Form 10-Q


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 June 30, 2006
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 is a large accelerated filer an accelerated file, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x    Accelerated filer o   Non-accelerated filer o

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:

23,140,006 shares of Common Stock as of August 3, 2006
 



ESSEX PROPERTY TRUST, INC.
FORM 10-Q
INDEX

   
Page No.
PART I. FINANCIAL INFORMATION 
                         
                                                                                                                                          
Item 1.
Financial Statements (Unaudited):
3
     
 
Consolidated Balance Sheets as of June 30, 2006 and December 31, 2005
     
 
Consolidated Statements of Operations for the three and six months ended June 30, 2006 and 2005
     
 
Consolidated Statements of Stockholders' Equity and Comprehensive Income for the six months ended June 30, 2006
     
 
Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2006 and 2005
     
 
Notes to Consolidated Financial Statements
     
Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
     
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
27
     
Item 4.
Controls and Procedures
28
     
PART II. OTHER INFORMATION
 
     
Item 1.
Legal Proceedings
28
     
Item 1A.
Risk Factors
28
     
Item 4.
Submissions of Matters to a Vote of Security Holders
29
     
Item 6.
Exhibits
29
     
Signatures
2

Part I -- Financial Information

Item 1: Financial Statements (Unaudited)

"Essex" or the "Company" means Essex Property Trust, Inc., a real estate investment trust incorporated in the State of Maryland, or where the context otherwise requires, Essex Portfolio, L.P., a limited partnership (the "Operating Partnership") in which Essex Property Trust, Inc. is the sole general partner.

The information furnished in the accompanying consolidated unaudited balance sheets, statements of operations, stockholders' equity and 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 consolidated financial statements for the interim periods.

The accompanying unaudited consolidated financial statements should be read in conjunction with the notes to such consolidated financial statements and Management's Discussion and Analysis of Financial Condition and Results of Operations herein. Additionally, these unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company's annual report on Form 10-K for the year ended December 31, 2005.


3

ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
(Unaudited)
(Dollars in thousands, except per share amounts)
   
 June 30,
 
 December 31,
 
Assets
 
 2006
 
 2005
 
Real estate:
           
Rental properties:
           
Land and land improvements
 
$
561,560
 
$
551,132
 
Buildings and improvements
   
1,994,741
   
1,932,113
 
     
2,556,301
   
2,483,245
 
Less accumulated depreciation
   
(437,154
)
 
(398,476
)
     
2,119,147
   
2,084,769
 
Real estate under development
   
75,429
   
54,416
 
Investments
   
36,498
   
27,228
 
     
2,231,074
   
2,166,413
 
Cash and cash equivalents-unrestricted
   
9,022
   
14,337
 
Cash and cash equivalents-restricted
   
14,035
   
13,937
 
Notes and other receivables from related parties
   
2,258
   
1,173
 
Notes and other receivables
   
29,845
   
5,237
 
Prepaid expenses and other assets
   
27,632
   
23,078
 
Deferred charges, net
   
14,378
   
15,115
 
Total assets
 
$
2,328,244
 
$
2,239,290
 
Liabilities and Stockholders' Equity
             
Mortgage notes payable
 
$
1,100,965
 
$
1,104,918
 
Exchangeable bonds
   
225,000
   
225,000
 
Lines of credit
   
95,030
   
25,000
 
Accounts payable and accrued liabilities
   
37,567
   
32,982
 
Dividends payable
   
23,317
   
22,496
 
Other liabilities
   
13,696
   
12,520
 
Deferred gain
   
2,193
   
2,193
 
           
Total liabilities
   
1,497,768
   
1,425,109
 
Minority interests
   
229,694
   
233,214
 
Stockholders' equity:
             
Common stock, $.0001 par value, 655,682,178
             
authorized, 23,047,162 and
             
22,851,953 issued and outstanding
   
2
   
2
 
Cumulative redeemable preferred stock; $.0001 par value:
             
No shares issued and outstanding:
             
7.875% Series B 2,000,000 shares authorized
   
-
   
-
 
7.875% Series D 2,000,000 shares authorized
   
-
   
-
 
7.8125% Series F 1,000,000 shares authorized,
             
1,000,000 and 1,000,000 shares issued and outstanding,
         
liquidation value
   
25,000
   
25,000
 
Excess stock, $.0001 par value, 330,000,000 shares
             
authorized and no shares issued and outstanding
   
-
   
-
 
Additional paid-in capital
   
648,142
   
632,646
 
Distributions in excess of accumulated earnings
   
(84,066
)
 
(77,341
)
Accumulated other comprehensive income
   
11,704
   
660
 
Total stockholders' equity
   
600,782
   
580,967
 
Commitments and contingencies
         
Total liabilities and stockholders' equity
 
$
2,328,244
 
$
2,239,290
 
See accompanying notes to the unaudited consolidated financial statements.
4

ESSEX PROPERTY TRUST, INC. AND SUBSIDIARES
Consolidated Statements of Operations
(Unaudited)
(Dollars in thousands, except per share amounts)
 
   
 Three Months Ended
 
 Six Months Ended
 
   
 June 30,
 
 June 30,
 
Revenues:
 
 2006
 
2005
 
 2006
 
2005
 
Rental and other property
 
$
86,656
 
$
79,662
 
$
171,919
 
$
157,938
 
Management and other fees from affiliates
   
830
   
931
   
1,654
   
7,507
 
     
87,486
   
80,593
   
173,573
   
165,445
 
Expenses:
                 
Property operating, excluding real estate taxes
   
22,095
   
20,685
   
44,710
   
40,913
 
Real estate taxes
   
7,374
   
6,610
   
14,770
   
13,451
 
Depreciation and amortization
   
20,675
   
20,043
   
40,766
   
39,622
 
Interest
   
19,497
   
18,153
   
38,487
   
36,300
 
Amortization of deferred financing costs
   
497
   
563
   
1,193
   
1,039
 
General and administrative
   
5,002
   
4,573
   
9,901
   
9,014
 
Other expenses
   
800
   
1,500
   
1,770
   
1,500
 
     
75,940
   
72,127
   
151,597
   
141,839
 
                           
Gain on sale of real estate
   
-
   
5,276
   
-
   
6,391
 
Interest and other income
   
654
   
2,431
   
3,048
   
2,954
 
Equity income in co-investments
   
(374
)
 
2,724
   
(816
)
 
17,316
 
Minority interests
   
(4,760
)
 
(5,360
)
 
(9,687
)
 
(11,801
)
Income from continuing operations before income
                 
tax provision
   
7,066
   
13,537
   
14,521
   
38,466
 
Income tax provision
   
(138
)
 
(1,100
)
 
(175
)
 
(1,201
)
Income from continuing operations
   
6,928
   
12,437
   
14,346
   
37,265
 
Income from discontinued operations (net of
                         
minority interests)
   
15,584
   
26,441
   
18,488
   
28,491
 
Net income
   
22,512
   
38,878
   
32,834
   
65,756
 
Dividends to preferred stockholders
   
(489
)
 
(488
)
 
(977
)
 
(977
)
Net income available to common stockholders
 
$
22,023
 
$
38,390
 
$
31,857
 
$
64,779
 
                   
Per common share data:
                         
Basic:
                         
Income from continuing operations available to
                         
common stockholders
 
$
0.28
 
$
0.52
 
$
0.58
 
$
1.57
 
Income from discontinued operations
   
0.68
   
1.14
   
0.81
   
1.24
 
Net income available to common stockholders
 
$
0.96
 
$
1.66
 
$
1.39
 
$
2.81
 
Weighted average number of common shares
                 
outstanding during the period
   
22,950,172
   
23,069,620
   
22,911,202
   
23,056,918
 
                   
Diluted:
                         
Income from continuing operations available to
                         
common stockholders
 
$
0.28
 
$
0.51
 
$
0.58
 
$
1.55
 
Income from discontinued operations
   
0.67
   
1.13
   
0.80
   
1.22
 
Net income available to common stockholders
 
$
0.95
 
$
1.64
 
$
1.38
 
$
2.77
 
Weighted average number of common shares
                 
outstanding during the period
   
23,226,466
   
23,372,873
   
23,154,818
   
23,363,756
 
                   
Dividend per common share
 
$
0.84
 
$
0.81
 
$
1.68
 
$
1.62
 
See accompanying notes to the unaudited consolidated financial statements.
5

ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholders' Equity and
Comprehensive Income for the six months ended June 30, 2006
(Unaudited)
(Dollars and shares in thousands)
 
                                                       
 
      
                     
 Additional
 
 Accumulated other
 
 Distributions
in excess of
      
   
Preferred stock
 
Common stock
 
 paid-in
 
 comprehensive
 
 accumulated
      
   
Shares
 
Amount
 
Shares
 
Amount
 
 capital
 
 income
 
 earnings
 
 Total
 
Balances at December 31, 2005
   
1,000
   $
25,000
   
22,851
   $
2
   $
632,646
    $
660
   $
(77,341
)
 $
580,967
 
Comprehensive income:
                                                 
     Net income
   
-
   
-
   
-
   
-
   
-
         
32,834
   
32,834
 
     Change in fair value of cash flow hedges
   
-
   
-
   
-
   
-
   
-
   
11,044
   
-
   
11,044
 
Comprehensive income
                                             
43,878
 
Issuance of common stock under:
                                                 
Stock-based compensation plans
   
-
   
-
   
56
   
-
   
2,709
   
-
   
-
   
2,709
 
Sale of common stock
   
-
   
-
   
140
   
-
   
14,813
   
-
   
-
   
14,813
 
Redemptions of minority interests, net
   
-
   
-
   
-
   
-
   
(2,026
)
 
-
   
-
   
(2,026
)
Dividends declared
   
-
   
-
   
-
   
-
   
-
   
-
   
(39,559
)
 
(39,559
)
Balances at June 30, 2006
   
1,000
 
$
25,000
   
23,047
 
$
2
 
$
648,142
 
$
11,704
 
$
(84,066
)
$
600,782
 
                                     





See accompanying notes to the unaudited consolidated financial statements.
6

ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(Dollars in thousands)
 
   
 Six Months Ended
 
   
 June 30,
 
   
 2006
 
2005
 
Net cash provided by operating activities
 
$
69,253
 
$
66,629
 
           
Cash flows (used in) provided by investing activities:
             
Additions to real estate:
             
Acquisitions and improvements to recent acquisitions
   
(60,115
)
 
(16,090
)
Redevelopment
   
(11,455
)
 
(7,711
)
Revenue generating capital expenditures
   
(1,092
)
 
(115
)
Other capital expenditures
   
(7,485
)
 
(6,116
)
Additions to real estate under development
   
(20,346
)
 
(15,031
)
Dispositions of real estate and investments
   
8,349
   
6,585
 
Changes in restricted cash and refundable deposits
   
6,271
   
7,646
 
Additions to notes receivable from related parties and other receivables
   
(8,284
)
 
(3,643
)
Repayments of notes receivable from related parties and other receivables
   
456
   
5,005
 
Net (contributions to) distributions from limited partnerships
   
(8,261
)
 
41,336
 
Net cash (used in) provided by investing activities
   
(101,962
)
 
11,866
 
           
Cash flows from financing activities:
             
Proceeds from mortgage notes payable and lines of credit
   
159,429
   
96,629
 
Repayment of mortgage notes payable and lines of credit
   
(93,030
)
 
(99,840
)
Additions to deferred charges
   
(456
)
 
(885
)
Net proceeds from stock options exercised
   
2,113
   
1,881
 
Net sale of common stock
   
14,813
   
-
 
Distributions to minority interest partners
   
(11,679
)
 
(11,545
)
Redemption of minority interest limited partnership units
   
(5,073
)
 
(4,466
)
Common and preferred stock dividends paid
   
(38,723
)
 
(37,837
)
Net cash provided by (used in) financing activities
   
27,394
   
(56,063
)
           
Net (decrease) increase in cash and cash equivalents
   
(5,315
)
 
22,432
 
Cash and cash equivalents at beginning of period
   
14,337
   
10,644
 
Cash and cash equivalents at end of period
 
$
9,022
 
$
33,076
 
           
Supplemental disclosure of cash flow information:
             
Cash paid for interest, net of $1,260 and $511 capitalized
             
in 2006 and 2005, respectively
 
$
36,858
 
$
35,600
 
               
See accompanying notes to the unaudited consolidated financial statements.
7

ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
June 30, 2006 and 2005
(Unaudited)
(Dollars in thousands, except for per share and unit amounts)

(1) Organization and Basis of Presentation

The unaudited 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. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company's annual report on Form 10-K for the year ended December 31, 2005.
 
All significant intercompany balances and transactions have been eliminated in the consolidated financial statements. Certain prior year balances have been reclassified to conform to the current year presentation.
 
The unaudited consolidated financial statements for the six months ended June 30, 2006 and 2005 include the accounts of the Company and Essex Portfolio, L.P. (the "Operating Partnership", which holds the operating assets of the Company). See below for a description of entities consolidated by the Operating Partnership. The Company is the sole general partner in the Operating Partnership, with a 90.3% and 90.4% general partnership interest as of June 30, 2006 and December 31, 2005, respectively.
 
As of June 30, 2006, the Company has ownership interests in 126 multifamily properties (containing 27,110 units), three office buildings (with approximately 166,340 square feet), two recreational vehicle parks (comprising 338 spaces) and one manufactured housing community (containing 157 sites), (collectively, the "Properties"). The Properties are located in Southern California (Los Angeles, Ventura, Orange, Riverside and San Diego counties), Northern California (the San Francisco Bay Area), the Pacific Northwest (the Seattle, Washington and Portland, Oregon metropolitan areas) and other areas (Houston, Texas).
 
Fund Activities
 
Essex Apartment Value Fund, L.P. ("Fund I" and “Fund II”), are investment funds formed by the Company to add value through rental growth and asset appreciation, utilizing the Company's development, redevelopment and asset management capabilities. All of the assets in Fund I were sold during 2004 and 2005, and Fund I is in the process of liquidation and will wind down affairs during 2006.
 
Fund II has eight institutional investors, including the Company, with combined partner equity commitments of $265.9 million. Essex has committed $75.0 million to Fund II, which represents a 28.2% interest as general partner and limited partner. Fund II expects to utilize leverage equal to approximately 65% of the estimated value of the underlying real estate. Fund II invests in multifamily properties in the Company’s targeted West Coast markets with an emphasis on investment opportunities in Seattle and the San Francisco Bay Area. Subject to certain exceptions, Fund II will be Essex’s exclusive investment vehicle until October 31, 2006, or when Fund II’s committed capital has been invested, whichever occurs first. Consistent with Fund I, Essex will record revenue for its asset management, property management, development and redevelopment services when earned, and promote distributions should Fund II exceed certain financial return benchmarks.

Variable Interest Entities

In accordance with Financial Accounting Standards Board (FASB) Interpretation No. 46 Revised (FIN 46R), “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51”, the Company consolidates Essex Management Corporation (EMC), Essex Fidelity I Corporation (EFC), 17 Down REIT limited partnerships (comprising ten properties), an office building that is subject to loans made by the Company, and the multifamily improvements owned by a third party in which the Company owns the land underlying these improvements and from which the Company receives fees, including land lease, subordination, property management, and incentive fees. The Company consolidated these entities because it is deemed the primary beneficiary under FIN 46R. The Company's total assets and liabilities related to these variable interest entities (VIEs), net of intercompany eliminations, were approximately $236.9 million and $146.7 million, respectively, at June 30, 2006 and $230.9 million and $146.7 million, respectively, at December 31, 2005.
 
8

Interest holders in VIEs consolidated by the Company are allocated net income equal to the cash payments made to those interest holders for services rendered or distributions from cash flow. The remaining results of operations are generally allocated to the Company.
 
As of June 30, 2006 the Company was involved with two VIEs, of which it is not deemed to be the primary beneficiary. Total assets and liabilities of these entities were approximately $79.3 million and $58.2 million, respectively, at June 30, 2006. As of December 31, 2005, the Company was involved with three VIEs, of which it was not deemed to be the primary beneficiary, total assets and liabilities of these entities were approximately $92.9 million and $72.5 million, respectively. The Company does not have a significant exposure to loss resulting from its involvement with these unconsolidated VIEs.
 
Stock-Based Compensation

We adopted the provisions of SFAS 123 revised effective January 1, 2006 using the modified prospective approach. Stock-based compensation expense for stock options under the fair value method totaled $481 and $115 for the three months ended June 30, 2006 and 2005, respectively, and $624 and $249 for the six months ended June 30, 2006 and 2005, respectively. The intrinsic value of the stock options exercised during the three months ended June 30, 2006 and 2005 totaled $0.9 million and $0.8 million, respectively, and $2.7 million and $1.4 million for the six months ended June 30, 2006 and 2005, respectively. As of June 30, 2006, the intrinsic value of the stock options outstanding and fully vested totaled $26.1 million and $17.8 million, respectively. As of June 30, 2006, total unrecognized compensation cost related to unvested share-based compensation granted under the stock option plans totaled $2.5 million. The cost is expected to be recognized over a weighted-average period of 3 to 5 years for the stock option plans.
 
Stock-based compensation expense for Z and Z-1 Units (collectively, “Z Units”) under the fair value method totaled $231 and $38 for the three months ended June 30, 2006 and 2005, respectively. Stock-based compensation capitalized for these Plans totaled $188 and $53 for the three months ended June 30, 2006 and 2005, respectively. As of June 30, 2006 the intrinsic value of the Z Units subject to conversion totaled $16.6 million. As of June 30, 2006, total unrecognized compensation cost related to Z Units subject to conversion in the future granted under the Z Units totaled $9.3 million. The cost is expected to be recognized over a weighted-average period of 5 to 15 years for the Z Units.
 
The Company’s stock-based compensation policies have not changed materially from information reported in Note 2(k), “Stock-Based Compensation,” and Note 14, “Stock-Based Compensation Plans,” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2005.
 
Accounting Estimates and Reclassifications
 
The preparation of 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.
 
Certain reclassifications have been made to prior year balances in order to conform to the current year presentation. Such reclassifications have no impact on reported earnings, cash flows, total assets, or total liabilities.
 
New Accounting Pronouncements
 
In December 2004, the FASB issued SFAS No. 123 revised, “Share-Based Payment”. This statement is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation”, and supersedes APB No. 25, “Accounting for Stock Issued to Employees”. The Statement requires companies to recognize in the income statement the grant-date fair value of stock options and other equity based compensation issued to employees. We adopted the provisions of SFAS 123 revised effective January 1, 2006 using the modified prospective approach. The adoption of this Statement did not have a material impact on our financial position, results of operations or cash flows.
 
In June 2005, the FASB ratified the EITF’s consensus on Issue No. 04-5 “Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights.” This consensus establishes the presumption that general partners in a limited partnership control that limited partnership regardless of the extent of the general partners’ ownership interest in the limited partnership.
 
9

The consensus further establishes that the rights of the limited partners can overcome the presumption of control by the general partners, if the limited partners have either (a) the substantive ability to dissolve (liquidate) the limited partnership or otherwise remove the general partners without cause or (b) substantive participating rights. Whether the presumption of control is overcome is a matter of judgment based on the facts and circumstances, for which the consensus provides additional guidance. This consensus applies to limited partnerships or similar entities, such as limited liability companies that have governing provisions that are the functional equivalent of a limited partnership. This consensus was applicable to the Company for new or modified partnerships in 2005, and is otherwise applicable to existing partnerships effective January 1, 2006. The adoption of this consensus did not have a material impact on our consolidated financial position, results of operations or cash flows.
 
In April 2006, the FASB issued FASB Staff Position (FSP) FIN 46R-6, “Determining the Variability to Be Considered in Applying FASB Interpretation No. 46 (R).” This FSP addresses certain implementation issues related to FIN 46R. Specifically, FSP FIN 46R-6 addresses how a reporting enterprise should determine the variability to be considered in applying FIN 46R. The variability that is considered in applying FIN 46R affects the determination of (a) whether an entity is a variable interest entity (VIE), (b) which interests are “variable interests” in the entity, and (c) which party, if any, is the primary beneficiary of the VIE. That variability affects any calculation of expected losses and expected residual returns, if such a calculation is necessary. The Company is required to apply the guidance in this FSP prospectively to all entities (including newly created entities) and to all entities previously required to be analyzed under FIN 46R when a “reconsideration event” has occurred, effective July 1, 2006. The Company will evaluate the impact of this Staff Position at the time any such “reconsideration event” occurs, and for any new entities.
 
In July 2006, the FASB issued FASB Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes-an Interpretation of FASB Statement 109.” FIN 48 increases the relevancy and comparability of financial reporting by clarifying the way companies account for uncertainty in measuring income taxes. FIN 48 prescribes a comprehensive model for how a company should recognize, measure, present, and disclose in its financial statements uncertain tax positions that the company has taken or expects to take on a tax return. This Interpretation only allows a favorable tax position to be included in the calculation of tax liabilities and expenses if a company concludes that it is more likely than not that its adopted tax position will prevail if challenged by tax authorities. FIN 48 is effective for fiscal years beginning after December 15, 2006. We are in the process of evaluating the impact of this Interpretation on our future consolidated financial position, results of operations and cash flows.
 
(2) Significant Transactions for the Quarter Ended June 30, 2006
 
(a) Dispositions
 
As part of our strategic plan to own quality real estate in supply-constrained markets, we continually evaluate our Properties and sell those which no longer meet our strategic criteria. We may use the capital generated from the dispositions to invest in higher-return Properties or repay debts. We believe that the sale of these Properties will not have a material impact on our future results of operations or cash flows nor will their sale materially affect our ongoing operations. Generally, any impact of earnings dilution resulting from these dispositions will be offset by the positive impact of our acquisitions, development and redevelopment activities.
 
In June 2006, the unconsolidated joint venture property, Vista Pointe, a 286-unit apartment community located in Anaheim, California, was sold for approximately $46 million. The Company’s share of the proceeds from the transaction totaled $19.3 million, resulting in an $8.8 million gain on the sale, and an additional $8.2 million for fees and a promote distribution.
 
(b) Equity
 
During July 2006, the Company sold 5.98 million shares of 4.875% Series G Cumulative Convertible Preferred Stock at $25 per share for estimated gross proceeds of $149.5 million. Holders may convert Series G Preferred Stock into shares of the Company’s common stock subject to certain conditions. The conversion rate will initially be .1830 shares of common stock per the $25 per share liquidation preference, which is equivalent to an initial conversion price of approximately $136.62 per share of common stock. The conversion rate will be subject to adjustment upon the occurrence of specified events. On or after July 31, 2011, the Company may, under certain conditions, cause some or all of the Series G Preferred Stock to be converted into that number of shares of common stock at the then prevailing conversion rate. The Company intends to use the net proceeds from the offering to pay down outstanding borrowings under the Company’s lines of credit, to fund the development pipeline and for general corporate purposes.
 
During the second quarter 2006, the Company issued and sold approximately 140,500 shares for $14.8 million, net of fees and commissions, under its Controlled Equity Offering program. Under this program, the Company may from time to time sell shares of common stock into the existing trading market at current market prices, and the Company anticipates using the net proceeds from such sales to fund the development and redevelopment pipelines.
 
10

(c) The Essex Apartment Value Fund II (“Fund II”)
 
In April 2006, Fund II acquired two land parcels including a 1.26 acre parcel of land, fully entitled for 149 units, located in Studio City, California for a total estimated cost of approximately $53.3 million, and a 0.9 acre parcel of fully entitled land for 127 units, located in Seattle, Washington, for a total estimated cost of approximately $29.5 million.
 
In April 2006, Fund II acquired Davey Glen, a 69-unit apartment community located in Belmont, California for approximately $13.5 million.
 
(d) Real Estate Rental Properties
 
During the second quarter of 2006, the Company recorded an impairment loss of $0.8 million resulting from the write-down of a property in Houston, Texas, to reduce the property’s carrying value to its estimated fair value as of June 30, 2006. The amount is recorded in other expenses in the accompanying consolidated statements of operations.
 
(3) Investments
 
The Company has investments in a number of affiliates, which are accounted for under the equity method. The affiliates own and operate multifamily rental properties. The following table details the Company's investments (dollars in thousands):
 
 
 
June 30,
 
December 31,
 
 
 
2006
 
2005
 
 
 
 
 
 
 
Investments in joint ventures accounted for under the equity
 
 
 
 
 
     method of accounting:
 
 
 
 
 
 
 
 
 
 
 
   Limited partnership interest of 20.4% and general partner
 
 
 
 
 
interest of 1% in Essex Apartment Value Fund, L.P (Fund I)
 
$
582
 
$
582
 
  Limited partnership interest of 27.2% and general partner
         
interest of 1% in Essex Apartment Value Fund II, L.P (Fund II)
   
28,610
   
19,340
 
  Preferred limited partnership interests in Mountain Vista
         
Apartments (A)
   
6,806
   
6,806
 
 
   
35,998
   
26,728
 
Investments accounted for under the cost method of accounting:
         
 
         
Series A Preferred Stock interest in Multifamily Technology
         
  Solutions, Inc.
   
500
   
500
 
Total investments
 
$
36,498
 
$
27,228
 
 
         


(A)  
The investment is held in an entity that includes an affiliate of The Marcus & Millichap Company (“TMMC”). TMMC’s Chairman is also the Chairman of the Company.
 
11

The combined summarized financial information of investments, which are accounted for under the equity method, is as follows (dollars in thousands).
 
 
 
 
 
 
 
 
 
 
 
 
June 30,
 
December 31,
 
 
 
 
 
 
 
2006
 
2005
 
 
 
 
 
Balance sheets:
 
 
 
 
 
 
 
 
 
 Real estate and real estate under development
 
$
474,100
 
$
431,655
         
 Other assets
   
20,509
   
18,655
         
 
                 
Total assets
 
$
494,609
 
$
450,310
         
 Mortgage notes payable
 
$
266,380
 
$
268,325
         
 Other liabilities
   
95,538
   
83,979
         
 Partners' equity
   
132,691
   
98,007
         
Total liabilities and partners' equity
 
$
494,609
 
$
450,311
         
 
                 
Company's share of equity
 
$
35,998
 
$
26,728
         
 
                 
 
 
Three Months Ended  
Six Months Ended
 
 
June 30,
June 30,
 
   
2006
 
 
2005
 
 
2006
 
 
2005
 
Statements of operations:
                 
Total property revenues
 
$
10,231
 
$
6,354
 
$
19,741
 
$
13,854
 
Total gain on the sales of real estate
   
-
   
4,422
   
-
   
33,008
 
Depreciation and amortization
   
(2,937
)
 
(1,536
)
 
(5,822
)
 
(3,240
)
Interest expense
   
(4,407
)
 
(2,712
)
 
(8,562
)
 
(5,048
)
Other operating expenses
   
(4,353
)
 
(3,088
)
 
(8,508
)
 
(6,100
)
Total net (loss) income
 
$
(1,466
)
$
3,440
 
$
(3,151
)
$
32,474
 
Company's share of net (loss) income
 
$
(374
)
$
2,724
 
$
(816
)
$
17,316
 
 
                 
(4) Notes Receivable and Other Receivables from Related Parties
 
Notes receivable and other receivables from related parties consist of the following as of June 30, 2006 and December 31, 2005 (dollars in thousands):
 
 
 
June 30,
 
December 31,
 
 
 
2006
 
2005
 
Related party receivables, unsecured:
 
 
 
 
 
   Loans to officers made prior to July 31, 2002, secured,
 
 
 
 
 
bearing interest at 8%, due beginning April 2007
 
$
375
 
$
375
 
   Other related party receivables, substantially due on demand
   
1,883
   
798
 
Total notes and other receivable from related parties
 
$
2,258
 
$
1,173
 
 
         
Other related party receivables consist primarily of accrued interest income on related party notes receivable from loans to officers, advances, and accrued management fees from Fund II.
 
12

(5) Notes and Other Receivables
 
Notes and other receivables consist of the following as of June 30, 2006 and December 31, 2005 (dollars in thousands):
 
 
 
 
 
 
   
 June 30,
 
 December 31,
 
   
 2006
 
 2005
 
Note receivable from Pacifica Companies, LLC, secured,
           
  bearing interest at 12%, due June 2008
   
2,193
   
2,193
 
Note receivable from Marketplace Mortgage, LLC, secured
             
  bearing interest at LIBOR + 3.69%, due June 2009
   
7,293
   
-
 
Other receivables
   
20,359
   
3,044
 
Total notes and other receivables
 
$
29,845
 
$
5,237
 
               
Other receivables consist primarily of proceeds from the sale of Vista Pointe for $19,297 held in escrow as of June 30, 2006, and a receivable due from the Vista Pointe joint venture for $2,176 as of December 31, 2005. A cash distribution for the entire amount was received from escrow on July 7, 2006.
 
(6) Related Party Transactions
 
Management and other fees from affiliates includes property management, asset management, development and redevelopment fees from the Company’s investees of $830 and $931 for the three months ended June 30, 2006 and 2005, respectively, and $1,654 and $7,507 for the six months ended June 30, 2006 and 2005, respectively, and promote income from Fund I of $241 for the three months ended June 30, 2005 and $5,114 for the six months ended June 30, 2005. There was no promote income from related parties for the six months ended June 30, 2006.
 
13

(7) Segment Information
 
The Company defines its reportable operating segments as the three geographical regions in which its properties are located: Southern California, Northern California and the Pacific Northwest. Excluded from segment revenues are properties outside of these regions, 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, recreational vehicle parks, and manufactured housing communities. Other non-segment assets include investments, real estate under development, cash, 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 June 30, 2006 and 2005 (dollars in thousands):
 
 
Three Months Ended
 
 
 
June 30,
 
 
 
2006
 
2005
 
Revenues:
 
 
 
 
 
Southern California
 
$
51,567
 
$
46,968
 
Northern California
   
18,057
   
16,796
 
Pacific Northwest
   
15,911
   
14,849
 
Other non-segment areas
   
1,121
   
1,049
 
Total property revenues
 
$
86,656
 
$
79,662
 
 
         
Net operating income:
         
Southern California
 
$
34,975
 
$
31,458
 
Northern California
   
12,235
   
11,457
 
Pacific Northwest
   
10,030
   
9,379
 
Other non-segment areas
   
(53
)
 
73
 
Total net operating income
   
57,187
   
52,367
 
 
         
Depreciation and amortization:
         
Southern California
   
(11,506
)
 
(10,360
)
Northern California
   
(4,161
)
 
(3,998
)
Pacific Northwest
   
(3,915
)
 
(3,706
)
Other non-segment areas
   
(1,093
)
 
(1,979
)
 
   
(20,675
)
 
(20,043
)
Interest expense:
         
Southern California
   
(7,550
)
 
(7,692
)
Northern California
   
(4,338
)
 
(3,777
)
Pacific Northwest
   
(1,731
)
 
(1,888
)
Other non-segment areas
   
(5,878
)
 
(4,796
)
 
   
(19,497
)
 
(18,153
)
 
         
Amortization of deferred financing costs
   
(497
)
 
(563
)
General and administrative
   
(5,002
)
 
(4,573
)
Other expenses
   
(800
)
 
(1,500
)
Management and other fees from affiliates
   
830
   
931
 
Gain on sale of real estate
   
-
   
5,276
 
Interest and other income
   
654
   
2,431
 
Equity income in co-investments
   
(374
)
 
2,724
 
Minority interests
   
(4,760
)
 
(5,360
)
Income tax provision
   
(138
)
 
(1,100
)
Income from continuing operations
 
$
6,928
 
$
12,437
 
 
         
14

The revenues, net operating income, and assets for each of the reportable operating segments are summarized as follows for the six months ended June 30, 2006 and 2005 (dollars in thousands):
 
 
Six Months Ended
 
 
 
June 30,
 
 
 
2006
 
2005
 
Revenues:
 
 
 
 
 
Southern California
 
$
102,686
 
$
93,260
 
Northern California
   
35,501
   
33,293
 
Pacific Northwest
   
31,443
   
29,407
 
Other non-segment areas
   
2,289
   
1,978
 
Total property revenues
 
$
171,919
 
$
157,938
 
 
         
Net operating income:
         
Southern California
 
$
69,475
 
$
62,642
 
Northern California
   
23,761
   
22,541
 
Pacific Northwest
   
19,652
   
18,429
 
Other non-segment areas
   
(449
)
 
(38
)
Total net operating income
   
112,439
   
103,574
 
 
         
Depreciation and amortization:
         
Southern California
   
(22,568
)
 
(20,496
)
Northern California
   
(8,236
)
 
(7,915
)
Pacific Northwest
   
(7,690
)
 
(7,334
)
Other non-segment areas
   
(2,272
)
 
(3,877
)
 
   
(40,766
)
 
(39,622
)
Interest expense:
         
Southern California
   
(14,694
)
 
(15,161
)
Northern California
   
(8,781
)
 
(7,568
)
Pacific Northwest
   
(3,421
)
 
(3,338
)
Other non-segment areas
   
(11,591
)
 
(10,233
)
 
   
(38,487
)
 
(36,300
)
 
           
Amortization of deferred financing costs
   
(1,193
)
 
(1,039
)
General and administrative
   
(9,901
)
 
(9,014
)
Other expenses
   
(1,770
)
 
(1,500
)
Management and other fees from affiliates
   
1,654
   
7,507
 
Gain on sale of real estate
   
-
   
6,391
 
Interest and other income
   
3,048
   
2,954
 
Equity income in co-investments
   
(816
)
 
17,316
 
Minority interests
   
(9,687
)
 
(11,801
)
Income tax provision
   
(175
)
 
(1,201
)
Income from continuing operations
 
$
14,346
 
$
37,265
 
 
 
June 30,
 
December 31,
 
 
 
2006
 
2005
 
Assets:
 
 
 
 
 
Net real estate assets:
 
 
 
 
 
     Southern California
 
$
1,270,774
 
$
1,211,373
 
     Northern California
   
451,850
   
456,093
 
     Pacific Northwest
   
358,892
   
359,432
 
Other non-segment areas
   
37,631
   
57,871
 
Total net real estate assets
   
2,119,147
   
2,084,769
 
Other non-segment assets
   
209,097
   
154,521
 
Total assets
 
$
2,328,244
 
$
2,239,290
 
15

(8) Net Income Per Common Share 
(Amounts in thousands, except per share data)

 
Three Months Ended
 
Three Months Ended
 
 
 
June 30, 2006
 
June 30, 2005
 
 
 
 
 
Weighted
 
Per
 
 
 
Weighted
 
Per
 
 
 
 
 
Average
 
Common
 
 
 
Average
 
Common
 
 
 
 
 
Common
 
Share
 
 
 
Common
 
Share
 
 
 
Income
 
Shares
 
Amount
 
Income
 
Shares
 
Amount
 
Basic:
 
 
 
 
 
 
 
 
 
 
 
 
 
Income from continuing operations available
 
 
 
 
 
 
 
 
 
 
 
 
 
to common stockholders
 
$
6,439
   
22,950
 
$
0.28
 
$
11,949
   
23,070
 
$
0.52
 
Income from discontinued operations
   
15,584
   
22,950
   
0.68
   
26,441
   
23,070
   
1.14
 
 
   
22,023
     
$
0.96
   
38,390
     
$
1.66
 
 
                           
Effect of Dilutive Securities (1)
   
-
   
276
       
-
   
303
     
 
                         
Diluted:
                         
Income from continuing operations available
                         
to common stockholders
   
6,439
   
23,226
 
$
0.28
   
11,949
   
23,373
 
$
0.51
 
Income from discontinued operations
   
15,584
   
23,226
   
0.67
   
26,441
   
23,373
   
1.13
 
 
 
$
22,023
     
$
0.95
 
$
38,390
     
$
1.64
 
 
              
 
 
Six Months Ended
 
 
Six Months Ended
 
 
 
June 30, 2006
 
 
June 30, 2005
  
 
 
 
 
Weighted
 
 
Per
 
 
 
 
 
Weighted
 
 
Per
 
 
 
 
 
Average
 
 
Common
 
 
 
 
 
Average
 
 
Common
 
 
 
 
 
Common
 
 
Share
 
 
 
 
 
Common
 
 
Share
                      
 
 
Income
 
Shares
 
 
Amount
 
 
Income
 
Shares
 
 
Amount
Basic:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 Income from continuing operations available
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
to common stockholders
 
$
13,369
 
22,911
 
$
0.58
 
$
36,288
 
 
23,057
 
$
1.57
Income from discontinued operations
 
 
18,488
 
22,911
 
 
0.81
 
 
28,491
 
 
23,057
 
 
1.24
 
 
 
31,857
 
 
 
$
1.39
 
 
64,779
 
 
 
 
$
2.81
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  
Effect of Dilutive Securities (1)
 
 
-
 
244
 
 
 
 
 
-
 
 
307
 
 
  
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Diluted:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
         
   Income from continuing operations available
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  
to common stockholders
 
 
13,369
 
23,155
 
$
0.58
 
 
36,288
 
 
23,364
 
$
1.55
   Income from discontinued operations
 
 
18,488
 
23,155
 
 
0.80
 
 
28,491
 
 
23,364
 
 
1.22
 
 
$
31,857
 
 
 
$
1.38
 
$
64,779
 
 
 
 
$
2.77
(1)  
Weighted convertible limited partnership units of 2,286,291 and 2,299,361 for the three months ended June 30, 2006 and 2005, respectively, and 2,290,113 and 2,312,216 for the six months ended June 30, 2006 and 2005, respectively, and Series Z incentive units of 184,000 for the three and six months ended June 30, 2006, were not included in the determination of diluted EPS because they were anti-dilutive. The Company has the ability and intent to redeem Down REIT Limited Partnership units for cash and does not consider them to be common stock equivalents.

On or after November 1, 2020, the holders of the $225 million exchangeable notes may exchange, at the then applicable exchange rate, the notes for cash and, at Essex’s option, a portion of the notes may be exchanged for Essex common stock; the current exchange rate is $103.25 per share of Essex common stock. The exchangeable notes will also be exchangeable prior to November 1, 2020, but only upon the occurrence of certain specified events. During the three and six months ended June 30, 2006, the weighted average common stock price exceeded the $103.25 strike price and therefore common stock issuable upon exchange of the exchangeable notes was included in the diluted share count. The treasury method was used to determine the shares to be added to the denominator for the calculation of earnings per diluted share.

Stock options of 19,148 and 39,274 for the three months ended June 30, 2006 and 2005, respectively, and 10,704 and 33,356 for the six months ended June 30, 2006 and 2005, respectively, are 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 quarter and, therefore, the stock options were anti-dilutive.
16

 
(9)  
Derivative Instruments and Hedging Activities
 
During the second quarter of 2006 the Company entered into two, ten-year forward-starting interest rate swaps for $50 million and $75 million with settlement dates of January 1, 2011 and February 1, 2011, respectively. As of June 30, 2006, the Company has entered into seven forward-starting interest rate swaps totaling a notional amount of $350 million with interest rates ranging from 4.9% to 5.9% and settlements dates ranging from October 1, 2007 to February 1, 2011. These derivatives qualify for hedge accounting and will economically hedge the cash flows associated with the refinancing of debt that matures between 2007 and early 2011. The increase in the fair value of these derivatives during the six months ended June 30, 2006 was approximately $11.7 million and is reflected in accumulated other comprehensive income in the Company’s consolidated financial statements. No hedge ineffectiveness on cash flow hedges was recognized during the six months ended June 30, 2006.
 
(10)  
Discontinued Operations
 
In the normal course of business, the Company will receive offers for sale of its properties, 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. Essex classifies real estate as "held for sale" when all criteria under SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets" (SFAS 144) have been met.
 
In January 2005, the Company sold four non-core assets that were acquired in conjunction with the John M. Sachs’ merger in 2002 for $14.9 million. The four non-core assets were: The Riviera Recreational Vehicle Park and a Manufactured Home Park, located in Las Vegas, Nevada, for which the Company had previously entered into master lease and option agreements with an unrelated entity; and two small office buildings, located in San Diego California, aggregating 7,200 square feet. The Company recorded a gain of $668 on the sale of these assets, net of minority interests.
 
In June 2005, the Company sold Eastridge Apartments, a 188-unit apartment community located in San Ramon, California for approximately $47.5 million. In conjunction with the sale, the Company deferred $2.2 million of the gain on the sale of Eastridge because Essex, through its wholly owned taxable subsidiary, originated a participating loan to the buyer in the amount of approximately $2.2 million, which allows the Company to financially participate in the buyer’s condominium conversion plan. The gain on the sale of the Eastridge property net of the deferral of the $2.2 participating loan was $28.5 million. The Company has recorded the operations for Eastridge Apartments as part of discontinued operations in the accompanying consolidated statements of operations.
 
In January 2006 the Company sold Vista Capri East and Casa Tierra apartment communities for approximately $7.0 million and in March 2006, the Company sold Diamond Valley, a Recreational Vehicle Park, for approximately $1.3 million. The total combined gain was $3.1 million offset by $277 in minority interest for a net gain of $2.8 million. The Company has recorded the gain on sale for the three properties as part of discontinued operations in the accompanying consolidated statements of operations. The Company did not reclass the following combined revenues, expenses, and net income for the these three properties for $142, $29, and $113 for the six months ended June 30, 2006, and $367, $147, and $220 for the six months ended June 30, 2005, to discontinued operations due to the fact the amounts are immaterial to the consolidated financial statements.
 
In June 2006, the unconsolidated joint venture property, Vista Pointe, a 286-unit apartment community located in Anaheim, California, was sold for approximately $46 million. The Company’s share of the proceeds from the transaction totaled $19.3 million, resulting in an $8.8 million gain on the sale, and an additional $8.2 million for fees and a promote distribution. The Company has recorded the ground lease income and all related gains and fees from the Vista Pointe joint venture as part of discontinued operations in the accompanying consolidated statements of operations.
 
17

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.

 
 
Three Months Ended
 
Six Months Ended
 
 
 
June 30,
 
June 30,
 
 
 
2006
 
2005
 
2006
 
2005
 
 
 
 
 
 
 
 
 
 
 
Rental revenues
 
$
-
 
$
574
 
$
-
 
$
1,233
 
Interest and other
   
119
   
119
   
238
   
1,373
 
      Revenues
   
119
   
693
   
238
   
2,606
 
 
                         
Property operating expenses
   
-
   
(114
)
 
-
   
(506
)
Minority interests
   
(11
)
 
(52
)
 
(22
)
 
(190
)
     Operating income from real estate sold
   
108
   
527
   
216
   
1,910
 
 
                     
Gain on sale of real estate
   
8,800
   
28,484
   
11,862
   
29,219
 
Promote interest and fees
   
8,221
   
-
   
8,221
   
-
 
Minority interests
   
(1,545
)
 
(2,570
)
 
(1,811
)
 
(2,638
)
     Net gain on sale of real estate
   
15,476
   
25,914
   
18,272
   
26,581
 
 
                         
Income from discontinued operations
 
$
15,584
 
$
26,441
 
$
18,488
 
$
28,491
 
 
                         
(11) Commitments and Contingencies
 
In April 2004, an employee lawsuit was filed against the Company in the California Superior Court in the County of Alameda. In this lawsuit, two former Company maintenance employees seek unpaid wages, associated penalties and attorneys’ fees on behalf of a putative class of the Company’s current and former maintenance employees who were required to wear a pager while they were on call during evening and weekend hours. In June 2005, the Company recorded $1.5 million for legal settlement costs. There has been no change to the settlement amount since the second quarter of 2005. However, litigation is subject to inherent uncertainties, and such amount represents management’s best estimate of the total cost of the litigation at this time.
 
Recently there has been an increasing number of lawsuits against owners and managers of multifamily properties alleging personal injury and property damage caused by the presence of mold in residential real estate. Some of these lawsuits have resulted in substantial monetary judgments or settlements. The Company has been sued for mold related matters and has settled some, but not all, of such matters. Insurance carriers have reacted to mold related liability awards by excluding mold related claims from standard policies and pricing mold endorsements at prohibitively high rates. The Company has, however, purchased pollution liability insurance, which includes coverage for mold. The Company has adopted programs designed to manage the existence of mold in its properties as well as guidelines for promptly addressing and resolving reports of mold to minimize any impact mold might have on residents or the property. Liabilities resulting from such mold related matters and the costs of carrying insurance to address potential mold related claims may also be substantial.
 
The Company is subject to various other lawsuits in the normal course of its business operations. Accordingly, such lawsuits, as well as the class action lawsuit described above, could result in substantial costs and diversion of resources and could have a material adverse effect on the Company’s financial condition, results of operations or cash flows.
18

Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations 
 
The following discussion should be read in conjunction with our Consolidated Condensed Financial Statements and accompanying Notes thereto included elsewhere herein and with our 2005 Annual Report on Form 10-K for the year ended December 31, 2005 and our Current Report on Form 10-Q for the three and six months ended June 30, 2006. (Unless otherwise noted, all dollar amounts are in thousands.)
 
Essex is a fully integrated Real Estate Investment Trust (REIT), and its property revenues are generated primarily from multifamily property operations, which are located in three major West Coast regions:
 
Southern California (Los Angeles, Ventura, Orange, Riverside and San Diego counties)
Northern California (the San Francisco Bay Area)
Pacific Northwest (Seattle, Washington and Portland, Oregon metropolitan areas)

The Company’s consolidated multifamily properties are as follows:
 
 
As of June 30, 2006
 
As of June 30, 2005
 
 
Number of Apartment Homes
%
Number of Apartment Homes
%
Southern California
12,957
55%
12,724
54%
Northern California
4,621
19%
4,621
20%
Pacific Northwest
5,847
25%
5,831
25%
Other
302
1%
302
1%
Total
23,727
100%
23,478
100%
 
 
 
 
 
Occupancy Rates

With respect to stabilized multifamily properties with sufficient operating history, occupancy rates are based on financial occupancy, which 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. 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.

Comparison of the Three Months Ended June 30, 2006 to the Three Months Ended June 30, 2005

Our average financial occupancies for the Company’s multifamily stabilized properties or “Quarterly Same Properties” (properties consolidated by the Company for each of the three months ended June 30, 2006 and 2005) decreased 0.1% to 96.6% as of June 30, 2006 from 96.7% as of June 30, 2005 for the multifamily Quarterly Same-Properties. The regional breakdown of the Company’s Quarterly Same-Property portfolio for financial occupancy for the three months ended June 30, 2006 and 2005 is as follows:

 
 
 
Three months ended
 
 
 
June 30,
 
 
 
2006
 
2005
Southern California
 
 
95.9%
 
96.5%
Northern California
 
 
97.8%
 
97.2%
Pacific Northwest
 
 
97.5%
 
96.8%
 
19

Total Property Revenues increased 8.8% to $86.7 million in the second quarter of 2006 from $79.7 million in the second quarter of 2005. The following table illustrates a breakdown of these revenue amounts, including revenues attributable to the Quarterly Same-Properties.

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended
 
 
 
 
 
 
 
Number of
 
June 30,
 
Dollar
 
Percentage
 
 
 
Properties
 
2006
 
2005
 
Change
 
Change
 
Revenues:
 
 
 
(dollars in thousands)
      
 
 
Property revenues
 
 
 
 
 
 
 
 
 
 
 
Quarterly Same-Properties:
 
 
 
 
 
 
 
 
 
 
 
Southern California
   
56
 
$
46,314
 
$
43,954
 
$
2,360
   
5.4
%
Northern California
   
20
   
18,057
   
16,796
   
1,261
   
7.5
 
Pacific Northwest
   
25
   
13,926
   
12,879
   
1,047
   
8.1
 
Total property revenues
                     
Quarterly Same-Properties
   
101
   
78,297
   
73,629
   
4,668
   
6.3
 
Property revenues - properties acquired
                     
   subsequent to March 31, 2005 (1)
       
8,359
   
6,033
   
2,326
   
38.6
 
Total property revenues
     
$
86,656
 
$
79,662
 
$
6,994
   
8.8
%
 
                     
(1) Also includes three office buildings, one multifamily property located in Houston, Texas, two recreational vehicle parks, one manufactured housing community, and redevelopment communities.
 
Quarterly Same-Property Revenues increased by $4.7 million or 6.3% to $78.3 million in the second quarter of 2006 from $73.6 million in the second quarter of 2005. The increase in second quarter of 2006 was primarily attributable to an increase in rental rates of $4.3 million or 5.9% and a decrease in rent concessions of $173 compared to the second quarter of 2005. Occupancy and delinquency rates were consistent for the two quarters.
 
Quarterly Non-Same Property Revenues increased by $2.3 million or 38.6% to $8.4 million in the second quarter of 2006 from $6.0 million in the second quarter of 2005. Quarterly Non-Same Properties include properties acquired subsequent to March 31, 2005, three office buildings, one multifamily property located in Houston, Texas, one manufactured housing community, two recreational vehicle parks, and redevelopment communities. The increase was primarily due to four properties acquired since March 31, 2005.
 
Total Expenses increased $3.8 million or 5% to $75.9 million in the second quarter of 2006 from $72.1 million in the second quarter of 2005. The increase was primarily due to an increased in real estate taxes, salaries, and interest offset by a decrease in other expenses of $700. Real estate taxes increased $764 over the prior quarter due mainly to increases in assessment of properties in the Pacific Northwest. Salaries increased mainly due to an increase in equity based compensation expense of $366, and an increase in payroll salaries over the prior year period as well as higher operating expenses due to the acquisition of properties in the past year.
 
Interest expense increased by $1.3 million or 7% in the second quarter of 2006 to $19.5 million, net of $711 in capitalized interest, compared to $18.2 million, net of $511 in capitalized interest for the second quarter of 2005. The increase was mainly due to an increase in total outstanding debt of $108 million between the two quarters, and an increase in short-term borrowing rates.
 
Other expenses included an impairment charge of $800 related to the write-down of the value of a property located in Houston, Texas during the second quarter of 2006, and during the second quarter of 2005 the Company recorded a $1.5 million charge for a legal settlement.
 
Gain on sale of real estate was $0 for the second quarter of 2006 compared to a gain of $3.8 million recorded in the second quarter of 2005 related to the deferred gain on sale of The Essex at Lake Merritt property, and a gain of $1.4 million from the Company’s taxable REIT subsidiaries.
 
Interest and other income decreased $1.8 million in the second quarter of 2006 due to the recognition of $1.8 million in interest income from the Essex at Lake Merritt participating loan during the second quarter of 2005.
 
20

Equity income in co-investments decreased $3.1 million in the second quarter of 2006 due mainly to the fact the Company recorded $2.7 million in equity income related to Fund I properties sold during the second quarter of 2005. For the second quarter of 2006 the Company recorded a net loss on its investment in Fund II for $374.
 
Discontinued operations for the second quarter of 2006 relates to the gain on sale of the Vista Pointe joint venture property for $8.8 million plus fees and a promote distribution from the sale for a total of $8.2 million. Discontinued operations for the second quarter of 2005, relates to the sale of the Eastridge Apartments, for a gain on sale of $28.5 million, and $575 in rental revenues related to Eastridge.

Comparison of the Six Months Ended June 30, 2006 to the Six Months Ended June 30, 2005

Our average financial occupancies for the Company’s multifamily stabilized properties or “Same Properties” (properties consolidated by the Company for each of the six months ended June 30, 2006 and 2005) decreased 0.1% to 96.5% as of June 30, 2006 from 96.6% as of June 30, 2005. The regional breakdown of the Company’s Same-Property portfolio for financial occupancy for the six months ended June 30, 2006 and 2005 is as follows:
 
 
 
Six Months Ended
 
 
 
 
June 30,
 
 
 
 
2006
 
 
2005
 
Southern California
 
 
96.1%
 
 
96.3%
 
Northern California
 
 
97.1%
 
 
97.0%
 
Pacific Northwest
 
 
97.1%