form10q.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 

 
FORM 10-Q
 


x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2010

OR

o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ________to _________

Commission file number 001-13106

ESSEX PROPERTY TRUST, INC.
(Exact name of Registrant as Specified in its Charter)

Maryland
 
77-0369576
(State or Other Jurisdiction of Incorporation or Organization)
 
(I.R.S. Employer Identification Number)

925 East Meadow Drive
Palo Alto, California    94303
(Address of Principal Executive Offices including 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 (or for such shorter period that the registrant was required to file reports), and (2) has been subject to such filing requirements for the past 90 days. YES  x NO  o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES x NO

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” ”accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer  x
 
Accelerated filer  o
 
Non-accelerated filer  o
 
Smaller reporting company  o
       
(Do not check if a smaller reporting company)
   

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o No  x

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:  31,330,980 shares of Common Stock as of November 8, 2010.
 


 
 

 

  
 
 
ESSEX PROPERTY TRUST, INC.
FORM 10-Q
INDEX

   
Page No.
PART I. FINANCIAL INFORMATION
 
     
Item 1.
3
     
 
4
     
 
5
     
 
6
     
 
7
     
 
8
     
Item 2.
20
     
Item 3.
29
     
Item 4.
30
     
PART II. OTHER INFORMATION
 
     
Item 1.
31
     
Item 1A.
31
     
Item 6
31
     
32

 
2


Part I -- Financial Information

Item 1: Condensed 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 (the "Operating Partnership") in which Essex Property Trust, Inc. is the sole general partner.

The information furnished in the accompanying unaudited condensed consolidated balance sheets, statements of operations, stockholders' equity, noncontrolling interest, and comprehensive income and cash flows of the Company reflects all adjustments which are, in the opinion of management, necessary for a fair presentation of the aforementioned condensed consolidated financial statements for the interim periods and are normal and recurring in nature, except as otherwise noted.

The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the notes to such unaudited condensed consolidated financial statements and Management's Discussion and Analysis of Financial Condition and Results of Operations herein.  Additionally, these unaudited condensed 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, 2009.

 
3


ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(Unaudited)
(Dollars in thousands, except per share amounts)
 
Assets
 
September 30,
2010
   
December 31,
2009
 
Real estate:
           
Rental properties:
           
Land and land improvements
  $ 747,125     $ 684,955  
Buildings and improvements
    3,025,220       2,727,975  
      3,772,345       3,412,930  
Less accumulated depreciation
    (842,484 )     (749,464 )
      2,929,861       2,663,466  
Real estate under development
    239,910       274,965  
Co-investments
    108,894       70,783  
      3,278,665       3,009,214  
Cash and cash equivalents-unrestricted
    14,668       20,660  
Cash and cash equivalents-restricted
    21,654       17,274  
Marketable securities
    95,933       134,844  
Notes and other receivables
    55,605       36,305  
Prepaid expenses and other assets
    22,842       21,349  
Deferred charges, net
    14,386       14,991  
Total assets
  $ 3,503,753     $ 3,254,637  
                 
Liabilities and  Equity
               
Mortgage notes payable
  $ 1,711,242     $ 1,603,549  
Lines of credit
    348,000       239,000  
Exchangeable bonds
    3,209       4,893  
Accounts payable and accrued liabilities
    57,274       38,514  
Construction payable
    9,613       10,327  
Dividends payable
    35,148       33,750  
Cash flow hedge liabilities
    71,671       30,156  
Other liabilities
    18,272       16,558  
Total liabilities
    2,254,429       1,976,747  
Commitments and contingencies
               
Cumulative convertible preferred stock; $.0001 par value:
               
4.875% Series G - 5,980,000 issued and 178,249 outstanding
    4,349       4,349  
Stockholders' equity and noncontrolling interest:
               
Common stock, $.0001 par value, 649,702,178 shares authorized 30,085,469 and 28,849,779 shares issued and outstanding
    3       3  
Cumulative redeemable preferred stock; $.0001 par value:
               
7.8125% Series F - 1,000,000 shares authorized,issued and outstanding, liquidation value
    25,000       25,000  
Additional paid-in capital
    1,379,059       1,275,251  
Distributions in excess of accumulated earnings
    (285,699 )     (222,952 )
Accumulated other comprehensive (loss) income
    (79,732 )     (24,206 )
Total stockholders' equity
    1,038,631       1,053,096  
Noncontrolling interest
    206,344       220,445  
Total stockholders' equity and noncontrolling interest
    1,244,975       1,273,541  
Total liabilities and equity
  $ 3,503,753     $ 3,254,637  
 
See accompanying notes to the unaudited condensed consolidated financial statements.

 
4


ESSEX PROPERTY TRUST, INC. AND SUBSIDIARES
Condensed Consolidated Statements of Operations
(Unaudited)
(Dollars in thousands, except per share amounts)

   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2010
   
2009
   
2010
   
2009
 
Revenues:
                       
Rental and other property
  $ 103,822     $ 100,670     $ 303,142     $ 307,060  
Management and other fees from affiliates
    959       1,024       3,458       3,377  
      104,781       101,694       306,600       310,437  
Expenses:
                               
Property operating, excluding real estate taxes
    27,747       26,893       77,692       75,818  
Real estate taxes
    10,140       9,216       29,416       27,248  
Depreciation and amortization
    31,638       29,843       93,385       87,711  
General and administrative
    6,175       6,086       17,988       18,135  
Impairment and other charges
    1,615       11,104       1,615       16,892  
      77,315       83,142       220,096       225,804  
                                 
Earnings from operations
    27,466       18,552       86,504       84,633  
                                 
Interest expense
    (22,202 )     (21,966 )     (64,043 )     (63,679 )
Interest and other income
    5,788       3,471       20,730       9,521  
Equity (loss) income in co-investments
    (626 )     (32 )     (1,027 )     664  
(Loss) gain on early retirement of debt
    -       -       (10 )     6,124  
Gain on sale of real estate
    -       -       -       103  
Income before discontinued operations
    10,426       25       42,154       37,366  
Income from discontinued operations
    -       2,324       -       5,772  
Net income
    10,426       2,349       42,154       43,138  
Net income attributable to noncontrolling interest
    (3,506 )     (3,588 )     (11,540 )     (12,984 )
Net income attributable to controlling interest
    6,920       (1,239 )     30,614       30,154  
Dividends to preferred stockholders
    (543 )     (902 )     (1,628 )     (4,311 )
Excess of the carrying amount of preferred stock redeemed over the cash paid to redeem preferred stock
    -       23,880       -       49,575  
Net income available to common stockholders
  $ 6,377     $ 21,739     $ 28,986     $ 75,418  
                                 
Per common share data:
                               
Basic:
                               
Income before discontinued operations available to common stockholders
  $ 0.21     $ 0.71     $ 0.99     $ 2.61  
Income from discontinued operations
    -       0.08       -       0.19  
Net income available to common stockholders
  $ 0.21     $ 0.79     $ 0.99     $ 2.80  
Weighted average number of common shares outstanding during the period
    29,690,910       27,591,341       29,334,359       26,887,537  
                                 
Diluted:
                               
Income before discontinued operations available to common stockholders
  $ 0.21     $ 0.66     $ 0.99     $ 2.50  
Income from discontinued operations
    -       0.08       -       0.19  
Net income available to common stockholders
  $ 0.21     $ 0.74     $ 0.99     $ 2.69  
Weighted average number of common shares outstanding during the period
    29,762,420       30,070,076       29,398,637       29,360,710  
                                 
Dividend per common share
  $ 1.033     $ 1.030     $ 3.098     $ 3.090  

See accompanying notes to the unaudited condensed consolidated financial statements.

 
5


ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Stockholders' Equity, Noncontrolling Interest, and
Comprehensive Income for the nine months ended September 30, 2010
(Unaudited)
(Dollars and shares in thousands)

   
Series F Preferred stock
   
Common stock
   
Additional paid-in
   
Distributions in excess of accumulated
   
Accumulated other comprehensive income
   
Noncontrolling
       
   
Shares
   
Amount
   
Shares
   
Amount
   
capital
   
earnings
   
(loss)
   
Interest
   
Total
 
Balances at December 31, 2009
    1,000     $ 25,000       28,849     $ 3     $ 1,275,251     $ (222,952 )   $ (24,206 )   $ 220,445     $ 1,273,541  
Comprehensive income:
                                                                       
Net income
    -       -       -       -       -       30,614       -       11,540       42,154  
Reversal of unrealized gains upon the sale of marketable securites
    -       -       -       -       -       -       (7,981 )     (654 )     (8,635 )
Change in fair value of cash flow hedges and amortization of swap settlements
    -       -       -       -       -       -       (52,551 )     (4,161 )     (56,712 )
Change in fair value of marketable securities
    -       -       -       -       -       -       5,006       421       5,427  
Comprehensive income (loss)
                                                                    (17,766 )
Issuance of common stock under:
                                                                       
Stock option and restricted stock plans
    -       -       98       -       3,828       -       -       -       3,828  
Sale of common stock
    -       -       1,138       -       116,641       -       -       -       116,641  
Equity based compensation costs
    -       -       -       -       (219 )     -       -       1,861       1,642  
Retirement of exchangeable bonds
    -       -       -       -       (95 )     -       -       -       (95 )
Contributions from noncontrolling interest
    -       -       -       -       -       -       -       3,990       3,990  
Distributions to noncontrolling interest
    -       -       -       -       -       -       -       (19,700 )     (19,700 )
Dividends declared
    -       -       -       -       -       (93,361 )     -       -       (93,361 )
Redemptions of noncontrolling interest
    -       -       -       -       (16,347 )     -       -       (7,398 )     (23,745 )
Balances at September 30, 2010
    1,000     $ 25,000       30,085     $ 3     $ 1,379,059     $ (285,699 )   $ (79,732 )   $ 206,344     $ 1,244,975  

See accompanying notes to the unaudited condensed consolidated financial statements.

 
6


ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(Dollars in thousands)

   
Nine Months Ended
 
   
September 30,
 
   
2010
   
2009
 
Net cash provided by operating activities
  $ 148,284     $ 147,662  
                 
Cash flows used in investing activities:
               
Additions to real estate:
               
Acquisitions
    (96,596 )     -  
Improvements to recent acquisitions
    (2,266 )     (2,560 )
Redevelopment expenditures
    (8,966 )     (20,345 )
Revenue generating capital expenditures
    (788 )     (190 )
Non-revenue generating capital expenditures
    (19,169 )     (14,989 )
Additions to real estate under development
    (110,972 )     (68,763 )
Dispositions of real estate
    -       31,998  
Changes in restricted cash and refundable deposits
    (3,046 )     17,702  
Purchases of marketable securities
    (18,294 )     (106,444 )
Sales and maturities of marketable securities
    65,889       15,200  
Proceeds from tax credit investor
    -       3,762  
Purchases of and advances under notes and other receivables
    (21,026 )     (1,566 )
Collections of notes and other receivables
    1,832       2,960  
Contributions from co-investments
    (78,513 )     (270 )
Distributions to co-investments
    40,397       -  
Net cash used in investing activities
    (251,518 )     (143,505 )
                 
Cash flows from financing activities:
               
Borrowings under mortgage and other notes payable and lines of credit
    616,385       304,563  
Repayment of mortgage and other notes payable and lines of credit
    (487,152 )     (134,943 )
Additions to deferred charges
    (1,832 )     (1,982 )
Retirement of exchangeable bonds
    (1,842 )     (66,460 )
Settlement of forward-starting swaps
    (16,667 )     -  
Retirement of common stock
    -       (20,271 )
Retirement of preferred stock, Series G
    -       (90,614 )
Net proceeds from stock options exercised
    3,108       704  
Net proceeds from issuance of common stock
    116,641       159,987  
Contributions from noncontrolling interest
    3,990       -  
Distributions to noncontrolling interest
    (19,694 )     (16,782 )
Redemptions of noncontrolling interest
    (23,745 )     (11,061 )
Common and preferred stock dividends paid
    (91,950 )     (87,265 )
Net cash provided by financing activities
    97,242       35,876  
                 
Net (decrease) increase in cash and cash equivalents
    (5,992 )     40,033  
Cash and cash equivalents at beginning of period
    20,660       41,909  
Cash and cash equivalents at end of period
  $ 14,668     $ 81,942  
                 
Supplemental disclosure of cash flow information:
               
Cash paid for interest, net of $7.3 million and $8.4 million capitalized in 2010 and 2009, respectively
  $ 61,595     $ 59,350  
Supplemental disclosure of noncash investing and financing activities:
               
Change in accrual of dividends
  $ 1,397     $ 1,626  
Change in value of cash flow hedge liabilities
  $ 24,945     $ 27,164  
Change in unrealized gain of marketable securities
  $ 3,208     $ 12,900  
Mortgage notes assumed in connection with purchase of real estate including the loan premiums recorded
  $ 87,540     $ -  
Change in construction payable
  $ 714     $ 9,167  

See accompanying notes to the unaudited condensed consolidated financial statements.

 
7


ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
September 30, 2010 and 2009
(Unaudited)

 (1)  Organization and Basis of Presentation

The unaudited condensed consolidated financial statements of the Company are prepared in accordance with U.S. 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, except as otherwise noted.  These unaudited condensed 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, 2009.

All significant intercompany balances and transactions have been eliminated in the condensed consolidated financial statements.

The unaudited condensed consolidated financial statements for the three and nine months ended September 30, 2010 and 2009 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, with a 93.2% general partnership interest as of September 30, 2010.  Total Operating Partnership units outstanding were 2,200,907 and 2,398,479 as of September 30, 2010 and December 31, 2009, respectively, and the redemption value of the units, based on the closing price of the Company’s common stock totaled $240.9 million and $200.6 million, as of September 30, 2010 and December 31, 2009, respectively.

As of September 30, 2010, the Company owned or had ownership interests in 139 apartment communities, (aggregating 28,702 units) (collectively, the “Communities”, and individually, a “Community”), five office and commercial buildings and four active development projects (collectively, the “Portfolio”).  The Communities are located in Southern California (Los Angeles, Orange, Riverside, Santa Barbara, San Diego, and Ventura counties), Northern California (the San Francisco Bay Area) and the Seattle metropolitan area.

Fund Activities
 
Essex Apartment Value Fund II, L.P. (“Fund II”) is an investment fund formed by the Company to add value through rental growth and asset appreciation, utilizing the Company’s development, redevelopment and asset management capabilities.  Fund II has eight institutional investors, and the Company, with combined partner equity contributions of $265.9 million.  The Company contributed $75.0 million to Fund II, which represents a 28.2% interest as general partner and limited partner.  Fund II utilized leverage equal to approximately 55% upon the initial acquisition of the underlying real estate.  Fund II invested in apartment communities in the Company’s targeted West Coast markets and, as of September 30, 2010, owned 14 apartment communities.  The Company records revenue for its asset management, property management, development and redevelopment services when earned, and promote income when realized if Fund II exceeds certain financial return benchmarks.

 
8


ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
September 30, 2010 and 2009
(Unaudited)

Marketable Securities

As of September 30, 2010, marketable securities consisted primarily of investment-grade unsecured bonds, a mortgage backed security and investment funds that invest in U.S. treasury or agency securities.  As of September 30, 2010, the Company classified its investment in the mortgage backed security, which matures November 2019, as held to maturity, and accordingly, this security is stated at its amortized cost of $18.2 million.  The estimated fair vale of the mortgage backed security (a level 2 security) is approximately equal to the carrying value.  As of September 30, 2010 the Company classified the following marketable securities as available for sale (dollars in thousands):

   
September 30, 2010
 
   
Amortized Cost
   
Gross Unrealized Gain/(Loss)
   
Fair Value
 
Investment-grade unsecured bonds
  $ 53,671     $ 7,831     $ 61,502  
Investment funds - US treasuries
    15,683       511       16,194  
Total
  $ 69,354     $ 8,342     $ 77,696  
                         
   
December 31, 2009
 
   
Amortized Cost
   
Gross Unrealized Gain/(Loss)
   
Fair Value
 
Investment-grade unsecured bonds
  $ 110,338     $ 12,718     $ 123,056  
Investment funds - US treasuries
    12,040       (252 )     11,788  
Total
  $ 122,378     $ 12,466     $ 134,844  
 
The Company uses the specific identification method to determine the cost basis of a security sold and to reclassify amounts from accumulated other comprehensive income for securities sold.  For the nine months ended September 30, 2010 and 2009, the proceeds from sales of available for sale securities totaled $64.7 million and $12.7 million, respectively.  These sales all resulted in gains, which totaled $9.0 million and $1.0 for the nine months ended September 30, 2010 and 2009, respectively.

Contractual maturities of the marketable securities classified as available for sale as of September 30, 2010 were as follows:

   
Amount
 
Due in 1-5 years
  $ 47,198  
Due in 5-10 years
    30,498  
Total
  $ 77,696  

The Company reports its available for sale securities at fair value, based on quoted market prices (Level 2 for the unsecured bonds and level 1 for the investment funds, as defined by the Financial Accounting Standards Board (“FASB”) standard entitled “Fair Value Measurements and Disclosures” as discussed later in Note 1), and any unrealized gain or loss is recorded as other comprehensive income (loss).  There were no impairment charges for the three and nine months ended September 30, 2010 and 2009.  Realized gains and losses and interest income are included in interest and other income on the condensed consolidated statement of operations.  Amortization of unearned discounts is included in interest income.

Variable Interest Entities

The Company consolidates 19 DownREIT limited partnerships (comprising twelve communities), an office building that is subject to loans made by the Company (the Company obtained the deed to the property in satisfaction of the outstanding loans during the third quarter 2010), and 55 low income housing units since the Company is the primary beneficiary of these variable interest entities (“VIEs”).  Total DownREIT units outstanding were 1,100,899 and 1,129,205 as of September 30, 2010 and December 31, 2009 respectively, and the redemption value of the units, based on the closing price of the Company’s common stock totaled $120.5 million and $94.5 million, as of September 30, 2010 and December 31, 2009, respectively.  The consolidated total assets and liabilities related to these VIEs, net of intercompany eliminations, were approximately $215.9 million and $165.9 million, respectively, as of September 30, 2010 and $237.9 million and $164.4 million, respectively, as of December 31, 2009.  Interest holders in VIEs consolidated by the Company are allocated net income equal to the cash payments made to those interest holders or distributions from cash flow.  The remaining results of operations are generally allocated to the Company.  As of September 30, 2010 and December 31, 2009, the Company did not have any VIE’s of which it was not deemed to be the primary beneficiary.

 
9


ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
September 30, 2010 and 2009
(Unaudited)

Stock-Based Compensation
 
The Company accounts for share based compensation using the fair value method of accounting.  The estimated fair value of stock options granted by the Company is being amortized over the vesting period of the stock options.  The estimated grant date fair values of the long term incentive plan units (discussed in Note 13, “Stock Based Compensation Plans,” in the Company’s Form 10-K for the year ended December 31, 2009) are being amortized over the expected service periods.

Stock-based compensation expense for options and restricted stock totaled $0.3 million and $0.2 million for the three months ended September 30, 2010 and 2009, respectively, and $0.7 million for the nine months ended September 30, 2010 and 2009, respectively.  The intrinsic value of the stock options exercised during the three months ended September 30, 2010 and 2009 totaled $0.4 million and $0.1 million, and $1.9 million and $0.5 million for the nine months ended September 30, 2010 and 2009, respectively.  As of September 30, 2010, the intrinsic value of the stock options outstanding and fully vested totaled $7.7 million.  As of September 30, 2010, total unrecognized compensation cost related to unvested share-based compensation granted under the stock option and restricted stock plans totaled $3.4 million.  The cost is expected to be recognized over a weighted-average period of 1 to 3 years for the stock option plans and is expected to be recognized straight-line over 7 years for the restricted stock awards.

The Company has adopted an incentive program involving the issuance of Series Z and Series Z-1 Incentive Units (collectively referred to as “Z Units”) of limited partnership interest in the Operating Partnership.  Stock-based compensation expense for Z Units totaled $0.4 million for the three months ended September 30, 2010 and 2009, respectively, and $1.8 million and $1.1 million for the nine months ended September 30, 2010 and 2009, respectively.

During June 2010, the Operating Partnership issued 108,000 Series Z-1 Incentive Units (the “2010 Z-1 Units”) of limited partner interest to twenty executives of the Company in exchange for cash from seven executive officers of the Company, and a capital commitment from the remaining thirteen executives of $1.00 per 2010 Z-1 Unit.  The 2010 Z-1 Units are convertible one-for-one into common units of the Operating Partnership (which, in turn, are convertible into common stock of the Company) upon the earlier to occur of 100 percent vesting of the units or the year 2025.  The conversion ratchet (accounted for as vesting) of the 2010 Z-1 Units into common units, will increase to 20 percent effective January 1, 2011 if the Company achieves the FFO target of $4.75 per diluted share in 2010.  Each year thereafter, vesting of the 2010 Z-1 Units will be consistent with the Company’s annual FFO growth, but is not to be less than zero or greater than 14 percent.  The 2010 Z-1 Unit holders are entitled to receive 10 percent of dividends distributed to common stockholders in 2010, and if the Company achieves the FFO target of $4.75 per diluted share in 2010, the 2010 Z-1 Unit holders will be entitled to 25 percent of annual dividends paid in 2011.  Each year thereafter, the percent of distributions received by the 2010 Z-1 Unit holders will increase by the same percentage amounts that the 2010 Z-1 Units vesting increases, provided that once the 2010 Z-1 Units holders receive distributions of 30 percent, such distribution percentage will not increase further until the 2010 Z-1 Unit vesting is at the 30 percent level.  Once such vesting percentage is at the 30 percent level, subsequent distributions for the 2010 Z-1 Unit holders will be equal to the vesting percentage with the 2010 Z-1 units.

Stock-based compensation capitalized totaled $0.1 million for the three months ended September 30, 2010 and 2009, respectively, and $0.6 million and $0.3 million for the nine months ended September 30, 2010 and 2009, respectively.  As of September 30, 2010, the intrinsic value of the Z Units subject to future vesting totaled $16.7 million.  As of September 30, 2010, total unrecognized compensation cost related to Z Units subject to future vesting totaled $7.8 million.  The unamortized cost is expected to be recognized over the next year to fifteen years subject to the achievement of the stated performance criteria.

Fair Value of Financial Instruments
 
The Company values its financial instruments based on the fair value hierarchy of valuation techniques described in the FASB statement entitled “Fair Value Measurements and Disclosures”.  Level 1 inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.  Level 2 inputs include quoted prices for similar assets and liabilities in active markets and inputs other than quoted prices observable for the asset or liability.   Level 3 inputs are unobservable inputs for the asset or liability.  The Company uses Level 1 inputs for the fair values of its cash equivalents and its marketable securities except for unsecured bonds and mortgage backed securities.  The Company uses Level 2 inputs for its investments in unsecured bonds, mortgage backed securities, notes receivable, notes payable, and cash flow hedges.  These inputs include interest rates for similar financial instruments.  The Company’s valuation methodology for cash flow hedges and the swap related to multifamily refunding bond for the 101 San Fernando apartment community, is described in more detail in Note 8.  The Company does not use Level 3 inputs to estimate fair values of any of its financial instruments.  The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

 
10


ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
September 30, 2010 and 2009
(Unaudited)

Management believes that the carrying amounts of its amounts outstanding under lines of credit, notes receivable and other receivables from related parties, and notes and other receivables approximate fair value as of September 30, 2010 and December 31, 2009, because interest rates, yields and other terms for these instruments are consistent with yields and other terms currently available for similar instruments.  Management has estimated that the fair value of the Company’s $1.45 billion of fixed rate debt at September 30, 2010 is approximately $1.54 billion and the fair value of the Company’s $265.0 million of variable rate debt, excluding borrowings under the lines of credit, at September 30, 2010 is $242.6 million based on the terms of existing mortgage notes payable and variable rate demand notes compared to those available in the marketplace.  Management believes that the carrying amounts of cash and cash equivalents, restricted cash, accounts payable and accrued liabilities, other liabilities and dividends payable approximate fair value as of September 30, 2010 due to the short-term maturity of these instruments.  Marketable securities, cash flow hedge liabilities, and the swap related to multifamily refunding bond for the 101 San Fernando apartment community, are carried at fair value as of September 30, 2010, as discussed further above and in Note 8.

Accounting Estimates and Reclassifications
 
The preparation of condensed consolidated financial statements, in accordance with U.S. generally accepted accounting principles, requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to acquiring, developing and assessing the carrying values of its real estate properties, its investments in and advances to joint ventures and affiliates, its notes receivables and its qualification as a Real Estate Investment Trust (“REIT”). The Company bases its estimates on historical experience, current market conditions, and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may vary from those estimates and those estimates could be different under different assumptions or conditions.

Reclassifications for discontinued operations have been made to prior year statements of operations balances in order to conform to current year presentation.  Such reclassifications have no impact on reported earnings, cash flows, total assets or total liabilities.

New Accounting Pronouncements
 
In June 2009, the FASB issued an accounting standard entitled, "Amendments to FASB Interpretation No. 46(R)”, that amends existing standards, which among other things, replaces the quantitative-based risks and rewards calculation for determining which enterprise, if any, has a controlling financial interest in a variable interest entity with an approach focused on identifying which enterprise has the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and (1) the obligation to absorb losses of the entity or (2) the right to receive benefits from the entity.  The Company adopted the standard on January 1, 2010 and there was no impact on the Company’s condensed consolidated financial statements.
 
(2)  Significant Transactions During the Third Quarter of 2010 and Subsequent Events

(a)  Acquisitions
 
In July, the Company acquired 101 San Fernando, a 323-unit community with 9,200 square feet of retail located in downtown San Jose, California for $64.1 million, and The Commons, a 264-unit community located in Campbell, California for $42.5 million.
 
 
11


ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
September 30, 2010 and 2009
(Unaudited)
 
In September, the Company acquired Bella Villagio, a 231-unit community located in San Jose, California for $54.0 million.  The Company also acquired Muse, a 152-unit community under development located in the North Hollywood Arts District of Los Angeles, California for $39.1 million.
 
In October, the Company acquired Santee Court, a 165-unit adaptive re-use condominium community with 36,700 square feet of retail space located in downtown Los Angeles, California for $31.1 million.  The Company also acquired two communities including Courtyard off Main, a 110-unit community with 7,500 square feet of retail located in Bellevue, Washington for $30.0 million and Magnolia Nest, a 97-unit condominium development located in the Valley Village district of Los Angeles, California for $29.9 million.
 
In November, the Company acquired Corbella at Juanita Bay, a 169-unit community located in Kirkland, Washington for $23.4 million.

(b) Equity
 
During the third quarter, the Company issued 495,900 shares of common stock at an average price of $109.81, for $53.6 million, net of fees and commissions.
 
During October the Company issued 491,100 shares of common stock at an average price of $112.89, for $54.6 million net of fees and commissions.  Year to date through October, the Company has issued 1,629,200 shares of common stock at an average price of $106.71, for $171.3 million, net of fees and commissions.

(c) Debt
 
In July, the Company paid-off two maturing loans that were cross collateralized by five communities totaling $129.5 million, including a $73.6 million loan at a fixed rate of 8.2% and a $55.9 million loan at a fixed rate of 7.7%.  The Company obtained fixed rate mortgage loans totaling $130.1 million for two of the communities that were part of the cross collateralized loan pool paid-off in July, secured by Hillcrest Park and Bel Air for $72.2 million and $57.9 million, respectively, which mature in July 2020, at a fixed rate of 4.6%.  The Company settled $100.0 million in forward-starting swap contracts in July for $16.7 million in payments to the counterparties.  The settlement of the forward-starting swaps increased the effective interest rate on the Hillcrest Park and Bel Air mortgage loans to 6.0%, and during the quarter, the Company incurred $1.6 million in expense related to the ineffectiveness of certain forward-starting swap hedges.
 
In conjunction with acquisition of Bella Villagio, the Company assumed a $35.6 million mortgage loan at a fixed rate of 6.1% which matures in October 2016.  The interest rate was unfavorable compared to currently available market rates for mortgage loans, and thus the Company recorded a $4.0 million loan premium to reflect the debt at fair value along with a corresponding increase to the carrying value of the property.  This results in an effective interest rate for this loan of 3.8%.
 
The joint venture that owns Essex Skyline at MacArthur Place obtained an $80.0 million secured loan in July, for a four year term plus a one year extension, at an interest rate of LIBOR plus 285 basis points.  Also during July, the Company entered into a swap transaction with respect to $38.0 million of the multifamily revenue refunding bonds for the 101 San Fernando apartment community (the "Bonds") with Citibank, N.A. ("Citibank").  Under the terms of the Swap, the Company pays a variable amount equal to the SIFMA Index plus a fixed spread on a notional amount that starts at $35.2 million and over the three-year term of the swap increases ratably to $38.0 million. In return, Citibank pays an amount equal to the coupon on the Bonds multiplied by the outstanding par value of the bonds, $38.0 million.  The Swap has a termination date of July 12, 2013 and may be terminated by the Company at anytime commencing in one year and by Citibank if certain events occur.  Upon termination of the swap, whether early or on the stated termination date, a payment based on the change in value of the Bonds will occur.  Should the Bonds decline in value from the $35.2 million value of the Bonds at the inception of the swap, the Company will be obligated to make a payment equal to 100% of the price depreciation.  Should the Bonds increase in value, Citibank will be obligated to make a payment equal to approximately 85% of the price appreciation.
 
 
12


ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
September 30, 2010 and 2009
(Unaudited)

(3) Co-investments
 
The Company has joint venture investments in co-investments, which are accounted for under the equity method.  The joint ventures own, operate and develop apartment communities. In August 2010, the Company invested $12.0 million as a preferred equity interest investment in a related party entity that owns a 768-unit apartment community in Anaheim, California.  The following table details the Company's co-investments (dollars in thousands):
 
   
September 30,
2010
   
December 31,
2009
 
             
Investments in joint ventures accounted for under the equity method of accounting:
           
             
Limited partnership interest of 27.2% and general partner interest of 1% in Essex Apartment Value Fund II, L.P ("Fund II")
  $ 67,167     $ 70,283  
Membership interest in a limited liability company that owns
               
Essex Skyline at MacArthur Place
    29,212       -  
Preferred interest in a related limited liability company that owns Madison Park at Anaheim
    12,015       -  
      108,394       70,283  
Investments accounted for under the cost method of accounting:
               
Series A Preferred Stock interest in Multifamily Technology Solutions, Inc.
    500       500  
Total co-investments
  $ 108,894     $ 70,783  
 
The combined summarized balance sheet and statements of operations for co-investments, which are accounted for under the equity method, are as follows (dollars in thousands).
 
   
September 30,
2010
   
December 31,
2009
 
Balance sheets:
           
Rental properties and real estate under development
  $ 755,300     $ 489,352  
Other assets
    19,660       30,458  
                 
Total assets
  $ 774,960     $ 519,810  
                 
Mortgage notes
  $ 451,806     $ 312,859  
Other liabilities
    19,051       6,645  
Equity
    304,103       200,306  
                 
Total liabilities and equity
  $ 774,960     $ 519,810  
                 
Company's share of equity
  $ 108,394     $ 70,283  
 
 
 
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2010
   
2009
   
2010
   
2009
 
Statements of operations:
                       
Property revenues
  $ 13,824     $ 11,684     $ 38,634     $ 35,395  
Property operating expenses
    (6,513 )     (4,882 )     (17,176 )     (13,878 )
Net property operating income
    6,765       6,802       20,913       21,517  
Interest expense
    (3,262 )     (2,878 )     (9,174 )     (7,723 )
Depreciation and amortization
    (5,419 )     (4,066 )     (14,628 )     (11,447 )
                                 
Total net (loss) income
  $ (1,370 )   $ (142 )   $ (2,344 )   $ 2,347  
                                 
Company's share of net (loss) income
  $ (626 )   $ (32 )   $ (1,027 )   $ 664  

 
13


ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
September 30, 2010 and 2009
(Unaudited)

(4) Notes and Other Receivables
 
Notes receivable secured by real estate, and other receivables consist of the following as of September 30, 2010 and December 31, 2009 (dollars in thousands):
 
   
September 30,
2010
   
December 31,
2009
 
             
Note receivable, secured, bearing interest at 4.95%, due October 2010
  $ 24,568     $ -  
Note receivable, secured, bearing interest at LIBOR + 4.75%, due March 2011
    7,390       7,317  
Note receivable, secured, bearing interest at LIBOR + 3.69%, due June 2011
    6,506       6,742  
Note receivable, secured, bearing interest at 6.5%, due August 2011
    3,221       3,199  
Note receivable, secured, bearing interest at 8.0%, due November 2011
    971       971  
Note receivable, secured, bearing interest at LIBOR + 3.25%, due December 2012
    10,923       12,551  
Other receivables
    2,026       5,525  
    $ 55,605     $ 36,305  

In May, 2010, the Company purchased a loan secured by the community known as “Santee Court” located in Los Angeles, California. This $25.7 million loan was purchased at a discount for $21.0 million.  The loan bears interest at 4.95%; however interest income is recorded based on the effective yield, which is substantially higher as a result of the discounted purchase price.  In late October, the Company purchased the property for $31.1 million in a multiple bid process.

(5) Related Party Transactions
 
Management and other fees from affiliates include management, development and redevelopment fees from Fund II of $1.0 million for the three months ended September 30, 2010 and 2009, and $3.0 million and $3.4 million for the nine months ended September 30, 2010 and 2009 respectively and property acquisition fee of $0.5 million from the limited liability company that owns Skyline at MacArthur Place for the nine months ended September 30, 2010.  All of these fees are net of intercompany amounts eliminated by the Company.
 
An Executive Vice President of the Company invested $4.0 million for a 6% limited partnership interest in a partnership with the Company that acquired a 50% interest in a limited liability company that acquired Essex Skyline at MacArthur Place.  The Executive Vice President’s investment is equal to a pro-rata share of the contributions, and distributions resulting from distributable cash generated by Essex Skyline at MacArthur Place will be calculated in the same manner as the calculation of distributions to the third party investor.  The Executive Vice President does not participate in any promote interest or fees paid to the Company by the Essex Skyline at MacArthur Place joint venture.

During the quarter, the Company invested $12.0 million as a preferred equity interest investment in a related party entity that owns a 768-unit apartment community in Anaheim, California.  The entity that owns the property is an affiliate of The Marcus & Millichap Company (“TMMC”), and TMCC’s Chairman is the Chairman of the Company.  The Company’s independent directors or its Board of Director approved the investment in this entity.  The preferred return for this investment during the first five years is 13% per annum and the preferred return increases to 15% thereafter.

 
14


ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
September 30, 2010 and 2009
(Unaudited)

(6) Segment Information

The Company defines its reportable operating segments as the three geographical regions in which its apartment communities are located: Southern California, Northern California and Seattle Metro.  Excluded from segment revenues are properties classified in discontinued operations, management and other fees from affiliates, and interest and other income.  Non-segment revenues and net operating income included in the following schedule also consist of revenue generated from commercial properties which are primarily office buildings.  Other non-segment assets include co-investments, real estate under development, cash and cash equivalents, marketable securities, notes receivable, other assets and deferred charges.  The revenues, net operating income, and assets for each of the reportable operating segments are summarized as follows for the three months ended September 30, 2010 and 2009 (dollars in thousands):
 
   
Three Months Ended
 
   
September 30,
 
   
2010
   
2009
 
Revenues:
           
Southern California
  $ 51,119     $ 51,104  
Northern California
    32,770       30,126  
Seattle Metro
    17,932       17,345  
Other real estate assets
    2,001       2,095  
Total property revenues
  $ 103,822     $ 100,670  
                 
Net operating income:
               
Southern California
  $ 33,015     $ 33,627  
Northern California
    20,922       19,244  
Seattle Metro
    10,882       10,435  
Other real estate assets
    1,116       1,255  
Total net operating income
    65,935       64,561  
                 
Depreciation and amortization
    (31,638 )     (29,843 )
Interest expense
    (22,202 )     (21,966 )
Interest and other income
    5,788       3,471  
General and administrative
    (6,175 )     (6,086 )
Management and other fees from affiliates
    959       1,024  
Equity (loss) income from co-investments
    (626 )     (32 )
Impairment and other charges
    (1,615 )     (11,104 )
Income before discontinued operations
  $ 10,426     $ 25  

 
15


ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
September 30, 2010 and 2009
(Unaudited)

The revenues, net operating income, and assets of the reportable operating segments are summarized as follows or the nine months ended September 30, 2010 and 2009 (dollars in thousands):
 
   
Nine Months Ended
 
   
September 30,
 
   
2010
   
2009
 
Revenues:
           
Southern California
  $ 152,999     $ 155,064  
Northern California
    92,731       91,465  
Seattle Metro
    51,377       54,146  
Other real estate assets
    6,035       6,385  
Total property revenues
  $ 303,142     $ 307,060  
                 
Net operating income:
               
Southern California
  $ 100,986     $ 104,386  
Northern California
    59,966       60,982  
Seattle Metro
    31,581       34,461  
Other real estate assets
    3,501       4,165  
Total net operating income
    196,034       203,994  
                 
Depreciation and amortization
    (93,385 )     (87,711 )
Interest expense
    (64,043 )     (63,679 )
General and administrative
    (17,988 )     (18,135 )
Impairment and other charges
    (1,615 )     (16,892 )
Management and other fees from affiliates
    3,458       3,377  
(Loss) gain on early retirement of debt
    (10 )     6,124  
Interest and other income
    20,730       9,521  
Equity (loss) income from co-investments
    (1,027 )     664  
Gain on sale of real estate
    -       103  
Income before discontinued operations
  $ 42,154     $ 37,366  
 
Total assets for each of the reportable operating segments are summarized as follows as of September 30, 2010 and December 31, 2009:
 
   
September 30,
2010
   
December 31,
2009
 
Assets:
           
Southern California
  $ 1,213,759     $ 1,239,657  
Northern California
    1,125,757       923,103  
Seattle Metro
    509,206       417,708  
Other real estate assets
    81,139       82,998  
Net reportable operating segments - real estate assets
    2,929,861       2,663,466  
Real estate under development
    239,910       274,965  
Cash and cash equivalents
    36,322       37,934  
Marketable securities
    95,933       134,844  
Co-investments
    108,894       70,783  
Notes and other receivables
    55,605       36,305  
Other non-segment assets
    37,228       36,340  
Total assets
  $ 3,503,753     $ 3,254,637  

 
16


ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
September 30, 2010 and 2009
(Unaudited)

(7)  Net Income Per Common Share
(Amounts in thousands, except per share and unit data)

   
Three Months Ended
   
Three Months Ended
 
   
September 30, 2010
   
September 30, 2009
 
   
Income
   
Weighted-average Common Shares
   
Per Common Share Amount
   
Income
   
Weighted-average Common Shares
   
Per Common Share Amount
 
Basic:
                                   
Income from continuing operations available to common stockholders
  $ 6,377       29,691     $ 0.21     $ 19,654       27,591     $ 0.71  
Income (loss) from discontinued operations available to common stockholders
    -       29,691       -       2,085       27,591       0.08  
      6,377             $ 0.21       21,739             $ 0.79  
                                                 
Effect of Dilutive Securities (1)(2)
    -       72               506       2,479          
                                                 
Diluted:
                                               
Income from continuing operations available to common stockholders
  $ 6,377                     $ 19,654                  
Add: noncontrolling interests OP unitholders
    -                       267                  
Adjusted income from continuing operations available to common stockholders (1)
    6,377       29,763     $ 0.21       19,921       30,070     $ 0.66  
Income from discontinued operations available to common stockholders
    -                       2,085                  
Add: noncontrolling interests OP unitholders
    -                       239                  
Adjusted income from discontinued operations available to common stockholders
    -       29,763       -       2,324       30,070       0.08  
    $ 6,377             $ 0.21     $ 22,245             $ 0.74  
 
   
Nine Months Ended
   
Nine Months Ended
 
   
September 30, 2010
   
September 30, 2009
 
   
Income
   
Weighted Average Common Shares
   
Per Common Share Amount
   
Income
   
Weighted Average Common Shares
   
Per Common Share Amount
 
Basic:
                                   
Income before discontinued operations available to common stockholders
  $ 28,986       29,334     $ 0.99     $ 70,115       26,888     $ 2.61  
Income (loss) from discontinued operations available to common stockholders
    -       29,334       -       5,303       26,888       0.19  
      28,986             $ 0.99       75,418             $ 2.80  
                                                 
Effect of Dilutive Securities (1)(2)
    -       64               3,638       2,473          
                                                 
Diluted:
                                               
Income from continuing operations available to common stockholders (1)
  $ 28,986             $       $ 70,115             $    
Add: noncontrolling interests OP unitholders
    -                       3,169                  
Adjusted income from continuing operations available to common stockholders (1)
    28,986       29,398       0.99     $ 73,284       29,361       2.50  
Income (loss) from discontinued operations available to common stockholders
    -                       5,303                  
Add: noncontrolling interests OP unitholders
    -                       469                  
Adjusted income from discontinued operations available to common stockholders
    -       29,398       -       5,772       29,361       0.19  
    $ 28,986             $ 0.99     $ 79,056             $ 2.69  

 
17


ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
September 30, 2010 and 2009
(Unaudited)

 
(1)
Weighted average convertible limited partnership units of 2,200,907 and 2,325,220, which includes vested Series Z incentive units, for the three and nine months ended September 30, 2010, respectively, were not included in the determination of diluted EPS because they were anti-dilutive. Weighted average convertible limited partnership units of 2,449,704 and 2,448,169, which includes vested Series Z incentive units, for the three and nine months ended September 30, 2009, respectively, were included in the determination of diluted EPS because they were dilutive.  The Company has the ability to redeem DownREIT limited partnership units for cash and does not consider them to be potentially dilutive securities.

The holders of the exchangeable notes may exchange, at the then applicable exchange rate, the notes for cash and, at the Company’s option, a portion of the notes may be exchanged for Essex common stock; the exchange rate as of September 30, 2010 was $100.48 per share of Essex common stock.  During the three months ended September 30, 2010 the weighted average common stock price exceeded the strike price and therefore common stock issuable upon exchange of the exchangeable notes of 1,518 shares were included in the diluted share count as the effect was dilutive.  During the nine months ended September 30, 2010 the weighted average common stock price did not exceed the strike price and therefore common stock issuable upon exchange of the exchangeable notes were not included in the diluted share count as the effect was anti-dilutive.

Stock options of 116,747 and 243,313 for the three months ended September 30, 2010 and 2009, respectively, and 133,432 and 257,857 for the nine months ended September 30, 2010 and 2009, respectively, were not included in the diluted earnings per share calculation because the exercise price of the options were greater than the average market price of the common shares for the three and nine months ended and, therefore, were anti-dilutive.  Stock options of 69,992 and 29,031 for the three months ended September 30, 2010 and 2009, respectively, and 64,278 and 25,003 for the nine months ended September 30, 2010 and 2009, respectively, were included in the determination of diluted EPS.

All shares of cumulative convertible preferred stock Series G have been excluded from diluted earnings per share for the three and nine months ended September 30, 2010 and 2009, as the effect of the approximately 33 thousand shares that would be issued upon conversion were anti-dilutive.

 
(2)
For the three and nine months ended September 30, 2010, net income allocated to convertible limited partnership units and vested Series Z units aggregating $0.5 million and $2.4 million, respectively, have been excluded from income available to common stock holders for the calculation of net income per common share since these units are excluded from the diluted weighted average common shares for the period.  For the three and nine months ended September 30, 2009, net income allocated to convertible limited partnership units and vested Series Z units aggregating $0.5 million and $3.6 million, respectively, have been included in income available to common stock holders for the calculation of net income per common share since these units are included in the diluted weighted average common shares for the period.
 
(8)  Derivative Instruments and Hedging Activities
 
Currently, the Company uses interest rate swaps and interest rate cap contracts to manage certain interest rate risks. The valuation of these instruments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves. The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts). The variable cash payments (or receipts) are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. The Company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements.
 
As of September 30, 2010 the Company had 5 forward-starting interest rate swap contracts totaling a notional amount of $275.0 million with interest rates ranging from 5.3% to 5.9% and settlements dates ranging from November 2010 to October 2011.  These derivatives qualify for hedge accounting as they are expected to economically hedge the cash flows associated with future financing of debt between 2010 and 2011.  The Company had twelve interest rate cap contracts totaling a notional amount of $191.9 million that qualify for hedge accounting as they effectively limit the Company’s exposure to interest rate risk by providing a ceiling on the underlying variable interest rate for the Company’s $213.5 million of tax exempt variable rate debt.  The aggregate carrying value of the forward-starting interest rate swap contracts was a net liability of $71.8 million and the aggregate carrying value of the interest rate cap contracts was an asset of $0.1 million.  The overall fair value of these derivatives changed by $24.9 million during the nine months ended September 30, 2010 to a net liability of $71.7 million as of September 30, 2010, and the derivative liability was recorded in cash flow hedge liabilities in the Company’s condensed consolidated financial statements.  During July, the Company settled $100 million of forward starting swaps for $16.7 million in payments to the counterparties which increased the effective interest rate on two mortgage loans obtained in July 2010 for $130.1 million from a fixed rate of 4.6% to an effective rate of 6.0%.  The changes in the fair values of the derivatives are reflected in other comprehensive (loss) income in the Company’s condensed consolidated financial statements.  During the quarter ended September 30, 2010, the Company incurred $1.6 million in expense related to ineffectiveness of certain forward starting swaps.
 
 
18


ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
September 30, 2010 and 2009
(Unaudited)
 
During July 2010, the Company entered into a swap transaction (the "swap") with respect to $38.0 million of multifamily revenue refunding bonds for the 101 San Fernando apartment community (the “Bonds”) with Citibank, N.A. (“Citibank”).  This swap is not designated as a hedge; accordingly the change in fair value of the swap is recorded as a gain or loss in the Company’s consolidated statement of operations.  Under the terms of the Swap, the Company pays a variable amount equal to the SIFMA Index plus a fixed spread on a notional amount that starts at $35.2 million and over the three-year term of the swap increases ratably to $38.0 million.  In return, Citibank pays an amount equal to the coupon on the Bonds multiplied by the outstanding par value of the bonds, $38.0 million.  The Swap has a termination date of July 12, 2013 and may be terminated by the Company at anytime commencing in one year and by Citibank if certain events occur.  Upon termination of the swap, whether early or on the stated termination date, a payment based on the change in value of the Bonds will occur.  Should the Bonds decline in value from the $35.2 million value of the Bonds at the inception of the swap, the Company will be obligated to make a payment equal to 100% of the price depreciation.  Should the Bonds increase in value, Citibank will be obligated to make a payment equal to approximately 85% of the price appreciation. As of September 30, 2010, the fair value of the swap was approximately $0.

(9)  Discontinued Operations
 
In the normal course of business, the Company will receive offers for sale of its communities, either solicited or unsolicited. For those offers that are accepted, the prospective buyer will usually require a due diligence period before consummation of the transaction.  It is not unusual for matters to arise that result in the withdrawal or rejection of the offer during this process.  The Company classifies real estate as "held for sale" when the sale is considered to be probable.

In the first quarter of 2009, the Company sold Carlton Heights Villas, a 70-unit property located in Santee, California and Grand Regency, a 60-unit property in Escondido, California for an aggregate gain of $2.4 million.  During the second quarter of 2009, the Company sold Mountain View Apartments, a 106-unit community located in Camarillo, California for a gain of $0.8 million.  During the third quarter of 2009, the Company sold Spring Lake, a 69-unit community located in Seattle, Washington.  During the fourth quarter of 2009, the Company sold Maple Leaf, a 48-unit community located in Seattle, Washington.  The operations for these sold communities are included in discontinued operations for the three and nine months ended September 30, 2009.

The components of discontinued operations are outlined below and include the results of operations for the respective periods that the Company owned such assets, as described above (dollars in thousands).

   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2010
   
2009
   
2010
   
2009
 
                         
Rental revenues
  $ -     $ 218     $ -     $ 1,871  
Property operating expenses
    -       (79 )     -       (728 )
Depreciation and amortization
    -       (52 )     -       (462 )
Income from real estate sold
    -       87       -       681  
Gain on sale
    -       2,467       -       5,708  
Internal disposition costs (1)
    -       (230 )     -       (617 )
              2,237       -          
                                 
Income from discontinued operations
  $ -     $ 2,324     $ -     $ 5,772  

(1)  Internal disposition costs relate to a disposition incentive program established to pay incremental bonuses for the sale of certain of the Company's communities that are part of the program.
 
(10)  Commitments and Contingencies
 
The Company is subject to various lawsuits in the normal course of its business operations.  Such lawsuits could, but are not expected to have a material adverse effect on the Company’s financial condition, results of operations or cash flows.
 
(11) Subsequent Events
 
On November 5, 2010, the Company entered into a 10-year $207.2 million credit facility with Fannie Mae encumbered by seven communities at a  fixed rate of 4.3%.  Communities may be substituted or outright released from the facility based on certain loan to value and debt service coverage ratios, as defined in the credit facility agreement.  Two of the loans are expected to be funded in November 2010 totaling $104.5 million including City View for $65.3 million and Hillsborough Park for $39.2 million, and the existing City View mortgage loan for $49.1 million at a fixed rate of 6.8% was paid-off.  The remaining loans are expected to be funded in late November 2010 and five existing mortgage loans totaling $49.9 million at an average interest rate of 7.0% will be paid-off.  In conjunction with the new credit facility, the Company settled $225.0 million of forward-starting swaps for $60.5 million in payments to counterparties.  The settlement of $100.0 million of forward-starting swaps in July and $225.0 million of forward-starting swaps in November increased the effective interest rate on the Hillcrest and Bel Air mortgage loans totaling $130.1 million with a fixed rate of 4.6% funded in July 2010 to an effective interest rate of 6.4%, and increased the effective interest rate on the Fannie Mae credit facility to 7.1%. 
 
 
19


Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations
 
The following discussion should be read in conjunction with our Condensed Consolidated Financial Statements and accompanying Notes thereto included elsewhere herein and with our 2009 Annual Report on Form 10-K for the year ended December 31, 2009 and our Current Report on Form 10-Q for the quarter ended September 30, 2010.
 
The Company is a fully integrated Real Estate Investment Trust (“REIT”), and its property revenues are generated primarily from apartment community operations.  Our investment strategy has two components:  constant monitoring of existing markets, and evaluation of new markets to identify areas with the characteristics that underlie rental growth.  Our strong financial condition supports our investment strategy by enhancing our ability to quickly shift our acquisition, development, and disposition activities to markets that will optimize the performance of the portfolio.
 
As of September 30, 2010, we had ownership interests in 139 apartment communities, comprising 28,702 apartment units.  Our apartment communities are located in the following major West Coast regions:

Southern California (Los Angeles, Orange, Riverside, Santa Barbara, San Diego and Ventura counties)
Northern California (the San Francisco Bay Area)
Seattle Metro (Seattle metropolitan area)

As of September 30, 2010, we also had ownership interests in five office and commercial buildings (with approximately 215,840 square feet).

As of September 30, 2010, our consolidated development pipeline was comprised of three development projects, two predevelopment projects, and four land parcels held for future development or sale aggregating 2,277 units, with total incurred costs of $239.9 million.  The estimated remaining project costs are $68.4 million and the total active development project costs are $308.3 million.

The Company has one unconsolidated joint venture development project, Essex Skyline at MacArthur Place, a 349-unit high rise condominium project.  As of September 30, 2010 total costs incurred are $132.4 million, with estimated remaining project costs of $2.3 million for total estimated costs of $134.7 million.

The Company’s consolidated apartment communities are as follows:
 
   
As of September 30, 2010
   
As of September 30, 2009
 
   
Apartment Units
   
%
   
Apartment Units
   
%
 
Southern California
    12,449       48 %     12,264       50 %
Northern California
    7,684       30 %     6,695       28 %
Seattle Metro
    5,701       22 %     5,297       22 %
Total
    25,834       100 %     24,256       100 %

Co-investments including Fund II communities and communities included in discontinued operations are not included in the table above for both years presented above.

Comparison of the Three Months Ended September 30, 2010 to the Three Months Ended September 30, 2009

Our average financial occupancies for the Company’s stabilized apartment communities or “Quarterly Same-Property” (stabilized properties consolidated by the Company for the quarters ended September 30, 2010 and 2009) decreased 30 basis points to 96.7% as of September 30, 2010 from 97.0% as of September 30, 2009.  Financial occupancy is defined as the percentage resulting from dividing actual rental revenue by total possible rental revenue. Actual rental revenue represents contractual rental revenue pursuant to leases without considering delinquency and concessions.  Total possible rental revenue represents the value of all apartment units, with occupied units valued at contractual rental rates pursuant to leases and vacant units valued at estimated market rents.  We believe that financial occupancy is a meaningful measure of occupancy because it considers the value of each vacant unit at its estimated market rate.

 
20

 
Market rates are determined using a variety of factors such as effective rental rates at the property based on recently signed leases and asking rates for comparable properties in the market.  The recently signed effective rates at the property are used as the starting point in the determination of the market rates of vacant units.  The Company then increases or decreases these rates based on the supply and demand in the apartment community’s market.  The Company will check the reasonableness of these rents based on its position within the market and compare the rents against the asking rents by comparable properties in the market.  Financial occupancy may not completely reflect short-term trends in physical occupancy and financial occupancy rates as disclosed by other REITs may not be comparable to our calculation of financial occupancy.
 
The Company does not take into account delinquency and concessions to calculate actual rent for occupied units and market rents for vacant units.  The calculation of financial occupancy compares contractual rates for occupied units to estimated market rents for unoccupied units, thus the calculation compares the gross value of all apartment units excluding delinquency and concessions. For apartment communities that are development properties in lease-up without stabilized occupancy figures, the Company believes the physical occupancy rate is the appropriate performance metric.  While an apartment community is in the lease-up phase, the Company’s primary motivation is to stabilize the property which may entail the use of rent concessions and other incentives, and thus financial occupancy which is based on contractual revenue is not considered the best metric to quantify occupancy.

The regional breakdown of the Company’s Quarterly Same-Property portfolio for financial occupancy for the quarter ended September 30, 2010 and 2009 is as follows:

   
Three months ended
 
   
September 30,
 
   
2010
 
2009
 
Southern California
 
96.5%
 
96.7%
 
Northern California
 
97.2%
 
97.6%
 
Seattle Metro
 
96.7%
 
97.0%
 

The following table provides a breakdown of revenue amounts, including revenues attributable to the Quarterly Same-Property portfolio:

         
Three Months Ended
             
   
Number of
   
September 30,
   
Dollar
   
Percentage
 
   
Properties
   
2010
   
2009
   
Change
   
Change
 
Property Revenues (dollars in thousands)
                       
Quarterly Same-Property:
                             
Southern California
    59     $ 49,259     $ 49,701     $ (442 )     (0.9 )%
Northern California
    28       28,602       29,179       (577 )     (2.0 )
Seattle Metro
    23       14,759       15,534       (775 )     (5.0 )
Total Quarterly Same-Property revenues
    110       92,620       94,414       (1,794 )     (1.9 )
Quarterly Non-Same Property Revenues (1)
            11,202       6,256       4,946       79.1  
Total property revenues
          $ 103,822     $ 100,670     $ 3,152       3.1 %

(1)
Includes five communities acquired after July 1, 2009, two redevelopment communities, five development communities, and three commercial buildings.

Quarterly Same-Property Revenues decreased by $1.8 million or 1.9% to $92.6 million in the third quarter of 2010 from $94.4 million in the third quarter of 2009.  The decrease was primarily attributable to a decrease in scheduled rents of $2.4 million as reflected in a decrease of 2.6% in average rental rates from $1,338 per unit in the third quarter of 2009 to $1,303 per unit in the third quarter of 2010.  Scheduled rents decreased in all regions by 1.9%, 2.3%, and 5.5% in Southern California, Northern California, and Seattle Metro, respectively.  The Company has experienced a decrease in scheduled rents due to the slowdown in the economy coupled with job losses during 2009.  During 2009 through the third quarter of 2010, the Company experienced a decrease in gross revenue in comparison to the prior year in the Company’s markets from the reduction in rents from leases entered during those periods.  On a sequential basis the Company experienced quarterly same-property revenue growth from the second to the third quarter of 2010 of 0.3%, which is the first sequential quarterly same-property revenue growth since the fourth quarter of 2008. The Company experienced sequential revenue growth in all regions during the third quarter of 2010 compared to the second quarter of 2010.  Quarterly same-property revenues also decreased due to a decrease in occupancy of 30 basis points or $0.2 million, from 97.0% for the third quarter of 2009 to 96.7% for the third quarter of 2010.  The decrease related to schedule rents and occupancy was offset by a decrease in bad debt expense of $0.2 million, a decrease in rent concessions of $0.3 million, and increase in ratio utility billing system (“RUBS”) income of $0.2 million.  The Company expects sequential total Quarterly Same-Property revenue growth for the fourth quarter of 2010 compared to the third quarter of 2010 and total Quarterly Same-Property revenues for the fourth quarter 2010 to be consistent with the fourth quarter of 2009.

 
21


Quarterly Non-Same Property Revenues increased by $4.9 million or 79.1% to $11.2 million in the third quarter of 2010 from $6.3 million in the third quarter of 2009.  The increase was primarily due to revenue generated from five development communities consisting of Joule, Fourth & U, Axis 2300, The Grand, and Belmont Station and five communities acquired since July 1, 2009 consisting of Regency at Encino, Eagle Rim, 101 San Fernando, The Commons, and Bella Villagio.

Real Estate taxes expense increased by $0.9 million or 10.0% for the third quarter of 2010 compared to the third quarter of 2009 due mainly to the acquisition of five communities which resulted in an increase in property taxes of $0.4 million and the completion of development communities which resulted in an increase in property taxes of $0.3 million compared to the third quarter of 2009.

Depreciation expense increased by $1.8 million or 6.0% for the third quarter of 2010 compared to the third quarter of 2009, due to the acquisition of  five communities, the completion of five development properties, and the capitalization of approximately $33.1 million in additions to rental properties for the nine months ended September 30, 2010 and the capitalization of approximately $55.6 million in additions to rental properties, including $26.7 million spent on redevelopment and revenue generating capital expenditures during 2009.

Impairment and other charges for the third quarter of 2010 relates to $1.6 million in expense recorded by the Company due to the ineffectiveness of certain forward-starting swaps. For the third quarter of 2009 the Company incurred $11.1 million in impairment and other charges due to the write-off of development costs totaling $6.7 million related to two land parcels that will no longer be developed by the Company, the write-off of $3.8 million in unamortized costs related to the cancellation of the Outperformance Plan, and $0.6 million recorded for additional loan loss reserves related to a note receivable secured by an apartment community in the Portland Metropolitan Area.

Interest and other income increased by $2.3 million for the third quarter of 2010 primarily due to increases of $3.4 million of interest income earned on the Santee Court note receivable that was purchased at a 20% discount to the outstanding principal on this loan during the second quarter of 2010 and recorded $0.5 million in income from an investment in mortgage backed securities made during the first quarter of 2010.  Those increases in interest and other income were offset partially by a decrease of $1.5 million in earnings from marketable securities compared to the third quarter of 2009 due to the fact the Company sold  a total of $42.2 million of marketable securities during the first quarter of 2010.

Equity (Loss) income in co-investments decreased by $0.6 million for the third quarter of 2010 compared to the third quarter of 2009, primarily because the Company recorded a loss from operations of $0.6 million related to the Company’s investment in Essex Skyline at MacArthur Place which was acquired in the first quarter of 2010 and is a development community in lease-up.

Income from discontinued operations for the third quarter of 2010 was $0 compared to $2.3 million for the third quarter of 2009. The 2009 amount includes a gain of $2.5 million from the sale of Spring Lake, and the operating results of Maple Leaf, which was sold in the fourth quarter of 2009.

Excess of the carrying amount of preferred stock redeemed over the cash paid to redeem preferred stock for the three months ended September 30, 2010 was $0 compared to $23.9 million for the three months ended September 30, 2009, which resulted from  the repurchase of $81.9 million of the Company's Series G Cumulative Convertible Preferred Stock at a discount to carrying value.

 
22


Comparison of the Nine Months Ended September 30, 2010 to the Nine Months Ended September 30, 2009

Our average financial occupancies for the Company’s stabilized apartment communities or “2010/2009 Same-Properties” (stabilized properties consolidated by the Company for the nine months ended September 30, 2010 and 2009) increased 30 basis points to 97.2% for the nine months ended September 30, 2010 from 97.0% for the nine months ended September 30, 2009.  The regional breakdown of the Company’s 2010/2009 Same-Property portfolio for financial occupancy for the nine months ended September 30, 2010 and 2009 is as follows:

   
Nine Months Ended
 
   
September 30,
 
   
2010
 
2009
 
Southern California
 
96.9%
 
96.5%
 
Northern California
 
97.6%
 
97.7%
 
Seattle Metro
 
97.3%
 
97.0%
 

The following table illustrates a breakdown of revenue amounts, including revenues attributable to 2010/2009 Same-Properties.

         
Nine Months Ended
             
   
Number of
   
September 30,
   
Dollar
   
Percentage
 
   
Properties
   
2010
   
2009
   
Change
   
Change
 
Property Revenues (dollars in thousands)
                       
2010/2009 Same-Properties:
                             
Southern California
    59     $ 147,556     $ 151,482     $ (3,926 )     (2.6 )%
Northern California
    28       85,591       90,041       (4,450 )     (4.9 )
Seattle Metro
    23       44,393       48,495       (4,102 )     (8.5 )
Total 2010/2009 Same-Property revenues
    110       277,540       290,018       (12,478 )     (4.3 )
2010/2009 Non-Same Property Revenues (1)
            25,602       17,042       8,560       50.2  
Total property revenues
          $ 303,142     $ 307,060     $ (3,918 )     (1.3 )%

(1) Includes five communities acquired after January 1, 2009, two redevelopment communities, five development communities, and three commercial buildings.

2010/2009 Same-Property Revenues decreased by $12.5 million or 4.3% to $277.5 million for the nine months ended September 30, 2010 from $290.0 million for the nine months ended September 30, 2009.  The decrease was primarily attributable to a decrease in scheduled rents of $15.3 million as reflected in a decrease of 5.3% in average rental rates from $1,372 per unit for the nine months ended September 30, 2009 to $1,299 per unit for the nine months ended September 30, 2010.  Scheduled rents decreased in all regions by 4.0%, 5.5%, and 9.6% in Southern California, Northern California, and Seattle Metro, respectively.  The Company has experienced a decrease in scheduled rents due to the slowdown in the economy coupled with job losses during 2009.  During 2009, through the nine months ended September 30, 2010, the Company experienced a decrease in gross revenue in comparison to the prior year in the Company’s markets from the reduction in rents from leases entered into during those periods.  The decrease in scheduled rents was partially offset by an increase of occupancy of 30 basis points or $1.2 million, from 96.9% for the nine months ended September 30, 2009 to 97.2% for the nine months ended September 30, 2010.  Bad debt expense and rent concessions decreased $0.6 million and $0.8 million, respectively, and RUBS income increased $0.6 million and other income decreased $0.4 million between periods.  The Company expects 2010/2009 Same Property revenues will decrease approximately 3.3% for the year ended 2010 compared to 2009.

2010/2009 Non-Same Property Revenues increased by $8.6 million or 50.2% to $25.6 million for the nine months ended September 30, 2010 from $17.0 million for the nine months ended September 30, 2009.  The increase was primarily due to revenue generated from five development communities consisting of Joule, Fourth & U, Axis 2300, The Grand, and Belmont Station and five communities acquired since January 1, 2009 consisting of Regency at Encino, Eagle Rim, 101 San Fernando, The Commons, and Bella Villagio.

Real Estate taxes expense increased by $2.2 million or 8.0% for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009 due mainly to the acquisition of five communities which resulted in an increase in property taxes of $0.5 million and the completion of development communities which resulted in an increase in property taxes of $0.9 million compared to the third quarter of 2009.

 
23


Depreciation expense increased by $5.7 million or 6.5% for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009 due to the acquisition of  five communities, the completion of five development properties, and the capitalization of approximately $33.1 million in additions to rental properties for the nine months ended September 30, 2010 and the capitalization of approximately $55.6 million in additions to rental properties, including $26.7 million spent on redevelopment and revenue generating capital expenditures during 2009.

Impairment and other charges for the nine months ended September 30, 2010 relates to $1.6 million in expense recorded by the Company due to the ineffectiveness of certain forward-starting swaps.  For the nine months ended September 30, 2009 the Company incurred $16.9 million in impairment and other charges due to the write-off of development costs totaling $6.7 million related to two land parcels that will no longer be developed by the Company, the write-off of $3.8 million in unamortized costs related to the write-off of the Outperformance Plan, $0.6 million recorded for additional loan loss reserves related to a note receivable secured by an apartment community in the Portland Metropolitan Area, and $5.8 million due to the write-off of an investment in a joint venture development project.

Interest and other income increased by $11.2 million for the nine months ended September 30, 2010 primarily due to $9.0 million in gains generated from the sale of marketable securities compared to $1.0 million in gains generated from the sale of marketable securities for the nine months ended September 30, 2009, and $3.4 million of  interest income earned on the Santee Court note receivable that was purchased at a 20% discount to the outstanding principal on this loan during the second quarter of 2010.

Equity (Loss) income in co-investments decreased by $1.7 million for the nine months ended September 30, 2010 compared to the nine months ended September 30, 2009 primarily because the Company recorded a loss from operations of $1.1 million related to the Company’s investment in Essex Skyline at MacArthur Place which is a development community in lease-up that was acquired in the first quarter of 2010 and the Company recorded $0.6 million less in income from its investment in Fund II in the 2010 period compared to the 2009 period primarily as a result of declines in rental revenues experienced by Fund II.

Gain on early retirement of debt was $0 for the nine months ended September 30, 2010 compared to $6.1 million for the nine months ended September 30, 2009 due to the gain recorded in the 2009 period related to the repurchase of $71.3 million of exchangeable bonds at a discount to par value.

Income from discontinued operations for the nine months ended September 30, 2010 was $0, compared to $5.8 million for the nine months ended September 30, 2009, which includes a gain of $2.5 million on the sale of Spring Lake, a gain of $1.6 million on the sale of Carlton Heights Villa, a gain of $0.9 million on the sale of Grand Regency, and a gain of $0.8 million on the sale of Mountain View, and the operating results of  Maple Leaf, which was sold in the fourth quarter of 2009.

Excess of the carrying amount of preferred stock redeemed over the cash paid to redeem preferred stock for the nine months ended September 30, 2010 was $0, compared to $49.6 million for the nine months ended September 30, 2009 related to the repurchase of $140.1 million of the Company's Series G Cumulative Convertible Preferred Stock at a discount to carrying value.

Liquidity and Capital Resources
 
At September 30, 2010, the Company had $14.7 million of unrestricted cash and cash equivalents and $95.9 million in marketable securities, of which $77.7 million were held available for sale.  We believe that cash flows generated by our operations, existing cash, cash equivalents, and marketable securities balances, availability under existing lines of credit, access to capital markets and the ability to generate cash from the disposition of real estate are sufficient to meet all of our reasonably anticipated cash needs during the next twelve months.  The timing, source and amounts of cash flows provided by financing activities and used in investing activities are sensitive to changes in interest rates and other fluctuations in the capital markets environment, which can affect our plans for acquisitions, dispositions, development and redevelopment activities.

The Company has two outstanding lines of credit in the aggregate of $450.0 million committed as of September 30, 2010.  The Company had a $200.0 million unsecured line of credit which was amended in October 2010 to $275 million with an accordion option to $350 million.  As of September 30, 2010 there was a $98.0 million balance on this unsecured line at an average interest rate of 3.4%.  The underlying interest rate on the $200.0 million line is based on a tiered rate structure tied to an S&P rating on the credit facility at LIBOR plus 3.0%.  The amendment in October adjusted the interest rate to LIBOR plus 2.4%.  This facility matures in December 2011 with two one-year extensions, exercisable by the Company.  The Company also has a $250.0 million credit facility from Freddie Mac, which matures in December 2013.  This line is secured by eleven apartment communities.  As of September 30, 2010, the Company had $250.0 million outstanding under this line of credit at an average interest rate of 1.4%. The underlying interest rate on this line is between 99 and 150 basis points over the Freddie Mac Reference Rate and the interest rate is subject to change by the lender in November 2011.  The Company’s unsecured line of credit agreements contain debt covenants related to limitations on indebtedness and liabilities and maintenance of minimum levels of consolidated earnings before depreciation, interest and amortization.  The Company was in compliance with the line of credit covenants as of September 30, 2010 and December 31, 2009.
 
 
24

 
The Company may from time to time sell shares of common stock into the existing trading market at current market prices as well as through negotiated transactions under its equity distribution programs with Cantor Fitzgerald & Co. (“Cantor”) and KeyBanc Capital Markets, Inc. (“KeyBanc”).  In May 2009, the Company’s Board of Directors approved the sale of up to 7,500,000 shares of common stock under the equity distribution program.  Pursuant to this approval, the Company entered into a sales agreement with Cantor on May 6, 2009, for the sale of up to 7,500,000 shares pursuant to the Cantor’s equity distribution program.  During March 2010, the Company entered into a new equity distribution agreement with Cantor and the Company also entered into an equity distribution agreement with KeyBanc for the sale, under the two agreements, of up to an aggregate of 5,175,000 shares which represented the shares of common stock that remain unsold under the May 2009 equity distribution program.  During the three and nine months ended September 30, 2010, pursuant to the equity distribution programs, the Company issued 495,900 shares and 1,138,100 of common stock at an average price of $109.81 and $104.04 for approximately $53.6 million and $116.6 million, net of fees and commissions, respectively.  During October the Company issued 491,100 shares of common stock at an average price of $112.89, for $54.6 million net of fees and commissions.
 
During March 2010, the Company filed a new shelf registration statement with the SEC, allowing the Company to sell an undetermined number or amount of certain equity and debt securities as defined in the prospectus.
 
In August 2007, the Company’s Board of Directors authorized a stock repurchase plan to allow the Company to acquire shares in an aggregate of up to $200.0 million.  In February 2009, the Company repurchased 350,000 shares of common stock for $20.3 million at an average price of $57.89 per share.  After the Series G Preferred Stock repurchases described below, the Company has authorization to repurchase an additional $41.8 million under the stock repurchase plan.
 
In 2006, the Company sold 5,980,000 shares of 4.875% Series G Cumulative Convertible Preferred Stock (the "Series G Preferred Stock") for net proceeds of $145.9 million.  Holders may convert Series G Preferred Stock into shares of the Company’s common stock subject to certain conditions.  During 2009, the Company repurchased $145.0 million in liquidation value of its Series G Preferred Stock at a discount to carrying value, and the excess of the carrying value over the cash paid to redeem the Series G Preferred Stock totaled $50.0 million.   As of September 30, 2010, the carrying value of the Series G Preferred Stock outstanding totaled $4.3 million.   The Company may continue to repurchase Series G Preferred Stock.

In May 2010, the Board of Directors approved the partial redemption for cash by the Operating Partnership, of limited Operating Partnership units that were held by the Company's Chairman and founder, Mr. George M. Marcus, at $106.76 per unit representing a 2% discount from the closing price of the Company’s common stock on May 17, 2010.  The Operating Partnership purchased 187,334 units from Mr. Marcus. Under the Operating Partnership’s partnership agreement, limited partnership units are exchangeable on a one-for-one basis into shares of the Company’s common stock, or at the Company’s option, for cash.  This transaction reduced Mr. Marcus’ ownership from 1,063,056 limited partnership units in the Operating Partnership to 875,722 units and following the transaction Mr. Marcus beneficially owned 1,587,041 shares or share equivalents, (including shares issuable upon the exchange of limited partnership units) of the Company’s stock.  The redemption was requested by the Chairman to achieve his estate planning objectives.

As of September 30, 2010, the Company’s mortgage notes payable totaled $1.7 billion which consisted of $1.4 billion in fixed rate debt with interest rates varying from 1.79% to 8.29% and maturity dates ranging from 2010 to 2020 and $265.0 million of variable rate debt with a weighted average interest rate of 1.6% ($213.5 million of the variable debt is tax-exempt variable rate demand notes).  The tax-exempt variable rate demand notes have maturity dates ranging from 2025 to 2039, and $191.9 million are subject to interest rate caps.
 
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 investment grade securities held available for sale or is used by the Company to reduce balances outstanding under its line of credit.
 
The Company’s current financing activities have been impacted by the instability and tightening in the credit markets which has led to an increase in spreads and pricing of secured and unsecured debt.  Our strong balance sheet, the established relationships with our unsecured line of credit bank group, the secured line of credit with Freddie Mac and access to Fannie Mae and Freddie Mac secured debt financing have provided some insulation to us from the turmoil being experienced by many other real estate companies.  The Company has benefited from borrowing from Fannie Mae and Freddie Mac, and there are no assurances that these entities will lend to the Company in the future.  The Company has experienced more restrictive loan to value and debt service coverage ratio limits and an expansion in credit spreads.   Continued turmoil in the capital markets could negatively impact the Company’s ability to make acquisitions, develop communities, obtain new financing, and refinance existing borrowing at attractive rates.
 
 
25

 
Derivative Activity
 
As of September 30, 2010 the Company had 5 forward-starting interest rate swap contracts totaling a notional amount of $275.0 million with interest rates ranging from 5.3% to 5.9% and settlements dates ranging from November 2010 to October 2011.  These derivatives qualify for hedge accounting as they are expected to economically hedge the cash flows associated with future financing of debt between 2010 and 2011.  The Company had twelve interest rate cap contracts totaling a notional amount of $191.9 million that qualify for hedge accounting as they effectively limit the Company’s exposure to interest rate risk by providing a ceiling on the underlying variable interest rate for the Company’s $213.5 million of tax exempt variable rate debt.  The aggregate carrying value of the forward-starting interest rate swap contracts was a net liability of $71.8 million and the aggregate carrying value of the interest rate cap contracts was an asset of $0.1 million.  The overall fair value of the derivatives changed by $24.9 million during the nine months ended September 30, 2010 to a net liability of $71.7 million as of September 30, 2010, and the derivative liability was recorded in cash flow hedge liabilities in the Company’s condensed consolidated financial statements.  During July, the Company settled $100 million of forward starting swaps for $16.7 million in payments to the counterparties which increased the effective interest rate on two mortgage loans obtained in July 2010 for $130.1 million from a fixed rate of 4.6% to an effective rate of 6.0%.  The changes in the fair values of the derivatives are reflected in other comprehensive (loss) income in the Company’s condensed consolidated financial statements.  During the quarter ended September 30, 2010, the Company incurred $1.6 million in expense related to ineffectiveness of certain forward starting swaps.
 
During July 2010, the Company entered into a swap transaction (the "swap") with respect to $38.0 million of multifamily revenue refunding bonds for the 101 San Fernando apartment community (the “Bonds”) with Citibank, N.A. (“Citibank”).  This swap is no designated as a hedge; accordingly the change in fair value of the swap is recorded as a gain or loss in the Company’s consolidated statement of operations.  Under the terms of the Swap, the Company pays a variable amount equal to the SIFMA Index plus a fixed spread on a notional amount that starts at $35.2 million and over the three-year term of the swap increases ratably to $38.0 million.  In return, Citibank pays an amount equal to the coupon on the Bonds multiplied by the outstanding par value of the bonds, $38.0 million.  The Swap has a termination date of July 12, 2013 and may be terminated by the Company at anytime commencing in one year and by Citibank if certain events occur.  Upon termination of the swap, whether early or on the stated termination date, a payment based on the change in value of the Bonds will occur.  Should the Bonds decline in value from the $35.2 million value of the Bonds at the inception of the swap, the Company will be obligated to make a payment equal to 100% of the price depreciation.  Should the Bonds increase in value, Citibank will be obligated to make a payment equal to a portion of the price appreciation. As of September 30, 2010, the fair value of the swap was approximately $0.