Investments in Real Estate Entities

12 Months Ended

Dec. 31, 2011

Investments in Real Estate Entities

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, 2011, the Company had investments in the following real estate entities:

• 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 has contributed $6,270,000 to this joint venture and holds a 20% equity interest (with a right to 50% of distributions after achievement of a threshold return, which was achieved in 2010 and 2011). 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, 2011, 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 has 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 has also guaranteed to the credit enhancer that CVP I, LLC will obtain a final certificate of occupancy for the project, which is expected in 2012. Our 80% partner in this venture has agreed that it will reimburse us its pro rata share of any amounts paid relative to these guaranteed obligations. The estimated fair value of and our obligation under these guarantees, both at inception and as of December 31, 2011, was not significant. As a result the Company has not recorded any obligation associated with these guarantees at December 31, 2011.

• 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 has contributed $6,433,000 to this venture and holds a 25% equity interest. 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 an 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.

• Avalon Del Rey Apartments, LLC – In March 2004, the Company entered into an agreement with an unrelated third party which provided that, upon construction completion, Avalon Del Rey would be owned and operated by a joint venture between the Company and the third party. Avalon Del Rey is a 309 apartment-home community located in Los Angeles, California that was developed by the Company, with construction completed during the third quarter of 2006. During the fourth quarter of 2006, the third-party venture partner invested $49,000,000 and was granted a 70% ownership interest in the venture, with the Company retaining a 30% equity interest. The Company continues to be responsible for the day-to-day operations of the community and is the management agent subject to the terms of a management agreement.

Avalon Del Rey Apartments, LLC has a variable rate loan secured by the underlying real estate assets of the community for $44,153,000 maturing in April 2016. The Company has not guaranteed the debt of Avalon Del Rey Apartments, LLC, nor does the Company have any obligation to fund this debt should Avalon Del Rey Apartments, LLC be unable to do so.

• 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 with a projected total capitalized cost of $23,621,000 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 has 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.

• Arna Valley View LP – In connection with the municipal approval process for the development of a consolidated community, the Company agreed to participate in the formation of a limited partnership in February 1999 to develop, finance, own and operate Arna Valley View, a 101 apartment-home community located in Arlington, Virginia. This community has affordable rents for 100% of 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 is responsible for the day-to-day operations of the community and is the management agent subject to the terms of a management agreement. As of December 31, 2011, Arna Valley View has $5,132,000 of variable rate, tax-exempt bonds outstanding, which mature in June 2032. In addition, Arna Valley View has $5,497,000 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.

• Fund I – In March 2005, the Company formed Fund I, a private, discretionary 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, plus two one-year extension options. Fund I has nine institutional investors, including the Company, and a combined equity capital contributions of $330,000,000. 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 made an equity investment of $42,121,000 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, representing a 15.2% combined general partner and limited partner equity interest. At December 31, 2011, Fund I was fully invested. The Company receives asset management fees, property management fees and redevelopment fees, as well as a promoted interest if certain thresholds are met.

During 2011, Fund I sold two communities:

• Avalon Columbia, located in Columbia, Maryland, for $34,650,000; and

• Avalon Redondo Beach, located in Redondo Beach, California, for $33,100,000.

Fund I recognized a gain of $22,246,000 on the sale of these two communities of which the Company’s proportionate share is $3,063,000.

In addition, Fund I sold two communities in 2012. See Note 14 – “Subsequent Events” for further details.

Subsidiaries of Fund I have 18 loans secured by individual assets (including a mortgage owned by the Company) with amounts outstanding in the aggregate of $378,177,000. Fund I subsidiary loans have varying maturity dates (or dates after which the loans can be prepaid without penalty), ranging from August 2013 to September 2016. These mortgage loans are secured by the underlying real estate. The mortgage loans are payable by the subsidiaries of Fund I with 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 has 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, 2011). As of December 31, 2011, 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 under the expected Fund I liquidation scenario. The estimated fair value of, and the Company’s obligation under this guarantee, both at inception and as of December 31, 2011, was not significant and therefore the Company has not recorded any obligation for this guarantee as of December 31, 2011.

• Fund II – In September, 2008, the Company formed Fund II, a private, discretionary investment vehicle with commitments from five institutional investors including the Company. In 2009, the Company completed the second and final closing of Fund II, admitting an additional joint venture partner, and additional equity commitments, both from existing as well as the new joint venture partner. The additional joint venture partner capital commitments raised as part of the second closing reduced the Company’s equity ownership interest to 31% from 45%. The Company’s total capital commitment to Fund II is $125,000,000. The Company’s uncalled capital commitment is $20,660,000 at December 31, 2011.

During the year ended December 31, 2011 subsidiaries of Fund II acquired the following four operating communities:

• Waterstone Carlsbad, a garden-style community consisting of 448 apartment homes located in Carlsbad (San Diego County), CA was acquired for a purchase price of $78,100,000;

• Yale Village Townhomes, a garden-style community consisting of 210 townhomes located in Rockville, MD was acquired for a purchase price of $49,500,000;

• Captain Parker Arms, a garden-style community consisting of 94 apartment homes located in Lexington, MA was acquired for a purchase price of $20,850,000; and

• Highlands at Rancho San Diego, consisting of 676 apartment homes located in San Diego, CA was acquired for a purchase price of $124,000,000. In conjunction with the acquisition, Fund II extinguished an outstanding mortgage note secured by the community, incurring a prepayment penalty, of which the Company’s proportionate share was approximately $950,000.

The investment period for Fund II ended in August, 2011. As of December 31, 2011 Fund II had invested $772,069,000. While the investment period for Fund II closed in August 2011, additional acquisitions may occur for active acquisition candidates identified prior to the end of the investment period.

Subsidiaries of Fund II have 12 loans secured by individual assets with amounts outstanding in the aggregate of $452,003,000, with maturity dates that vary from November 2014 to September 2019. The mortgage loans are payable by the subsidiaries of Fund II with 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 has 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 $8,348,000 as of December 31, 2011). As of December 31, 2011, 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 under the expected Fund II liquidation scenario. The estimated fair value of, and the Company’s obligation under this guarantee, both at inception and as of December 31, 2011, was not significant and therefore the Company has not recorded any obligation for this guarantee as of December 31, 2011.

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) (unaudited):

	12-31-11		12-31-10
	(unaudited)		(unaudited)
Assets:
Real estate, net	$	1,583,397	$	1,393,274
Other assets		70,233		67,278
Total assets	$	1,653,630	$	1,460,552
Liabilities and partners’ capital:
Mortgage notes payable and credit facility	$	1,074,429	$	965,931
Other liabilities		27,335		24,835
Partners’ capital		551,866		469,786
Total liabilities and partners’ capital	$	1,653,630	$	1,460,552

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

	For the year ended (unaudited)
	12-31-11			12-31-10			12-31-09
	(unaudited)			(unaudited)			(unaudited)
Rental and other income	$	160,066		$	114,755		$	101,748
Operating and other expenses		(71,926	)		(56,322	)		(49,730	)
Impairment loss		—			—			(17,162	)
Gain on sale of communities		22,246			—			—
Interest expense, net		(50,530	)		(40,050	)		(37,156	)
Depreciation expense		(47,920	)		(36,631	)		(32,909	)
Net income (loss)	$	11,936		$	(18,248	)	$	(35,209	)

In conjunction with the formation of Fund I and 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 $9,167,000 at December 31, 2011 and $10,644,000 at December 31, 2010 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
	12-31-11			12-31-10			12-31-09
Avalon Del Rey, LLC		102			1			79
CVP I, LLC (1)		4,493			4,368			7,330
MVP I, LLC		(626	)		(881	)		(684	)
AvalonBay Value Added Fund, L.P. (2)(3)		2,204			(1,653	)		(4,109	)
AvalonBay Value Added Fund II, L.P.		(1,053	)		(1,073	)		(48	)
Aria at Hathorne, LLC		—			—			(1,127	)
Total	$	5,120		$	762		$	1,441

₍₁₎ Equity in income from this entity for 2011, 2010, and 2009 includes $2,815, $2,839, and $6,192, respectively, relating to the Company’s recognition of its promoted interest.

₍₂₎ Equity in income for 2009 includes an impairment loss of $2,600 for the Company’s proportionate share of the impairment charge on an operating community.

₍₃₎ Equity in income for 2011 includes the Company’s proportionate share of the gain on the sale of two Fund I assets of $3,063.

Investments in Consolidated Real Estate Entities

In April 2011, the Company completed an exchange of assets with an apartment operator. The transaction included exchanging a portfolio of three communities and a parcel of land owned by the Company in exchange for a portfolio of six communities and $26,000,000 in cash. The Company’s portfolio consisted of two properties and a small land parcel located in metropolitan Boston and one property located in San Francisco. The portfolio received is located in Southern California (Los Angeles, Orange County and San Diego). The Company accounted for the exchange as a nonmonetary transaction based on the carrying value of the assets relinquished by the Company. The Company recognized a partial gain of $7,675,000, related to the monetary consideration received, representing the proportionate share of the assets sold. In addition, the Company assumed a $55,400,000 5.24% fixed-rate mortgage loan that matures in June 2013. In exchange, the Company relinquished a $55,800,000 5.86% fixed-rate mortgage loan that matures in May 2019.

In addition, in April 2011, the Company acquired Fairfax Towers, located in Falls Church, Virginia. Fairfax Towers contains 415 apartment homes and was acquired for a purchase price of $89,200,000. In conjunction with this acquisition, the Company assumed the existing 4.75% fixed-rate mortgage loan with an outstanding principal amount of $44,044,000 which matures in August 2015.

The Company accounted for the acquisition of Fairfax Towers as a business combination and allocated the purchase price to the acquired assets and assumed liabilities, including identifiable intangibles, based on their fair values. The Company looked to third party pricing for the value of the land, and an internal model to determine the fair value of the real estate assets, in place leases and mortgage loan. 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 used a discounted cash flow analysis on the expected cash flows of the mortgage note to determine its fair value, considering the contractual terms of the instrument and observable market-based inputs. The fair value of the mortgage loan is considered a Level 2 price as the majority of the inputs used fall within Level 2 of the fair value hierarchy.

Transaction costs for the asset exchange and acquisition of Fairfax Towers were $958,000. These costs are included in operating expenses, excluding property taxes on the accompanying Consolidated Statements of Comprehensive Income.

In 2010, the Company purchased a non-recourse mortgage note secured by a Fund I operating community, on an arms length basis. Upon acquisition of the note, the Company determined that it had control of the Fund I subsidiary, as a result of its collective equity and debt investments, the relationship between the Company and Fund I, and the nature of the Company’s operations being more similar to those of the Fund I subsidiary than those of Fund I. Therefore, the Company consolidates the results of operations and net assets of the Fund I subsidiary.