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Investments in Real Estate Entities

9 Months Ended

Sep. 30, 2012

5. Investments in Real Estate Entities

Investments in consolidated entities

In July 2012, the Company acquired Avalon Del Rey, a 309 apartment home community which was owned by a joint venture in which the Company held a 30% ownership interest. As part of this transaction, the venture repaid the $43,606,000 variable rate note secured by the community. The Company paid approximately $67,200,000 for its joint venture partner’s 70% interest as well as contributing its proportionate share of the note repayment to the venture. Upon the acquisition of Avalon Del Rey, the Company consolidated the community, recognized income from its promoted interest of $4,055,000 included in equity in income of unconsolidated equities, and a gain of $14,194,000, as gain on acquisition of unconsolidated entity in the Condensed Consolidated Statements of Comprehensive Income (Loss). The gain recognized reflects the amount by which the fair value of the Company’s previously owned investment interest exceeded its carrying value.

The Company accounted for the acquisition of Avalon Del Rey as a business combination and recorded the acquired assets and assumed liabilities, including identifiable intangibles, at their fair values. The Company looked to internal pricing for the value of the land, and an internal model to determine the fair value of the real estate assets and in place leases. Given the heterogeneous nature of multi-family 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.

Investment in unconsolidated entities

As of September 30, 2012, the Company had investments in four unconsolidated real estate entities with ownership interest percentages ranging from 15.2% to 31.3%. The Company accounts for its investments in unconsolidated real estate entities under the equity method of accounting. The significant accounting policies of the Company’s unconsolidated real estate entities are consistent with those of the Company in all material respects.

There were no other changes in the Company’s ownership interest in, or presentation of, its investments in unconsolidated real estate entities during the three months ended September 30, 2012.

The following is a combined summary of the financial position of the entities accounted for using the equity method, as of the dates presented (dollars in thousands):

	9-30-12		12-31-11
	(unaudited)		(unaudited)
Assets:
Real estate, net	$	1,477,756	$	1,583,397
Other assets	88,627		70,233
Total assets	$	1,566,383	$	1,653,630

Liabilities and partners’ capital:
Mortgage notes payable and credit facility	$	1,033,226	$	1,074,429
Other liabilities	26,379		27,335
Partners’ capital	506,778		551,866
Total liabilities and partners’ capital	$	1,566,383	$	1,653,630

The following is a combined summary of the operating results of the entities accounted for using the equity method, for the periods presented (dollars in thousands):

	For the three months ended						For the nine months ended
	(unaudited)						(unaudited)
	9-30-12			9-30-11			9-30-12			9-30-11

Rental and other income	$	43,168		$	40,953		$	130,300		$	117,407
Operating and other expenses	(18,733		)	(18,829		)	(56,533		)	(53,474		)
Gain on sale of communities	44,723			12,445			57,457			12,445
Interest expense, net	(12,742		)	(12,818		)	(38,468		)	(37,596		)
Depreciation expense	(11,947		)	(12,363		)	(37,244		)	(35,702		)

Net income	$	44,469		$	9,388		$	55,512		$	3,080

In conjunction with the formation of AvalonBay Value Added Fund I, L.P. (“Fund I”) and AvalonBay Value Added Fund II, L.P. (“Fund II”), as well as the acquisition and development of certain other investments in unconsolidated entities, the Company incurred costs in excess of its equity in the underlying net assets of the respective investments. These costs represent $8,305,000 at September 30, 2012 and $9,167,000 at December 31, 2011 of the respective investment balances.

As part of the formation of Fund I and Fund II, the Company provided separate and distinct guarantees to one of the limited partners in each of the ventures. These guarantees are specific to the respective fund and any impacts or obligation of the Company to perform under one of the guarantees has no impact on the Company’s obligations with respect to the other guarantee. The guarantees provide that, if, upon final liquidation of Fund I or Fund II, the total amount of all distributions to the guaranteed partner during the life of the respective fund (whether from operating cash flow or property sales) does not equal the total capital contributions made by that partner, then the Company will pay the guaranteed partner an amount equal to the shortfall, but in no event more than 10% of the total capital contributions made by the guaranteed partner (maximum of approximately $7,500,000 for Fund I and approximately $8,910,000 for Fund II as of September 30, 2012). As of September 30, 2012, the expected realizable values of the real estate assets owned by Fund I and Fund II are considered adequate to cover such potential payments under a liquidation scenario. The estimated fair value of, and the Company’s obligation under these guarantees, both at inception and as of September 30, 2012, was not significant and therefore the Company has not recorded any obligation for either of these guarantees as of September 30, 2012.

Abandoned Pursuit Costs and Impairment of Long-Lived Assets

The Company capitalizes pre-development costs incurred in pursuit of new development opportunities for which the Company currently believes future development is probable (“Development Rights”). Future development of these Development Rights is dependent upon various factors, including zoning and regulatory approval, rental market conditions, construction costs and the availability of capital. Initial pre-development costs incurred for pursuits for which future development is not yet considered probable are expensed as incurred. In addition, if the status of a Development Right changes, making future development by the Company no longer probable, any capitalized pre-development costs are written off with a charge to expense. The Company expensed costs related to abandoned pursuits, which includes the abandonment of Development Rights as well as costs incurred in pursuing the acquisition of assets or the disposition of assets for which such disposition activity did not occur, in the amounts of $608,000 and $633,000 for the three months ended September 30, 2012 and 2011, respectively, and $1,749,000 and $2,636,000 for the nine months ended September 30, 2012 and 2011, respectively. These costs are included in operating expenses, excluding property taxes on the accompanying Condensed Consolidated Statements of Comprehensive Income (Loss). Abandoned pursuit costs can vary greatly, and the costs incurred in any given period may be significantly different in future periods.

The Company evaluates its operating real estate and other long-lived assets for impairment when potential indicators of impairment exist. Such assets are stated at cost, less accumulated depreciation and amortization, unless the carrying amount of the asset is not recoverable. If events or circumstances indicate that the carrying amount of a long-lived asset may not be recoverable, the Company assesses its recoverability by comparing the carrying amount of the long-lived asset to its estimated undiscounted future cash flows. If the carrying amount exceeds the aggregate undiscounted future cash flows, the Company recognizes an impairment loss to the extent the carrying amount exceeds the estimated fair value of the long-lived asset. Based on periodic tests of recoverability of long-lived assets, the Company did not record any impairment losses for its operating communities for the three and nine months ended September 30, 2012 and 2011.

The Company assesses its portfolio of land, both held for development and for investment, for impairment if the intent of the Company changes with respect to either the development of, or the expected holding period for the land. The Company did not recognize any impairment charges on its investment in land for the three and nine months ended September 30, 2012. The Company also evaluates its unconsolidated investments for impairment, considering both its carrying value of the investment, estimated as the expected proceeds that it would receive if the entity were dissolved and the net assets were liquidated at their current GAAP basis, as well as the Company’s proportionate share of any impairment of assets held by unconsolidated investments. There were no impairment losses recognized by any of the Company’s investments in unconsolidated entities during the three and nine months ended September 30, 2012.

In the third quarter of 2011, the Company concluded that the carrying basis of two land parcels being held for investment were not fully recoverable. In addition, the Company determined that its investment in an unconsolidated development joint venture was not recoverable and that the impairment was other than temporary. As a result, the Company recognized an aggregate charge of $14,052,000 for the impairment of these land parcels and the investment in the unconsolidated joint venture.