6. Investments in Real Estate Entities

Investments in Unconsolidated Real Estate Entities

The Company accounts for its investments in unconsolidated real estate entities under the equity method of accounting, except as otherwise noted below, as discussed in Note 1, "Organization and Basis of Presentation," under Principles of Consolidation. The significant accounting policies of the Company's unconsolidated real estate entities are consistent with those of the Company in all material respects.

As of December 31, 2013, the Company had investments in the following real estate entities:

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AvalonBay Value Added Fund, LP ("Fund I")—In March 2005, the Company formed Fund I, a private, discretionary real estate investment vehicle, which acquired and operates communities in the Company's markets. Fund I served as the principal vehicle through which the Company acquired investments in apartment communities, subject to certain exceptions, until March 2008. Fund I has a term that expires in March 2015, after having exercised two one-year extension options. Fund I has nine institutional investors, including the Company. A significant portion of the investments made in Fund I by its investors were made through AvalonBay Value Added Fund, Inc., a Maryland corporation that qualifies as a REIT under the Code (the "Fund I REIT"). A wholly-owned subsidiary of the Company is the general partner of Fund I and has a 15.2% combined general partner and limited partner equity interest. Excluding costs incurred in excess of our equity in the underlying net assets of Fund I, the Company has an equity investment of $14,209,000 in Fund I and the Fund I REIT, net of distributions and excluding the purchase by the Company of a mortgage note secured by a Fund I community. The Company receives asset management fees, property management fees and redevelopment fees, as well as a promoted interest if certain thresholds are met.

During 2013, Fund I sold seven communities:

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Avalon Yerba Buena, located in San Francisco, CA, for $103,000,000;

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Avalon at Civic Center, located in Norwalk, CA, for $45,844,000;

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Avalon at Cedar Place, located in Columbia, MD, for $26,000,000;

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Avalon Sunset, located in Los Angeles, CA, for $25,800,000;

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Avalon Crystal Hill, located in Pomona, NY, for $33,050,000;

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Avalon Centerpoint, located in Baltimore, MD, for $75,250,000; and

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Middlesex Crossing, located in Billerica, MA, for $40,250,000.

The Company's proportionate share of the gain in accordance with GAAP recognized on the sale of these seven communities was $11,484,000.

- Subsidiaries of Fund I have four loans secured by individual assets (including a mortgage owned by the Company) with aggregate amounts outstanding of $66,132,000. Fund I subsidiary loans have varying maturity dates (or dates after which the loans can be prepaid without penalty), ranging from October 2014 to September 2016. These mortgage loans are secured by the underlying real estate. The mortgage loans are payable by the subsidiaries of Fund I from operating cash flow or disposition proceeds from the underlying real estate. The Company has not guaranteed the debt of Fund I, nor does the Company have any obligation to fund this debt should Fund I be unable to do so.
  
  In addition, as part of the formation of Fund I, the Company provided to one of the limited partners a guarantee. The guarantee provides that if, upon final liquidation of Fund I, the total amount of all distributions to that partner during the life of Fund I (whether from operating cash flow or property sales) does not equal a minimum of the total capital contributions made by that partner, then the Company will pay the partner an amount equal to the shortfall, but in no event more than 10% of the total capital contributions made by the partner (maximum of approximately $7,500,000 as of December 31, 2013). Under the expected Fund I liquidation scenario, as of December 31, 2013, the expected realizable value of the real estate assets owned by Fund I is considered adequate to avoid payment under such guarantee to that partner. The estimated fair value of, and the Company's obligation under this guarantee, both at inception and as of December 31, 2013, was not significant and therefore the Company has not recorded any obligation for this guarantee as of December 31, 2013.
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AvalonBay Value Added Fund II, LP ("Fund II")—In September 2008, the Company formed Fund II, a private, discretionary real estate investment vehicle which acquired and operates communities in the Company's markets. Fund II served as the exclusive vehicle through which the Company acquired investment interests in apartment communities, subject to certain exceptions, through the close of its investment period in August 2011. Fund II has six institutional investors, including the Company. One of the Company's wholly owned subsidiaries is the general partner of Fund II and, excluding costs incurred in excess of our equity in the underlying net assets of Fund II, the Company has made an equity investment of $93,714,000 (net of distributions), representing a 31.3% combined general partner and limited partner equity interest.

- During the year ended December 31, 2013, Fund II sold Avalon Rothbury, located in Gaithersburg, MD, for $39,600,000. The Company's proportionate share of the gain in accordance with GAAP for the disposition was $2,790,000.
  
  Subsidiaries of Fund II have 13 loans secured by individual assets with aggregate amounts outstanding of $467,959,000, with maturity dates that vary from November 2014 to September 2019. The mortgage loans are payable by the subsidiaries of Fund II from operating cash flow or disposition proceeds from the underlying real estate. The Company has not guaranteed repayment of this debt, nor does the Company have any obligation to fund this debt should Fund II be unable to do so.
  
  In addition, as part of the formation of Fund II, the Company provided to one of the limited partners a guarantee. The guarantee provides that if, upon final liquidation of Fund II, the total amount of all distributions to that partner during the life of Fund II (whether from operating cash flow or property sales) does not equal a minimum of the total capital contributions made by that partner, then the Company will pay the partner an amount equal to the shortfall, but in no event more than 10% of the total capital contributions made by the partner (maximum of approximately $8,910,000 as of December 31, 2013). Under the expected Fund II liquidation scenario, as of December 31, 2013, the expected realizable value of the real estate assets owned by Fund II is considered adequate to avoid payment under such guarantee to that partner. The estimated fair value of, and the Company's obligation under, this guarantee, both at inception and as of December 31, 2013, was not significant and therefore the Company has not recorded any obligation for this guarantee as of December 31, 2013.
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CVP I, LLC—In February 2004, the Company entered into a joint venture agreement with an unrelated third-party for the development of Avalon Chrystie Place, a 361 apartment-home community located in New York, New York, for which construction was completed in 2005. The Company holds a 20% equity interest in the venture (with a right to 50% of distributions after achievement of a threshold return, which was achieved in 2012 and 2013). The Company is the managing member of CVP I, LLC, however, property management services at the community are performed by an unrelated third party.

- As of December 31, 2013, CVP I, LLC has outstanding tax-exempt, variable rate bonds maturing in November 2036 in the amount of $117,000,000 which have permanent credit enhancement. The Company agreed to guarantee, under limited circumstances, the repayment to the credit enhancer of any advances it may make in fulfillment of CVP I, LLC's repayment obligations under the bonds. The Company's 80% partner in this venture agreed that it will reimburse us its pro rata share of any amounts paid relative to the outstanding guaranteed obligation. The estimated fair value of the Company's obligation under the outstanding guarantee, both at inception and as of December 31, 2013, was not significant. As a result the Company has not recorded any obligation associated with the guarantee at December 31, 2013.
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MVP I, LLC—In December 2004, the Company entered into a joint venture agreement with an unrelated third-party for the development of Avalon at Mission Bay North II. Construction of Avalon at Mission Bay North II, a 313 apartment-home community located in San Francisco, California, was completed in December 2006. The Company holds a 25% equity interest in the venture (with a right to 45% of distributions after achievement of a threshold return, which was achieved in 2013). The Company is responsible for the day-to-day operations of the community and is the management agent subject to the terms of a management agreement. In December 2007, MVP I, LLC executed a fixed-rate conventional loan, which is secured by the underlying real estate assets of the community, for $105,000,000. The loan is a fixed rate, interest-only note bearing interest at 6.02%, maturing in December 2015. The Company has not guaranteed the debt of MVP I, LLC, nor does the Company have any obligation to fund this debt should MVP I, LLC be unable to do so.

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Arna Valley View LP—In connection with the municipal approval process to develop a consolidated community, the Company entered into a limited partnership in February 1999 to develop, finance, own and operate Arna Valley View, a 101 apartment-home community in Arlington, Virginia. This community has affordable rents for 100% of the apartment homes related to the tax-exempt bond financing and tax credits used to finance construction of the community. A subsidiary of the Company is the general partner of the partnership with a 0.01% ownership interest. The Company manages the community and is subject to a management agreement. As of December 31, 2013, Arna Valley View has $4,829,000 of 6.25% fixed rate, tax-exempt bonds outstanding, which mature in November 2030. In addition, Arna Valley View has $5,836,000 of 4% fixed rate county bonds outstanding that mature in December 2030. Arna Valley View's debt is neither guaranteed by, nor recourse, to the Company. Due to the Company's limited ownership in this venture and the terms of the management agreement regarding the rights of the limited partners, it is accounted for using the cost method.

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Aria at Hathorne Hill, LLC—In the second quarter of 2007, a wholly-owned taxable REIT subsidiary of the Company entered into an LLC agreement with a joint venture partner to develop 64 for-sale town homes in Danvers, Massachusetts on an out parcel adjacent to our Avalon Danvers rental apartment community. Approximately 30% of the homes have been built and sold. The out parcel was zoned for for-sale activity, and was contributed to the LLC by a subsidiary of the Company in exchange for a 50% ownership interest. During 2011, the Company concluded that because the market for for-sale housing development had not improved as expected, its investment in the venture was impaired and that impairment was other than temporary. As a result, the Company recognized a charge of $1,955,000 for the impairment of the investment in the unconsolidated joint venture, which holds nondepreciable real estate assets. In December 2011, the Company acquired the note that the venture had with a third party lender for $1,700,000. In 2013, the venture repaid the balance of the note and the Company sold its interest to the unrelated third party partners in the venture, recognizing a gain in accordance with GAAP of $975,000.

In conjunction with the Archstone Acquisition, the Company acquired interests in the following entities:

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The U.S. Fund was formed in July 2011 and is fully invested. As of December 31, 2013, the U.S. Fund owns nine communities containing 1,726 apartment homes, one of which includes a marina containing 229 boat slips. Through subsidiaries the Company owns the general partner of the fund and holds a 28.6% interest in the fund.

- Subsidiaries of the U.S. Fund have nine loans secured by individual assets with amounts outstanding in the aggregate of $327,849,000 with varying maturity dates, ranging from January 2019 to November 2022. The mortgage loans are payable by the subsidiaries of the U.S. Fund with operating cash flow or disposition proceeds from the underlying real estate. The Company has not guaranteed the debt of the U.S. Fund, nor does the Company have any obligation to fund this debt should the U.S. Fund be unable to do so.
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The AC JV is a joint venture in which the Company acquired Archstone's 20% ownership interest. The AC JV was formed in 2011 and as of December 31, 2013 owned two operating apartment communities containing 818 apartment homes in Cambridge, MA and Herndon, VA. The AC JV partnership agreement contains provisions that require the Company to provide a right of first offer ("ROFO") to the AC JV in connection with additional opportunities to acquire or develop additional interests in multifamily real estate assets within a specified geographic radius of the existing assets, generally one mile or less. During the year ended December 31, 2013, the Company provided the AC JV with the opportunity to acquire a parcel of land owned by the Company as required in the right of first offer provisions for the joint venture. The AC JV exercised its right to acquire the land parcel for development and commenced construction of an additional apartment community located in Cambridge, MA. The Company sold the parcel of land to the AC JV in exchange for a cash payment and a capital account credit, and is overseeing the development in exchange for a developer fee. The Company owns one additional land parcel for the development of 301 apartment homes, classified as a Development Right in Cambridge, MA, acquired as part of the Archstone Acquisition that is subject to ROFO restrictions. The ROFO restriction expires in 2019.
- As of December 31, 2013, subsidiaries of the AC JV have eight unsecured loans outstanding in the aggregate of $162,300,000 which mature in July 2021, and which were made by the investors in the venture, including the Company, in proportion to the investors' respective equity ownership interest. The unsecured loans are payable by the subsidiaries of the AC JV with operating cash flow from the venture. The Company has not guaranteed the debt of the AC JV, nor does the Company have any obligation to fund this debt should the AC JV be unable to do so.
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Brandywine owns a 305 apartment home community located in Washington, DC. The community is managed by a third party. Brandywine is comprised of five members who hold various interests in the joint venture. In conjunction with the Archstone Acquisition, the Company acquired a 26.1% equity interest in the venture, and subsequently purchased an additional 2.6% interest, and as of December 31, 2013, holds a 28.7% equity interest in the venture.

- Brandywine has an outstanding $24,839,000 fixed rate mortgage loan that is payable by the venture. The Company has not guaranteed the debt of Brandywine, nor does the Company have any obligation to fund this debt should Brandywine be unable to do so.
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Through the Residual JV, the Company and Equity Residential acquired (i) certain assets of Archstone that the Company and Equity Residential plan to divest (to third parties or to the Company or Equity Residential) over time (the "Residual Assets"), and (ii) various liabilities of Archstone that the Company and Equity Residential agreed to assume in conjunction with the Archstone Acquisition (the "Residual Liabilities"). The Residual Assets include interests in apartment communities in Germany (including through a fund which Archstone managed); a 20.0% interest in Lake Mendota Investments, LLC and Subsidiaries ("SWIB"), a joint venture which owns and manages six apartment communities with 1,902 apartment homes in the United States; two land parcels; and various licenses, insurance policies, contracts, office leases and other miscellaneous assets. The Residual Liabilities include most existing or future litigation and claims related to Archstone's operations for periods before the close of the Archstone Acquisition, except for (i) claims that principally relate to the physical condition of the assets acquired directly by us or Equity Residential, which generally remain the sole responsibility of us or Equity, as applicable, and (ii) certain tax and other litigation between Archstone and various equity holders in Archstone related to periods before the close of the Archstone Acquisition, and claims which may arise due to changes in the capital structure of Archstone that occurred prior to closing, for which Lehman has agreed to indemnify the Company and Equity Residential. The Company and Equity Residential jointly control the Residual JV and the Company holds a 40% economic interest in the assets and liabilities of the Residual JV.

- As of December 31, 2013, SWIB has two loans and draws on a credit facility secured by individual assets with amounts outstanding in the aggregate of $187,021,000 with varying maturity dates, ranging from December 2014 to December 2029. The Company has not guaranteed the debt of SWIB, nor does the Company have any obligation to fund this debt should SWIB be unable to do so.

The following is a combined summary of the financial position of the entities accounted for using the equity method, excluding joint venture entities the Company formed with Equity Residential as part of the Archstone Acquisition, as of the dates presented (dollars in thousands):

	12-31-13		12-31-12

Assets:
Real estate, net	$	1,890,496	$	1,337,084
Other assets		402,644		73,252


Total assets	$	2,293,140	$	1,410,336




Liabilities and partners' capital:
Mortgage notes payable and credit facility	$	1,251,067	$	943,259
Other liabilities		29,677		20,405
Partners' capital		1,012,396		446,672


Total liabilities and partners' capital	$	2,293,140	$	1,410,336

The following is a combined summary of the operating results of the entities accounted for using the equity method, excluding joint venture entities the Company formed with Equity Residential as part of the Archstone Acquisition, for the years presented (dollars in thousands):

	For the year ended

	12-31-13			12-31-12			12-31-11
Rental and other income	$	208,979		$	172,076		$	160,066
Operating and other expenses		(86,247	)		(73,955	)		(71,926	)
Gain on sale of real estate(1)		96,152			106,195			22,246
Interest expense, net		(61,404	)		(53,904	)		(50,530	)
Depreciation expense		(61,002	)		(47,748	)		(47,920	)


Net income	$	96,478		$	102,664		$	11,936

(1): Amount for the year ended December 31, 2012 includes $44,700 of gain recognized by the joint venture associated with the Company's acquisition of Avalon Del Rey from its joint venture partner.

In conjunction with the formation of Fund I and Fund II, the Company incurred costs in excess of its equity in the underlying net assets of the respective investments. These costs represent $5,439,000 at December 31, 2013 and $7,342,000 at December 31, 2012 of the respective investment balances.

The following is a summary of the Company's equity in income of unconsolidated entities for the years presented (dollars in thousands):

	For the year ended

	12-31-13			12-31-12		12-31-11
Fund I(1)	$	10,924		$	7,041	$	2,204
Fund II(2)		6,206			2,130		(1,053	)
CVP I, LLC(3)		5,783			5,394		4,493
MVP I, LLC(4)		1,137			493		(626	)
Avalon Del Rey, LLC(5)		181			4,000		102
Juanita Village(6)		378			1,856		—
U.S. Fund(7)		(661	)		—		—
AC JV(7)		2,569			—		—
Brandywine(7)		661			—		—
Residual JV(7)(8)		(38,332	)		—		—


Total	$	(11,154	)	$	20,914	$	5,120

(1): Equity in income for the years ended December 31, 2013, 2012 and 2011 includes the Company's proportionate share of the gain on the sale of Fund I assets of $11,484, $7,971, and $3,063, respectively.
(2): Equity in income for 2013 includes the Company's proportionate share of the gain on the sale of one Fund II asset of $2,790.
(3): Equity in income from this entity for 2013, 2012, and 2011 includes $5,527, $5,260, and $5,078, respectively, relating to the Company's recognition of its promoted interest.
(4): Equity in income from this entity for 2013 includes $516 relating to the Company's recognition of its promoted interest.
(5): During 2012, the Company purchased its joint venture partner's interest in this venture.
(6): The Company's equity in income for this entity represents its residual profits from the sale of the community.
(7): The Company's joint venture partner's interest was acquired in conjunction with the Archstone Acquisition.
(8): Equity in income for the Residual JV includes certain expensed Archstone Acquisition costs borne by the venture.

Investments in Consolidated Real Estate Entities

In December 2013, the Company acquired Arboretum at Burlington, located in Burlington, MA. Arboretum at Burlington contains 312 apartment homes and was acquired for a purchase price of $79,850,000.

The Company accounted for this acquisition as a business combination and recorded the acquired assets and assumed liabilities, including identifiable intangibles, based on their fair values. The Company looked to third party pricing or internal models for the values of the land, and an internal model to determine the fair values of the real estate assets and in-place leases. Given the heterogeneous nature of multifamily real estate, the fair values for the land, real estate assets and in-place leases incorporated significant unobservable inputs and therefore are considered to be Level 3 prices within the fair value hierarchy.

The Company expenses transaction costs associated with acquisition activity as they are incurred. Expensed transaction costs associated with the acquisitions made by the Company in 2013 and 2012, as well as costs associated with the Archstone Acquisition, totaled $44,052,000 and $9,593,000, respectively, reported as a component of expensed acquisition, development and other pursuit costs on the accompanying Consolidated Statements of Comprehensive Income. Acquisition costs in 2011 were not significant.