-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, VVlHpE4XWiPSQic2MYk4RfFQSIGNfEcr0f8cZlprYuFBr1HW2cHM+B6+ABRVJHd3 qeGqWrfDDPEKCpBcdtkbwA== 0001012870-01-501557.txt : 20010814 0001012870-01-501557.hdr.sgml : 20010814 ACCESSION NUMBER: 0001012870-01-501557 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20010630 FILED AS OF DATE: 20010813 FILER: COMPANY DATA: COMPANY CONFORMED NAME: ESSEX PROPERTY TRUST INC CENTRAL INDEX KEY: 0000920522 STANDARD INDUSTRIAL CLASSIFICATION: REAL ESTATE INVESTMENT TRUSTS [6798] IRS NUMBER: 770369576 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-13106 FILM NUMBER: 1706365 BUSINESS ADDRESS: STREET 1: 925 EAST MEADOW DR CITY: PALO ALTO STATE: CA ZIP: 94303 BUSINESS PHONE: 6504943700 MAIL ADDRESS: STREET 1: 925 EAST MEADOW DRIVE CITY: PALO ALTO STATE: CA ZIP: 94303 10-Q 1 d10q.txt FORM 10-Q PERIOD ENDED 06/30/2001 FORM 10-Q SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 (X) QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended June 30, 2001 OR ( ) TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____ to _____ Commission File No. 1-13106 ESSEX PROPERTY TRUST, INC. (Exact name of Registrant as specified in its Charter) Maryland 77-0369576 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 925 East Meadow Drive, Palo Alto, California 94303 (Address of principal executive offices) (Zip code) (650) 494-3700 (Registrant's telephone number, including area code) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months for such shorter period that the Registrant was required to file such report, and (2) has been subject to such filing requirements for the past 90 days. Yes X No ---- ---- APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of Common Stock, as of the latest practicable date: 18,474,237 shares of Common Stock as of August 1, 2001 TABLE OF CONTENTS FORM 10-Q Part I Page No. -------- Item 1 Financial Statements (Unaudited) 3 Consolidated Balance Sheets as of June 30, 2001 and December 31, 2000 4 Consolidated Statements of Operations for the three months ended June 30, 2001 and 2000 5 Consolidated Statements of Operations for the six months ended June 30, 2001 and 2000 6 Consolidated Statements of Stockholders' Equity for the six months ended June 30, 2001 and the year ended December 31, 2000 7 Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2001 and 2000 8 Notes to Consolidated Financial Statements 9 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations 17 Item 3 Quantitative and Qualitative Disclosure About Market Risk 25 Part II Item 2 Changes in Securities and Use of Proceeds 26 Item 4 Submission of Matter to a Vote of Security Holders 27 Item 6 Exhibits and Reports on Form 8-K 27 Signatures 28 2 Part I Financial Information Item 1: Financial Statements (Unaudited) "Essex" or the "Company" means Essex Property Trust, Inc., a real estate investment trust incorporated in the State of Maryland, or where the context otherwise requires, Essex Portfolio, L.P., a limited partnership in which Essex Property Trust, Inc. is the sole general partner. The information furnished in the accompanying consolidated unaudited balance sheets, statements of operations, stockholders' equity and cash flows of the Company reflects all adjustments which are, in the opinion of management, necessary for a fair presentation of the aforementioned financial statements for the interim periods. The accompanying unaudited consolidated financial statements should be read in conjunction with the notes to such financial statements and Management's Discussion and Analysis of Financial Condition and Results of Operations. 3 ESSEX PROPERTY TRUST, INC. Consolidated Balance Sheets (Unaudited) (Dollars in thousands, except per share amounts)
June 30, December 31, Assets 2001 2000 ------ ------------ ------------ Real estate: Rental properties: Land and land improvements $ 291,245 $ 289,796 Buildings and improvements 875,452 866,612 ------------ ------------ 1,166,697 1,156,408 Less accumulated depreciation (137,734) (119,499) ------------ ------------ 1,028,963 1,036,909 Investments 77,113 65,703 Real estate under development 62,728 38,231 ------------ ------------ 1,168,804 1,140,843 Cash and cash equivalents-unrestricted 12,666 6,600 Cash and cash equivalents-restricted 16,530 18,965 Notes receivable from investees and related parties 118,236 77,081 Notes and other receivables 29,050 24,062 Prepaid expenses and other assets 7,429 7,654 Deferred charges, net 6,207 6,644 ------------ ------------ $ 1,358,922 $ 1,281,849 ============ ============ Liabilities and Stockholders' Equity ------------------------------------ Mortgage notes payable $ 566,024 $ 502,066 Lines of credit 95,158 93,469 Accounts payable and accrued liabilities 29,040 30,430 Dividends payable 16,553 14,538 Other liabilities 6,417 6,539 Deferred gain 5,002 5,002 ------------ ------------ Total liabilities 718,194 652,044 Minority interests 250,796 238,130 Stockholders' equity: 8.75% Convertible Preferred Stock, Series 1996A: $.0001 par value, no shares authorized, issued and outstanding - - Common stock, $.0001 par value, 656,682,178 and 656,682,178 authorized, 18,473,237 and 18,130,317 issued and outstanding 2 2 Cumulative redeemable preferred stock; $.0001 par value, no shares issued and outstanding: 7.875% Series B 2,000,000 shares authorized - - 9.125% Series C 500,000 shares authorized - - 9.30% Series D 2,000,000 shares authorized - - 9.25% Series E 2,200,000 shares authorized - - Excess stock, $.0001 par value, 330,000,000 shares authorized and no shares issued and outstanding - - Additional paid-in capital 429,960 428,433 Distributions in excess of accumulated earnings (40,030) (36,760) ------------ ------------ Total stockholders' equity 389,932 391,675 ------------ ------------ $ 1,358,922 $ 1,281,849 ============ ============
See accompanying notes to the consolidated unaudited financial statements. 4 ESSEX PROPERTY TRUST, INC. Consolidated Statements of Operations (Unaudited) (Dollars in thousands, except per share amounts) Three months ended ------------------------------- June 30, June 30, 2001 2000 ------------ ------------ Revenues: Rental $ 45,044 $ 39,056 Other property 1,465 1,151 ------------ ------------ Total property 46,509 40,207 Interest and other 4,536 2,205 ------------ ------------ Total revenues 51,045 42,412 ------------ ------------ Expenses: Property operating expenses Maintenance and repairs 2,927 2,413 Real estate taxes 2,961 2,863 Utilities 2,492 1,967 Administrative 3,622 3,440 Advertising 648 515 Insurance 233 249 Depreciation and amortization 8,927 6,950 ------------ ------------ 21,810 18,397 Interest 9,637 6,467 Amortization of deferred financing costs 207 160 General and administrative 1,854 1,170 ------------ ------------ Total expenses 33,508 26,194 ------------ ------------ Income before minority interests 17,537 16,218 Minority interests (6,010) (5,945) ------------ ------------ Net income 11,527 10,273 Preferred stock dividends - (129) ------------ ------------ Net income available to common stockholders $ 11,527 $ 10,144 ============ ============ Per share data: Basic: Net income $ 0.62 $ 0.56 ============ ============ Weighted average number of shares outstanding during the period 18,462,237 18,109,641 ============ ============ Diluted: Net income $ 0.61 $ 0.55 ============ ============ Weighted average number of shares outstanding during the period 18,777,636 18,617,756 ============ ============ Dividend per share $ 0.70 $ 0.61 ============ ============
See accompanying notes to the consolidated unaudited financial statements. 5 ESSEX PROPERTY TRUST, INC. Consolidated Statements of Operations (Unaudited) (Dollars in thousands, except per share amounts) Six months ended ------------------------------- June 30, June 30, 2001 2000 ------------ ------------ Revenues: Rental $ 89,635 $ 75,902 Other property 2,923 2,105 ------------ ------------ Total property 92,558 78,007 Interest and other 8,596 3,941 ------------ ------------ Total revenues 101,154 81,948 ------------ ------------ Expenses: Property operating expenses Maintenance and repairs 5,668 4,564 Real estate taxes 6,042 5,461 Utilities 4,981 4,024 Administrative 7,245 6,772 Advertising 1,358 1,011 Insurance 495 470 Depreciation and amortization 17,753 13,617 ------------ ------------ 43,542 35,919 Interest 19,061 12,275 Amortization of deferred financing costs 367 319 General and administrative 3,729 2,295 ------------ ------------ Total expenses 66,699 50,808 ------------ ------------ Income before gain on the sales of real estate and minority interests 34,455 31,140 Gain on the sales of real estate - 4,022 ------------ ------------ Income before minority interests 34,455 35,162 Minority interests (11,880) (12,139) ------------ ------------ Net income 22,575 23,023 Preferred stock dividends - (246) ------------ ------------ Net income available to common stockholders $ 22,575 $ 22,777 ============ ============ Per share data: Basic: Net income $ 1.22 $ 1.26 ============ ============ Weighted average number of shares outstanding during the period 18,445,361 18,088,667 ============ ============ Diluted: Net income $ 1.20 $ 1.24 ============ ============ Weighted average number of shares outstanding during the period 18,785,349 18,556,332 ============ ============ Dividend per share $ 1.40 $ 1.16 ============ ============
See accompanying notes to the consolidated unaudited financial statements. 6 ESSEX PROPERTY TRUST, INC. Consolidated Statements of Stockholders' Equity for the six months ended June 30, 2001 and the year ended December 31, 2000 (Unaudited) (Dollars and shares in thousands)
Distributions Preferred stock Common stock Additional in excess of ------------------- ----------------- paid - in accumulated Shares Amount Shares Amount capital earnings Total ------ ------ ------ ------ --------- ------------ ------ Balances at December 31, 1999 185 $ 1 18,050 $ 2 $425,089 $(37,399) $387,693 Shares issued on conversion of Convertible Preferred Stock (185) (1) 211 - - - (1) Net proceeds from options exercised - - 156 - 3,344 - 3,344 Net income - - - - - 44,353 44,353 Dividends declared - - - - - (43,714) (43,714) ------- ----- ------ ---- -------- -------- -------- Balances at December 31, 2000 - - 18,417 2 428,433 (36,760) 391,675 Net proceeds from options exercised - - 56 - 1,527 - 1,527 Net income - - - - - 22,575 22,575 Dividends declared - - - - - (25,845) (25,845) ------- ----- ------ ---- -------- -------- -------- Balances at June 30, 2001 - $ - 18,473 $ 2 $429,960 $(40,030) $389,932 ======= ===== ====== ==== ======== ======== ========
See accompanying notes to the consolidated unaudited financial statements 7 ESSEX PROPERTY TRUST, INC. Condensed Consolidated Statements of Cash Flows (Unaudited) (Dollars in thousands) Six months ended ------------------------- June 30, June 30, 2001 2000 --------- -------- Net cash provided by operating activities: $ 50,305 $ 36,395 --------- -------- Cash flows from investing activities: Additions to real estate (13,658) (29,677) Proceeds received from the disposition of real estate - 31,302 Proceeds received from contribution of real estate to corporate investee 15,987 - Decrease / (increase) in restricted cash 2,435 124 Additions to notes receivable from investees, related parties and other receivables (61,846) (36,135) Repayment of notes receivable from investees, related parties and other receivables 13,818 3,566 Additions to real estate under development (17,519) (16,888) Net contribution to investments in corporations and limited partnerships (11,762) (2,281) --------- -------- Net cash used in investing activities (72,545) (49,989) --------- -------- Cash flows from financing activities: Proceeds from mortgage and other notes payable and lines of credit 169,294 88,596 Repayment of mortgage and other notes payable and lines of credit (109,791) (51,522) Additions to deferred charges (140) (847) Net proceeds from stock options exercised and shares issued through dividend reinvestment plan 1,527 1,857 Contributions from minority interest partners 6,000 - Distributions to minority interest partners (11,928) (11,449) Redemption of operating partnership units (2,555) (164) Dividends paid (24,101) (19,988) --------- -------- Net cash provided by financing activities 28,306 6,483 --------- -------- Net increase in cash and cash equivalents 6,066 (7,111) Cash and cash equivalents at beginning of period 6,600 12,348 --------- -------- Cash and cash equivalents at end of period $ 12,666 $ 5,237 ========= ======== Supplemental disclosure of cash flow information: Cash paid for interest, net of $1,303 and $1,356 capitalized $ 18,213 $ 10,899 ========= ======== Supplemental disclosure of non-cash investing and financing activities: Issuance of Operating Partnership Units in connection with the purchase of real estate $ 10,381 $ 2,365 ========= ======== Real estate under development transferred to rental properties $ - $ 89,483 ========= ======== Exchange of notes receivable from investees for investments $ 8,347 $ - ========= ======== Contribution of real estate in exchange for notes receivable and investments $ 22,463 $ - ========= ======== Consolidation of previously unconsolidated investment $ 8,087 $ - ========= ======== Mortgage note payable assumed in connection with purchase of real estate $ 6,144 $ 53,900 ========= ======== Exchange of investment for note receivable from investee $ 1,501 $ - ========= ========
See accompanying notes to consolidated unaudited financial statements. 8 Notes to Consolidated Financial Statements June 30, 2001 and 2000 (Unaudited) (Dollars in thousands, except per share and per unit amounts) (1) Organization and Basis of Presentation The unaudited consolidated financial statements of the Company are prepared in accordance with generally accepted accounting principles for interim financial information and in accordance with the instructions to Form 10-Q. In the opinion of management, all adjustments necessary for a fair presentation of the financial position, results of operations and cash flows for the periods presented have been included and are normal and recurring in nature. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company's annual report on Form 10-K for the year ended December 31, 2000. The unaudited consolidated financial statements for the three and six months ended June 30, 2001 and 2000 include the accounts of the Company and Essex Portfolio, L.P. (the "Operating Partnership", which holds the operating assets of the Company). The Company is the sole general partner in the Operating Partnership, owning an 89.0%, 89.6% and 89.5% general partnership interest as of June 30, 2001, December 31, 2000 and June 30, 2000, respectively. As of June 30, 2001, the Company operates and has ownership interests in 84 multifamily properties (containing 18,914 units) and five commercial properties (with approximately 290,000 square feet) (collectively, the "Properties"). The Properties are located in Northern California (the San Francisco Bay Area), Southern California (Los Angeles, Ventura, Orange and San Diego counties), and the Pacific Northwest (the Seattle, Washington and Portland, Oregon metropolitan areas). All significant intercompany balances and transactions have been eliminated in the consolidated financial statements. (2) Significant Transactions (A) Acquisition Activities On May 1, 2001 the Company purchased Andover Park Apartments, a 240-unit apartment community located in Beaverton, Oregon for a contract price of $16,633. The Company plans to contribute this property to a joint venture that was formed (see Note F, "Subsequent Event"). Accordingly, the Company's investment is reflected in the Company's financial statements as notes receivable from investees and related parties and investments. On June 1, 2001 the Company completed the partner buyout of Mt. Sutro Terrace Apartments, a 99-unit apartment community located in San Francisco, California. The buyout was at the Company's option under a capped pricing formula which terms were agreed to at the time of the Company's initial investment in September 1999. In conjunction with the partner buyout the Company issued 50,725 Operating Partnership units which are convertible into Common Stock at the option of the holder. On June 29, 2001, the Company purchased Moanalua Hillside Apartments through one of its taxable REIT subsidiaries. Moanalua Hillside Apartments is a 700-unit apartment community located in Honolulu, Hawaii which was acquired for a contract price of $42,200. The Company has entered into a contract to resell this property to an unrelated third party at a price in excess of the Company's purchase price. However, there can be no assurance that the sale of the property will close as expected. Accordingly, the Company's net investment is reflected in the Company's financial statements as notes receivable and investments from investees and related parties. 9 Notes to Consolidated Financial Statements June 30, 2001 and 2000 (Unaudited) (Dollars in thousands, except per share and per unit amounts) (B) Development Communities The Company defines development communities as new apartment properties that are being constructed or are newly constructed and in a phase of lease-up and have not yet reached stabilized operations. At June 30, 2001, the Company has ownership interests in six development communities, with an aggregate of 1,678 multifamily units. (C) Redevelopment Communities The Company defines redevelopment communities as existing properties owned or recently acquired which have been targeted for investment by the Company with the expectation of increased financial returns through property improvement. Redevelopment communities typically have apartment units that are not available for rent and, as a result, may have less than stabilized operations. At June 30, 2001, the Company has ownership interests in six redevelopment communities, which contain an aggregate of 1,786 units with total originally projected investment of $35,375 of which approximately $13,374 remains to be expended. (D) Debt Transactions On May 3, 2001 the Company entered into a $5,144 long-term non-recourse second mortgage secured by a property. This loan bears interest at a fixed rate of 7.49% and is due in April 2008. On June 26, 2001 the Company entered into a $16,600 long-term non-recourse mortgage secured by a previously unencumbered property. The loan bears interest at a fixed rate of 7.03% and is due in July 2011. The proceeds from these mortgages were used to reduce outstanding balances on the Company's unsecured lines of credit. Acquisition and development and redevelopment and other activities for the second quarter of 2001 were funded through Operating Partnership unit issuance and debt transactions as noted above and the Company's unsecured lines of credit. (E) Equity Transactions On June 28, 2001, the Operating Partnership issued 200,000 Series Z Incentive Units of limited partner interest (the "Series Z Incentive Units") to eleven senior executives of the Company in exchange for a capital commitment of $1.00 per Series Z Incentive Unit, for an aggregate offering price of $200,000. Upon certain triggering events, the Series Z Incentive Units will automatically convert into common Operating Partnership units based on a conversion ratio that may increase over time upon satisfaction of specific conditions. The conversion ratio, initially set at zero, will increase on January 1 of each year for each participating executive who remains employed by the Company if the Company has met a specified "funds from operations" per share target for the prior year, up to a maximum conversion ratio of 1.0. In certain change of control situations, the participating executives will also be given the option to convert their units at the then-effective conversion ratio. In addition, the Operating Partnership has the option to redeem Series Z Incentive Units held by any executive whose employment has been terminated for any reason and the obligation to redeem any such units following the death of the holder. In such event, the Operating Partnership will redeem the units for, at its option, either common Operating Partnership units or shares of the Company's common stock based on the then-effective conversion ratio. 10 Notes to Consolidated Financial Statements June 30, 2001 and 2000 (Unaudited) (Dollars in thousands, except per share and per unit amounts) The Series Z Incentive Units are entitled to participate in regular quarterly distributions on an adjusted basis. Initially, each Series Z Incentive Unit will receive 10% of the distribution received by each common Operating Partnership unit. Over time the distribution percentage may increase, generally based on satisfaction of the same conditions as increases in the conversion ratio. (F) Subsequent Event On July 11, 2001, Essex Apartment Value Fund, L.P. (the "Fund"), an investment fund controlled by the Company, had its initial closing with three institutional investors. The Fund will acquire, develop, and manage multifamily properties located in California, Oregon, and Washington. The Fund's objective is to add value through rental growth and appreciation, using the Company's development, redevelopment and asset management capabilities. The total equity committed to the Fund by investors, including the Operating Partnership, at the initial closing was $105 million. An affiliate of the Company, Essex VFGP, L.P., is the Fund's general partner (the "General Partner"). The Operating Partnership owns a 99% limited partner interest in the General Partner. Additional closings are expected to occur as investors who have been offered the opportunity to invest in the Fund make their determinations, before the final closing date of January 15, 2002. The Fund is currently anticipated to have total capital commitments of between $200 million and $250 million and will utilize leverage of between 60% to 65% of the value of the underlying real estate portfolio. After the initial closing, the Company, through the General Partner, has a 47.62% interest in the Fund on economic terms identical to the other investors with respect to capital invested. Though the Company expects its interest in the Fund to be diluted as a result of future closings, the Company is committed to invest an amount equal to or greater than 20% of the aggregate capital committed to the Fund. The General Partner will transfer to the Fund ownership of several properties which were acquired over the last eleven months in anticipation of the Fund's formation. These properties include six apartment properties having 1377 apartment units and two development land parcels on which approximately 368 units are planned for construction. Following such transfer, five of the properties will be encumbered by non-recourse mortgages in the aggregate amount of approximately $70 million. The Company's net investment in these six properties has been carried in notes receivable from investees and related parties. In addition to distributions with respect to its share of the Fund's invested capital, the General Partner (1) will receive distributions from the Fund in the annual amount of 1% of the Fund's committed capital, payable quarterly for managing the Fund's operations, and (2) may receive over the life of the Fund incentive distributions up to 20% of the cumulative net profits on all of the Fund's investments, if the Fund exceeds certain financial return benchmarks, including a minimum 10% compounded annual return on the investors' total capital contributions. The General Partner will also be paid fees consistent with industry standards for its property management, development and redevelopment services with respect to the Fund's investments. The General Partner will not receive transaction fees, such as acquisition, disposition, financing or similar fees, in connection with the operation of the Fund. 11 Notes to Consolidated Financial Statements June 30, 2001 and 2000 (Unaudited) (Dollars in thousands, except per share and per unit amounts) Subject to specific exceptions, the Fund will generally be the Company's exclusive investment vehicle for new investments until the earlier of (i) the date at least 90% of the Fund's aggregate capital commitments have been invested or committed or reserved for investments or (ii) December 31, 2003. The exceptions are: (1) properties acquired to complete transactions intended to qualify for non-recognition under Section 1031 of the Internal Revenue , (2) transactions involving properties with 75 units or less, (3) transactions which require equity securities of the Company, including convertible or exchangeable securities, with a value of at least $750,000, (4) mezzanine loans, (4) follow-on investments and re-building of properties which have been destroyed or damaged, (5) land leases with remaining terms of less than 35 years; and (6) other transactions which are prohibited from being consummated on behalf of the Fund due to express restrictions or diversification limitations. The Company's senior executives, Keith Guericke, Michael Schall, John Eudy, Craig Zimmerman and John Burkart, serve as the Fund's investment committee and are required to devote such time as is reasonably necessary to achieve the objectives of the Fund. Investors have the right to suspend their capital commitments to the Fund if two or more of these executives are no longer actively involved in the management of the Fund. John Burkart serves as portfolio manager and is committed to devote substantially all of his time to the Fund during the investment period. The Fund has a five-person advisory committee representing the investors. 12 Notes to Consolidated Financial Statements June 30, 2001 and 2000 (Unaudited) (Dollars in thousands, except per share and per unit amounts) (3) Related Party Transactions All general and administrative expenses of the Company and Essex Management Corporation, an unconsolidated preferred stock subsidiary of the Company ("EMC"), are initially borne by the Company, with a portion subsequently allocated to EMC. Expenses allocated to EMC for the three months ended June 30, 2001 and 2000 totaled $488 and $270, respectively, and $918 and $503 for the six months ended June 30, 2001 and 2000, respectively. The allocation is reflected as a reduction in general and administrative expenses in the accompanying consolidated statements of operations. Other income includes interest income of $1,319 and $827 for the three months ended June 30, 2001 and 2000, respectively, and $2,219 and $1,471 for the six months ended June 30, 2001 and 2000, respectively. The majority of interest income was earned on the notes receivable from investees. Other income also includes management fee income and investment income from the Company's investees of $423 and $706 for the three months ended June 30, 2001 and 2000, respectively, and $770 and $1,344 for the six months ended June 30, 2001 and 2000, respectively. Notes receivable from investees and related parties as of June 30, 2001 and December 31, 2000 consist of the following:
June 30, December 31, 2001 2000 ---- ---- Notes receivable from joint ventures investees: Notes receivable from VFGP L.P.'s, secured, bearing interest at 9% - Prime + 3%, due 2001-2010 $ 56,943 $ 47,840 Note receivable from Highridge Apartments, secured, bearing interest at 9%, due March 2008 - 1,047 Note receivable from Highridge Apartments, secured, bearing interest at 10%, due on demand 2,950 2,950 Notes receivable from Fidelity 1, secured, bearing interest at 7% - LIBOR + 2.5%, due 2002-2004 41,741 5,613 Receivables from Down REIT entities, non interest bearing, due on demand - 8,281 Receivable from Newport Beach North LLC and Newport Beach South LLC, non interest bearing, due on demand 648 1,753 Receivable from City Heights LP, non interest bearing, due on demand 865 865 Receivables from VFGP L.P.s, non interest bearing, due on demand 9,991 4,804 Other related party receivables: Loans to officers, secured, bearing interest at 8%, due April 2006 633 633 Other related party receivables, substantially due on demand 4,465 3,295 --------- -------- $ 118,236 $ 77,081 ========= ========
Other related party receivables consist primarily of accrued interest income on notes receivable from joint venture investees and loans to officers, advances and accrued management fees from joint venture investees and unreimbursed expenses due from EMC. 13 Notes to Consolidated Financial Statements June 30, 2001 and 2000 (Unaudited) (Dollars in thousands, except per share and per unit amounts) (4) New Accounting Pronouncements The Company has adopted SFAS 133 "Accounting for Derivative Instruments and Hedging Activities." effective January 1, 2001. Under the SFAS 133 derivative instruments are required to be included in the balance sheet at fair value. The changes in the fair value of the derivatives are accounted for depending on the use of the derivative and whether it has been designated and qualifies as a part of hedging relationship. If the hedged exposure is a cash flow exposure, the effective portion of the gain or loss on the derivative instrument is reported initially as a component of other comprehensive income and subsequently reclassified into earnings when the forecasted transaction affects earnings. The ineffective portion of the gain or loss is reported in earnings immediately. The difference between a derivative's previous carrying amount and its fair value was recorded as a transition adjustment, which was allocated between net income and other comprehensive income based on the entity's strategy for assessing the effectiveness of the hedge. During 1996 and 1999, the Company purchased interest rate cap contracts in order to reduce the risks associated with increases in interest rates on its tax exempt variable rate demand bonds. The Company has the right to receive cash if interest rates increase above a specified level. The purpose of the caps is to hedge the exposure to variability in expected future interest cash flows above a fixed interest rate, and, accordingly, they are accounted for as cash flow hedges under SFAS 133. The Company determines the fair value of the caps and assesses the ineffectiveness of the hedge based on changes in the time value of the caps. As of January 1, 2001, there were no changes in the intrinsic value of the caps since the date the caps were purchased, and the changes in fair value of the caps is attributable entirely to changes in time value. The amortized cost of the cap contracts exceeded their fair value by approximately $450,000, which resulted in a transition adjustment (charge to earnings) of that amount in the quarter ended March 31, 2001. In July 2001, the FASB issued Statement No. 141, Business Combinations, and Statement No. 142, Goodwill and Other Intangible Assets. Statement 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001 and also specifies the criteria that intangible assets acquired in a business combination must meet in order to be recognized and reported apart from goodwill. Statement 142 requires that goodwill and intangible assets with indefinite useful lives no longer be amortized, but instead be tested for impairment at least annually in accordance with the provisions of Statement 142. Statement 142 also requires that intangible assets with definite useful lives be amortized over their respective estimated useful lives to their estimated residual values, and reviewed for impairment in accordance with SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. We do not expect the adoption of Statements 141 and 142 to have a material effect on our financial statements. 14 Notes to Consolidated Financial Statements June 30, 2001 and 2000 (Unaudited) (Dollars in thousands, except per share and per unit amounts) (5) Segment Information The Company defines its reportable operating segments as the three geographical regions in which its properties are located: Northern California, Southern California and the Pacific Northwest. Excluded from segment revenues are interest and other corporate income. Other non-segment assets include investments, real estate under development, cash, receivables and other assets. The revenues, net operating income, and assets for each of the reportable operating segments are summarized as follows for the periods presented.
Three months ended June 30, 2001 June 30, 2000 ---------------------------------------------------------------------------------- Revenues Northern California $ 16,869 $ 13,556 Southern California 18,249 16,772 Pacific Northwest 11,391 9,879 ------------- ------------- Total segment revenues 46,509 40,207 Interest and other income 4,536 2,205 ------------- ------------- Total revenues $ 51,045 $ 42,412 ============= ============= Net operating income: Northern California $ 13,036 10,379 Southern California 12,681 11,697 Pacific Northwest 7,909 6,684 ------------- ------------- Total segment net operating income 33,626 28,760 Interest and other income 4,536 2,205 Depreciation and amortization (8,927) (6,950) Interest (9,637) (6,467) Amortization of deferred financing costs (207) (160) General and administrative (1,854) (1,170) ------------- ------------- Income before gain on the sales of real estate, minority interests and extraordinary item $ 17,537 $ 16,218 ============= ============= Six months ended June 30, 2001 June 30, 2000 ---------------------------------------------------------------------------------- Revenues Northern California $ 33,794 $ 26,190 Southern California 35,986 32,545 Pacific Northwest 22,778 19,272 ------------- ------------- Total segment revenues 92,558 78,007 Interest and other income 8,596 3,941 ------------- ------------- Total revenues $ 101,154 $ 81,948 ============= ============= Net operating income: Northern California $ 26,167 20,211 Southern California 24,908 22,417 Pacific Northwest 15,694 13,077 ------------- ------------- Total segment net operating income 66,769 55,705 Interest and other income 8,596 3,941 Depreciation and amortization (17,753) (13,617) Interest (19,061) (12,275) Amortization of deferred financing costs (367) (319) General and administrative (3,729) (2,295) ------------- ------------- Income before gain on the sales of real estate, minority interests and extraordinary item $ 34,455 $ 31,140 ============= =============
15 Notes to Consolidated Financial Statements June 30, 2001 and 2000 (Unaudited) (Dollars in thousands, except per share and per unit amounts) (5) Segment Information (continued) -------------------------------
June 30, 2001 December 31, 2000 - ----------------------------------------------------------------------------------------- Assets: Northern California $ 305,506 $ 289,839 Southern California 459,259 478,835 Pacific Northwest 264,198 268,235 ------------- ------------- Total segment net real estate assets 1,028,963 1,036,909 Non-segment assets 329,959 244,940 ------------- ------------- Total assets $ 1,358,922 $ 1,281,849 ============= ============= (6) Net Income Per Share -------------------- Three months ended Three months ended June 30, 2001 June 30, 2000 ------------------------------ ------------------------------ Weighted Per Weighted Per Average Share Average Share Income Shares Amount Income Shares Amount Net Income $ 11,527 $ 10,273 Less: dividends on preferred stock - (129) -------- -------- Basic: Income available to common stockholders 11,527 18,462 $ 0.62 10,144 18,110 $ 0.56 -------- ------- ====== -------- ------- ====== Effect of Dilutive Securities: Convertible limited partnership units - - (1) - - (1) Convertible preferred stock - - 129 211 Stock options - 316 - 297 -------- ------- -------- ------- Diluted: Income available to common Stockholders plus assumed conversions $ 11,527 18,778 $ 0.61 $ 10,273 18,618 $ 0.55 ======== ======= ====== ======== ======= ====== Six months ended Six months ended June 30, 2001 June 30, 2000 ------------------------------ ------------------------------ Weighted Per Weighted Per Average Share Average Share Income Shares Amount Income Shares Amount Net Income $ 22,575 $ 23,023 Less: dividends on preferred stock - (246) -------- -------- Basic: Income available to common stockholders 22,575 18,445 $ 1.22 22,777 18,089 $ 1.26 -------- ------- ====== -------- ------- ====== Effect of Dilutive Securities: Convertible limited partnership units - - (1) - - (1) Convertible preferred stock - - 246 211 Stock options - 340 - 256 -------- ------- -------- ------- Diluted: Income available to common Stockholders plus assumed conversions $ 22,575 18,785 $ 1.20 $ 23,023 18,556 $ 1.24 ======== ======= ====== ======== ======= ======
(1) Securities not included because they were anti-dilutive. 16 Item 2: Management's Discussion and Analysis of Financial Condition and --------------------------------------------------------------- Results of Operations --------------------- The following discussion is based primarily on the consolidated unaudited financial statements of Essex Property Trust, Inc. ("Essex" or the "Company") for the three and six months ended June 30, 2001 and 2000. This information should be read in conjunction with the accompanying consolidated unaudited financial statements and notes thereto. These consolidated financial statements include all adjustments which are, in the opinion of management, necessary to reflect a fair statement of the results and all such adjustments are of a normal recurring nature. Substantially all of the assets of the Company are held by, and substantially all operations are conducted through, Essex Portfolio, L.P. (the "Operating Partnership"). The Company is the sole general partner of the Operating Partnership and, as of June 30, 2001, December 31, 2000 and June 30, 2000, owned an 89.0%, 89.6% and 89.5% general partnership interest in the Operating Partnership, respectively. The Company has elected to be treated as a real estate investment trust (a "REIT") for federal income tax purposes. Certain statements in this "Management's Discussion and Analysis of Financial Condition and Results of Operations," and elsewhere in the quarterly report on Form 10-Q which are not historical facts may be considered forward looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended, including statements regarding the Company's expectations, hopes, intentions, beliefs and strategies regarding the future. Forward looking statements include the Company's expectation as to its resale of the Moanalua Hillside Apartments, the Company's expectations as to the total capital commitments of the Essex Apartment Value Fund and the acquisition activities of that fund, statements regarding the Company's expectation as to the timing of completion of current development projects, beliefs as to the adequacy of future cash flows to meet operating requirements, and to provide for dividend payments in accordance with REIT requirements and expectations as to the amount of non-revenue generating capital expenditures for the year ended December 31, 2001, potential acquisitions and developments, the anticipated performance of existing properties, future acquisitions and developments and statements regarding the Company's financing activities. Such forward-looking statements involve known and unknown risks, uncertainties and other factors including, but not limited to, that the Company's resale of the Moanlua Hillside Apartments will not be completed as expected, that the total capital commitments and acquisition activities of the Essex Apartment Value Fund will be less than anticipated, that the actual completion of development projects will be subject to delays, that such development projects will not be completed, that future cash flows will be inadequate to meet operating requirements and/or will be insufficient to provide for dividend payments in accordance with REIT requirements, that the actual non-revenue generating capital expenditures will exceed the Company's current expectations, as well as those risks, special considerations, and other factors discussed under the caption "Other Matters/Risk Factors" in Item 1 of the Company's Annual Report on Form 10-K for the year ended December 31, 2000, and those other risk factors and special considerations set forth in the Company's other filings with the Securities and Exchange Commission (the "SEC") which may cause the actual results, performance or achievements of the Company to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. General Background The Company's property revenues are generated primarily from multifamily property operations, which accounted for greater than 99% of its property revenues for the three and six months ended June 30, 2001 and 2000. The Company's multifamily properties (the "Properties") are located in Northern California (the San Francisco Bay Area), Southern California (Los Angeles, Ventura, Orange and San Diego counties) and the Pacific Northwest (the Seattle, Washington and Portland, Oregon metropolitan areas). The average occupancy levels of the Company's portfolio has exceeded 95% for the last five years. 17 The Company has elected to be treated as a real estate investment trust ("REIT") for federal income tax purposes, commencing with the year ended December 31, 1994. The Company provides some of its fee-based asset management and disposition services as well as third-party property management and leasing services through Essex Management Corporation ("EMC"), in order to maintain compliance with REIT tax rules. The Company owns 100% of EMC's 19,000 shares of Series A non-voting Preferred Stock and 6,085 shares of Series B non-voting Preferred Stock. Executives of the Company own 100% of EMC's 1,000 shares of Common Stock. Since the Company's initial public offering (the "IPO") in June 1994, the Company has acquired ownership interests in 69 multifamily residential properties and its headquarter and regional office buildings. Of the multifamily properties acquired since the IPO, 14 are located in Northern California, 35 are located in Southern California, 15 are located in the Seattle, Washington metropolitan area and five are located in the Portland, Oregon metropolitan area. In total, these acquisitions consist of 15,007 multifamily units with total capitalized acquisition costs of approximately $1,198.2 million. Additionally since its IPO, the Company has developed and has ownership interests in eight multifamily development properties that have reached stabilized operations. These development properties consist of 1,540 units with total capitalized development costs of $180.6 million. As part of its active portfolio management strategy, the Company has disposed of, since its IPO, 8 multifamily residential properties (six in Northern California, one in Southern California and one in the Pacific Northwest) consisting of a total of 1,021 units, six retail shopping centers in the Portland, Oregon metropolitan area and one commercial property in Northern California at an aggregate gross sales price of approximately $116.4 million resulting in total net realized gains of approximately $27.2 million and a deferred gain of $5.0 million. The Company is currently developing six multifamily residential communities, with an aggregate of 1,678 multifamily units. In connection with these development projects, the Company has directly, or in some cases through its joint venture partners, entered into contractual construction related commitments with unrelated third parties for approximately $212.2 million. As of June 30, 2001, together with its joint venture partners, the Company's remaining development commitment is approximately $89.3 million. Results of Operations Comparison of the Three Months Ended June 30, 2001 to the Three Months Ended - ---------------------------------------------------------------------------- June 30, 2000 - ------------- Average financial occupancy rates of the Company's multifamily Quarterly Same Store Properties (properties owned by the Company for each of the three months ended June 30, 2001 and 2000) was 95.6% and 97.1%, for the three months ended June 30, 2001 and 2000, respectively. "Financial occupancy" is defined as the percentage resulting from dividing actual rental income by total possible rental income. Total possible rental income is determined by valuing occupied units at contractual rents and vacant units at market rents. The regional breakdown of financial occupancy for the multifamily Quarterly Same Store Properties for the three months ended June 30, 2001 and 2000 are as follows: June 30, June 30, 2001 2000 ---- ---- Southern California 95.8% 96.3% Northern California 95.6% 98.1% Pacific Northwest 95.2% 96.7% 18 Total Revenues increased by $8,633,000 or 20.4% to $51,045,000 in the second quarter of 2001 from $42,412,000 in the second quarter of 2000. The following table sets forth a breakdown of these revenue amounts, including the revenues attributable to the Quarterly Same Store Properties.
Three Months Ended June 30, Number of -------- Dollar Percentage Properties 2001 2000 Change Change ---------- ---- ---- ------ ------ Revenues Property revenues Quarterly Same Store Properties Southern California 16 $ 11,181 $ 10,418 $ 763 7.3% Northern California 14 14,553 12,796 1,757 13.7 Pacific Northwest 19 8,986 8,716 270 3.1 -- -------- -------- ------- ----- Properties 49 34,720 31,930 2,790 8.7 Property revenues properties acquired/disposed of subsequent March 31, 2000 11,789 8,277 3,512 42.4 -------- -------- ------- ----- Total property revenues(1) 46,509 40,207 6,302 15.7 -------- -------- ------- ----- Interest and other income 4,536 2,205 2,331 105.7 -------- -------- ------- ----- Total revenues $ 51,045 $ 42,412 $ 8,633 20.4% ======== ======== ======= =====
(1) Also includes two commercial properties, redevelopment communities, and development communities. As set forth in the above table, $3,512,000 of the $8,633,000 net increase in total revenues is attributable to properties acquired or disposed of subsequent to March 31, 2000, redevelopment communities, development communities and two commercial properties. During this period, the Company acquired interests in thirteen multifamily properties and reached stabilized operations at two development communities (the "Quarterly Acquisition Properties"). Of the increase in total revenues, $2,790,000 is attributable to increases in property revenues from the Quarterly Same Store Properties. Property revenues from the Quarterly Same Store Properties increased by approximately 8.7% to $34,720,000 in the second quarter of 2001 from $31,930,000 in the second quarter of 2000. The majority of this increase was attributable to the 14 Quarterly Same Store Properties located in Northern California. The property revenues of the Quarterly Same Store Properties in Northern California increased by $1,757,000 or 13.7% to $14,553,000 in the second quarter of 2001 from $12,796,000 in the second quarter of 2000. This $1,757,000 increase is primarily attributable to rental rate increases as offset by a decrease in financial occupancy to 95.6% in the second quarter of 2001 from 98.1% in the second quarter of 2000. The 16 Quarterly Same Store Properties located in Southern California accounted for the next largest regional component of the Quarterly Same Store Property revenue increase. The property revenues of these properties increased by $763,000 or 7.3% to $11,181,000 in the second quarter of 2001 from $10,418,000 in the second quarter of 2000. The $763,000 increase is attributable to rental rate increases as offset by a decrease in financial occupancy to 95.8% in the second quarter of 2001 from 96.3% in the second quarter of 2000. The 19 multifamily residential properties located in the Pacific Northwest also contributed to the Quarterly Same Store Properties property revenues increase. The property revenues of these properties increased by $270,000 or 3.1% to $8,986,000 in the second quarter of 2001 from $8,716,000 in the second quarter of 2000. The $270,000 increase is primarily attributable to rental rate increases as offset by a decrease in financial occupancy to 95.2% in the second quarter of 2001 from 96.7% in the second quarter of 2000. The increase in total revenue also reflected an increase of $2,331,000 attributable to interest and other income, which primarily relates to interest income on notes receivables and income earned on the Company's joint venture investments. 19 Total Expenses increased by $7,314,000 or approximately 27.9% to $33,508,000 in the second quarter of 2001 from $26,194,000 in the second quarter of 2000. Interest expense increased by $3,170,000 or 49.0% to $9,637,000 in the second quarter of 2001 from $6,467,000 in the second quarter of 2000. Such increase was primarily due to the net addition of outstanding mortgage debt in connection with property and investment acquisitions which was offset in part by capitalization of interest charges relating to the Company's development and redevelopment communities. Property operating expenses, exclusive of depreciation and amortization, increased by $1,436,000 or 12.5% to $12,883,000 in the second quarter of 2001 from $11,447,000 in the second quarter of 2000. Of such increase, $1,086,000 was attributable to the Quarterly Acquisition Properties. Utility cost, a component of property operating expense, increased by $525,000 or 29.7% to $2,492,000 in the second quarter of 2001 from $1,967,000 in the second quarter of 2000 and was attributable to the Quarterly Acquisition Properties and as a result of shortages of natural gas and electricity throughout the western region of the United States. Depreciation and amortization increased by $1,977,000 or approximately 28.4% to $8,927,000 in the second quarter of 2001 from $6,950,000 in the second quarter of 2000, primarily due to the acquisition of assets. General and administrative expenses represent the costs of the Company's various acquisition and administrative departments as well as partnership administration and non-operating expenses. Such expenses increased by $684,000 in the second quarter of 2001 from the amount for the second quarter of 2000. This increase is largely due to additional staffing requirements resulting from the growth of the Company as offset by an increase in the allocation of general and administrative expenses to EMC. Net income increased by $1,254,000 to $11,527,000 in the second quarter of 2001 from $10,273,000 in the second quarter of 2000. This increase is primarily attributable to the net contribution of the Quarterly Acquisition Properties and the increase in net operating income from the Quarterly Same Store Properties. Comparison of the Six Months Ended June 30, 2001 to the Six Months Ended June 30, 2000 - ------------------------------------------------------------------------------- Average financial occupancy rates of the Company's multifamily Same Store Properties (properties owned by the Company for each of the six months June 30, 2001 and 2000) was 95.9% and 96.7%, for the six months ended June 30, 2001 and 2000, respectively. "Financial occupancy" is defined as the percentage resulting from dividing actual rental income by total possible rental income. Total possible rental income is determined by valuing occupied units at contractual rents and vacant units at market rents. The regional breakdown of financial occupancy for the multifamily Same Store Properties for the six months ended June 30, 2001 and 2000 are as follows: June 30, June 30, 2001 2000 ---- ---- Southern California 95.7% 96.3% Northern California 96.3% 97.7% Pacific Northwest 95.3% 95.7% 20 Total Revenues increased by $19,206,000 or 23.4% to $101,154,000 in the six months ended June 30, 2001 from $81,948,000 in the six months ended June 30, 2000. The following table sets forth a breakdown of these revenue amounts, including the revenues attributable to the Same Store Properties.
Six Months Ended June 30, Number of -------- Dollar Percentage Properties 2001 2000 Change Change ---------- ---- ---- ------ ------ Revenues Property revenues Same Store Properties Southern California 16 $ 22,183 $ 20,748 $ 1,435 6.9% Northern California 14 29,030 25,007 4,023 16.1 Pacific Northwest 19 17,985 17,126 859 5.0 -- -------- -------- -------- ------- Properties 49 69,198 62,881 6,317 10.0 Property revenues properties acquired/disposed of subsequent December 31, 1999 23,360 15,126 8,234 54.4 -------- -------- -------- ------- Total property revenues(1) 92,558 78,007 14,551 18.7 -------- -------- -------- ------- Interest and other income 8,596 3,941 4,655 118.1 -------- -------- -------- ------- Total revenues $101,154 $ 81,948 $ 19,206 23.4% ======== ======== ======== =======
(1) Also includes two commercial properties, redevelopment communities, and development communities. As set forth in the above table, $8,234,000 of the $19,206,000 net increase in total revenues is attributable to properties acquired or disposed of subsequent to December 31, 1999, redevelopment communities, development communities and two commercial properties. During this period, the Company acquired interests in thirteen multifamily properties and reached stabilized operations at five development communities (the "Post 1999 Acquisition Properties") and disposed of one multifamily property (the "Post 1999 Disposition Properties"). Of the increase in total revenues, $6,317,000 is attributable to increases in property revenues from the Same Store Properties. Property revenues from the Same Store Properties increased by approximately 10.0% to $69,198,000 in the six months ended June 30, 2001 from $62,881,000 in the six months ended June 30, 2000. The majority of this increase was attributable to the 14 Same Store Properties located in Northern California. The property revenues of the Same Store Properties in Northern California increased by $4,023,000 or 16.1% to $29,030,000 in the six months ended June 30, 2001 from $25,007,000 in the six months ended June 30, 2000. This $4,023,000 increase is primarily attributable to rental rate increases offset by a decrease in financial occupancy to 96.3% in the six months ended June 30, 2001 from 97.7% in the six months ended June 30, 2000. The 16 Same Store Properties located in Southern California accounted for the next largest regional component of the Same Store Property revenue increase. The property revenues of these properties increased by $1,435,000 or 6.9% to $22,183,000 in the six months ended June 30, 2001 from $20,748,000 in the six months ended June 30, 2000. The $1,435,000 increase is attributable to rental rate increases as offset by a decrease in financial occupancy to 95.7% in the six months ended June 30, 2001 from 96.3% in the six months ended June 30, 2000. The 19 multifamily residential properties located in the Pacific Northwest also contributed to the Same Store Properties property revenues increase. The property revenues of these properties increased by $859,000 or 5.0% to $17,985,000 in the six months ended June 30, 2001 from $17,126,000 in the six months ended June 30, 2000. The $859,000 increase is primarily attributable to rental rate increases and as offset be a decrease in financial occupancy to 95.3% in the six months ended June 30, 2001 from 95.7% in the six months ended June 30, 2000. The increase in total revenue also reflected an increase of $4,655,000 attributable to interest and other income, which primarily relates to interest income on notes receivables and income earned on the Company's joint venture investments. 21 Total Expenses increased by $15,891,000 or approximately 31.3% to $66,699,000 in the six months ended June 30, 2001 from $50,808,000 in the six months ended June 30, 2000. Interest expense increased by $6,786,000 or 55.3% to $19,061,000 in the six months ended June 30, 2001 from $12,275,000 in the six months ended June 30, 2000. Such increase was primarily due to the net addition of outstanding mortgage debt in connection with property and investment acquisitions which was offset in part by capitalization of interest charges relating to the Company's development and redevelopment communities. Property operating expenses, exclusive of depreciation and amortization, increased by $3,487,000 or 15.6% to $25,789,000 in the six months ended June 30, 2001 from $22,302,000 in the six months ended June 30, 2000. Of such increase, $2,613,000 was attributable to the Post 1999 Acquisition Properties and the Post 1999 Disposition Properties. Utility cost, a component of property operating expense, increased by $957,000 or 23.8% to $4,981,000 in the second quarter of 2001 from $4,024,000 in the second quarter of 2000 and was attributable to the Post 1999 Acquisition Properties and the Post 1999 Disposition Properties and as a result of shortages of natural gas and electricity throughout the western region of the United States. Depreciation and amortization increased by $4,136,000 or approximately 30.4% to $17,753,000 in the six months ended June 30, 2001 from $13,617,000 in the six months ended June 30, 2000, primarily due to the acquisition of assets. General and administrative expenses represent the costs of the Company's various acquisition and administrative departments as well as partnership administration and non-operating expenses. Such expenses increased by $1,434,000 in the six months ended June 30, 2001 from the amount for the six months ended June 30, 2000. This increase is largely due to additional staffing requirements resulting from the growth of the Company as offset by an increase in the allocation of general and administrative expenses to EMC. Net income decreased by $448,000 to $22,575,000 in the six months ended June 30, 2001 from $23,023,000 in the six months ended June 30, 2000. This decrease is primarily attributable to the gain on the sales of real estate of $4,022,000 in the first six months of 2000. There was no gain on the sales of real estate in the first six months of 2001. This decrease was offset by the net contribution of the Post 1999 Acquisition Properties and the increase in net operating income from the Same Store Properties. Liquidity and Capital Resources At June 30, 2001 the Company had $12,666,000 of unrestricted cash and cash equivalents. The Company expects to meet its short-term liquidity requirements by using its working capital, cash generated from operations and amounts available under lines of credit. The Company believes that its current net cash flows will be adequate to meet operating requirements and to provide for payment of dividends by the Company in accordance with REIT qualification requirements. The Company expects to meet its long-term funding requirements relating to property acquisition and development (beyond the next 12 months) by using working capital, amounts available from its lines of credit, net proceeds from public and private debt and equity issuances, and proceeds from the disposition of properties that may be sold from time to time. There can, however, be no assurance that the Company will have access to the debt and equity markets in a timely fashion to meet such future funding requirements or that future working capital, and borrowings under its lines of credit will be available, or if available, will be sufficient to meet the Company's requirements or that the Company will be able to dispose of properties in a timely manner and under terms and conditions that the Company deems acceptable. The Company has two outstanding unsecured lines of credit for an aggregate amount of $150,000,000. The first line, in the amount of $120,000,000, matures in May 2002, with an option to extend it for one year thereafter. Outstanding balances under this line of credit bear interest at a rate which uses a tiered rate structure tied to the Company corporate ratings, if any, and leverage rating which has been priced at LIBOR plus 1.15% during its term. At June 30, 2001 the Company had $95,158,000 outstanding on this line of credit, which bore interest rates of approximately 5.0%. A second line of credit in the amount of $30,000,000 matures in August 2001, with an option to extend for one year thereafter. Outstanding balances, if any, on this second line bear interest based on a tiered rate structure currently at LIBOR plus 1.175%. At June 30, 2001 the Company had no outstanding balances on this line of credit. 22 In addition to the unsecured lines of credit, the Company had $566,024,000 of secured indebtedness at June 30, 2001. Such indebtedness consisted of $507,204,000 in fixed rate debt with interest rates varying from 5.8% to 8.3% and maturity dates ranging from 2002 to 2026. The indebtedness also included $58,820,000 of debt represented by tax exempt variable rate demand bonds with interest rates paid during the second quarter of 2001 ranging from 4.0% to 5.5% and maturity dates ranging from 2020 to 2026. The tax-exempt variable rate demand bonds are capped at interest rates ranging from 7.1% to 7.3%. The Company's unrestricted cash balance increased by $6,066,000 from $6,600,000 as of December 31, 2000 to $12,666,000 as of June 30, 2001. This increase was primarily a result of $50,305,000 net cash provided by operating activities and $28,306,000 of net cash provided by financing activities, which was offset by $72,545,000 of net cash used in investing activities. Of the $28,306,000 of net cash provided by financing activities, $169,294,000 was received in proceeds from mortgage and other notes payable and lines of credit, which was off set by $109,791,000 in repayments of mortgage and other notes payable and lines of credit, and $24,101,000 in dividends/distributions paid. The $72,545,000 of net cash used in investing activities was primarily a result of $61,846,000 in additions to notes receivable and investments made to finance real estate acquisitions by the Company's investees, related party notes and other receivables, $17,519,000 used to fund real estate under development, and $13,658,000 used to purchase and upgrade rental properties which was offset by $15,987,000 in proceeds received from contribution of real estate to corporate investee. Non-revenue generating capital expenditures are improvements and upgrades that extend the useful life of the property and are not related to preparing a multifamily property unit to be rented to a tenant. The Company expects to incur approximately $330 per weighted average occupancy unit in non-revenue generating capital expenditures for the year ended December 31, 2001. These expenditures do not include the improvements required in connection with the origination of mortgage loans, expenditures for renovations and improvements on recently acquired properties which are expected to generate additional revenue, and renovation expenditures required pursuant to tax-exempt bond financings. The Company expects that cash from operations and/or its lines of credit will fund such expenditures. However, there can be no assurance that the actual expenditures incurred during 2001 and/or the funding thereof will not be significantly different than the Company's current expectations. The Company is developing six multifamily residential communities, with an aggregate of 1,678 multifamily units. Such projects involve certain risks inherent in real estate development. See "Other Matters/Risk Factors - Risks That Development Activities Will Be Delayed or Not Completed" in Item 1 of the Company's Annual Report on Form 10-K for the year ended December 31, 2000. In connection with these development projects, the Company has directly, or in some cases through its joint venture partners, entered into contractual construction related commitments with unrelated third parties for a total amount of approximately $212,200,000. As of June 30, 2001, the Company's remaining commitment to fund the estimated cost to complete is approximately $89,300,000. The Company expects to fund such commitments with a combination of its working capital, operating cash flows, amounts available on its lines of credit, net proceeds from public and private equity and debt issuances, and proceeds from the disposition of properties, which may be sold from time to time. Pursuant to existing shelf registration statements, the Company has the capacity to issue up to $342,000,000 of equity securities and the Operating Partnership has the capacity to issue up to $250,000,000 of debt securities. The Company pays quarterly dividends from cash available for distribution. Until it is distributed, cash available for distribution is invested by the Company primarily in short-term investment grade securities or is used by the Company to reduce balances outstanding under its line of credit. 23 Funds from Operations Industry analysts generally consider funds from operations, ("Funds From Operations"), an appropriate measure of performance of an equity REIT. Generally, Funds From Operations adjusts the net income of equity REITs for non-cash charges such as depreciation and amortization of rental properties, gains/losses on sales of real estate property and extraordinary items. Management considers Funds From Operations to be a useful financial performance measurement of an equity REIT because, together with net income and cash flows, Funds From Operations provides investors with an additional basis to evaluate the ability of a REIT to incur and service debt and to fund acquisitions and other capital expenditures. Funds From Operations does not represent net income or cash flows from operations as defined by generally accepted accounting principles ("GAAP") and is not intended to indicate whether cash flows will be sufficient to fund cash needs. It should not be considered as an alternative to net income as an indicator of the REIT's operating performance or to cash flows as a measure of liquidity. Funds From Operations does not measure whether cash flow is sufficient to fund all cash needs including principal amortization, capital improvements and distributions to shareholders. Funds From Operations also does not represent cash flows generated from operating, investing or financing activities as defined under GAAP. Further, Funds from Operations as disclosed by other REITs may not be comparable to the Company's presentation of Funds From Operations. The following table sets forth the Company's calculation of Funds from Operations for the three and six months ended June 30, 2001 and 2000.
Three months ended Six months ended ------------------ ---------------- June 30, 2001 June 30, 2000 June 30, 2001 June 30, 2000 ------------- ------------- ------------- ------------- Income before gain on the sales of real estate and minority interests $ 17,537,000 $ 16,218,000 $ 34,455,000 $ 31,140,000 Adjustments: Depreciation and amortization 8,927,000 6,950,000 17,753,000 13,617,000 Unconsolidated joint ventures 1,201,000 1,054,000 2,438,000 2,063,000 Minority interests(1) (4,602,000) (4,778,000) (9,206,000) (9,504,000) ------------ ------------- ------------- ------------- Funds From Operations $ 23,063,000 $ 19,444,000 $ 45,440,000 $ 37,316,000 ============ ============= ============ ============ Weighted average number shares outstanding diluted(1) 21,034,366 20,708,639 20,970,138 20,641,343 ============ ============= ============ ============
(1) Assumes conversion of all outstanding operating partnership interests in the Operating Partnership. Minority interests have been adjusted to reflect such conversion. 24 Item 3: Quantitative and Qualitative Disclosures About Market Risk ---------------------------------------------------------- The Company is exposed to interest rate changes primarily as a result of its lines of credit and long-term debt used to maintain liquidity and fund capital expenditures and expansion of the Company's real estate investment portfolio and operations. The Company's interest rate risk management objective is to limit the impact of interest rate changes on earnings and cash flows and to lower its overall borrowing costs. To achieve its objectives the Company borrows primarily at fixed rates and may enter into derivative financial instruments such as interest rate swaps, caps and treasury locks in order to mitigate its interest rate risk on a related financial instrument. The Company does not enter into derivative or interest rate transactions for speculative purposes. The Company's interest rate risk is monitored using a variety of techniques. The table below presents the principal amounts and weighted average interest rates by year of expected maturity to evaluate the expected cash flows and sensitivity to interest rate changes. The Company believes that the principal amounts of the Company's mortgage notes payable and line of credit approximate fair value as of June 30, 2001 as interest rates and other terms are consistent with yields currently available to the Company for similar instruments.
For Year Ended: 2001 2002 2003 2004 2005 Thereafter Total - --------------------------------------------------------------------------------------------------------------------------- Fixed rate debt (In thousands) Amount $ 1,826 12,225 21,490 3,602 35,624 432,437 $ 507,204 Average interest rate 7.3% 7.0% 7.0% 7.3% 6.8% 6.8% Variable rate LIBOR debt (In thousands) Amount $ - 94,158 - - - 58,820(1) $ 153,978 Average interest - 5.0% - - - 5.1%
(1) Capped at interest rates ranging from 7.1% to 7.3%. The Company does not have any exposures related to forward contracts at June 30, 2001. 25 Part II Other Information - ------- ----------------- Item 2: Changes in Securities and Use of Proceeds On June 1, 2001, in connection with the completion of its acquisition of the Mt. Sutro Terrace Apartments, the Company issued 50,725 Operating Partnership Units, which are convertible into common stock of the Company at the option of the holder. This private placement of operating partnership units was completed pursuant to the exemption from registration contained in Section 4(2) of the Securities Act of 1933, as amended. On June 28, 2001, the Operating Partnership completed a private placement of 200,000 Series Z Incentive Units of limited partner interest (the "Series Z Incentive Units") as part of the Company's Long Term Incentive Plan. The Operating Partnership offered these Series Z Incentive Units to eleven senior executives of the Company in exchange for a capital commitment of $1.00 per Series Z Incentive Unit, for an aggregate offering price of $200,000. Upon certain triggering events, the Series Z Incentive Units will automatically convert into common Operating Partnership units based on a conversion ratio that may increase over time upon satisfaction of specific conditions. The conversion ratio, initially set at zero, will increase on January 1 of each year for each participating executive who remains employed by the Company if the Company has met a specified "funds from operations" per share target for the prior year, up to a maximum conversion ratio of 1.0. The Series Z Incentive Units will automatically convert (1) if the conversion ratio reaches the maximum level of 1.0, (2) if none of the participating executives remain employed by the Company, (3) if the Company dissolves or is liquidated or, (4) at the latest, on January 1, 2016. In certain change of control situations, the participating executives will also be given the option to convert their units at the then-effective conversion ratio. In addition, the Operating Partnership has the option to redeem Series Z Incentive Units held by any executive whose employment has been terminated for any reason and the obligation to redeem any such units following the death of the holder. In such event, the Operating Partnership will redeem the units for, at its option, either common Operating Partnership units or shares of the Company's common stock based on the then-effective conversion ratio. The Series Z Incentive Units are entitled to participate in regular quarterly distributions on an adjusted basis. Initially, each Series Z Incentive Unit will receive 10% of the distribution received by each common Operating Partnership unit. Over time the distribution percentage may increase, generally based on satisfaction of the same conditions as increases in the conversion ratio. The Operating Partnership did not engage any underwriters or placement agents in connection with the private placement and no commissions were paid. The Company anticipates collecting the capital commitment by offsetting future distributions to the participating executives and using the proceeds for working capital purposes. In light of information received by the Operating Partnership in connection with such transaction, management believes that the private placement was exempt from registration under Section 4(2) of the Securities Act of 1933, as amended. 26 Item 4: Submission of Matters to a Vote of Security Holders At the Company's annual meeting, held on May 15, 2001 in Menlo Park, California, the following votes of security holders occurred: (a) The following persons were duly elected by the holders of the Company's Common Stock (the "Stockholders") as Class I directors of the Company, each for a three (3) year term (until 2004) and until their successors are elected and qualified: (1) Keith R. Guericke, 16,854,796 votes for and 22,356 votes withheld; (2) Issie N. Rabinovitch, 16,855,096 votes for and 22,056 votes withheld; and (3) Thomas E. Randlett, 16,855,096 votes for and 22,056 votes withheld. (b) The Stockholders ratified the appointment of KPMG LLP as the Company's independent public auditors for the year ending December 31, 2001 by a vote of 16,570,456 for, 11,711 votes against and 294,984 votes abstaining. Item 6: Exhibits and Reports on Form 8-K A. Exhibits -------- 10.1 Sixth Amendment to the First Amended and Restated Agreement of Limited Partnership of Essex Portfolio, L.P. B. Reports on Form 8-K ------------------- None 27 Signatures Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ESSEX PROPERTY TRUST, INC. /S/ MARK J. MIKL ----------------------------------------- Mark J. Mikl, Vice President and Controller (Authorized Officer and Principal Accounting Officer) August 13, 2001 --------------- Date 28 EX-10.1 3 dex101.txt AMENDED AND RESTATED AGRMT OF LIMITED PARTNERSHIP EXHIBIT 10.1 SIXTH AMENDMENT TO THE FIRST AMENDED AND RESTATED AGREEMENT OF LIMITED PARTNERSHIP OF ESSEX PORTFOLIO, L.P. Dated as of June 28, 2001 This Sixth Amendment to the First Amended and Restated Agreement of Limited Partnership of Essex Portfolio, L.P., as amended (as amended, the "Partnership Agreement"), dated as of the date shown above (the "Amendment"), is executed by Essex Property Trust, Inc., a Maryland corporation (the "General Partner"), as the General Partner and on behalf of the existing Limited Partners of Essex Portfolio, L.P. (the "Partnership"), and the individuals whose names are set forth on Exhibit Q as holders of Series Z Incentive Units issued pursuant to this Amendment (the "Series Z Partners"). RECITALS WHEREAS, the Partnership was formed pursuant to the Partnership Agreement; WHEREAS, the Partnership desires to issue as of the date hereof an aggregate amount of 200,000 Series Z Incentive Units (the "Series Z Incentive Units") of limited partnership interests in the Partnership with rights, terms and conditions as set forth herein, in exchange for a capital commitment (the "Capital Commitment") in the amount of $1.00 per unit; WHEREAS, as of the date hereof, each of the Series Z Partners has made a capital commitment to the Partnership in the amount set forth on Exhibit Q, in exchange for which such Partner is entitled to receive the number Series Z Incentive Units set forth on Exhibit Q; WHEREAS, pursuant to the authority granted to the General Partner under the Partnership Agreement, the General Partner desires to amend the Partnership Agreement to reflect (i) the issuance of the Series Z Incentive Units, (ii) the admission of the Series Z Partners as Additional Limited Partners and holders of a certain number of Series Z Incentive Units and (iii) certain other matters described herein; and WHEREAS, the Series Z Partners desire to become parties to the Partnership Agreement as Limited Partners and to be bound by all terms, conditions and other provisions of this Amendment and the Partnership Agreement. NOW THEREFORE, in consideration of the premises and for other good and valuable consideration, the receipt and sufficiency of which hereby are acknowledged, the General Partner hereby amends the Partnership Agreement as follows: 1. Definitions. Capitalized terms used herein, unless otherwise defined herein, shall have the same meanings as set forth in the Partnership Agreement. 2. Amended Definitions. Section 1.1 of the Partnership Agreement is hereby amended to delete the definition of "Percentage Interest" in its entirety and substituting the following definition of "Percentage Interest," in its place: "Percentage Interest" shall mean (i) with respect to any Partner other than holders of Series B Preferred Units, Series C Preferred Units, Series D Preferred Units, Series E Preferred Units or Series Z Incentive Units, the undivided percentage ownership interest of such Partner in the Partnership, as determined by dividing (A) the number of Partnership Units owned by such Partner by (B) the sum of (x) the total number of Partnership Units then outstanding (excluding the Series A Preferred Interest, the Series B Preferred Interest, the Series B Partnership Units, the Series C Preferred Interest, the Series C Preferred Units, the Series D Preferred Interest, the Series D Preferred Units, the Series E Preferred Interest, the Series E Preferred Units and the Series Z Incentive Units) and (y) the total number of outstanding Series Z Incentive Units multiplied by the Distribution Ratchet Percentage with respect to each such Series Z Incentive Unit, calculated on a unit-by-unit basis, and (ii) with respect to any holder of Series Z Incentive Units, the undivided percentage ownership interest of such Partner in the Partnership as determined by dividing (A) the product resulting from multiplying the total number of outstanding Series Z Incentive Units owned by such Partner by the Distribution Ratchet Percentage attributable to such holder's Series Z Incentive Units, by (B) the sum of (x) the total number of Partnership Units then outstanding (excluding the Series A Preferred Interest, the Series B Preferred Interest, the Series B Partnership Units, the Series C Preferred Interest, the Series C Preferred Units, the Series D Preferred Interest, the Series D Preferred Units, the Series E Preferred Interest, the Series E Preferred Units and the Series Z Incentive Units) and (y) the total number of outstanding Series Z Incentive Units multiplied by the Distribution Ratchet Percentage with respect to each such Series Z Incentive Unit, calculated on a unit-by-unit basis. If any Partner holds both Common Units and Series Z Incentive Units, then such Partner's Percentage Interest shall equal the sum of the amounts calculated under clauses (i) and (ii) of this definition of "Percentage Interest", determined by assuming for purposes of clause (i) that such Partner holds only Common Units and for purposes of clause (ii) that such Partner holds only Series Z Incentive Units. 3. Definitions. Section 1.1 of the Partnership Agreement is hereby amended to include the following definitions, to be inserted in alphabetical order in such Section 1.1: "Actual FFO" shall mean with respect to any fiscal period "funds from operations" of the General Partner as determined with respect to such fiscal period by the Board of Directors of the General Partner using a consistently applied methodology that conforms with the standards for computation of "funds from operations" established by the National Association of Real Estate Investment Trusts, Inc. (or successor organizations) from time to time; it being understood that, to the extent that the General Partner discloses "funds from operations" for any fiscal period in any of its periodic reports publicly filed with the Securities and Exchange Commission, Actual FFO for 2 such fiscal period for the purposes of this Agreement will conform to such publicly disclosed "funds from operations." "Actual FFO Per Share" shall mean with respect to any fiscal period the Actual FFO for such period divided by the number of Common Equivalent Shares. "Change in Control" shall mean the earliest to occur of any of the following events: (i) any "person," as such term is used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended (the "Exchange Act") other than any trustee, fiduciary or other person or entity holding securities under any employee benefit plan or trust of any of the General Partner or any of its subsidiaries or affiliates), together with all "affiliates" and "associates" (as such terms are defined in Rule 12b-2 under the Exchange Act) of such person, shall become the "beneficial owner" (as such term is defined in Rule 13d-3 under the Exchange Act), directly or indirectly, of securities of the General Partner representing thirty percent (30%) or more of the combined voting power of the General Partner's then outstanding securities having the right to vote in an election of the General Partner's Board of Directors ("Voting Securities") (other than as a result of an acquisition of securities directly from the General Partner). Notwithstanding the foregoing, a "Change in Control" shall not be deemed to have occurred for purposes of this clause (i) solely as the result of an acquisition of securities by the General Partner which, by reducing the number of shares of Voting Securities outstanding, increases the proportionate number of shares of Voting Securities beneficially owned by any person (as defined in the foregoing clause) to thirty percent (30%) or more of the combined voting power of all then outstanding Voting Securities; provided, however, that if such person shall thereafter become the beneficial owner of any additional shares of Voting Securities (other than pursuant to a stock split, stock dividend, or similar transaction or as a result of an acquisition of securities directly from the General Partner) and immediately thereafter beneficially owns thirty percent (30%) or more of the combined voting power of all then outstanding Voting Securities, then a "Change in Control" shall be deemed to have occurred for purposes of this clause (i). (ii) the moment immediately prior to the consummation of a merger, reorganization or consolidation of the General Partner or the occurrence of any other event (including without limitation a tender or exchange offer), the result of which is that the "beneficial owners" (as such term is defined in Rule 13d-3 of the Exchange Act) of the Voting Securities of the General Partner before the merger, reorganization, consolidation or other transaction are not the "beneficial owners", directly or indirectly, of a majority of the voting power of the surviving or resulting entity upon completion of such merger, reorganization, consolidation or other transaction; (iii) the moment immediately prior to the consummation of a merger, reorganization or consolidation of the Partnership, unless the General Partner immediately prior to such merger, reorganization or consolidation remains the sole general partner of the Partnership after such merger; 3 (iv) the moment immediately prior to the consummation of a change (whether by removal, withdrawal, transfer or otherwise) in the general partner of the Partnership; (v) persons who, as of June 1, 2001, constitute the General Partner's Board of Directors (the "Incumbent Directors") cease for any reason, including, without limitation, as a result of a tender or exchange offer, proxy contest, merger or similar transaction, to constitute at least a majority of the Board of Directors of the General Partner (rounded up to the next whole number), provided that any person becoming a director of the General Partner subsequent to such date shall be considered an Incumbent Director if such person's election was approved by or such person was nominated for election by a vote of a majority of the Incumbent Directors; provided, however, that any person whose initial assumption of office is in connection with an actual or threatened election contest relating to the election of members of the Board of Directors or other actual or threatened solicitation of proxies or consents by or on behalf of a "person" other than the Board of Directors, including by reason of agreement intended to avoid or settle any such actual or threatened contest or solicitation, shall not be considered an Incumbent Director; or (vi) the moment immediately prior to the consummation of a sale of all or substantially all of the assets of the General Partner and/or the Partnership. "Clawback Amount" shall mean at any time with respect to each Series Z Incentive Unit, an amount equal to the positive difference, if any, between (i) the then unpaid Capital Commitment with respect to such Series Z Incentive Unit, and (ii) the sum of any distributions deemed to offset the Clawback Amount in accordance with Section 6 below. The unpaid Capital Commitment of a Series Z Partner with respect to a Series Z Incentive Unit shall never be greater than the Clawback Amount with respect to such Series Z Incentive Unit, as adjusted from time to time. "Common Equivalent Shares" shall mean the total number of shares of Common Stock outstanding on a fully diluted basis, calculated in a manner consistent with the manner used by the General Partner for reporting diluted earnings or loss per share under generally accepted accounting principles, it being understood that, to the extent that the General Partner discloses diluted earnings or loss per share in any of its periodic reports publicly filed with the Securities and Exchange Commission, Common Equivalent Shares for such period for the purposes of this Agreement shall be calculated in a manner consistent with such public disclosure. "Common Unit" shall mean a Partnership Unit representing an interest in the Partnership, other than a Series A Preferred Interest, Series B Preferred Unit, Series B Preferred Interest, Series C Preferred Unit, Series C Preferred Interest, Series D Preferred Unit, Series D Preferred Interest, Series E Preferred Unit, Series E Preferred Interest, Series Z Incentive Unit or any other Preferred Interest or Preferred Partnership Units. "Compensation Committee" shall mean the Compensation Committee of the Board of Directors of the General Partner or, if no such committee exists, the full Board of Directors of the General Partner. 4 "Conversion Ratchet Percentage" with respect to any Series Z Incentive Unit (i) shall equal 0% on the date hereof, (ii) shall increase by twenty percentage points on January 1 of the first calendar year after the date hereof on which (x) the holder of such Series Z Incentive Unit is an employee of the General Partner and/or the Partnership and/or any subsidiary or affiliate thereof as of such January 1, (y) the Actual FFO Per Share of the General Partner for the calendar year preceding such January 1 is greater than or equal to the Target FFO for such year, and (z) the Conversion Ratchet Percentage prior to such increase is less than 100%, and (iii) shall increase ten percentage points on January 1 of every calendar year thereafter on which the conditions in clauses (x), (y) and (z) of the immediately preceding clause (ii) are met; provided, however, that if the Compensation Committee determines that Actual FFO Per Share is no longer an appropriate corporate performance parameter for establishing management objectives or that the applicable target levels are no longer feasible in light of factors or circumstances outside of the Partnership's or the General Partner's control (such as general economic conditions, legal/regulatory changes, war or similar events), it may, in its reasonable good faith discretion without any consent or other action on the part of the Series Z Partners or any other Partners of the Partnership, revise and amend the requirement in (y) above (and any definitions involved therein) to reflect one or more different or additional parameters, objectives or performance measures, so long as the Compensation Committee, in its reasonable good faith discretion, determines that the revised or amended clause (y) is, considered as a whole, comparable or more effective as a means for analyzing the performance of the Partnership and incentivizing the Series Z Partners (it being understood that such amended or restated clause (y) shall not be more difficult to achieve than the present requirements of clause (y)). "Distribution Ratchet Percentage" with respect to any Series Z Incentive Unit (i) shall equal 10% on the date hereof, (ii) shall increase on January 1, 2002, to (a) twenty-five percent (25%) if the Conversion Ratchet Percentage with respect to such Series Z Incentive Units also increases to 20%, or (b) fifteen percent (15%) if the Conversion Ratchet Percentage with respect to such Series Z Incentive Units remains at 0%, (iii) shall increase, to the extent it has not already done so, to twenty-five percent (25%) at such time as such Conversion Ratchet Percentage is equal to 20%, and (iv) after such time as the Conversion Ratchet Percentage with respect to such Series Z Incentive Units is equal to or greater than 30%, the Distribution Ratchet Percentage shall be equal to the Conversion Ratchet Percentage with respect to such Series Z Incentive Units. "Forfeited Capital Account" shall mean that portion of the Capital Account attributable to a Series Z Incentive Unit equal to the product of (a) the excess of (i) the Adjusted Capital Account Balance (as defined in Section 10.9(a)) allocable to such Series Z Incentive Unit over (ii) the sum of (A) the capital contribution made with respect to such Series Z Incentive Unit and (B) the excess of the sum of the net allocations of operating income made with respect to such Series Z Incentive Unit for all fiscal years (taking into account allocations of Net Operating Loss made with respect to such Series Z Incentive Unit for all fiscal years) over the distributions of operating cash flow made to such Series Z Unit (except to the extent such allocations have reduced the Clawback Amount) multiplied by (b) 100% minus the Conversion Ratchet Percentage applicable to such Series Z Incentive Unit. 5 "Net Operating Income" shall mean, for any fiscal year or portion thereof, the excess of the items of income and gain over the items of deduction and loss, excluding, in each case, items of gain or loss realized in connection with the sale or disposition of real property and other capital assets. "Net Operating Loss" shall mean, for any fiscal year or portion thereof, the excess the items of deduction and loss over the items of income and gain, excluding, in each case, items of gain or loss realized in connection with the sale or disposition of real property and other capital assets. "Net Property Gain" shall mean, for any fiscal year or portion thereof, the excess of gains realized from the sale or disposition of real property and other capital assets over the losses realized in connection with the sale or disposition of real property and other capital assets. "Net Property Loss" shall mean, for any fiscal year or portion thereof, the excess of losses realized from the sale or disposition of real property and other capital assets over the gains realized in connection with the sale or disposition of real property and other capital assets. "Series Z Incentive Unit" shall mean a Series Z Incentive Unit of limited partnership interest in the Partnership with the rights set forth in this Agreement. "Target FFO" shall mean Actual FFO Per Share equal to $4.29 with respect to fiscal year 2001 and, with respect to each fiscal year thereafter, shall mean Actual FFO Per Share equal to the lesser of (x) the product of $4.29 times 1.1N, where "N" is equal to 1 with respect to fiscal year 2002 plus an additional 1 for each fiscal year thereafter, and (y) 110% of the Actual FFO Per Share applicable to the immediately preceding fiscal year; provided, however, that if the Compensation Committee determines that Actual FFO Per Share is no longer an appropriate corporate performance parameter for establishing management objectives or that the applicable target levels are no longer feasible in light of factors or circumstances outside of the Partnership's or the General Partner's control (such as general economic conditions, legal/regulatory changes, war or similar events), it may, in its reasonable good faith discretion without any consent or other action on the part of the Series Z Partners or any other Partners of the Partnership, revise and amend this definition of Target FFO (and any definitions involved herein) to reflect one or more different or additional parameters, objectives or performance measures, so long as the Compensation Committee, in its reasonable good faith discretion, determines that the revised or amended definition is, considered as a whole, comparable as a means for analyzing the performance of the Partnership and incentivizing the Series Z Partners (it being understood that such amended or restated definition shall not be more difficult to achieve than the present requirements of this definition). "Trigger Event" shall mean the earliest to occur of any of the following events: (i) such time as a plan of dissolution or liquidation (but not including a deemed liquidation for tax purposes in connection with one or more transfers of interest 6 in the Partnership) of the General Partner and/or the Partnership is duly adopted by appropriate corporate or partnership action; (ii) the date on which the Conversion Ratchet Percentage applicable to all Series Z Incentive Units held by then current employees of the General Partner and/or the Partnership (i.e., other than holders of Series Z Incentive Units whose employment with the General Partner and/or the Partnership has terminated) reaches 100%; (iii) the earliest date on which the employment of all holders of Series Z Incentive Units has been terminated; and (iv) January 1, 2016. "Weighted Number of Series Z Incentive Units" as determined from time to time shall mean the total number of outstanding Series Z Incentive Units, multiplied by the Conversion Ratchet Percentage with respect to each such Series Z Incentive Unit, calculated on a unit-by-unit basis. 4. Restatement of Exhibit A, Exhibit E and Exhibit M. Exhibit A to the Partnership Agreement is amended and restated by replacing such Exhibit A with Exhibit A attached to this Amendment. Exhibit E to the Partnership Agreement is amended and restated by replacing such Exhibit E with Exhibit E attached to this Amendment. Exhibit M to the Partnership Agreement is amended and restated by replacing such Exhibit M with Exhibit M attached to this Amendment. 5. Admission of Series Z Partners. Effective immediately prior to the effectiveness of the next succeeding sentence, the capital accounts of the Partnership shall be adjusted to reflect each Partner's share of the net fair market value of the Partnership's assets (a "book-up") by adjusting the Gross Asset Values of all Partnership assets to their respective gross fair market values and allocating the amount of such adjustment as Net Property Gain or Net Property Loss pursuant to Section 2(b) or 2(c) of Exhibit E hereof. Each of the Series Z Partners is hereby admitted as an Additional Limited Partner in accordance with Section 4.6 of the Partnership Agreement holding that number of Series Z Incentive Units as is set forth next to his or her name on Exhibit Q. Each of the Series Z Partners hereby agrees to become a party to the Partnership Agreement as a Limited Partner and to be bound by all the terms, conditions and other provisions of the Partnership Agreement, as amended by this Amendment. Pursuant to Section 4.6(b) of the Partnership Agreement, the General Partner hereby consents to the admission of each of the Series Z Partners as an Additional Limited Partner of the Partnership. The admission of the Series Z Partners shall become effective as of the date of this Amendment, which shall also be the date on which the name of each Series Z Partner is recorded on the books and records of the Partnership. 6. Distributions to Series Z Partners. The Partnership Agreement is hereby amended by adding the following language after Section 6.2(c) thereof: "(d) Notwithstanding the foregoing, at any time that the Clawback Amount with respect to a Series Z Incentive Unit is greater than zero, then, to the extent of such Clawback Amount, the distributions otherwise provided for by this Section with respect to such 7 Series Z Incentive Unit shall not be paid in cash and shall instead be deemed to offset the applicable Series Z Partners' unpaid Capital Commitment and thereby reduce the then existing Clawback Amount with respect to such Series Z Incentive Unit in an amount equal to the distributions that would have otherwise been paid with respect to such Series Z Incentive Unit." 7. Transfer Restrictions. Section 9.2A of the Partnership Agreement shall be amended by inserting the following as the last sentence thereof: "In addition, the Partners hereby acknowledge and agree that the Series Z Incentive Units shall not be Transferred, other than (a) by operation of law to the estate of a Series Z Partner or (b) to the Partnership or the General Partner." 8. Conversion Rights of Series Z Partners. (a) Section 10.8 of the Partnership Agreement is hereby amended by deleting the first sentence thereof and replacing it with the following: "So long as Code Section 1014 or a successor provision remains in effect and provides for the "step-up" in basis of an asset upon death, as determined by the Partnership's counsel, upon the death of a Limited Partner, all of such Limited Partner's Partnership Units shall, without the taking of any action by the General Partner or any heir, representative, administrator or executor of or for such Limited Partner, automatically convert as of the date of such death into shares of Common Stock in the amount of the Common Stock Amount; provided that the General Partner, in its sole and absolute discretion, shall have the option, instead of issuing the Common Stock Amount to the estate of the decedent Limited Partner, of paying to such estate the Cash Amount or any combination of cash and Common Stock equal to the Cash Amount; provided, however, that, notwithstanding the foregoing, the provisions of this Section shall not apply to any Series Z Incentive Units held by such Limited Partner." (b) The Partnership Agreement is hereby amended by adding the following language after Section 10.8 thereof: "10.9 Conversion and Redemption of Series Z Incentive Units. (a) Upon the occurrence of any Trigger Event with respect to the Series Z Incentive Units, the Forfeited Capital Account with respect to such Series Z Incentive Units shall be forfeited and each such Series Z Incentive Unit shall, without the taking of any action by the General Partner or any Series Z Partners, automatically convert into that number of Common Units calculated by dividing (i) the remainder resulting from (x) the portion of the adjusted Capital Account balance properly allocable to each such Series Z Incentive Unit at the time of conversion, as determined by the General Partner, taking into account all allocations made pursuant to Exhibit E hereof (including Section 2(d) thereof) through and including the date of the conversion (as so adjusted, the "Adjusted Capital Account Balance"), minus (y) the Forfeited Capital Account as of the time of conversion minus (z) the Clawback Amount, if any, with respect to such Series Z Incentive Unit, by (ii) the adjusted Capital Account balance properly allocable to one Common Unit determined immediately prior to such 8 conversion, after taking into account any adjustments made pursuant to Exhibit E hereof (including Section 2(d) thereof) through and including the date of conversion. (b) In the event of a Change in Control, (1) the Partnership shall give each Series Z Partner notice as required by Section 10.9(d) and otherwise comply with the procedures set forth in such section and (2) upon or at any time (except as expressly provided in clause (ii) below) following the occurrence of such Change in Control, each Series Z Partner shall have the right to elect, in accordance with the procedures set forth in Section 10.9(d), to forfeit the Forfeited Capital Account with respect to all of the Series Z Incentive Units held by such Series Z Partner and convert each such Series Z Incentive Unit into either: (i) that number of Common Units calculated by dividing (I) the remainder resulting from (x) the Adjusted Capital Account balance properly allocable to each such Series Z Incentive Unit at the time of an election pursuant to this Section 10.9(b), as determined by the General Partner after taking into account all allocations required to be made pursuant to Exhibit E hereof, including Section 2(d) thereof) minus (y) the Forfeited Capital Account as of the time of conversion, minus (z) the Clawback Amount, if any, with respect to such Series Z Incentive Unit, by (II) the adjusted Capital Account balance properly allocable to one Common Unit determined immediately prior to such conversion, after taking into account any adjustments made pursuant to Exhibit E hereof (including Section 2(d) thereof) through and including the date of conversion; provided, however, that, if applicable, references to "Common Units" in this clause shall be deemed to refer to the class or series of equity interests in the Substitute Umbrella Partnership (as defined in Section 10.9(c)) most comparable to the Common Units, after taking into account all relevant rights, benefits, terms and conditions and economic factors and all references to capital account balances and numbers of Common Units shall be equitably adjusted, as nearly as may be practicable, to give effect to the rights and obligations of the Series Z Incentive Units or, if applicable, the Substitute Incentive Units; or (ii) that amount and type of cash, securities or other property as such holder would have received in connection with such Change in Control if he, she or it had elected to convert such Series Z Incentive Units into Common Units in accordance with the immediately preceding clause (i) prior to the consummation of the Change in Control and received (or had the right to elect to receive) such consideration in connection with the Change in Control as the Holder of the number of Common Units into which such Series Z Incentive Units would have converted as of the date of occurrence of such Change of Control without any increase in the Conversion Ratchet Percentage that may have occurred after such date; provided, however, that any election pursuant to this clause (ii) must be made within the twelve (12) month period immediately following the occurrence of such Change in Control. For the avoidance of doubt, it is the intent of the parties hereto that a holder's right to make the election provided in this clause (ii) shall continue notwithstanding that, within such twelve (12) month period, another Change in Control occurs, such holder's employment is terminated as referred to in clause (e) below, or such holder dies as referred to in clause (f) below; provided, further, that if a Trigger Event occurs, such holder's right to make the election 9 provided in this clause (ii) shall continue only until the moment immediately prior to the occurrence of such Trigger Event. For the avoidance of doubt, the Series Z Incentive Units of any Series Z Partner who has not made the election contemplated by this Section 10.9(b) shall remain outstanding until such election is made or another clause of this Section 10.9 becomes applicable, and thereafter shall continue to be entitled to all the rights and benefits of the Series Z Incentive Units, including without limitation the right to make an election pursuant to this Section 10.9(b) with respect to any subsequent Change in Control and the potential for continued increase in the Conversion Ratchet Percentage. (c) Notwithstanding anything in this Agreement to the contrary, in connection with any Change in Control following which the Partnership will not continue to exist as a separate legal entity or following which the Partnership, despite continuing in legal existence, will no longer conduct its business in a fashion substantially similar to the fashion in which it conducted its business immediately prior to such Change of Control (e.g., owning similar properties and operating in a comparable fashion), the General Partner shall use commercially reasonable efforts (after taking into account the fiduciary duties owed by the General Partner to the other Partners in the Partnership in connection with negotiating the Change in Controltransaction as a whole) to cause the resulting or surviving entity and/or the entity primarily succeeding to the business of the Partnership, as the case may be, to be a partnership, limited liability company or other pass-through entity organized under the laws of any state of the United States or the District of Columbia (a "Substitute Umbrella Partnership"), and, in the event the Change in Control does result in a Substitute Umbrella Partnership, shall use commercially reasonable efforts to (1) cause the Substitute Umbrella Partnership to issue in connection with such Change in Control in substitution for any Series Z Incentive Units remaining outstanding as of the effective time thereof other interests in the Substitute Umbrella Partnership having substantially the same terms and rights as the Series Z Incentive Units, including with respect to distributions, conversions, ratcheting, voting rights and rights upon liquidation, dissolution or winding-up (the "Substitute Incentive Units"), (2) make equitable and appropriate provisions for adjustments to the terms of the Substitute Incentive Units such that the rights and obligations of the Series Z Partners after such Change in Control as holders of Substitute Incentive Units of the Substitute Umbrella Partnership shall be equivalent, as nearly as may be practicable, to their rights and obligations as holders of Series Z Incentive Units of the Partnership, and (3) secure a commitment of the general partner or other controlling person of the Substitute Umbrella Partnership to undertake to perform the obligations and covenants of the General Partner with respect to the Series Z Partners. (d) As promptly as possible prior to the consummation of a Change of Control (but in any event not later than ten (10) days following consummation of such Change in Control), the Partnership shall deliver a written notice of such Change of Control to each Series Z Partner at their addresses as shown on the records of the Partnership, containing all instructions and materials necessary to enable such Series Z Partners to make an election pursuant to Section 10.9(b) hereof and describing the circumstances and relevant facts regarding such Change of Control, including without 10 limitation the expected date of consummation. Failure to give or receive such notice or any defect therein shall not affect the legality or validity of any proceedings in connection with such Change of Control or otherwise as contemplated by this Agreement. Each Series Z Partner may exercise his or her right to convert in accordance with Section 10.9(b) by delivering written notice of such intent (and specifying whether he or she is electing to convert pursuant to Section 10.9(b)(i) or Section 10.9(b)(ii)) to the Partnership, Attn: Chief Financial Officer, with a copy to Goodwin Procter LLP, Attn: Ettore A. Santucci, P.C. (such notice, an "Election Notice") On or before the later of (i) the effective date of such Change in Control and (ii) the tenth (10th) business day following the date of such Election Notice, the Partnership shall issue the consideration required by Section 10.9(b) to the Series Z Partner making the election in exchange for his or her Series Z Incentive Units (or, if applicable, Substitute Incentive Units). (e) Effective as of such time as (other than by reason of death, as provided in Section 10.9(f)) a holder of Series Z Incentive Units is no longer an employee of the Partnership, the General Partner or any of their subsidiaries or affiliates, the Forfeited Capital Account with respect to such holder's Series Z Incentive Units shall be forfeited and the Partnership shall have the right, for 90 days following the date of termination of such holder's employment, to redeem each Series Z Incentive Unit held by such holder in exchange for, at the Partnership's option, either (1) a number of shares of Common Stock then owned by the Partnership calculated by dividing (i) the remainder resulting from (x) the Adjusted Capital Account Balance properly allocable to each such Series Z Incentive Unit as determined by the General Partner after taking into account all allocations required to be made pursuant to Exhibit E hereto (including Section 2(d) thereof) and, in the event the provisions of Section 2(f) thereof are inapplicable, in a manner consistent with the provisions of Treasury Regulation Section 1.704-1(b)(2)(iv)(f) minus (y) the Forfeited Capital Account as of the time of redemption minus (z) the Clawback Amount, if any, with respect to such Series Z Incentive Unit, by (ii) the Closing Price of Common Stock determined as of such date; or (2) a number of Common Units calculated by dividing (i) the remainder resulting from (x) the Adjusted Capital Account Balance which would be allocable to each such Series Z Incentive Unit as determined by the General Partner after taking into account all allocations required to be made pursuant to Exhibit E hereof (including Section 2(d) thereof) and assuming that the Capital Accounts of the Partners were adjusted at such time as provided in Section 2(f) of Exhibit E hereto minus (y) the Forfeited Capital Account minus (z) the Clawback Amount, if any, with respect to such Series Z Incentive Unit, by (ii) the adjusted Capital Account balance properly allocable to one Common Unit determined immediately prior to such redemption, after taking into account any adjustments made pursuant to Exhibit E hereof (including Section 2(d) thereof) and assuming that the Capital Accounts of the Partners were adjusted at such time as provided in Section 2(f) of Exhibit E hereto through and including the date of redemption. The Partnership may exercise its rights under this Section 10.9(e) by providing written notice to the terminated Series Z Partner within 90 days of such termination and consummating the redemption promptly thereafter. (f) Upon the death of a holder of Series Z Incentive Units, the Forfeited Capital Account with respect to such Series Z Incentive Units shall be forfeited 11 and each such Series Z Incentive Unit held by such holder shall be redeemed by the Partnership for, at its option, either (1) a number of shares of Common Stock then owned by the Partnership calculated by dividing (i) the remainder resulting from (x) the Adjusted Capital Account Balance properly allocable to each such Series Z Incentive Unit as determined by the General Partner after taking into account all allocations required to be made by Exhibit E hereto (including Section 2(d) thereof) and in the event that the provisions of Section 2(f) are inapplicable, in a manner consistent with the provisions of Treasury Regulation Section 1.704-1(b)(2)(iv)(f) minus (y) the Forfeited Capital Account as of the time of redemption minus (z) the Clawback Amount, if any, with respect to such Series Z Incentive Unit, by (ii) the Closing Price of Common Stock determined immediately prior to such redemption; or (2) a number of Common Units calculated by dividing (i) the remainder resulting from (x) the Adjusted Capital Account Balance which would be allocable to each such Series Z Incentive Unit as determined by the General Partner after taking into account all allocations required to be made by Exhibit E hereto (including Section 2(d) thereof) and in the event that the provisions of Section 2(f) are inapplicable, in a manner consistent with the provisions of Treasury Regulation Section 1.704-1(b)(2)(iv)(f) minus (y) the Forfeited Capital Account as of the time of redemption minus (z) the Clawback Amount, if any, with respect to such Series Z Incentive Unit, by (ii) the average adjusted Capital Account balance properly allocable to one Common Unit determined immediately prior to such redemption, as determined by the General Partner after taking into account all allocations required to be made by Exhibit E hereto (including Section 2(d) thereof) and in the event that the provisions of Section 2(f) are inapplicable in a manner consistent with the provisions of Treasury Regulation Section 1.704-1(b)(2)(iv)(f). The Partnership shall effect the redemption required by this Section 10.9(f) within 60 days follow its receipt of written notification of the death of a Series Z Partner. (g) In lieu of delivering a fractional share of Common Stock pursuant to this Section 10.9, the Partnership may deliver cash equal to the Closing Price attributable to such fractional share. In lieu of issuing a fractional Common Unit pursuant to this Section 10.9, the Partnership may deliver cash equal to the product of (i) the Closing Price multiplied by the Conversion Factor, and (ii) such fractional Common Unit. For the avoidance of doubt, as to any fractional Common Unit or fraction of a share of Common Stock which would otherwise be delivered, the Partnership shall pay a cash adjustment in respect of such final fraction (which for each holder of Series Z Incentive Units shall be deemed to be a fraction of the last fractional Common Unit or fraction of a share of Common Stock after taking into account all Series Z Incentive Units held by such holder, not on a unit-by-unit basis) in the amount provided for in this clause (g). (h) The holder of any Common Units received upon a conversion or redemption of Series Z Incentive Units pursuant to this Section 10.9 shall have an aggregate Capital Account balance with respect to such Common Units equal to the remainder resulting from (x) the Adjusted Capital Account Balance of such holder's Series Z Incentive Units (determined pursuant to the applicable sub-section of this Section 10.9) immediately prior to conversion or redemption minus (y) the Forfeited Capital Account minus (z) the Clawback Amount, if any, with respect to such Series Z 12 Incentive Unit, and such holder of Common Units shall have all of the rights of holders of Common Units as set forth in this Agreement. Immediately upon conversion or redemption of any Series Z Incentive Units pursuant to this Section 10, the aggregate Forfeited Capital Accounts with respect to all Series Z Incentive Units being converted or redeemed shall be reallocated among the Capital Accounts of the holders of Common Units immediately subsequent to such conversion or redemption on a pro rata basis, in proportion to the Capital Account balances of all such units immediately subsequent to such conversion or redemption. Any Common Units received upon the conversion or redemption of Series Z Incentive Units pursuant to this Section 10.9 may thereafter be converted into Common Stock pursuant to Section 10.8 and the holder of such Common Units shall have the Rights provided in Article XI; provided, however, that, notwithstanding anything to the contrary contained in Section 10.8, Article XI or Exhibit I, (i) the General Partner may, in its sole discretion, choose to assign its obligation pursuant to Section 10.8, Article XI or Exhibit I, as the case may be, to the Partnership, in which case the Partnership will deliver shares of Common Stock that it holds on such date in exchange for the Common Units to be converted or redeemed, in lieu of the General Partner issuing new shares of Common Stock to the holder of such Common Units and (ii) neither the General Partner nor the Partnership shall pay cash (in whole or in part) with respect to the conversion of Common Units received upon conversion or redemption of Series Z Incentive Units." 9. Restatement of Exhibit E. Exhibit E to the Partnership Agreement is hereby amended and restated in its entirety by replacing such Exhibit E with Exhibit E attached to this Amendment. 10. Voting Rights. (a) Holders of the Series Z Incentive Units will not have any voting rights or rights to consent to any matters, except as set forth in Section 10(b) below. (b) So long as any Series Z Incentive Units remains outstanding, the Partnership shall not, without the affirmative vote of the holders of at least two-thirds (2/3) of the Weighted Number of Series Z Incentive Units (i) amend, alter or repeal any provisions of the Partnership Agreement, including without limitation as a result of or in connection with a merger, consolidation or otherwise, in a manner that would materially and adversely affect the powers, special rights, preferences, privileges or voting power of the Series Z Incentive Units or the holders thereof; provided, however, that the following shall be deemed not to materially and adversely affect such powers, special rights, preferences, privileges or voting power of the Series Z Incentive Units: (a) any revision or amendment of the definition of "Conversion Ratchet Percentage" or "Target FFO" in accordance with the proviso contained in each such definition; (b) any increase in the amount of Partnership Interests or the creation or issuance of any other class or series of Partnership Interests or obligation or security convertible into or evidencing the right to purchase any such Partnership Interests ranking senior to, junior to or on a parity with the Series Z Incentive Units with respect to payment of distributions or the distribution of assets upon liquidation, dissolution or winding up; or (c) any amendment, alteration or repeal of any provision(s) of the Partnership Agreement that also materially and adversely affects the Common Units or the holders thereof in a comparable and proportionate fashion; provided, further, that 13 with respect to the occurrence of a merger, consolidation or comparable transaction, so long as (l) the Partnership is the surviving entity and the Series Z Incentive Units remain outstanding with the terms thereof unchanged, or (2) the resulting, surviving or transferee entity is a partnership, limited liability company or other pass-through entity organized under the laws of any state and substitutes the Series Z Incentive Units for other interests in such entity having substantially the same terms and rights as the Series Z Incentive Units, including with respect to distributions, conversions, voting rights and rights upon liquidation, dissolution or winding-up, then the occurrence of any such event shall not be deemed to materially and adversely affect such rights, privileges or voting powers of the holders of the Series Z Incentive Units. Notwithstanding anything in this Section 10 to the contrary, the holders of Series Z Incentive Units shall have no right to vote or consent with respect to any transaction that constitutes a Trigger Event or that constitutes a Change in Control so long as the provisions of Section 10.9(b) remain in effect. 11. Exhibit Q. The Partnership Agreement is hereby amended by adding Exhibit Q, a copy of which is attached hereto. Exhibit Q is hereby inserted into the Partnership Agreement following Exhibit P. 12. Ranking. The Series Z Incentive Units shall rank (i) junior to any and all presently outstanding or subsequently issued Preferred Interests and preferred Partnership Units of the Partnership, unless the terms of such Preferred Interests and/or preferred Partnership Units expressly provide that they shall rank junior to or pari passu with the Series Z Incentive Units or Common Units, and (ii) pari passu with the Common Units and with any other class or series of presently existing or subsequently issued Partnership Units of the Partnership, the terms of which do not expressly provide that such Partnership Units shall rank senior to the Series Z Incentive Units or the Common Units with respect to the receipt of distributions and of amounts distributable upon liquidation, dissolution or winding up. 13. Continuing Effect of Partnership Agreement. Except as modified herein, the Partnership Agreement is hereby ratified and confirmed in its entirety and shall remain and continue in full force and effect, provided, however, that to the extent there shall be a conflict between the provisions of the Partnership Agreement and this Amendment, the provisions in this Amendment will prevail. All references in any document to the Partnership Agreement shall mean the Partnership Agreement, as amended hereby. 14. Counterparts. This Agreement may be executed in any number of counterparts, each of which shall be deemed to be an original and all of which shall constitute one and the same agreement. Facsimile signatures shall be deemed effective execution of this Agreement and may be relied upon as such by the other party. In the event facsimile signatures are delivered, originals of such signatures shall be delivered to the other party within three business days after execution. 14 IN WITNESS WHEREOF, the General Partner and the Series Z Partners have executed this Amendment as of the date indicated above. GENERAL PARTNER ESSEX PROPERTY TRUST, INC., a Maryland corporation as General Partner of Essex Portfolio, L.P. and on behalf of the existing Limited Partners By: /s/ Keith R. Guericke ---------------------------------------- Keith R. Guericke Chief Executive Officer & President S-1 SERIES Z PARTNERS: By: /s/ Keith R. Guericke ------------------------------------ Keith R. Guericke By: /s/ Michael J. Schall ------------------------------------ Michael J. Schall By: /s/ John D. Eudy ------------------------------------ John D. Eudy By: /s/ Craig K. Zimmerman ------------------------------------ Craig K. Zimmerman By: /s/ Robert C. Talbott ------------------------------------ Robert C. Talbott By: /s/ Jordan E. Ritter ------------------------------------ Jordan E. Ritter By: /s/ Gerald E. Kelly ------------------------------------ Gerald E. Kelly By: /s/ Mark J. Mikl ------------------------------------ Mark J. Mikl By: /s/ John F. Burkart ------------------------------------ John F. Burkart S-2 By: /s/ Bryan W. Meyer ------------------------------------ Bryan W. Meyer By: /s/ Bruce Knoblock ------------------------------------ Bruce Knoblo S-3 EXHIBIT E ALLOCATIONS 1. Allocation of Net Operating Income and Net Operating Loss. (a) Net Operating Income. Except as otherwise provided herein, Net Operating Income for any fiscal year or other applicable period shall be allocated in the following order and priority: (1) First, to the Partners, until the cumulative Net Operating Income allocated pursuant to this subparagraph 1(a)(1) for the current and all prior periods equals the cumulative Net Operating Loss allocated pursuant to subparagraph 1(b)(2) hereof for all prior periods, among the Partners in the same ratio and reverse order that such Net Operating Loss was allocated to the Partners pursuant to subparagraph 1(b)(2) hereof (and, in the event of a shift of a Partner's interest in the Partnership, to the Partners in a manner that most equitably reflects the successors in interest to the Partners). (2) Thereafter, the balance of the Net Operating Income, if any, shall be allocated to the Partners in accordance with their respective Percentage Interests. (b) Net Operating Loss. Except as otherwise provided herein, Net Operating Loss of the Partnership for each fiscal year or other applicable period shall be allocated as follows: (1) To the Partners in accordance with their respective Percentage Interests. (2) Notwithstanding subparagraph 1(b)(1) hereof, to the extent any Net Operating Loss allocated to a Partner under subparagraph 1(b)(1) hereof or this subparagraph 1(b)(2) would cause such Partner (hereinafter, a "Restricted Partner") to have an Adjusted Capital Account Deficit as of the end of the fiscal year to which such Net Operating Loss relates, such Net Operating Loss shall not be allocated to such Restricted Partner and instead shall be allocated to the other Partner(s) (hereinafter, the "Permitted Partners") pro rata in accordance with their relative Percentage Interests. (c) Notwithstanding Sections 1(a) and (b) above, on any date on which any Series A Preferred Stock, any Series B Preferred Stock, any Series C Preferred Stock, any Series D Preferred Stock, any Series E Preferred Stock, or any Series B Preferred Unit, any Series C Preferred Unit, any Series D Preferred Unit or any Series E Preferred Unit (or other Preferred Stock or other Preferred Units) is outstanding, Net Operating Income and Net Operating Loss shall be allocated as follows: (1) Net Operating Income for any fiscal year or other applicable period shall be allocated in the following order and priority: (i) First, to the Partners, until the cumulative Net Operating Income allocated pursuant to this subparagraph 1(c)(l)(i) for the current and all prior periods equals the cumulative Net Operating Loss allocated pursuant to subparagraphs 1(c)(2)(iii) and E-1 (iv) hereof for all prior periods, among the Partners in the same ratio and reverse order that such Net Operating Loss was allocated (and, in the event of a shift of a Partner's interest in the Partnership, to the Partners in a manner that most equitably reflects the successors in interest to such Partners); (ii) Second, to the General Partner, until the cumulative Net Operating Income allocated pursuant to this subparagraph 1(c)(1)(ii) for the current and all prior periods equals the cumulative Net Operating Loss allocated pursuant to subparagraph 1(c)(2)(ii) hereof for all prior periods; (iii) Third, on a pari passu basis, to (A) the General Partner until the cumulative amount of Net Operating Income allocated pursuant to this subparagraph 1(c)(1)(iii) equals the total amount of dividends paid on the Series A Preferred Stock, the Series B Preferred Stock, the Series C Preferred Stock, the Series D Preferred Stock and the Series E Preferred Stock (and other Preferred Stock) as of or prior to the date of such allocation plus the total amount of accrued but unpaid dividends on the Series A Preferred Stock, the Series B Preferred Stock, the Series C Preferred Stock, the Series D Preferred Stock and the Series E Preferred Stock (and other Preferred Stock) as of such date; (B) to the holders of Series B Preferred Units until the cumulative amount of Net Operating Income allocated pursuant to this subparagraph 1(c)(i)(iii) equals the total amount of Priority Return paid on the Series B Preferred Units as of or prior to the date of such allocation plus the total amount of accrued but unpaid Priority Return on the Series B Preferred Units; (C) to the holders of Series C Preferred Units until the cumulative amount of Net Operating Income allocated pursuant to this subparagraph 1(c)(i)(iii) equals the total amount of Priority Return paid on the Series C Preferred Units as of or prior to the date of such allocation plus the total amount of accrued but unpaid Priority Return on the Series C Preferred Units; (D) to the holders of Series D Preferred Units until the cumulative amount of Net Operating Income allocated pursuant to this subparagraph 1(c)(i)(iii) equals the total amount of Priority Return paid on the Series D Preferred Units as of or prior to the date of such allocation plus the total amount of accrued but unpaid Priority Return on the Series D Preferred Units; and (E) to the holders of Series E Preferred Units until the cumulative amount of Net Operating Income allocated pursuant to this subparagraph 1(c)(i)(iii) equals the total amount of Priority Return paid on the Series E Preferred Units as of or prior to the date of such allocation plus the total amount of accrued but unpaid Priority Return on the Series E Preferred Units. (iv) Thereafter, the balance of the Net Operating Income, if any, shall be allocated to the Partners in accordance with their respective Percentage Interests. (2) Net Operating Loss of the Partnership for each fiscal year or other applicable period shall be allocated as follows: (i) First, to the Partners in accordance with their respective Percentage Interests until the Capital Account balances of the Limited Partners (not including the holders of the Series B Preferred Units, the Series C Preferred Units, the Series D Preferred Units and the Series E Preferred Units) are reduced to zero (for purposes of this calculation, each Partner's Capital Account balance shall be credited with the amount such Partner is obligated to restore pursuant to the provisions of Section 1.704-1(b)(2)(ii)(c) of the Regulations, or is deemed to be obligated to restore with respect to any deficit balance pursuant to the penultimate sentences of Sections 1.704-2(g)(1) and 1.704-2(i)(5) of the Regulations); E-2 (ii) Second, on a pari passu basis, to (A) the General Partner until its Capital Account balance has been reduced to zero; (B) to the holders of Series B Preferred Units until their Capital Account balances have been reduced to zero (for purposes of this calculation, such Partners' share of Partnership Minimum Gain shall be added back to their Capital Accounts); (C) to the holders of Series C Preferred Units until their Capital Account balances have been reduced to zero; (D) to the holders of Series D Preferred Units until their Capital Account balances have been reduced to zero; and (E) to the holders of Series E Preferred Units until their Capital Account balances have been reduced to zero (for purposes of each such calculation, each Partner's Capital Account balance shall be credited with the amount such Partner is obligated to restore pursuant to the provisions of Section 1.704-1(b)(2)(ii)(c) of the Regulations, or is deemed to be obligated to restore with respect to any deficit balance pursuant to the penultimate sentences of Sections 1.704-2(g)(1) and 1.704-2(i)(5) of the Regulations); (iii) Thereafter, to the Partners in accordance with their then Percentage Interests; (iv) Notwithstanding subparagraph 2(c)(2)(iii) hereof, to the extent any Net Operating Loss allocated to a Partner under subparagraph 2(c)(2) would cause such Partner (hereinafter, a "Restricted Partner") to have an Adjusted Capital Account Deficit as of the end of the fiscal year to which such Net Operating Loss relates, such Net Operating Loss shall not be allocated to such Restricted Partner and instead shall be allocated to the other Partner(s) (hereinafter, the "Permitted Partners") pro rata in accordance with their relative Percentage Interests. (d) Adjustment of Percentage Interests Upon Conversion of Convertible Preferred Stock to Common Stock. Upon the conversion of any Series A Preferred Stock to Common Stock of the General Partner, the Percentage Interests of the Partners shall be adjusted in accordance with the provisions of Article 4 of the Partnership Agreement as if, on the date of such conversion, the General Partner had made an additional Capital Contribution to the Partnership in an amount equal to the number of shares of Common Stock issued as a result of such conversion multiplied by the fair market value of such shares on the date of conversion, and provided that in calculating such adjustments, the General Partner shall be deemed not to have incurred any expenses in connection with raising the funds used to make such additional Capital Contribution. 2. Allocation of Net Property Gain and Net Property Loss. After the allocation of Net Operating Income or Net Operating Loss has been made pursuant to Section 1 above, Net Property Gain and Net Property Loss shall be allocated as follows: (a) Net Property Gain. Except as otherwise provided herein, Net Property Gain for any fiscal year or other applicable period shall be allocated in the following order and priority: (1) First, to the Partners, until the cumulative Net Property Gain allocated pursuant to this subparagraph 2(a)(1) for the current and all prior periods equals the cumulative Net Property Loss allocated pursuant to subparagraph 2(b)(2) hereof for all prior periods, among the Partners in the same ratio and reverse order that such Net Property Loss was allocated to the E-3 Partners pursuant to subparagraph 2(b)(2) hereof (and, in the event of a shift of a Partner's interest in the Partnership, to the Partners in a manner that most equitably reflects the successors in interest to the Partners). (2) Thereafter, the balance of the Net Property Gain, if any, shall be allocated to the Partners in accordance with their respective Percentage Interests. (b) Net Property Loss. Except as otherwise provided herein, Net Property Loss of the Partnership for each fiscal year or other applicable period shall be allocated as follows: (1) To the Partners in accordance with their respective Percentage Interests. (2) Notwithstanding subparagraph 2(b)(1) hereof, to the extent any Net Property Loss allocated to a Partner under subparagraph 2(b)(1) hereof or this subparagraph 2(b)(2) would cause such Partner (hereinafter, a "Restricted Partner") to have an Adjusted Capital Account Deficit as of the end of the fiscal year to which such Net Property Loss relates, such Net Property Loss shall not be allocated to such Restricted Partner and instead shall be allocated to the other Partner(s) (hereinafter, the "Permitted Partners") pro rata in accordance with their relative Percentage Interests. (c) Notwithstanding Sections 2(a) and (b) above, on any date on which any Series A Preferred Stock, any Series B Preferred Stock, any Series C Preferred Stock, any Series D Preferred Stock, any Series E Preferred Stock or any Series B Preferred Unit, any Series C Preferred Unit, any Series D Preferred Unit or any Series E Preferred Unit (or other Preferred Stock or other Preferred Units) is outstanding, Net Property Gain and Net Property Loss shall be allocated as follows: (1) Net Property Gain for any fiscal year or other applicable period shall be allocated in the following order and priority: (i) First, to the Partners, until the cumulative Net Property Gain allocated pursuant to this subparagraph 2(c)(l)(i) for the current and all prior periods equals the cumulative Net Property Loss allocated pursuant to subparagraphs 2(c)(2)(iii) and (iv) hereof for all prior periods, among the Partners in the same ratio and reverse order that such Net Property Loss was allocated (and, in the event of a shift of a Partner's interest in the Partnership, to the Partners in a manner that most equitably reflects the successors in interest to such Partners); (ii) Second, to the General Partner, until the cumulative Net Property Gain allocated pursuant to this subparagraph 2(c)(1)(ii) for the current and all prior periods equals the cumulative Net Property Loss allocated pursuant to subparagraph 2(c)(2)(ii) hereof for all prior periods; (iii) Third, on a pari passu basis, to (A) the General Partner until the sum of (x) the total cumulative amount of Net Operating Income allocated to the General Partner under Section 1(c)(1)(iii) for the current and all prior periods plus (y) the total cumulative amount of Net Property Gain allocated pursuant to this subparagraph 2(c)(1)(iii) equals the total amount of dividends paid on the Series A Preferred Stock, the Series B Preferred Stock, the Series C Preferred Stock, the Series D Preferred Stock and the Series E Preferred Stock (and E-4 other Preferred Stock) as of or prior to the date of such allocation plus the total amount of accrued but unpaid dividends on the Series A Preferred Stock, the Series B Preferred Stock, the Series C Preferred Stock, the Series D Preferred Stock and the Series E Preferred Stock (and other Preferred Stock) as of such date; (B) to the holders of Series B Preferred Units until the sum of (x) the total cumulative amount of Net Operating Income allocated to the holders of the Series B Preferred Units under Section 1(c)(1)(iii) for the current and all prior periods plus (y) the total cumulative amount of Net Property Gain allocated pursuant to this subparagraph 2(c)(i)(iii) to the holders of the Series B Preferred Units equals the total amount of Priority Return paid on the Series B Preferred Units as of or prior to the date of such allocation plus the total amount of accrued but unpaid Priority Return on the Series B Preferred Units; (C) to the holders of Series C Preferred Units until the sum of (x) the total cumulative amount of Net Operating Income allocated to the holders of the Series C Preferred Units under Section 1(c)(1)(iii) for the current and all prior periods plus (y) the total cumulative amount of Net Property Gain allocated pursuant to this subparagraph 2(c)(i)(iii) to the holders of the Series C Preferred Units equals the total amount of Priority Return paid on the Series C Preferred Units as of or prior to the date of such allocation plus the total amount of accrued but unpaid Priority Return on the Series C Preferred Units; (D) to the holders of Series D Preferred Units until the sum of (x) the total cumulative amount of Net Operating Income allocated under Section 1(c)(1)(iii) for the current and all prior periods plus (y) the cumulative amount of Net Property Gain allocated pursuant to this subparagraph 2(c)(i)(iii) to the holders of the Series D Preferred Units equals the total amount of Priority Return paid on the Series D Preferred Units as of or prior to the date of such allocation plus the total amount of accrued but unpaid Priority Return on the Series D Preferred Units; (E) to the holders of Series E Preferred Units until the sum of (x) the total cumulative amount of Net Operating Income allocated under Section 1(c)(1)(iii) for the current and all prior periods plus (y) the cumulative amount of Net Property Gain allocated pursuant to this subparagraph 2(c)(i)(iii) to the holders of the Series E Preferred Units equals the total amount of Priority Return paid on the Series E Preferred Units as of or prior to the date of such allocation plus the total amount of accrued but unpaid Priority Return on the Series E Preferred Units. (iv) Thereafter, the balance of the Net Property Gain, if any, shall be allocated to the Partners in accordance with their respective Percentage Interests. (2) Net Property Loss of the Partnership for each fiscal year or other applicable period shall be allocated as follows: (i) First, to the Partners in accordance with their respective Percentage Interests until the Capital Account balances of the Limited Partners (not including the holders of the Series B Preferred Units, the Series C Preferred Units, the Series D Preferred Units and the Series E Preferred Units) are reduced to zero (for purposes of this calculation, such Partners' share of Partnership Minimum Gain shall be added back to their Capital Accounts); (ii) Second, on a pari passu basis, to (A) the General Partner until its Capital Account balance has been reduced to zero (for purposes of this calculation, such Partner's share of Partnership Minimum Gain shall be added back to its Capital Account); (B) to the holders of Series B Preferred Units until their Capital Account balances have been reduced to zero (for purposes of this calculation, such Partners' share of Partnership Minimum Gain shall be added back to their Capital Accounts); (C) to the holders of Series C Preferred Units until their E-5 Capital Account balances have been reduced to zero (for purposes of this calculation, such Partners' share of Partnership Minimum Gain shall be added back to their Capital Accounts); (D) to the holders of Series D Preferred Units until their Capital Account balances have been reduced to zero (for purposes of this calculation, such Partners' share of Partnership Minimum Gain shall be added back to their Capital Accounts); and (E) to the holders of Series E Preferred Units until their Capital Account balances have been reduced to zero (for purposes of this calculation, such Partners' share of Partnership Minimum Gain shall be added back to their Capital Accounts); (iii) Thereafter, to the Partners in accordance with their then Percentage Interests; (iv) Notwithstanding subparagraph 2(c)(2)(iii) hereof, to the extent any Net Property Loss allocated to a Partner under subparagraph 2(c)(2) would cause such Partner (hereinafter, a "Restricted Partner") to have an Adjusted Capital Account Deficit as of the end of the fiscal year to which such Net Property Loss relates, such Net Property Loss shall not be allocated to such Restricted Partner and instead shall be allocated to the other Partner(s) (hereinafter, the "Permitted Partners") pro rata in accordance with their relative Percentage Interests. (d) Special Allocation to Holders of Series Z Incentive Units. (1) Subject only to the provisions of Section 2(c)(iii) but notwithstanding any other provision of this Section 2, in the year in which the Partnership sells or otherwise disposes of all or substantially all of its assets in a single transaction or a series of related transactions, Net Property Gain shall first be allocated to the holders of the Series Z Incentive Units pro rata in proportion to the number of such Series Z Incentive Units outstanding, until the Capital Account balance attributable to each such Series Z Incentive Unit is equal to (A) the aggregate Capital Account balance attributable to the Common Units outstanding (including any other Partnership Units convertible into Common Units) divided by (B) the number of such Common Units outstanding. If Net Property Gain is insufficient to make the full allocation provided in the preceding sentence, then, in lieu of such special allocation of Net Property Gain provided in the preceding sentence, items of gross capital gain shall be allocated to the holders of Series Z Incentive Units, and, if such gross items are insufficient to make the full required allocation, items of gross capital loss shall be allocated pro rata with respect to such Common Units. The allocations pursuant to this paragraph (d) shall be made after the allocation of Net Operating Income or Net Operating Loss for the applicable period in which such sale or other disposition occurs. For purposes of this clause (i) of this Section 2(d) "all or substantially all" means assets representing not less than 95% of the aggregate fair market value of the Partnership's assets. (2) Notwithstanding anything herein to the contrary, for the 12-month period following the occurrence of a Change of Control (A) Net Operating Loss and Net Property Loss, if any, shall be allocated pursuant to Section 1(b) or 1(c)(2), as applicable, or Section 2(b) or 2(c)(2), as applicable, as if the Percentage Interest of each Series Z Partner were zero, and (B) with respect to each Series Z Partner at the earlier of (x) the date such Partner makes the election to convert his Series Z Incentive Units pursuant to Section 10.9(b)(i) or (y) the expiration of a period of twelve (12) months after such Change in Control, items of income, gain, deduction and loss shall be allocated so as to cause the Capital Account balance of each E-6 such Series Z Partner, and, as soon as possible after the end of such twelve month period, the Capital Account balances of all Partners, to be in the same ratio and amounts as if the allocations required by clause (A) of this Section 2(d)(2) had not been made. (e) Definition of Percentage Interest. Solely for purposes of allocating Net Property Gain and Net Property Loss under this Section 2, the Percentage Interest of a Series Z Incentive Unit holder attributable to such Units shall be deemed to be the undivided percentage ownership interest of such holder in the Partnership as determined by dividing (A) the total number of outstanding Series Z Incentive Units owned by such holder by (B) the total number of Partnership Units then outstanding (excluding the Series A Preferred Interest, the Series B Preferred Interest, the Series B Preferred Units, the Series C Preferred Interest, the Series C Preferred Units, the Series D Preferred Interest, the Series D Preferred Units, the Series E Preferred Interest, and the Series E Preferred Units). (f) Book-Up and Capital Account Adjustments. On any day on which (i) Series A Preferred Stock (or other Preferred Stock), any series of Preferred Units or Incentive Units are redeemed or converted into Common Stock or Common Units, (ii) Percentage Interests are adjusted in the manner required in subparagraph 1(d), or (iii) in connection with the issuance of the Series Z Incentive Units the Partnership shall adjust the Gross Asset Values of all Partnership assets to equal their respective gross fair market values and shall allocate the amount of such adjustment as Net Property Gain or Net Property Loss pursuant to Section 2(c) hereof, provided, however, that if no Series A Preferred Stock (or other Preferred Stock) is outstanding after such redemption or conversion, such Net Property Gain or Net Property Loss shall be allocated in such a manner that after such allocation the Capital Accounts of the Partners are in proportion to their Percentage Interests. 3. Special Allocations. Notwithstanding any provision of sections 1 and 2 of this Exhibit E, the following special allocations shall be made in the following order: (a) Minimum Gain Chargeback (Nonrecourse Liabilities). If there is a net decrease in Partnership Minimum Gain for any Partnership fiscal year (except as a result of conversion or refinancing of Partnership indebtedness, certain capital contributions or revaluation of the Partnership property as further outlined in Regulation Sections 1.704-2(d)(4), (f)(2) or (f)(3)), each Partner shall be specially allocated items of Partnership income and gain for such year (and, if necessary, subsequent years) in an amount equal to that Partner's share of the net decrease in Partnership Minimum Gain. The items to be so allocated shall be determined in accordance with Regulation Section 1.704-2(f). This paragraph 3(a) is intended to comply with the minimum gain chargeback requirement in said section of the Regulations and shall be interpreted consistently therewith. Allocations pursuant to this paragraph 3(a) shall be made in proportion to the respective amounts required to be allocated to each Partner pursuant hereto. (b) Minimum Gain Attributable to Partner Nonrecourse Debt. If there is a net decrease in Minimum Gain Attributable to Partner Nonrecourse Debt during any fiscal year (other than due to the conversion, refinancing or other change in the debt instrument causing it to become partially or wholly nonrecourse, certain capital contributions, or certain revaluations of Partnership property as further outlined in Regulations Sections 1.704-2(i)(4), each Partner shall E-7 be specially allocated Partnership income and gain for such year (and, if necessary, subsequent years) in an amount equal to that Partner's share of the net decrease in the Minimum Gain Attributable to Partner Nonrecourse Debt. The items to be so allocated shall be determined in accordance with Regulation Section 1.704-2(i)(4) and (j)(2). This paragraph 3(b) is intended to comply with the minimum gain chargeback requirement with respect to Partner Nonrecourse Debt contained in said section of the Regulations and shall be interpreted consistently therewith. Allocations pursuant to this paragraph 3(b) shall be made in proportion to the respective amounts required to be allocated to each Partner pursuant hereto. (c) Qualified Income Offset. In the event a Limited Partner unexpectedly receives any adjustments, allocations or distributions described in Regulation Section 1.704-1(b)(2)(ii)(d)(4), (5),or (6), and such Limited Partner has an Adjusted Capital Account Deficit, items of Partnership income and gain shall be specially allocated to such Partner in an amount and manner sufficient to eliminate the Adjusted Capital Account Deficit as quickly as possible. This paragraph 3(c) is intended to constitute a "qualified income offset" under Regulation Section 1.704-1(b)(2)(ii)(d) and shall be interpreted consistently therewith. (d) Nonrecourse Deductions. Nonrecourse Deductions for any fiscal year or other applicable period shall be allocated to the Partners in accordance with their respective Percentage Interests. (e) Partner Nonrecourse Deductions. Partner Nonrecourse Deductions for any fiscal year or other applicable period shall be specially allocated to the Partner that bears the economic risk of loss for the debt (i.e., the Partner Nonrecourse Debt) in respect of which such Partner Nonrecourse Deductions are attributable (as determined under Regulation Section 1.704-2(b)(4) and (i)(1)). (f) Curative Allocations. The allocations set forth in paragraphs (a)-(e) and Section 1(b)(2), Section 1(c)(2)(iv), Section 2(b)(2) and Section 2(c)(2)(iv), (the "Regulatory Allocations") are intended to comply with the requirements of Treasury Regulations Sections 1.704-1(b) and 1.704-2. Notwithstanding any other provisions of Sections 1 and 2, the Regulatory Allocations shall be taken into account in allocating other items of income, gain, deduction and loss among the Partners so that, to the extent possible, the net amount of such allocations of other items and the Regulatory Allocations to each Partner shall be equal to the net amount that would have been allocated to each such Partner if the Regulatory Allocations had not occurred. This paragraph (f) shall be interpreted and applied in such a manner and to such extent as is reasonably necessary to eliminate, as quickly as possible, permanent economic distortions that would otherwise occur as a consequence of the Regulatory Allocations in the absence of this paragraph (f). 4. Tax Allocations. (a) Generally. Subject to paragraphs 4(b) and (c) hereof, items of income, gain, loss, deduction and credit to be allocated for income tax purposes (collectively, "Tax Items") shall be allocated among the Partners on the same basis as their respective book items. (b) Sections 1245/1250 Recapture. If any portion of gain form the sale of property is treated as gain which is ordinary income by virtue of the application of Code Section 1245 or E-8 1250 ("Affected Gain"), then (A) such Affected Gain shall be allocated among the Partners in the same proportion that the depreciation and amortization deductions giving rise to the Affected Gain were allocated and (B) other Tax Items of gain of the same character that would have been recognized, but for the application of Code Sections 1245 and/or 1250, shall be allocated away from those Partners who are allocated Affected Gain pursuant to Clause (A) so that, to the extent possible, the other Partners are allocated the same amount, and type, of capital gain that would have been allocated to them had Code Sections 1245 and/or 1250 not applied; provided, however, that the net amount of Tax Items allocated to each Partner shall be the same as if this paragraph 4(b) did not exist. For purposes hereof, in order to determine the proportionate allocations of depreciation and amortization deductions for each fiscal year or other applicable period, such deductions shall be deemed allocated on the same basis as Net Property Gain and Net Property Loss for such respective period. (c) Allocations Respecting Section 704(c) and Revaluations. If any Partnership property is subject to Code Section 704(c) or is reflected in the Capital Accounts of the Partners and on the books of the Partnership at a book value that differs from the adjusted tax basis of such property, then the tax items with respect to such property shall, in accordance with the requirements of Regulations Section 1.704-1(b)(4)(i), be shared among the Partners in a manner that takes account of the variation between the adjusted tax basis of the applicable property and its book value in the same manner as variations between the adjusted tax basis and fair market value of property contributed to the Partnership are taken into account in determining the Partners' share of tax items under Code Section 704(c). The General Partner is authorized to choose any reasonable method permitted by the Regulations pursuant to Code Section 704(c), including the "remedial allocation" method, the "curative allocation" method and the traditional method; provided that the General Partner agrees to use reasonable efforts to minimize the amount of taxable income in excess of book income allocated to the holders of the Series B Preferred Units, the Series C Preferred Units, the Series D Preferred Units and the Series E Preferred Units. (d) Code Section 752 Specification. Pursuant to Regulations Section 1.752-3, the Partners' interest in Partnership profits for purposes of determining the Partners' shares of excess nonrecourse liabilities shall be their Percentage Interests. E-9 -----END PRIVACY-ENHANCED MESSAGE-----