ASSOCIATED ESTATES REALTY CORPORATION
TABLE OF CONTENTS
FORM 10-K ANNUAL REPORT
FOR THE YEAR ENDED DECEMBER 31, 2010

PART I

Except as the context otherwise requires, all references to "we," "our," "us" and the "Company" in this report collectively refer to Associated Estates Realty Corporation ("AERC") and its consolidated subsidiaries.

Item 1.  Business

GENERAL DEVELOPMENT OF BUSINESS

We are a self-administered and self-managed equity real estate investment trust ("REIT").  We are publicly traded on the New York Stock Exchange ("NYSE") and the Nasdaq Global Market ("NASDAQ") under the ticker symbol "AEC."  Our headquarters is located at 1 AEC Parkway in Richmond Heights, Ohio.  The headquarters is comprised of one office building of approximately 42,000 square feet and two adjacent parcels of land containing approximately 1.1 and 3.0 acres, respectively, all of which are suitable for further development or expansion and all of which we own under a long-term ground lease.

We engage in property management, development, acquisition, disposition, construction, operation and ownership activities involving multifamily residential real estate.  We own a taxable REIT subsidiary that performs construction services for our own account and for third parties.  During 2010, a second taxable REIT subsidiary completed its final asset management service contract for a third party owner.  As of December 31, 2010, our operating property portfolio consisted of 52 owned apartment communities containing 13,662 units in eight states.  See Item 2 for a state-by-state listing of our portfolio.  Our consolidated financial statements include the accounts of all subsidiaries and qualified REIT subsidiaries, including the two taxable REIT subsidiaries, each of which is separately taxed for federal income tax purposes as a Taxable REIT Subsidiary ("TRS") under the REIT Modernization Act ("RMA") implemented in 1999.  Our consolidated financial statements also include a partnership in which we hold a 90.0% equity interest and an Operating Partnership structured as a DownREIT in which we own 97.4% equity interest.

BUSINESS SEGMENTS

All of our properties are multifamily rental communities that have similar economic characteristics.  Management evaluates the performance of our properties on an individual basis.  Our multifamily properties provided approximately 88.4% of our consolidated revenue for 2010.  Our subsidiary, Merit Enterprises, Inc. (“Merit”), is a general contractor that acts as our in-house construction division and provides general contracting and construction management services to third parties.  For 2010, construction services provided approximately 11.1% of our consolidated revenue.  As a result, we have determined that as of December 31, 2010, we have two reportable segments which are multifamily properties and construction and other services.

OPERATING STRATEGY AND BUSINESS OBJECTIVES

See Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" of this report on Form 10-K for additional discussion of our 2011 outlook and strategy.

Acquisition/Disposition.  Our acquisition/disposition strategy in recent years has been to buy properties outside of the Midwest, sell older, low margin "legacy" properties located in the Midwest and sell properties in markets where we owned a single asset or didn’t plan to grow.  In 2010, we expanded our presence in Northern Virginia, completing the acquisitions of three properties aggregating 1,272 units for a total of approximately $234 million.  We also acquired a 222-unit property in Dallas, Texas for approximately $21 million and broke ground on a new development property in Nashville, Tennessee, announcing our intentions to expand our presence in these new markets.  Since 2005, we have also acquired six other properties consisting of 2,131 units located in Florida, Georgia and Virginia and have completed a 60-unit addition to a Virginia property.

While most of our property sales have been comprised of Midwest and single property locations, we continually monitor the profitability of all of our properties and we will consider opportunistic sales of properties in any market, including our targeted growth markets, if we determine that the proceeds from such sales would provide a greater return on equity and increased cash flow when invested in other properties or used to reduce debt.

Since 2005, we have sold 31 properties containing a total of 6,923 units including 12 Affordable Housing properties, 14 Ohio non-core properties and one property in Florida that we sold at the height of the condo conversion boom.

Property Operations.  We operate in many different markets and submarkets.  Each of these markets may have economic characteristics that differ from other markets, and, as a result, the degree to which we can increase rents varies between markets.  However, our goal is to maximize property net operating income in all of our markets through a combination of increasing net collected rents and by continual efforts to contain controllable operating expenses.  Strategies to increase rents include constant monitoring of our markets, providing superior resident service and desirable communities in which to live, leveraging the power of the internet through enhanced property websites and resident portals and the implementation of programs such as utility and refuse reimbursements.  Our AEC Academy for Career Development provides training and support for our employees, which helps us to provide better trained, quality personnel at our communities as well as minimizing employee turnover.  We attempt to control operating expenses through strategies such as utilizing centralized purchasing contracts benefiting multiple properties and through diligent upkeep and regular maintenance at our apartment communities.

Financing and Capital.  Proceeds received from new debt, debt refinancing, property sales or equity issuances are invested based upon the expected return and the impact on our balance sheet.  Reducing overall interest costs and increasing the number of unencumbered assets have been two of our principal objectives.  During 2007, 2008, 2009 and 2010, we continued to focus on lowering our cost of debt by financing, refinancing and defeasing/prepaying debt.  Our weighted average interest rate on our total debt declined 170 basis points from 7.2% at the end of 2006 to 5.5% at December 31, 2010.  Our interest coverage ratio and fixed charge coverage ratio were 1.97:1 and 1.85:1, respectively, at December 31, 2010, up from 1.54:1 and 1.38:1, respectively, at December 31, 2006.

During 2010, we increased our $150.0 million unsecured revolving credit facility, or revolver, to $250.0 million.  This facility provides financial flexibility and the opportunity to capitalize on strategic acquisitions without the delays associated with financing contingencies.  As of December 31, 2010, we had $157.5 million of availability under our unsecured revolving credit facility.  In addition, we have a credit facility agreement with Wells Fargo Multifamily Capital, on behalf of the Federal Home Loan Mortgage Corporation, or Freddie Mac.  Pursuant to the terms of the facility, we have the potential to borrow up to $100.0 million over a two-year period with obligations being secured by project specific, nonrecourse, non cross-collateralized fixed or variable rate mortgages having terms of five, seven or ten years.  In August, 2010, we used this facility to borrow $36.0 million at a fixed rate of 5.1% for a term of 10 years, leaving $64.0 million of availability under the terms of this facility.

During 2010, we sold 23,575,000 of our common shares in three separate underwritten public offerings.  The net proceeds from these offerings, which totaled $288.8 million, were used to repay maturing debt, redeem all our outstanding 8.70% Class B Series II Preferred Shares, redeem all of our Trust Preferred Securities, partially pay for three operating properties, acquire a parcel of land that we are developing in a partnership, repay borrowings on our unsecured revolver and for general corporate purposes.

General Contractor/Construction.  Our subsidiary, Merit, is a general contractor that acts as our in-house construction division and provides general contracting and construction management services to third parties.  Among other things, we believe we realize significant cost savings and improved reliability and quality in implementing our strategy to enhance the quality of our building exteriors and interiors as a result of the in-house services performed by Merit.

INCOME TAXES

See Note 1 of the Notes to the Consolidated Financial Statements presented in Part II, Item 8 of this report on Form 10-K.

COMPETITIVE CONDITIONS

See Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" of this report on Form 10-K.

CUSTOMERS

Our business, taken as a whole, is not dependent upon any single customer or a few customers.

EMPLOYEES

On February 11, 2011, we employed approximately 390 people.  Satisfactory relations have generally prevailed between our employees and us.

AVAILABLE INFORMATION

Shareholders may obtain, free of charge from our Internet site at http://www.AssociatedEstates.com, a copy of our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act of 1934, as amended, as soon as reasonably practicable after we file such material electronically with, or furnish it to, the Securities and Exchange Commission ("SEC").

REPORTS TO SECURITY HOLDERS

We issue annual reports to our security holders that contain financial statements.

Item 1A. Risk Factors

We are subject to certain risks and uncertainties as described below.  These risks and uncertainties are not the only ones we face and there may be additional risks that we do not presently know of or that we currently consider immaterial.  All of these risks could adversely affect our business, financial condition, results of operations and cash flows.  Our ability to pay dividends on, and the market price of, our equity securities may be adversely affected if any of such risks are realized.

We are subject to risks inherent in the real estate business and operation of a REIT.  We own and manage multifamily apartment communities that are subject to varying degrees of risk generally incident to the ownership of real estate.  Our financial condition, the value of our properties and our ability to make distributions to our shareholders will be dependent upon our continued access to the debt and equity markets and our ability to operate our properties in a manner sufficient to generate income in excess of operating expenses and debt service charges, which may be affected by the following risks, some of which are discussed in more detail below:

We are dependent on rental income from our multifamily apartment communities.  If we are unable to attract and retain residents or if our residents are unable to pay their rental obligations, our financial condition and funds available for distribution to our shareholders may be adversely affected.

Our multifamily apartment communities are subject to competition.  Our apartment communities are located in developed areas that include other apartment communities and compete with other housing alternatives, such as condominiums, single and multifamily rental homes and owner occupied single and multifamily homes.  In certain markets, such as Florida, failed condominium conversions or properties originally developed as condominiums are reverting to apartment rentals, creating increasing competition in those markets.  Foreclosed single family homes that become rental properties could create additional competition in certain of our markets.  Such competition may affect our ability to attract and retain residents and to increase or maintain rental rates.

The properties we own are concentrated in Ohio and Michigan.  As of December 31, 2010, approximately 29% and 21% of the units in properties we own were located in Ohio and Michigan, respectively.  Our performance, therefore, is linked to economic conditions and the market for available rental housing in the sub-markets located in these areas.  The decline in the market for apartment housing in these various sub-markets may adversely affect our financial condition, results of operations and ability to make distributions to our shareholders.

Our insurance may not be adequate to cover certain risks.  There are certain types of risks, generally of a catastrophic nature, such as earthquakes, floods, windstorms, acts of war and terrorist attacks that may be uninsurable, are not economically insurable, or are not fully covered by insurance.  Moreover, certain risks, such as mold and environmental exposures, generally are not covered by our insurance.  Other risks are subject to various limits, sub-limits, deductibles and self insurance retentions, which help to control insurance costs, but which may result in increased exposures to uninsured loss.  Significant uninsured losses could have a material adverse effect on our business, financial condition and results of operations.

Secured debt financing could adversely affect our performance.  At December 31, 2010, 27 of our 52 properties were encumbered by project specific, non-recourse, and except for five properties, non-cross-collateralized mortgage debt.  There is a risk that these properties may not have sufficient cash flow from operations to pay required principal and interest.  We may not be able to refinance these loans at an amount equal to the loan balance and the terms of any refinancing may not be as favorable as the terms of existing indebtedness.  If we are unable to make required payments on indebtedness that is secured by a mortgage, the property securing the mortgage may be foreclosed with a consequent loss of income and value to us.  Although Fannie Mae and Freddie Mac continue to provide needed financing to qualified borrowers, such as ourselves, there is no assurance that those mortgage capital sources will remain available or available on competitively favorable terms.

Real estate investments are generally illiquid, and we may not be able to sell our properties when it is economically or strategically advantageous to do so.  Real estate investments generally cannot be sold quickly, and our ability to sell properties may be affected by market conditions.  We may not be able to further diversify or vary our portfolio in accordance with our strategies or in response to economic or other conditions.  In addition, provisions of the Internal Revenue Code of 1986, as amended (the "Code"), limit the ability of a REIT to sell its properties in some situations when it may be economically advantageous to do so, thereby potentially adversely affecting our ability to make distributions to our shareholders.

Litigation may result in unfavorable outcomes.  Like many real estate operators, we are frequently involved in lawsuits involving premises liability claims, housing discrimination claims and alleged violations of landlord-tenant laws, which may give rise to class action litigation or governmental investigations.  Any material litigation not covered by insurance, such as a class action, could result in substantial costs being incurred.

The costs of complying with laws and regulations could adversely affect our cash flow.  Our properties must comply with Title III of the Americans with Disabilities Act (the "ADA") to the extent that they are "public accommodations" or "commercial facilities" as defined in the ADA.  The ADA does not consider apartment communities to be public accommodations or commercial facilities, except for portions of such communities that are open to the public.  In addition, the Fair Housing Amendments Act of 1988 (the "FHAA") requires apartment communities first occupied after March 13, 1990 to be accessible to disabled individuals.  Other state and local laws also require apartment communities to be disability accessible.  The Fair Housing Act also prohibits discrimination against protected classes of individuals.  Noncompliance with these laws could result in the imposition of fines or an award of damages to private litigants.  We have been subject to lawsuits alleging violations of handicap design laws in connection with certain of our developments.

Under various federal, state and local laws, an owner or operator of real estate may be liable for the costs of removal or remediation of certain hazardous or toxic substances on, under or in the property.  This liability may be imposed without regard to whether the owner or operator knew of, or was responsible for, the presence of the substances.  Other laws impose on owners and operators certain requirements regarding conditions and activities that may affect human health or the environment.  Failure to comply with applicable requirements could complicate our ability to lease or sell an affected property and could subject us to monetary penalties, costs required to achieve compliance and potential liability to third parties.  We are not aware of any material noncompliance, liability or claim relating to hazardous or toxic substances or other environmental matters in connection with any of our properties.  Nonetheless, it is possible that material environmental contamination or conditions exist, or could arise in the future in the apartment communities or on the land upon which they are located.

We are subject to risks associated with construction, development, acquisition and expansion of multifamily apartment communities.  Development projects, acquisitions and expansions of apartment communities are subject to a number of risks, including:

The foregoing risks are also applicable to Merit, our construction services subsidiary, whether engaged in providing services for our properties or for third parties (see “Construction Business Risk” below).

We impose stock ownership limitations that may discourage a takeover otherwise considered favorable by shareholders.  With certain limited exceptions, our Second Amended and Restated Articles of Incorporation, as amended, prohibit the ownership of more than 4.0% of our outstanding common shares and more than 9.8% of the shares of any series of any class of our preferred shares by any person, (the "Ownership Limit"), unless we grant a waiver.  Absent such a waiver, any shares owned in excess of such ownership limit are subject to repurchase by us and to other consequences as set forth in our Second Amended and Restated Articles of Incorporation, as amended.  A transfer of shares may be void if it causes a person to violate the Ownership Limit.  The Ownership Limit could delay or prevent a change in control and, therefore, could adversely affect our security holders' ability to realize a premium over the then prevailing market price for their shares.

We have a shareholders rights plan which would delay or prevent a change in control.   We also have a shareholders rights plan, which may be triggered if any person or group becomes the beneficial owner of, or announces an offer to acquire 15.0% or more of our common shares.  We are incorporated in the State of Ohio, where various state statutes place certain restrictions on takeover activity.  While our Board of Directors believes that our shareholders rights plan could assist in maximizing value for our shareholders in a change in control transaction, our shareholders rights plan and these restrictions are likely to have the effect of precluding acquisition of control of us without our consent.

We may fail to qualify as a REIT and our shareholders may incur tax liability as a result.  Commencing with our taxable year ending December 31, 1993, we have operated in a manner so as to permit us to qualify as a REIT under the Code, and we intend to continue to operate in such a manner.  Many of the REIT requirements, however, are highly technical and complex.  We cannot, therefore, guarantee that we have qualified or will qualify in the future as a REIT.  The determination that we are a REIT requires an analysis of various factual matters that may not be totally within our control.  For example, to qualify as a REIT, our gross income must generally come from rental and other real estate or passive related sources that are itemized in the REIT tax laws.  We are also required to distribute to security holders at least 90.0% of our REIT taxable income excluding capital gains.  If we were to fail to qualify as a REIT in any taxable year, we would not be allowed a deduction for distributions to our shareholders in computing our taxable income and would be subject to federal income tax (including any applicable alternative minimum tax) on our taxable income at regular corporate rates.  Unless we are entitled to relief under certain Code provisions, we also would be disqualified from treatment as a REIT for the four taxable years following the year during which REIT qualification was lost.  As a result, the cash available for distribution to our shareholders could be reduced or eliminated for each of the years involved.

We depend on our key personnel.  Our success depends to a significant degree upon the continued contribution of key members of our management team, who may be difficult to replace.  The loss of services of these executives could have a material adverse effect on us.  There can be no assurance that the services of such personnel will continue to be available to us.  Our Chairman of the Board, President and Chief Executive Officer, Mr. Jeffrey I. Friedman, is a party to an employment agreement with us.  Other than Mr. Friedman, we do not have employment agreements with key personnel.  We do not hold key-man life insurance on any of our key personnel.

We may be exposed to construction business risk.  Our subsidiary, Merit, is engaged in the construction business as a general contractor.  Inherent risks of those operations include the following:

Item 1B.  Unresolved Staff Comments

None.

Item 2.  Properties

Our Portfolio.  The following table represents our portfolio as of December 31, 2010, which consists of properties we owned, directly or indirectly.

Indebtedness Encumbering the Properties.  We have financed, and in many cases refinanced, the acquisition, development and rehabilitation of our properties with a variety of sources of mortgage indebtedness.  At December 31, 2010, 25 of the 52 wholly owned properties were unencumbered.  The remaining 27 properties were encumbered by conventional mortgages, of which five properties were encumbered by cross-collateralized, cross-defaulted mortgage loans.

Item 3.  Legal Proceedings

For information concerning current legal proceedings, see Note 7 of the Notes to Consolidated Financial Statements presented in Part II, Item 8 of this report on Form 10-K.

Item 4.  Submission of Matters to a Vote of Security Holders

No matter was submitted to a vote of security holders during the fourth quarter of 2010.

Executive Officers of the Registrant and Other Key Employees

The following information regarding our executive officers is provided pursuant to Instruction 3 to Item 401(b) of Regulation S-K.

Jeffrey I. Friedman has served as our Chairman of the Board and Chief Executive Officer since the Company was organized in 1993 and served as our President from the Company's organization until February 24, 2000.  In August 2002, Mr. Friedman reassumed the role of President.  Mr. Friedman joined the Company's predecessor, Associated Estates Group ("AEG"), in 1974 and later became Chief Executive Officer and President of Associated Estates Corporation, a company in the AEG group.

Lou Fatica joined the Company in 1999 as Controller, and was promoted to Vice President-Controller during 2000.  On March 15, 2001, Mr. Fatica became Vice President, Treasurer and Chief Financial Officer of the Company.  Mr. Fatica is a Certified Public Accountant (CPA), a member of the American Institute of Certified Public Accountants (AICPA) and the Ohio Society of CPA's.

John T. Shannon joined the Company in 2004 as Senior Vice President, Operations.  Mr. Shannon had previously held the position of Vice President of Operations at The Shelter Group.  He has a degree in Business Administration with a concentration in real estate finance and construction management from the University of Denver.  Mr. Shannon has 21 years of property management experience.

Bradley A. Van Auken joined the Company in November of 2010 and has been serving as Vice President, General Counsel and Secretary since January 1, 2011.  Prior to that time he was engaged in the private practice of law, served as First Vice President-Legal for Equity Residential, and worked as Senior Vice President, General Counsel and Secretary of Lexford Residential Trust.  Mr. Van Auken received both his undergraduate and law degrees from Notre Dame. 

In addition to the officers named in the table above, the following persons have been appointed as officers of the Company and hold positions in senior management as indicated:

Michelle B. Creger joined the Company in 2009 as Vice President, Associate General Counsel.  Ms. Creger was previously the Vice President of Human Resources at U-Store-It Trust, and has also worked for American Greetings Corporation and McDonald Hopkins, a major Cleveland law firm.  She earned her law degree from Case Western Reserve University School of Law and a Bachelor's degree in Economics from Creighton University.  Ms. Creger has over 28 years of legal experience and is 55 years old.

Patrick Duffy joined the Company in 2005 as Vice President of Strategic Marketing.  Mr. Duffy plays a key role in our diversification plan by assisting in identifying markets for asset acquisitions and dispositions.  In addition, he is responsible for developing property-specific marketing plans and strategies to assist in maximizing top line revenue growth for our properties, while also assisting with pricing and positioning strategies.  Mr. Duffy previously held the position of Senior Vice President of Marketing at The Shelter Group.  He graduated from Loyola College and holds a Master's Degree in Administrative Sciences from Johns Hopkins University.  Mr. Duffy has over 24 years of experience in the real estate industry and is 49 years old.

Jason A. Friedman joined the Company in 2009 as Vice President, Construction and Development and as President of Merit Enterprises, Inc.  He previously was the President of JAS Construction, Inc., a general contractor specializing in multifamily renovations.  During his tenure at JAS, he was involved in approximately $100 million of multifamily renovation projects in various states.  Mr. Friedman has also worked for PricewaterhouseCoopers where he provided valuation and advisory services to real estate clients.  He graduated from Auburn University with a major in Communications and Business.  Mr. Friedman is a member of the Urban Land Institute.  Mr. Friedman has over 11 years of real estate experience and is 36 years old.

Daniel E. Gold joined the Company in 2009 as Vice President of Human Resources.  Mr. Gold previously served as the Director of Corporate Human Resources for Falcon Transport and has also worked for Rockwell Automation, Cap Gemini and Bailey Controls.  Mr. Gold is responsible for the oversight of all Human Resource functions, including employee development, compensation, benefits, recruiting and payroll.  Mr. Gold has a Bachelor's of Science degree in Communications from Ohio University, and is a member of both the Ohio Human Resource Planning Society and the Society for Human Resource Management.  Mr. Gold has over 17 years of Human Resources experience and is 42 years old.

Jeremy S. Goldberg joined Associated Estates in February, 2010, and is currently serving as the Vice President of Corporate Finance and Investor Relations.  Mr. Goldberg’s responsibilities include developing and implementing financial and capital markets strategies, facilitating the underwriting and analysis for acquisitions and dispositions and establishing and maintaining investor and sell-side analyst contacts and relationships.  Prior to joining Associated Estates, Mr. Goldberg was in commercial and retail banking for 15 years, at Bank of America and AmTrust Bank.  He received his Bachelor Degree from the University of Michigan and his Master of Business Administration from Case Western Reserve University.  Mr. Goldberg is 37 years old.

John P. Hinkle joined the Company in 2010 as Vice President of Acquisitions.  Mr. Hinkle most recently served as a consultant for Federal Capital Partners.  His previous acquisitions experience also includes Fairfield Residential, Van Metre Companies and Archstone-Smith Trust.  Mr. Hinkle has responsibility for identifying and generating acquisition opportunities that are consistent with the Company’s long-term investment and growth strategy.  He received his Bachelor of Science in Finance from Lehigh University and is a member of the Urban Land Institute.  Mr. Hinkle has over 13 years of experience in the acquisition, development, management and valuation of investment properties and is 39 years old.

Miria C. Rabideau joined the Company in 1994 as a Property Manager, and was promoted to Regional Manager in 2003.  During 2006, she was promoted to Regional Vice President and during 2009 she was promoted to Vice President of Operations.  Ms. Rabideau is responsible for properties in Indiana, Michigan, Northeast Ohio and Florida.  Ms. Rabideau has 18 years of asset and property management experience. She has a Bachelor's degree from Michigan State University and is 41 years old.

Beth L. Stoll joined the Company in 2004 as a Regional Vice President, and was promoted to Vice President of Operations during 2006.  She is responsible for properties in Georgia, Maryland, Virginia, Central Ohio and Texas.  Ms. Stoll is also responsible for the AEC Academy for Career Development, which provides training and support for our employees.  Ms. Stoll previously held the position of Regional Vice President at The Shelter Group.  Ms. Stoll has over 23 years of property management experience and is 55 years old.

PART II

Item 5.  Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

Our common shares are traded on the NYSE and NASDAQ under the trading symbol "AEC."  The following table sets forth for the periods indicated the high and low closing sale prices per common share as reported on the NYSE (composite tape) and the dividends declared per common share.

During the year ended December 31, 2010, net income attributable to AERC was less than the total dividends declared on our common shares.  However, cash flow from operations was sufficient to pay cash dividends.  For a discussion of liquidity and capital resources, see Part II, Item 7 of this report on Form 10-K.

On February 11, 2011, there were approximately 800 holders of record and approximately 8,730 beneficial owners of our common shares.  For information concerning security ownership of certain beneficial owners and management and related shareholder matters, see Part III, Item 12 of this report on Form 10-K.

We maintain a dividend reinvestment plan under which shareholders may elect to reinvest their dividends automatically in our common shares and may also make optional purchases of our common shares.  The administrator of the plan will purchase shares directly from us at our option (either treasury shares or newly-issued common shares), or in the open market, or in privately negotiated transactions with third parties.  All shares purchased by the plan administrator during 2009 and 2010 were open market purchases.

There is a total of $26.3 million remaining on our Board of Director authorizations to repurchase our common shares.  Additionally, we have a policy which allows employees to pay their portion of the income taxes related to restricted shares vesting by surrendering a number of shares to us equal in value on the day of vesting to the amount of taxes due up to the statutory withholding amount.  The following table sets forth our repurchase activities for the fourth quarter of 2010.

Item 6.  Selected Financial Data

The following tables set forth selected financial and other data for us on a consolidated basis.  The historical financial information contained in the tables has been derived from and should be read in conjunction with (i) our Consolidated Financial Statements and Notes thereto and (ii) Management's Discussion and Analysis of Financial Condition and Results of Operations both included elsewhere herein.

Item 7.  Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the consolidated financial statements and notes thereto included in Part II, Item 8 of this report on Form 10-K.  This discussion may contain forward-looking statements based on current judgments and current knowledge of management, which are subject to certain risks, trends and uncertainties that could cause actual results to vary from those projected, including but not limited to, expectations regarding our 2010 performance that are based on certain assumptions.  Accordingly, readers are cautioned not to place undue reliance on forward-looking statements which speak only as of the date of the document.  These forward-looking statements are intended to be covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.  The words "expects," "projects," "believes," "plans," "anticipates" and similar expressions are intended to identify forward-looking statements.  Investors are cautioned that these forward-looking statements involve risks and uncertainty that could cause actual results to differ from estimates or projections contained in these forward-looking statements.  For a discussion of these risks and uncertainties, see "Risk Factors" in Item 1A of this report on Form 10-K.

Overview.  We are engaged primarily in the ownership and operation of multifamily residential units.  Our subsidiary, Merit, is a general contractor that acts as our in-house construction division and provides general contracting and construction management services to third parties.  Our two primary sources of cash and revenue from operations are rents from the leasing of owned apartment units, which represented 88.4% of our consolidated revenue and construction services, which represented 11.1% of our consolidated revenue for the year ended December 31, 2010.

The operating performance of our properties is affected by general economic trends including, but not limited to, factors such as household formation, job growth, unemployment rates, population growth, immigration, the supply of new multifamily rental communities and in certain markets the supply of other housing alternatives, such as condominiums, single and multifamily rental homes and owner occupied single and multifamily homes.  Additionally, our performance may be affected by the access to, and cost of, debt and equity.

Rental revenue collections are impacted by rental rates, occupancy levels and rent concessions.  We adjust our rental rates and concessions in our continuing efforts to adapt to changing market conditions and maximize rental revenue.  We continuously monitor physical occupancy and net collected rent per unit to track our success in maximizing rental revenue.  These indicators are more fully described in the Results of Operations comparison.  Additionally, we consider property NOI and FFO to be important indicators of our overall performance.  Property NOI (property operating revenue less property operating and maintenance expenses) is a measure of the profitability of our properties and has the largest impact on our financial condition and operating results.  FFO is used in the real estate industry as a supplemental measure of the operating performance of real estate companies because it excludes charges such as real estate depreciation that are generally considered not to be reflective of the actual value of real estate assets over time.  Additionally, gains and losses from the sale of most real estate assets and certain other items are also excluded from FFO.  See Selected Financial Data presented in Part II, Item 6 of this report on Form 10-K for reconciliations of property NOI and FFO to consolidated net (loss) income in accordance with accounting principles generally accepted in the United States ("GAAP").

Our Same Community portfolio for the years 2009 and 2010 consists of 48 properties containing 12,108 units and accounted for 83.9% of total revenue in 2010 and 94.3% of our property NOI.  Our same community portfolio includes our properties that we have owned and operated for the entire two-year period ending December 31, 2010.  Same Community NOI increased 0.8% in 2010 compared to 2009 primarily as a result of a $537,000 or 3.1% increase in NOI from our Southeast portfolio.  Our Midwest portfolio NOI increased $276,000 or 0.7% while our Mid-Atlantic portfolio NOI declined $218,000 or 1.6% in 2010. 

Effective in October 2009, Merit, our wholly owned subsidiary, changed its concentration from a subcontractor and painting company to a general contractor that acts as our in-house construction division and also provides general contracting and construction management services to third parties.  Merit’s 2010 revenue and expenses, which represent construction supervision for third parties and are recorded on the percentage of completion method, exceed Merit’s painting and subcontracting revenues and expenses recorded during 2009.

The following table presents property NOI results for 2010 and 2009:

Our 2011 earnings guidance anticipates the acquisition of approximately $50.0 million to $150.0 million of properties and the disposition of approximately zero to $50.0 million of properties.  Additionally, Merit has commenced the development of a 242-unit property, which is held by a partnership in which we are a 90.0% partner.  We anticipate that our development costs on this project for 2011 will be approximately $25.0 million to $30.0 million.  We intend to continue to evaluate potential property acquisitions when our investment criteria warrants an acquisition.  We also may sell properties where market conditions are such that the reinvestment of cash proceeds derived from a sale are expected to provide, over time, a significantly greater return on equity, an increase in cash flow or further enhance our strategic objectives. We will continue to focus on the ratio of our total debt and preferred stock to gross real estate assets which improved to 45.9% at December 31, 2010 compared with 61.0% at December 31, 2009.  We will also continue to focus on the reduction of our overall weighted average interest rate on our borrowings, which improved to 5.5% at December 31, 2010 compared with 6.2% at December 31, 2009 and our fixed charge coverage ratio which improved to 1.85 times at December 31, 2010 from 1.53 times at December 31, 2009.

  In order to maximize property NOI, we plan to continue to focus our efforts on improving revenue, controlling costs and realizing operational efficiencies at the property level, both regionally and portfolio-wide.  In 2011, at the midpoint of our guidance, we expect Same Community NOI to increase 4.5%, driven by a 3.5% increase in property revenue and a 2.0% increase in property operating expenses compared to 2010.  However, the uncertainties caused by economic and financial conditions complicate our ability to forecast future performance.  We believe that the apartment industry is better situated to weather a continuing recessionary environment or delayed recovery than other real estate sectors because people will normally choose shelter over discretionary spending such as going to the mall or hotel stays and because government sponsored agencies such as Fannie Mae and Freddie Mac continue to provide attractive apartment financing, which may be unavailable to other commercial real estate sectors. However, our 2011 expectations may be adversely impacted if recessionary forces resume or if Congress curtails Fannie Mae or Freddie Mac financing support to the apartment industry.  Moreover, unless and until real job growth occurs in our markets, significant rental growth may be limited.

Federal Income Taxes.  We have elected to be taxed as a Real Estate Investment Trust ("REIT") under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended, commencing with our taxable year ending December 31, 1993.  REITs are subject to a number of organizational and operational requirements including a requirement that 90.0% of the income that would otherwise be considered as taxable income be distributed to shareholders.  Providing we continue to qualify as a REIT, we will generally not be subject to federal income tax on net income.  However, our two REIT subsidiaries are subject to federal income tax.

A REIT is precluded from owning more than 10.0% of the outstanding voting securities of any one issuer, other than a wholly owned subsidiary or another REIT, and more than 10.0% of the value of all securities of any one issuer.  As an exception to this prohibition, a REIT is allowed to own up to 100% of the securities of a TRS that can provide non-customary services to REIT tenants and others without disqualifying the rents that a REIT receives from its tenants.  However, no more than 25.0% of the value of a REIT's total assets can be represented by securities of one or more TRS's.  The amount of intercompany interest and other expenses between a TRS and a REIT are subject to arms length allocations.  We have elected TRS status for our two REIT subsidiaries.

LIQUIDITY AND CAPITAL RESOURCES

Cash Flows and Liquidity.  Significant sources and uses of cash in the past three years are summarized as follows:

Significant Cash Sources (Uses):

Our primary sources of liquidity are cash flow provided by operations, short-term borrowings on the unsecured revolver, project specific loans and the sale of debt or equity securities.  Our debt repayment obligations are relatively modest.  We had six mortgage loans totaling approximately $78.3 million that matured in 2010.  We repaid five of the maturing loans and refinanced the other one.  In 2011, we have seven mortgage loans that mature totaling approximately $53.5 million.  On February 10, 2011 we prepaid three of these loans having an outstanding balance of approximately $19.4 million.  It is our intention to prepay the balance of the other four loans on March 1, 2011.  The funding of the repayment of these loans will come from our unsecured revolver and/or other secured or unsecured financings.

In December 2009, we entered into a credit facility agreement with Wells Fargo Multifamily Corporation on behalf of Freddie Mac.  Pursuant to the terms of the facility, we have the potential to borrow up to $100.0 million over a two-year period with obligations being secured by nonrecourse, non cross-collateralized fixed or variable rate mortgages having terms of five, seven or ten years.  In August 2010, we used this facility to borrow $36.0 million at a fixed rate of 5.1% for a term of 10 years leaving $64.0 million of availability under this facility.

In October 2010, we entered into an Amended and Restated Credit Agreement that among other things increased the maximum amount of borrowings under the revolver to $250.0 million, extends the maturity date to October 18, 2013 and provides for a one year extension option.  The Credit Agreement also provides for an increase to the total facility to $300.0 million upon our request and the agreement of the lenders participating in the facility.  At December 31, 2010 we had borrowings of $92.5 million outstanding under this facility.

Our ability to access the capital markets affords us additional liquidity as demonstrated by our sale of 23,575,000 of our common shares in 2010 in three separate underwritten offers to the public markets.  The net proceeds from these offerings, which totaled approximately $288.8 million, were used to repay maturing debt, redeem all of our outstanding 8.70% Class B Series II Cumulative Redeemable Preferred Shares, redeem all of our Trust Preferred Securities, partially pay for three newly acquired operating properties, acquire a parcel of land that we are developing in a partnership, to repay borrowings on our unsecured revolver, and for general corporate purposes.

Cash flow provided by operations increased slightly when comparing 2010 to 2009.  The increase was primarily due to the increase in construction receivables net of the increase in construction payables and the increase in share-based compensation.  The increase in construction activity was due to our subsidiary, Merit, commencing several construction projects during 2010.  Merit records its revenues and related expenses based on the percentage of completion method and as such records receivables and payables as part of the estimate of the amounts completed.  

Cash flow provided by operations increased during 2009 compared to 2008 primarily due to changes in accounts payable and accrued expenses.  These changes were primarily the result of an increase in the fair value of deferred compensation, the payment of real estate taxes in 2008 related to the sale of 15 properties and the payment of other liabilities in 2008 related to funds held for managed properties and our exit from the affordable housing management business.

Shelf Availability.  We have a shelf registration statement that became effective in June 2010.  This registration statement relates to possible offerings, from time to time, of debt securities (including convertible debt), preferred shares, depositary shares, common shares and common share warrants.  This registration statement will expire in June 2013.  In January 2010, we issued $57.4 million of new common shares under our prior registration statement that was dated May 2009 and was scheduled to expire May 2012.  In May 2010, we issued $119.6 million of new common shares under our prior registration statement.  After these two offerings the amount available had been reduced to $37.7 million.  Therefore, we decided to file a new registration statement, which increased the availability to $500.0 million.  In October 2010 we issued $125.1 million of new common shares under this current registration statement.  Securities and/or debt offerings up to $374.9 million are available under this shelf registration statement, after giving effect to the October 2010 common share offering.  Additionally, effective August 4, 2010, we registered a continuous offering program, where we can sell up to $25.0 million of our common shares in open market transactions at the then market price per share.  As of the date of this filing no shares have been sold under this program.

Liquidity:  Normal Business Operations.  We anticipate that we will meet our normal business operations and liquidity requirements for the upcoming year generally through net cash provided by operations.  We believe that if net cash provided by operations is below projections, other sources, such as the unsecured revolver, secured and unsecured borrowings are or can be made available and should be sufficient to meet our normal business operations and liquidity requirements.

Liquidity:  Non-Operational Activities.  Sources of cash available for repayment of debt, any property acquisitions and funding other capital expenditures are expected to be provided primarily by proceeds from the refinancing of debt borrowings, our unsecured revolver, the sale of properties, and possibly the sale of common shares.  The partnership in which we are a 90.0% partner, is developing a 242-unit apartment project that is expected to be completed during 2012.  We anticipate financing the construction costs through a construction loan which the partnership has already obtained.

Long-Term Contractual Obligations.  The following table summarizes our long-term contractual obligations at December 31, 2010, as defined by Item 303(a) 5 of Regulation S-K of the Securities and Exchange Act of 1934.

Debt Payable - Principal.  Debt payable - principal includes principal payments on all property specific mortgages and the unsecured revolving credit facility based on amounts and terms of debt in existence at December 31, 2010.  For detailed information about our debt, see Note 5 of the Notes to Consolidated Financial Statements presented in Part II, Item 8 of this report on Form 10-K.

Debt Payable - Interest.   Debt payable - interest includes accrued interest at December 31, 2010 and interest payments as required based upon the terms of the debt in existence at December 31, 2010.  Interest related to floating rate debt included in the above table was calculated based on applicable rates as of December 31, 2010.

Operating Leases.  We lease certain equipment and facilities under operating leases.  For detailed information about our lease obligations, see Note 7 of the Notes to Consolidated Financial Statements presented in Part II, Item 8 of this report on Form 10-K.

Purchase Obligations.  Purchase obligations represent agreements to purchase goods or services and contracts for the acquisition of properties that are legally binding and enforceable and that specify all significant terms of the agreement.  Our purchase obligations include, but are not limited to, obligations under construction contracts for labor and materials as well as vendor contracts for property operations entered into in the normal course of operations, such as for landscaping, snow removal, elevator maintenance, security, trash removal and electronically generated services. Obligations included in the above table represent agreements dated December 31, 2010, or earlier.

Dividends.  On December 9, 2010, we declared a dividend of $0.17 per common share, which was paid on February 1, 2011, to shareholders of record on January 14, 2011.  We anticipate that we will continue paying quarterly regular dividends in cash. 

Capital Expenditures.  We anticipate incurring approximately $11.4 million in capital expenditures for 2011.  This includes replacement of worn carpet and appliances, parking lots and similar items in accordance with our current property expenditure plan, as well as commitments for investment/revenue enhancing and non-recurring expenditures.  We expect to use cash provided by operating activities to pay for these expenditures.

Financing and Other Commitments.  The following table identifies our total debt outstanding as of December 31, 2010 (dollar amounts in thousands):

The following table provides information on fixed rate mortgage loans repaid at par as well as loans obtained during 2010:

On February 10, 2011, we prepaid three mortgage loans at par that were scheduled to mature on May 10, 2011 for a total of $19.4 million.  This leaves a balance of $34.1 million of mortgage loans that will mature in 2011.  Our current intention is to prepay these loans at par on March 1, 2011.   Funding for the prepayments of all seven of these loans have been and will be made from borrowings under our unsecured revolver or other secured or unsecured financings.

At December 31, 2010, we had 25 unencumbered properties.  These properties had net income of $8.9 million for the year ended December 31, 2010, and a net book value of $410.8 million at December 31, 2010.

We lease certain equipment and facilities under operating leases.  Future minimum lease payments under all non-cancellable-operating leases in which we are the lessee, are included in the previous table of contractual obligations.

Operating Partnership.  As provided in the AERC HP Investors Limited Partnership Agreement ("DownREIT Partnership"), we, as general partner, have guaranteed the obligation of the DownREIT Partnership to redeem OP units held by the limited partners.  The DownREIT Partnership was formed in 1998 and owns and operates Windsor Pines, a 368-unit property in Pembroke Pines, Florida.  Under the terms of the DownREIT Partnership Agreement, the DownREIT Partnership is obligated to redeem OP units for our common shares or cash, at our discretion, at a price per OP unit equal to the 20 day trailing price of our common shares for the immediate 20 day period preceding a limited partner's redemption notice.  As of December 31, 2010 there were 74,083 OP units remaining having a carrying value of $1.7 million, and 447,949 of the original 522,032 OP units had been redeemed.  These transactions had the effect of increasing our interest in the DownREIT Partnership from 85.0% to 97.6%.  For additional information regarding the OP units, see Note 1 of the Notes to the Consolidated Financial Statements presented in Part II, Item 8 of this report on Form 10-K.

Development Partnership.  On September 24, 2010, we entered into a partnership agreement with Bristol Development Group, an unrelated third-party, for the development of Vista Germantown, a 242-unit apartment community located in downtown Nashville, Tennessee.  We contributed $9.4 million to the partnership and hold a 90.0% equity interest.  We have determined that this entity is not a variable interest entity and that we hold a controlling financial interest in the entity.  As such, this entity is included in our consolidated financial statements.  We have also determined that the non-controlling interest in this entity meets the criterion to be classified as a component of permanent equity.  The partnership has engaged Merit to act as general contractor in the construction of this property.  Construction commenced during the fourth quarter of 2010 and is anticipated to be completed in 2012.   We have arranged for a $23.4 million construction loan and have guaranteed the partnership's repayment of the loan.  No amounts had been borrowed under the loan at December 31, 2010.

Acquisition and Development Activities.  On May 18, 2010, we acquired Riverside Station, a 304-unit apartment community located in Woodbridge, Virginia for a purchase price of approximately   $54 million.  We paid cash for this acquisition, a portion of which was funded with proceeds from our May 12, 2010, equity offering.  We determined that the fair value of the property was the same as the purchase price.  Subsequently, in August 2010 we obtained a $36.0 million first mortgage loan which is secured by this property.

On September 15, 2010, we acquired The Ashborough, a 504-unit apartment community located in Ashburn, Virginia for a purchase price of approximately $90 million.  We used cash on hand and borrowings on our unsecured revolver to fund the acquisition.  We determined that the fair value of the property was the same as the purchase price.  Subsequently, on October 1, 2010 we completed an equity offering, a portion of which was used to repay the borrowings on our unsecured revolver.

On October 12, 2010, we acquired San Raphael Apartments, a 222-unit apartment community located in Dallas, Texas for a purchase price of approximately $21 million.  We paid cash for this acquisition, which was funded with proceeds from our October 1, 2010 equity offering.  We determined that the fair value of the property was the same as the purchase price.

On December 14, 2010, we acquired Westwind Farms, a 464-unit apartment community located in Ashburn, Virginia for a purchase price of approximately $90 million.  We used cash on hand and borrowings on our unsecured revolver to fund the acquisition.  We determined that the fair value of the property was the same as the purchase price.

During the quarter ended June 30, 2010, we completed the construction of a 60-unit expansion of our existing 240-unit River Forest apartment community located in the Richmond, Virginia metropolitan market area.  Total cost of development was approximately $6.8 million, which included $311,000 of capitalized interest.

We intend to continue to evaluate land and property acquisitions.  Any future acquisitions or developments would be financed with the most appropriate sources of capital, which may include the assumption of mortgage indebtedness, bank and other institutional borrowings, the exchange of properties, undistributed earnings, secured or unsecured debt financings, or the issuance of shares or units exchangeable into common shares.

Dispositions.  During 2010, we did not complete any sales of our properties, but we continue to evaluate our portfolio for possible dispositions. 

Management and Service Operations.  During 2010 all remaining management contracts with third parties were terminated, both property and asset management contracts, and as such will no longer record such fees.

General Contractor/Construction.  Our subsidiary, Merit, is engaged as a general contractor and construction manager which acts as our in-house construction division as well as provides general contracting and construction management services to third parties.  Merit intends to concentrate its efforts on rehabilitation and ground-up construction projects, primarily for multifamily housing projects.  During 2010 Merit worked on ten projects for third parties, five of which have been completed.  Additionally, Merit completed the rehabilitation of one of our properties and is currently constructing a 242-unit property for a partnership in which we are a 90.0% partner, as previously described.

RESULTS OF OPERATIONS

In the following discussion of the comparison of the year ended December 31, 2010 to the year ended December 31, 2009 and the year ended December 31, 2009 to the year ended December 31, 2008, Same Community properties represent 48 wholly owned properties that were owned during all of 2008, 2009 and 2010.  Acquired/Development properties represent four properties acquired in 2010 and a 60-unit expansion of a Virginia property, which was completed in June 2010.

The net loss from continuing operations decreased $1.1 million during 2010 compared to 2009 primarily as a net result of an increase in total revenues of $23.3 million net of an increase of $21.8 in expenses during 2010.  The net loss from continuing operations decreased $384,000 in 2009 compared to 2008 primarily as a net result of a $1.4 million decrease in interest expense and a $665,000 increase in insurance recoveries, net of a decrease in equity in net income of joint ventures of $1.5 million primarily resulting from the  sale of our joint venture property in 2008. 

The following chart is intended to reflect the amount and percentage change in line items that are relevant to the changes in overall operating performance:

Property Revenue.  Property revenue is impacted by a combination of rental rates, rent concessions and occupancy levels, i.e., net collected rent per unit.  Physical occupancy at the end of each period and net collected rent per unit are presented in the following tables:

Property revenue increased in 2010 compared to 2009 primarily as a result of an increase of $6.9 million contributed by the acquired and development properties.  Property revenue for the Same Community properties increased $1.0 million primarily due to an increase in net rents (potential rent less concessions) and a decline in the amount of vacancy losses.  The majority of the improvement was in the Southeast portfolio.  Property revenues remained consistent when comparing 2009 to 2008.

Fees, Reimbursements and Other.  The management and service company revenues – fees, reimbursements and others declined $470,000 when comparing 2010 to 2009.  Effective during 2010 our remaining property and asset management contracts were terminated.  Therefore, we will no longer be reporting management fee revenue.  The decline when comparing 2009 to 2008 was due to the termination of a large third party management contract during 2009.

Property Operating and Maintenance Expenses.  Property operating and maintenance expenses increased $2.8 million when comparing 2010 to 2009.  This increase was primarily due to property operating and maintenance expenses for the acquired/development properties being $2.4 million in 2010 compared to zero for 2009. Property operating and maintenance expenses remained relatively flat for the Same Community properties in 2009 compared to 2008.

Depreciation and Amortization.  Depreciation and amortization expenses increased $4.7 million when comparing 2010 to 2009.  This increase was primarily due to an increase of approximately $3.6 million in depreciation due to the acquisition/development properties and an increase of $1.1 million in amortization of intangible assets recorded in connection with the acquired properties.  The intangible assets are being amortized over a 12 to 16 month period. Depreciation and amortization expenses decreased in  2009 compared to 2008 primarily as a result of the amortization of the intangible assets recorded in connection with the properties acquired in 2008 having their amortization being completed amortized during 2009.

Direct Property Management and Service Company Expenses.  Direct property management and service company expenses decreased in 2010 compared to 2009 due to the termination of all property and asset management contracts and in 2009 compared to 2008 as a result of the reduction in the number of properties managed for third party owners. 

Construction and Other Services.  Our subsidiary, Merit, is engaged as a general contractor and construction manager which acts as our in-house construction division as well as provides general contracting and construction management services to third parties.  Merit intends to concentrate its efforts on rehabilitation and ground-up construction projects, primarily for multifamily housing projects.  During 2010 Merit worked on ten projects for third parties, five of which have been completed.  Additionally, Merit completed the rehabilitation of one of our properties and is currently constructing a 242-unit property for a partnership in which we are a 90.0% partner, as described above.  Merit records revenue and related expenses on the percentage of completion method.  Also, in accordance with the rules of consolidation, revenue and related expenses for the rehabilitation project that Merit completed for us and the construction of the 242-unit project that Merit is currently working on are eliminated in consolidation .  The revenue and expenses shown for 2010 represent construction services for third parties, while the revenue and expenses shown for 2009 were from third party painting services that Merit provided at that time but has since ceased providing.

General and Administrative Expenses.  General and administrative expenses increased $1.7 million when comparing 2010 to 2009.  This increase was primarily due to an increase in adjustments to various payroll and incentive compensation accruals, including a one-time charge of approximately $400,000 related to the resignation of our former Vice President and General Counsel, net of a decline in directors’ deferred compensation expense.  Prior to January 1, 2010, the fair value of the directors’ deferred compensation was adjusted based upon the closing price of our common shares at the end of each period.  Effective January 1, 2010 this plan was modified to provide that all distributions under the plan will be in the form of our common shares instead of cash.  As a result, the fair value of the deferred compensation is no longer adjusted based upon the closing price of our common shares.  There were no significant variances when comparing 2009 to 2008.

Interest Expense.  Interest expense decreased $2.5 million when comparing 2010 to 2009.  The decrease was primarily due to mortgage loan interest expense declining $2.3 million due to a reduction in mortgage loans of $21.3 million during 2010.  Additionally, on June 30, 2010 we redeemed all of our 7.92% Trust Preferred Securities, which resulted in a reduction in interest expense of $1.0 million.  In connection with the original issuance of the Trust Preferred Securities we incurred issuance costs that were recorded as other assets and subsequently charged to interest expense each period over the life of the securities.  We recognized the remaining balance of $727,000 of issuance costs as a one-time non-cash charge to interest expense in 2010. Additionally, the average interest rate dropped to 5.5% at December 31, 2010 from 6.2% at December 31, 2009.  Interest expense decreased $1.4 million in 2009 compared to 2008 primarily due to the receipt in the first quarter of 2009 of refunds totaling $563,000 of defeasance costs in connection with certain previously defeased loans and decreased interest expense of $310,000 for borrowings on our revolver as well as a reduction in mortgage loans of $20.0 million during 2009. 

Gain on Insurance Recoveries.  During 2010 we settled a wind storm damage claim at one of our central Ohio properties for the aggregate sum of $245,000 which is net of our deductible.  During 2009, we settled a wind storm damage claim involving 13 of our central Ohio properties for the aggregate sum of $906,000, net of our deductible.  Also included in this category for 2009 was a settlement of $271,000, net of our deductible in connection with a clubhouse fire at one of our Ohio properties.  The gain on insurance recoveries recorded in 2010 and 2009 represent insurance proceeds received or to be received in amounts greater than the depreciated carrying (book) value of the assets written off and costs incurred to make repairs (a total of zero in 2010 and $512,000 in 2009).

Equity in Net Income of Joint Ventures.  On December 31, 2008, the joint venture in which we were a 50.0% partner sold the Affordable Housing property that it owned.  Our proportionate share of the gain recognized in 2008 was $1.6 million.

Income from Discontinued Operations.  Included in discontinued operations for the years ended December 31, 2009 and 2008, are the operating results and the gains related to two wholly owned properties that were sold in 2009, and 15 wholly owned properties that were sold in 2008.  The operating loss from discontinued operations in 2008 was primarily due to costs incurred to defease loans that were secured by properties that were sold.  There were no discontinued operations in 2010 as we did not dispose of any properties.  For further details on "Income from discontinued operations," see Note 2 of the Notes to the Consolidated Financial Statements presented in Part II, Item 8 of this report on Form 10-K.

Preferred Share Repurchase Costs.  On June 7, 2010, we redeemed all of our 8.70% Class B Series II Cumulative Redeemable Preferred Shares at a cost of approximately $48.3 million, plus accrued and unpaid dividends through the redemption date.  In connection with the issuance of the 8.70% Class B Preferred Shares in December 2004, we incurred approximately $1.0 million in issuance costs and recorded such costs as a reduction to shareholders’ equity.  We recognized the $1.0 million of issuance costs as a reduction in net earnings in computing our net (loss) income applicable to common shares for the year ended December 31, 2010.

Discount on Preferred Share Repurchase.  In 2008, we repurchased 278,000 of our preferred depositary shares, which each represent 1/10th of a share of our 8.70% Class B Series II Cumulative Redeemable Preferred Shares.  The depositary shares have a recorded value of $25.00 per share.  The average price that we paid per share for the 2008 repurchases was $16.77, and we therefore recognized a total discount of $2.3 million.

Inflation.  We believe that the effects of inflation only minimally impacts our operational performance because our leases are mostly for 12 month terms, which allows us the opportunity to increase our new lease and lease renewal rents to account for inflationary price increases.  We are careful to account for inflationary factors when entering into guaranteed maximum price contracts for third party construction services; however, there can be no assurance that inflation will not have a material adverse impact upon the profitability of our construction services subsidiary in future periods.  See Item 1A "Risk Factors."

Critical Accounting Estimates

Our consolidated financial statements include accounts of all subsidiaries, the two REIT subsidiaries, the Operating Partnership structured as a DownREIT and the joint venture partnership in which we are a 90.0% partner.  The preparation of the consolidated financial statements in conformity with GAAP requires us to make estimates and assumptions in certain circumstances that affect amounts reported in the consolidated financial statements and related notes.  In preparing these consolidated financial statements, we have utilized information available including industry practice and our own past history in forming estimates and judgments of certain amounts included in the consolidated financial statements, giving due consideration to materiality.  It is possible that the ultimate outcome that we anticipated in formulating the estimates inherent in these consolidated financial statements may not materialize.  As a result, actual results could differ from these estimates.  In addition, other companies may utilize different estimates that may impact comparability of our results of operations to those of other companies in similar businesses.

The Company has identified five significant accounting policies as critical accounting policies.  These critical accounting policies are those that have the most impact on the reporting of our financial condition and those requiring significant judgments and estimates.  With respect to these critical accounting policies, management believes that the application of judgments and estimates is consistently applied and produces financial information that fairly presents the results of operations for all periods presented.  The five critical accounting policies are:

Construction Services.  We account for general contracting and construction management services that we provide to third parties using the percentage completion method.  Under this method, the amount of revenue and expense to be recognized for each project that we are engaged in at the end of each reporting period is estimated based on the percentage of work completed on that date.  The use of judgment and/or estimates is required in determining the percentage of work completed, the expected total cost of a project in process, and in certain circumstances the total amount of revenue for a project in process.  If we had used different estimates, different amounts would have been recognized in revenue and expense which may have resulted in a material impact to our results of operations.  If actual costs or revenue differ from estimates, it may require us to make a material adjustment to our results of operations.

Impairment of Long-Lived Assets.  We assess the recoverability of the carrying value of long-lived assets when an event of impairment has occurred.  In performing this analysis, we estimate holding periods of the assets, changes in fair market value of the assets and cash flows related to the operations of the assets to determine the range of potential alternatives and assign a probability to the various alternatives under consideration by management.  Should the estimates used to determine alternatives or the probabilities of the occurrence thereof change, impairment may result which could materially impact our results of operations.

We review goodwill annually and whenever there is an impairment indicator.  In performing this analysis, we use a multiple of revenues to the range of potential alternatives and assign a probability to the various alternatives we consider.  Should estimates used to determine the alternatives considered or the probabilities of the occurrence thereof change, impairment may result which could materially impact our results of operations.

Share Based Compensation.  We estimate the fair value of share-based compensation awarded.  We use the Black-Scholes option-pricing model to estimate the fair value of the stock options, and the Monte Carlo method to estimate the fair value of restricted share awards in which the number of shares that will ultimately vest are subject to market conditions.  The use of judgment and/or estimates is required in determining certain of the assumptions used by these valuation models, such as volatility of share prices and forfeitures of awards.  If we had used different judgment and/or estimates, different valuations would have been produced that may have resulted in a material change to our results of operations.  We also estimate future performance results related to certain share-based awards.  If the results vary from our estimate, it may require us to make a material adjustment to our results of operations.

Real Estate Taxes.  We estimate the amount of real estate taxes for which we will be liable based upon assumptions relating to possible changes in millage rates and property value reassessments.  In most circumstances, the actual millage rates or reassessment values are not available until the following reporting period and consequently these rates or values could differ from assumptions and require material adjustments to the liabilities recorded.

Acquisitions of Investment Properties.  The Company allocates the purchase price of properties to net tangible and identified intangible assets acquired based on their fair values.  In making estimates of fair values for purposes of allocating purchase price, the Company utilizes a number of sources, including independent appraisals that may be obtained in connection with the acquisition or financing of the respective property, our own analysis of recently acquired and existing comparable properties in our portfolio and other market data.  The Company also considers information obtained about each property as a result of its pre-acquisition due diligence, marketing and leasing activities in estimating the fair value of the tangible and intangible assets acquired.

Quantitative and Qualitative Disclosures About Market Risk

Interest Rate Risk.  Based on our variable rate debt outstanding at December 31, 2010, an interest rate change of 100 basis points would impact interest expense by approximately $1.3 million on an annual basis.  Additionally, we have interest rate risk associated with fixed rate debt at maturity.  We have managed, and will continue to manage, interest rate risk as follows:  (i) maintain what we believe to be a conservative ratio of fixed rate, long-term debt to total debt such that variable rate exposure is kept at an acceptable level; (ii) consider hedges for certain long term variable and/or fixed rate debt through the use of interest rate swaps or interest rate caps; and (iii) consider the use of treasury locks where appropriate to hedge rates on anticipated debt transactions.  We use various financial models and advisors to assist us in analyzing opportunities to achieve those objectives.  For additional information related to interest rate hedge agreements, see "Derivative Instruments and Hedging Activities" in Note 1 of the Notes to Consolidated Financial Statements presented in Part II, Item 8 of this report on Form 
10-K.  The table below provides information about our financial instruments that are sensitive to change in interest rates.  For debt obligations, the table below presents principal cash flows and related weighted average interest rates based on expected maturity dates.