether the new standard will have a material effect on its financial position or results of operations.

In February 2015, the FASB issued ASU 2015-02, Consolidation: Amendments to the Consolidation Analysis, which amends the criteria for determining variable interest entities (“VIEs”), amends the criteria for determining if a service provider possesses a variable interest in a VIE, and eliminates the presumption that a general partner should consolidate a limited partnership. The guidance is effective in the first quarter of 2016 and allows for early adoption. The Company is currently assessing the effect of adoption on its consolidated financial statements.

In April 2015, the FASB issued ASU 2015-03, Interest - Imputation of Interest: Simplifying the Presentation of Debt Issuance Costs. The guidance requires debt issuance costs related to a recognized debt liability to be presented as a direct deduction from the carrying amount of that debt liability. The new guidance will only impact financial statement presentation. In August 2015, the FASB issued ASU 2015-15, Interest-Imputation of Interest: Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements. The guidance codified the SEC staff's view on the presentation and subsequent measurement of debt issuance costs associated with line-of-credit arrangements. The guidance is effective in the first quarter of 2016 and allows for early adoption. The Company does not expect the adoption of this standard to materially impact its consolidated financial statements.