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 September 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:

23,352,112 shares of Common Stock as of November 1, 2006
 
1




ESSEX PROPERTY TRUST, INC.
FORM 10-Q
INDEX

   
       Page No.
PART I. FINANCIAL INFORMATION
                            
                                                                                                                                              
Item 1.
Financial Statements (Unaudited):
     
 
Consolidated Balance Sheets as of September 30, 2006 and December 31, 2005
     
 
Consolidated Statements of Operations for the three and nine months ended September 30, 2006 and 2005
     
 
Consolidated Statements of Stockholders' Equity and Comprehensive Income for the nine months ended September 30, 2006
     
 
Condensed Consolidated Statements of Cash Flows for the nine months ended September 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
     
PART II. OTHER INFORMATION
 
     
Item 1.
Legal Proceedings
28
     
Item 1A.
Risk Factors
28
     
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
28
     
Item 6.
Exhibits
29
     
Signatures
30
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 unaudited consolidated 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)

     
September 30,
   
December 31,
 
     
2006
   
2005
 
Assets
   
 
   
 
 
Real estate:
             
Rental properties:
             
Land and land improvements
 
$
561,582
 
$
551,132
 
Buildings and improvements
 
 
2,103,595
   
1,932,113
 
 
 
 
2,665,177
   
2,483,245
 
Less accumulated depreciation
 
 
(457,220)
   
(398,476)
 
 
 
 
2,207,957
   
2,084,769
 
Real estate under development
 
 
101,562
   
54,416
 
Investments
 
 
53,806
   
27,228
 
 
 
 
2,363,325
   
2,166,413
 
Cash and cash equivalents-unrestricted
 
 
30,142
   
14,337
 
Cash and cash equivalents-restricted
 
 
14,999
   
13,937
 
Notes and other receivables from related parties
 
 
1,841
   
1,173
 
Notes and other receivables
 
 
17,043
   
5,237
 
Prepaid expenses and other assets
 
 
18,523
   
23,078
 
Deferred charges, net
 
 
13,617
   
15,115
 
Total assets
 
$
2,459,490
 
$
2,239,290
 
     
 
   
 
 
Liabilities and Stockholders' Equity
 
           
Mortgage notes payable
 
$
1,097,330
 
$
1,104,918
 
Exchangeable bonds
   
225,000
   
225,000
 
Lines of credit
 
 
80,000
   
25,000
 
Accounts payable and accrued liabilities
 
 
49,414
   
32,982
 
Dividends payable
 
 
24,735
   
22,496
 
Other liabilities
   
14,459
   
12,520
 
Deferred gain
 
 
2,193
   
2,193
 
Total liabilities
 
 
1,493,131
   
1,425,109
 
Minority interests
 
 
227,761
   
233,214
 
Cumulative convertible preferred stock; $.0001 par value:              
   4.875% Series G - 5,980,000 and 0 shares authorized,              
   issued and outstanding, respectively    
 145,912
   
 -
 
Stockholders' equity:
 
           
Common stock, $.0001 par value, 655,682,178
 
           
authorized, 23,177,330 and
 
           
22,851,953 issued and outstanding, respectively
 
 
2
   
2
 
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
 
Excess stock, $.0001 par value, 330,000,000 shares
 
           
authorized and no shares issued and outstanding
 
 
-
   
-
 
Additional paid-in capital
 
 
662,043 
   
632,646
 
Distributions in excess of accumulated earnings
 
 
(92,849)
   
(77,341)
 
Accumulated other comprehensive income (loss)
 
 
(1,510)
   
660
 
Total stockholders' equity
 
 
592,686 
   
580,967
 
Commitments and contingencies
   
 
   
 
 
Total liabilities and stockholders' equity
 
$
2,459,490
 
$
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   
 
 Nine Months Ended  
 
   
 September 30,  
 September 30,  
 
   
 2006
 
 2005
 
 2006
 
 2005
 
Revenues:
                         
   Rental and other property
 
$
89,670
 
$
81,881
 
$
261,589
 
$
239,819
 
   Management and other fees from affiliates
   
1,872
   
1,601
   
3,526
   
9,108
 
     
91,542
   
83,482
   
265,115
   
248,927
 
Expenses:
                         
      Property operating, excluding real estate taxes
   
23,307
   
21,254
   
68,017
   
62,167
 
      Real estate taxes
   
7,535
   
7,066
   
22,305
   
20,517
 
      Depreciation and amortization
   
20,666
   
20,323
   
61,432
   
59,945
 
      Interest
   
18,525
   
18,566
   
57,012
   
54,866
 
      Amortization of deferred financing costs
   
778
   
451
   
1,971
   
1,490
 
      General and administrative
   
5,289
   
4,560
   
15,190
   
13,574
 
      Other expenses
   
-
   
1,400
   
1,770
   
2,900
 
     
76,100
   
73,620
   
227,697
   
215,459
 
  Earnings from operations
   
15,442
   
9,862
   
37,418
   
33,468
 
                           
  Gain on sale of real estate
   
-
   
-
   
-
   
6,391
 
  Interest and other income
   
1,701
   
4,978
   
4,749
   
7,932
 
  Equity income (loss) in co-investments
   
(368)
 
 
(98)
 
 
(1,184)
 
 
17,217
 
  Minority interests
   
(5,212)
 
 
(4,918)
 
 
(14,899)
 
 
(16,719)
 
  Income before discontinued operations and
                         
    tax provision
   
11,563
   
9,824
   
26,084
   
48,289
 
  Income tax provision
   
(150)
 
 
(1,185)
 
 
(325)
 
 
(2,386)
 
  Income before discontinued operations
   
11,413
   
8,639
   
25,759
   
45,903
 
  Income from discontinued operations (net of
                         
    minority interests)
   
1,064
   
108
   
19,552
   
28,600
 
  Net income
   
12,477
   
8,747
   
45,311
   
74,503
 
  Dividends to preferred stockholders
   
(1,791)
 
 
(488)
 
 
(2,768)
 
 
(1,465)
 
  Net income available to common stockholders
 
$
10,686
 
$
8,259
 
$
42,543
 
$
73,038
 
                           
Per common share data:
                         
   Basic:
                         
      Income before discontinued operations available to
                         
         common stockholders
 
$
0.41
 
$
0.36
 
$
1.00
 
$
1.93
 
     Income from discontinued operations
   
0.05
   
-
   
0.85
   
1.24
 
     Net income available to common stockholders
 
$
0.46
 
$
0.36
 
$
1.85
 
$
3.17
 
     Weighted average number of common shares
                         
        outstanding during the period
   
23,142,385
   
23,106,569
   
22,988,083
   
23,073,650
 
                           
   Diluted:
                         
       Income before discontinued operations available to
                         
          common stockholders
 
$
0.40
 
$
0.35
 
$
0.98
 
$
1.91
 
       Income from discontinued operations
   
0.05
   
-
   
0.84
   
1.22
 
       Net income available to common stockholders
 
$
0.45
 
$
0.35
 
$
1.82
 
$
3.13
 
       Weighted average number of common shares
                         
           outstanding during the period
   
23,677,569
   
23,411,959
   
23,353,791
   
23,364,039
 
                           
   Dividend per common share
 
$
0.84
 
$
0.81
 
$
2.52
 
$
2.43
 
                           
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 nine months ended September 30, 2006
(Unaudited)
(Dollars and shares in thousands)

                                                                                                             
 Distributions
      
                     
 Additional
 
 Accumulated other
 
 in excess of
                 
   
Preferred stock
 
Common stock
 
 paid-in
 
 comprehensive
 
 accumulated
          
   
Shares
 
Amount
 
Shares
 
Amount
 
 capital
 
 income (loss)
 
 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
   
-
   
-
   
-
   
-
   
-
   
-
   
45,311
   
45,311
 
     Change in fair value of cash flow hedges
   
-
   
-
   
-
   
-
   
-
   
(2,170
)
 
-
   
(2,170
)
  Comprehensive income
                                             
43,141
 
  Issuance of common stock under:
                                                 
Stock-based compensation plans
   
-
   
-
   
72
   
-
   
4,198
   
-
   
-
   
4,198
 
Sale of common stock
   
-
   
-
   
254
   
-
   
27,225
   
-
   
-
   
27,225
 
  Redemptions of minority interests, net
   
-
   
-
   
-
   
-
   
(2,026
)
 
-
   
-
   
(2,026
)
  Dividends declared
   
-
   
-
   
-
   
-
   
-
   
-
   
(60,819
)
 
(60,819
)
  Balances at September 30, 2006
   
1,000
 
$
25,000 
   
23,177
 
$
2
 
$
662,043
 
$
(1,510
)
$
(92,849
)
$
592,686 
 
                                     
 






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)

     
Nine Months Ended
   
September 30,
   
2006
 
 
2005
Net cash provided by operating activities
 
$
137,501
 
$
106,652
     
 
   
 
Cash flows used in investing activities:
           
Additions to real estate:
 
         
Acquisitions and improvements to recent acquisitions
 
 
(161,998)
   
(30,968)
Redevelopment
   
(17,753)
   
(15,384)
Revenue generating capital expenditures
   
(1,746)
   
(146)
Non-revenue generating capital expenditures
 
 
(10,648)
   
(7,980)
Additions to real estate under development
 
 
(52,957)
   
(22,540)
Dispositions of real estate and investments
   
15,883
   
6,585
Changes in restricted cash and refundable deposits
 
 
5,162
   
6,228
Additions to notes receivable from related parties and other receivables
 
 
(15,279)
   
(3,278)
Repayments of notes receivable from related parties and other receivables
 
 
2,295
   
4,925
Net (contributions to) distributions from limited partnerships
 
 
(25,938)
   
43,341
Net cash used in investing activities
 
 
(262,979)
   
(19,217)
     
 
   
 
Cash flows from financing activities:
 
         
Proceeds from mortgage notes payable and lines of credit
 
 
281,325
   
152,971
Repayment of mortgage notes payable and lines of credit
 
 
(233,442)
   
(154,813)
Additions to deferred charges
 
 
(472)
   
(1,167)
Issuance of preferred stock - Series G
 
 
145,912
   
-
Net proceeds from stock options exercised
 
 
3,136
   
4,143
Net sale of common stock
 
 
27,225
   
-
Distributions to minority interest partners
 
 
(17,482)
   
(17,353)
Redemption of minority interest limited partnership units
 
 
(6,360)
   
(5,463)
Common and preferred stock dividends paid
 
 
(58,559)
   
(57,032)
Net cash provided by (used in) financing activities
 
 
141,283
   
(78,714)
     
 
   
 
Net increase in cash and cash equivalents
 
 
15,805
   
8,721
Cash and cash equivalents at beginning of period
 
 
14,337
   
10,644
Cash and cash equivalents at end of period
 
$
30,142
 
$
19,365
     
 
   
 
Supplemental disclosure of cash flow information:
 
         
Cash paid for interest, net of $2,413 and $647 capitalized
 
         
in 2006 and 2005, respectively
 
$
52,386
 
$
54,245
             
See accompanying notes to the unaudited consolidated financial statements.
7

ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
September 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 nine months ended September 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 90.4% general partnership interest as of September 30, 2006 and December 31, 2005.
 
As of September 30, 2006, the Company has ownership interests in 129 multifamily properties (containing 27,491 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), Seattle, Washington and other regions (Portland, Oregon metropolitan area and 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.
 
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 apartment communities 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 has been Essex’s exclusive investment vehicle during 2005 and 2006. As of October 2006, management has fully committed the available capital and Fund II will not make any additional acquisitions. Consistent with Fund I, Essex records revenue for its asset management, property management, development and redevelopment services when earned, and promote income 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 consolidates 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 $237.8 million and $146.7 million, respectively, at September 30, 2006 and $230.9 million and $146.7 million, respectively, at December 31, 2005.
 
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
 
8

 
allocated to the Company.
 
As of September 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 $79.1 million and $58.5 million, respectively, at September 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, and 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 $439 and $270 for the three months ended September 30, 2006 and 2005, respectively, and $1.1 million and $519 for the nine months ended September 30, 2006 and 2005, respectively. The intrinsic value of the stock options exercised during the three months ended September 30, 2006 and 2005 totaled $1.0 million and $2.6 million, respectively, and $3.7 million and $3.9 million for the nine months ended September 30, 2006 and 2005, respectively. As of September 30, 2006, the intrinsic value of the stock options outstanding and fully vested totaled $41.9 million and $14.3 million, respectively. As of September 30, 2006, total unrecognized compensation cost related to unvested share-based compensation granted under the stock option plans totaled $3.4 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 September 30, 2006 and 2005, respectively. Stock-based compensation capitalized for stock options and the Z Units totaled $188 and $53 for the three months ended September 30, 2006 and 2005, respectively. As of September 30, 2006 the intrinsic value of the Z Units subject to conversion totaled $16.6 million. As of September 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. The consensus
 
9

 
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.
 
In September 2006, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin (“SAB”) No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.” SAB No. 108 was issued to address diversity in practice in quantifying financial statement misstatements. Current practice allows for the evaluation of materiality on the basis of either (1) the error quantified as the amount by which the current year income statement was misstated (“rollover method”) or (2) the cumulative error quantified as the cumulative amount by which the current year balance sheet was misstated (“iron curtain method”). The guidance provided in SAB 108 requires both methods to be used in evaluating materiality (“dual approach”). SAB No. 108 permits companies to initially apply its provisions either by (1) restating prior financial statements as if the dual approach had always been used or (2) recording the cumulative effect of initially applying the “dual approach” as adjustments to the carrying values of assets and liabilities as of January 1, 2006 with an offsetting adjustment recorded to the opening balance of retained earnings. 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
 
(a) Acquisitions
 
On September 13, 2006, the Company acquired Hillsdale Garden Apartments, a 697-unit community located in San Mateo, California for approximately $97.3 million. The property is subject to a ground lease with annual payments of $46 that will expire in 2047.
 
 
During October 2006, the Company acquired Belmont Terrace, a 71-unit community located in Belmont, California for approximately $14.7 million in transaction structured as an UpREIT. The community was built in 1974 and consists of one four-story building located in the Belmont hills.
 
(b) Dispositions
 
Currently, the Company is in the process of a condo conversion of Peregrine Point, a taxable REIT subsidiary (TRS), in Issaquah, Washington. In April of 2006 the property was reclassified from a rental property to real estate under
10

development held for sale. During the third quarter of 2006, the Company sold 28 of the 66 available condominiums, for a gain of $1.1 million, net of minority interest, taxes, and expenses.
 
(c) Equity
 
During the third quarter of 2006, the Company sold 5.98 million shares of 4.875% Series G Cumulative Convertible Preferred Stock for 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 circumstances, 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.
 
During the third quarter 2006, the Company issued and sold approximately 114,100 shares of common stock for $12.4 million, net of fees and commissions. The Company used the net proceeds from the Series G offering and stock sales to pay down outstanding borrowings under the Company’s lines of credit, to fund the development pipeline and for general corporate purposes.
 
(d) The Essex Apartment Value Fund II (“Fund II”)
 
Fund II acquired two communities in September of 2006. Renaissance Apartments, a 168-unit apartment community located in Los Angeles, California was acquired for approximately $46.3 million and Alderwood Park Apartments, a 96-unit apartment community located in Newark, California was acquired for approximately $13.4 million.
 
During the fourth quarter of 2006, management anticipates closing on a land parcel, entitled for 119-units, located in Chatsworth, California for a total estimated cost of approximately $39.4 million.
 
As of October 31, 2006, management has determined that Fund II is fully committed and closed for any future acquisitions or development.
 
(3) Investments
 
The Company has investments in a number of affiliates, which are accounted for under the equity method. The affiliates own and operate apartment communities. The following table details the Company's investments (dollars in thousands):
 
 
 
 
September 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)
 
 
45,918
 
 
19,340
     Preferred limited partnership interests in Mountain Vista
 
 
 
 
 
 
Apartments (A)
 
 
6,806
 
 
6,806
 
 
 
53,306
 
 
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
 
$
53,806
 
$
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).
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
September 30,
 
 
December 31,
 
 
 
 
 
 
 
 
 
2006
 
 
2005
 
 
 
 
 
 
Balance sheets:
 
 
 
 
 
 
 
 
 
 
 
 
  Real estate and real estate under development
 
$
545,602
 
$
431,655
 
 
 
 
 
 
  Other assets
 
 
20,699
 
 
18,655
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total assets
 
$
566,301
 
$
450,310
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Mortgage notes payable
 
$
302,739
 
$
268,325
 
 
 
 
 
 
Other liabilities
 
 
62,437
 
 
83,979
 
 
 
 
 
 
Partners' equity
 
 
201,125
 
 
98,007
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total liabilities and partners' equity
 
$
566,301
 
$
450,311
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Company's share of equity
 
$
53,306
 
$
26,728
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended
 
 
Nine Months Ended
 
 
 
September 30,
 
 
September 30,
 
 
 
2006
 
 
2005
 
 
2006
 
 
2005
Statements of operations:
 
 
 
 
 
 
 
 
 
 
 
 
Total property revenues
 
$
10,887
 
$
6,705
 
$
30,631
 
$
20,812
Total gain on the sales of real estate
 
 
-
 
 
5,889
 
 
-
 
 
38,897
Depreciation and amortization
 
 
(3,122)
 
 
(1,815)
 
 
(8,945)
 
 
(5,056)
Interest expense
 
 
(4,169)
 
 
(2,814)
 
 
(12,731)
 
 
(7,862)
Other operating expenses
 
 
(5,074)
 
 
(2,562)
 
 
(13,600)
 
 
(8,925)
 
 
 
 
 
 
 
 
 
 
 
 
 
Total net (loss) income
 
$
(1,478)
 
$
5,403
 
$
(4,645)
 
$
37,866
 
 
 
 
 
 
 
 
 
 
 
 
 
Company's share of net (loss) income
 
$
(368)
 
$
(98)
 
$
(1,184)
 
$
17,217
 
 
 
 
 
 
 
 
 
 
 
 
 
 
(4) Notes Receivable and Other Receivables from Related Parties
 
Notes receivable and other receivables from related parties consist of the following as of September 30, 2006 and December 31, 2005 (dollars in thousands):
 
 
 
September 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
 
 
1,466
 
 
798
Total notes and other receivable from related parties
 
$
1,841
 
$
1,173
 
 
 
 
 
 
 
Other related party receivables consist primarily of accrued interest income on related party notes receivable from loans to officers and advances, and $1 million in accrued promote income from Fund I as of September 30, 2006.
12

(5) Notes and Other Receivables
 
Notes receivables, secured by real estate, and other receivables consist of the following as of September 30, 2006 and December 31, 2005 (dollars in thousands):
 
     
September 30,
   
December 31,
     
2006
   
2005
 
           
Note receivable, secured, bearing interest at 12%, due June 2008
 
$
2,193
 
$
2,193
Note receivable, secured, bearing interest at LIBOR + 3.69%, due June 2009
   
7,311
   
-
Note receivable, secured, bearing interest at LIBOR + 4.65%, due November 2008
   
6,656
   
-
Other receivables
 
 
883
   
3,044
Total notes and other receivables
 
$
17,043
 
$
5,237
             

Included in other receivable as of December 31, 2005, was an amount due from the Vista Pointe joint venture for $2,176. A cash distribution for the entire amount was received from escrow in July 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 $872 and $705 for the three months ended September 30, 2006 and 2005, respectively, and $2,526 and $3,098 for the nine months ended September 30, 2006 and 2005, respectively, and promote income from Fund I of $1,000 and $896 for the three months ended September 30, 2006 and 2005, respectively, and $1,000 and $6,010 for the nine months ended September 30, 2006 and 2005, respectively.
 

 
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 Seattle. Excluded from segment revenues are properties outside of these regions including properties in Portland, Oregon and Houston, Texas, 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 2005 operations and assets for the properties held in Portland, Oregon have been reclassified from the Seattle/Pacific Northwest region to the other non-segment areas for comparison to the current segment presentation. 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, 2006 and 2005 (dollars in thousands):
 
 
Three Months Ended
 
       
 
September 30,
 
 
 
2006
 
 
2005
Revenues:
 
 
 
 
 
 
Southern California
 
$
53,110
 
$
48,996
Northern California
 
 
18,985
 
 
16,763
Seattle
 
 
14,381
 
 
13,138
Other non-segment areas
 
 
3,194
 
 
2,984
Total property revenues
 
$
89,670
 
$
81,881
 
 
 
 
 
 
 
Net operating income:
 
 
 
 
 
 
Southern California
 
$
36,127
 
$
33,176
Northern California
 
 
12,609
 
 
11,037
Seattle
 
 
8,853
 
 
8,118
Other non-segment areas
 
 
1,239
 
 
1,230
Total net operating income
 
 
58,828
 
 
53,561
 
 
 
 
 
 
 
Depreciation and amortization:
 
 
 
 
 
 
Southern California
 
 
(11,457)
 
 
(10,619)
Northern California
 
 
(4,218)
 
 
(4,023)
Seattle
 
 
(3,470)
 
 
(3,208)
Other non-segment areas
 
 
(1,521)
 
 
(2,473)
 
 
 
(20,666)
 
 
(20,323)
Interest expense:
 
 
 
 
 
 
Southern California
 
 
(7,285)
 
 
(7,543)
Northern California
 
 
(4,559)
 
 
(4,451)
Seattle
 
 
(1,749)
 
 
(1,964)
Other non-segment areas
 
 
(4,932)
 
 
(4,608)
 
 
 
(18,525)
 
 
(18,566)
 
 
 
 
 
 
 
Amortization of deferred financing costs
 
(778)
 
 
(451)
General and administrative
 
 
(5,289)
   
(4,560)
Other expenses
 
 
-
   
(1,400)
Management and other fees from affiliates
 
1,872
   
1,601
Interest and other income
 
 
1,701
 
 
4,978
Equity income (loss) in co-investments
 
 
(368)
 
 
(98)
Minority interests
 
 
(5,212)
   
(4,918)
Income tax provision
 
 
(150)
 
 
(1,185)
 
 
 
 
 
 
 
Income before discontinued operations
 
$
11,413
 
$
8,639
 
 
 
 
 
 
 
14

The revenues, net operating income, and assets for each of the reportable operating segments are summarized as follows for the nine months ended September 30, 2006 and 2005 (dollars in thousands):
 
 
       Nine Months Ended
 
 
 
September 30,
 
 
 
2006
 
 
2005
Revenues:
 
 
 
 
 
 
Southern California
 
$
155,797
 
$
142,257
Northern California
 
 
54,485
 
 
50,056
Seattle
 
 
41,786
 
 
38,738
Other non-segment areas
 
 
9,521
 
 
8,768
Total property revenues
 
$
261,589
 
$
239,819
 
 
 
 
 
 
 
Net operating income:
 
 
 
 
 
 
Southern California
 
$
105,603
 
$
95,818
Northern California
 
 
36,369
 
 
33,578
Seattle
 
 
26,084
 
 
24,263
Other non-segment areas
 
 
3,211
 
 
3,476
Total net operating income
 
 
171,267
 
 
157,135
 
 
 
 
 
 
 
Depreciation and amortization:
 
 
 
 
 
 
Southern California
 
 
(34,025)
 
 
(31,115)
Northern California
 
 
(12,454)
 
 
(11,938)
Seattle
 
 
(10,139)
 
 
(9,545)
Other non-segment areas
 
 
(4,814)
 
 
(7,347)
 
 
 
(61,432)
 
 
(59,945)
Interest expense:
 
 
 
 
 
 
Southern California
 
 
(21,565)
 
 
(22,295)
Northern California
 
 
(13,754)
 
 
(12,428)
Seattle
 
 
(5,170)
 
 
(5,302)
Other non-segment areas
 
 
(16,523)
 
 
(14,841)
 
 
 
(57,012)
 
 
(54,866)
 
 
 
 
 
 
 
Amortization of deferred financing costs
 
(1,971)
 
 
(1,490)
General and administrative
 
 
(15,190)
 
 
(13,574)
Other expenses
 
 
(1,770)
 
 
(2,900)
Management and other fees from affiliates
 
3,526
 
 
9,108
Gain on sale of real estate
 
 
-
 
 
6,391
Interest and other income
 
 
4,749
 
 
7,932
Equity income (loss) in co-investments
 
 
(1,184)
   
17,217
Minority interests
 
 
(14,899)
   
(16,719)
Income tax provision
 
 
(325)
 
 
(2,386)
Income before discontinued operations
 
$
25,759
 
$
45,903
 
 
 
 
 
 
 
 
 
September 30,
 
 
December 31,
 
 
 
2006
 
 
2005
Assets:
 
 
 
 
 
 
Net real estate assets:
 
 
 
 
 
 
    Southern California
 
$
1,235,107
 
$
1,211,373
    Northern California
 
 
548,373
 
 
456,093
    Seattle
 
 
315,763
 
 
315,108
Other non-segment areas
 
 
108,714 
 
 
102,195
Total net real estate assets
 
 
2,207,957
 
 
2,084,769
Other non-segment assets
 
 
251,533
 
 
154,521
Total assets
 
$
2,459,490
 
$
2,239,290
 
 
 
 
 
 
 
15

(8) Net Income Per Common Share 
(Amounts in thousands, except per share and unit data)
 
 
Three Months Ended
 
 
Three Months Ended
 
 
 
September 30, 2006
 
 
September 30, 2005
 
 
 
 
 
Weighted
 
 
Per
 
 
 
 
 
Weighted
 
 
Per
 
 
 
 
 
Average
 
 
Common
 
 
 
 
 
Average
 
 
Common
 
 
 
 
 
Common
 
 
Share
 
 
 
 
 
Common
 
 
Share
 
 
 
Income
 
Shares
 
 
Amount
 
 
Income
 
 
Shares
 
 
Amount
Basic:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Income before discontinued operations available
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
to common stockholders
 
$
9,622
 
23,142
 
$
0.41
 
$
8,151
 
 
23,107
 
$
0.36
  Income from discontinued operations
 
 
1,064
 
23,142
 
 
0.05
 
 
108
 
 
23,107
 
 
-
 
 
 
10,686
 
 
 
$
0.46
 
 
8,259
 
 
 
 
$
0.36
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Effect of Dilutive Securities (1)
 
 
-
 
536
 
 
 
 
 
-
 
 
305
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Diluted:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Income before discontinued operations available
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
to common stockholders
 
 
9,622
 
23,678
 
$
0.40
 
 
8,151
 
 
23,412
 
$
0.35
  Income from discontinued operations
 
 
1,064
 
23,678
 
 
0.05
 
 
108
 
 
23,412
 
 
-
 
 
$
10,686
 
 
 
$
0.45
 
$
8,259
 
 
 
 
$
0.35
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended
 
 
Nine Months Ended
 
 
 
September 30, 2006
 
 
September 30, 2005
 
 
 
 
 
Weighted
 
 
Per
 
 
 
 
 
Weighted
 
 
Per
 
 
 
 
 
Average
 
 
Common
 
 
 
 
 
Average
 
 
Common
 
 
 
 
 
Common
 
 
Share
 
 
 
 
 
Common
 
 
Share
 
 
 
Income
 
Shares
 
 
Amount
 
 
Income
 
Shares
 
 
Amount
Basic:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Income before discontinued operations available
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
to common stockholders
 
$
22,991
 
22,988
 
$
1.00
 
$
44,438
 
 
23,074
 
$
1.93
  Income from discontinued operations
 
 
19,552
 
22,988
 
 
0.85
 
 
28,600
 
 
23,074
 
 
1.24
 
 
 
42,543
 
 
 
$
1.85
 
 
73,038
 
 
 
 
$
3.17
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Effect of Dilutive Securities (1)
 
 
-
 
366
 
 
 
 
 
-
 
 
290
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Diluted:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
  Income before discontinued operations available
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
to common stockholders
 
 
22,991
 
23,354
 
$
0.98
 
 
44,438
 
 
23,364
 
$
1.91
  Income from discontinued operations
 
 
19,552
 
23,354
 
 
0.84
 
 
28,600
 
 
23,364
 
 
1.22
 
 
$
42,543
 
 
 
$
1.82
 
$
73,038
 
 
 
 
$
3.13
 
 
 
 
 
 
 
 
 
 
 
.
 
 
 
 
 
 
(1)  
Weighted convertible limited partnership units of 2,281,874 and 2,299,361 for the three months ended September 30, 2006 and 2005, respectively, and 2,287,377 and 2,307,884 for the nine months ended September 30, 2006 and 2005, respectively, and Series Z incentive units of 184,000 for the three and nine months ended September 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 nine months ended September 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 0 and 4,788 for the three months ended September 30, 2006 and 2005, respectively, and 0 and 26,930 for the nine months ended September 30, 2006, 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 three and nine months ended and, therefore, were anti-dilutive.

5,980,000 shares of cumulative convertible preferred stock Series G has been excluded from diluted earnings per share for the three and nine months ended September 30, 2006 as the effect was anti-dilutive.
16

 
(9)  
Derivative Instruments and Hedging Activities
 
During the third quarter of 2006 the Company entered into a ten-year forward-starting interest rate swap for a notional amount of $50 million with a settlement date of February 1, 2011. As of September 30, 2006, the Company has entered into forward-starting interest rate swaps totaling a notional amount of $400 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 decrease in the fair value of these derivatives during the nine months ended September 30, 2006 was approximately $2.2 million and is reflected in accumulated other comprehensive income (loss) in the Company’s consolidated financial statements. No hedge ineffectiveness on cash flow hedges was recognized during the nine months ended September 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 a 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 reclassify the following combined revenues, expenses, and net income for the these three properties of $144, $33, and $111 for the nine months ended September 30, 2006, and $552, $339, and $213 for the nine months ended September 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.
 
As of September 30, 2006, the Company has sold 28 of 66 available condominiums at the Peregrine Point property. The Company recorded a gain of approximately $1.1 million, net of minority interest, taxes, and expenses during the three and nine months ended September 30, 2006. The Company did not reclassify the following combined revenues, expenses, and net income for this property during the condo conversion process totaling $584, $580, and $4 for the nine months ended September 30, 2006 and $842, $631, and $211 for the nine months ended September 30, 2005, to discontinued operations due to the fact the amounts are immaterial to the consolidated financial statements.
 
 
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
 
 
Nine Months Ended
 
 
 
 
September 30,
 
 
September 30,
 
 
 
 
2006
 
 
2005
 
 
2006
 
 
2005
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Rental revenues
 
$
-
 
$
-
 
$
-
 
$
1,233
 
Interest and other
 
 
-
 
 
119
 
 
238
 
 
1,492
 
     Revenues
 
 
-
 
 
119
 
 
238
 
 
2,725
 
 
 
 
 
 
 
 
 
         
 
Property operating expenses
 
 
-
 
 
-
 
 
-
 
 
(506)
 
Minority interests
 
 
-
 
 
(11)
 
 
(22)
 
 
(200)
 
     Operating income from real estate sold
 
 
-
 
 
108
 
 
216
 
 
2,019
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Gain on sale of real estate
 
 
1,170
 
 
-
 
 
13,032
 
 
29,219
 
Promote interest and fees
 
 
-
 
 
-
 
 
8,221
   
-
 
Minority interests
 
 
(106)
 
 
-
 
 
(1,917)
   
(2,638)
 
     Net gain on sale of real estate
 
 
1,064
 
 
-
 
 
19,336
   
26,581
 
 
 
 
 
 
 
 
 
         
 
Income from discontinued operations
 
$
1,064
 
$
108
 
$
19,552
 
$
28,600
 
 
 
 
 
 
 
 
 
         
 
 
(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 sought 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 to resolve this lawsuit and these costs were paid during the third quarter of 2006.
 
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 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 nine months ended September 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 apartment community operations, which are located in following major West Coast regions:
 
Southern California (Los Angeles, Ventura, Orange, Riverside and San Diego counties)
Northern California (the San Francisco Bay Area)
Seattle (Seattle metropolitan area)
Other Regions (Portland metropolitan area, and Houston, Texas)

The Company’s consolidated multifamily properties are as follows:


 
As of September 30, 2006
 
As of September 30, 2005
 
 
Number of Apartment
Homes
%
Number of Apartment
Homes
%
Southern California
12,957
53%
12,784
54%
Northern California
5,318
22%
4,621
20%
Seattle
4,943
20%
4,956
21%
Other Regions
1,177
5%
1,177
5%
Total
24,395
100%
23,538
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 September 30, 2006 to the Three Months Ended September 30, 2005

Our average financial occupancies for the Company’s stabilized apartment communities or “Quarterly Same-Properties” (properties consolidated by the Company for each of the three months ended September 30, 2006 and 2005) decreased 0.1% to 96.7% as of September 30, 2006 from 96.8% as of September 30, 2005 for the Quarterly Same-Properties. The regional breakdown of the Company’s Quarterly Same-Property portfolio for financial occupancy for the three months ended September 30, 2006 and 2005 is as follows:

 
 
Three months ended
 
 
 
 
September 30,
 
 
 
 
2006
 
2005
 
Southern California
 
 
96.6%
 
96.8%
 
Northern California