Sept2014q

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, 2014

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 1-12486
Associated Estates Realty Corporation
(Exact name of registrant as specified in its charter)

OHIO
 
34-1747603
(State or other jurisdiction of
 
(I.R.S. Employer
 incorporation or organization)
 
Identification Number)

1 AEC Parkway, Richmond Hts., Ohio 44143-1550
(Address of principal executive offices)
(216) 261-5000
(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 such reports), and (2) has been subject to such filing requirements for the past 90 days.Yes x  No ¨
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x   No ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer x   Accelerated filer ¨ Non-accelerated filer ¨  (Do not check if a smaller reporting company) Smaller reporting company ¨
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨  No x
 
The number of shares outstanding as of October 28, 2014 was 57,647,647 shares.



ASSOCIATED ESTATES REALTY CORPORATION

Index
 
Page
 
 
 
 
ITEM 1
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
ITEM 2
 
 
 
 
 
ITEM 3
 
 
 
ITEM 4
 
 
 
 
 
 
 
ITEM 1
 
 
 
ITEM 1A
 
 
 
ITEM 2
 
 
 
ITEM 6
 
 
 

2

PART 1. FINANCIAL INFORMATION
ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
ASSOCIATED ESTATES REALTY CORPORATION
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
 
 
September 30,
 
December 31,
(In thousands, except share and per share amounts)
 
2014
 
2013
ASSETS
 
 
 
 
Real estate assets
 
 
 
 
Land
 
$
248,407

 
$
298,441

Buildings and improvements
 
1,333,153

 
1,370,560

Furniture and fixtures
 
39,999

 
39,725

Construction in progress
 
85,437

 
42,793

Gross real estate
 
1,706,996

 
1,751,519

Less: accumulated depreciation
 
(396,495
)
 
(386,841
)
Net real estate owned
 
1,310,501

 
1,364,678

Investment in unconsolidated entities
 
45,921

 
9,321

Total net real estate
 
1,356,422

 
1,373,999

Cash and cash equivalents
 
5,328

 
4,586

Restricted cash
 
24,071

 
3,465

Accounts receivable, net
 
 
 
 
Rents
 
1,182

 
1,230

Other
 
2,633

 
1,258

Other assets, net
 
32,195

 
37,959

Total assets
 
$
1,421,831

 
$
1,422,497

LIABILITIES AND EQUITY
 
 
 
 
Mortgage notes payable
 
$
287,824

 
$
279,474

Unsecured notes
 
250,000

 
250,000

Unsecured revolving credit facility
 
41,500

 
133,500

Unsecured term loan
 
150,000

 
150,000

Total debt
 
729,324

 
812,974

Accounts payable and other liabilities
 
48,805

 
42,882

Dividends payable
 
12,188

 
12,178

Resident security deposits
 
3,898

 
4,112

Accrued interest
 
4,792

 
5,551

Total liabilities
 
799,007

 
877,697

 
 
 
 
 
Equity
 
 
 
 
Common shares, without par value, $.10 stated value; 91,000,000
 
 
 
 
authorized; 57,708,675 issued and 57,647,647 outstanding at
 
 
 
 
September 30, 2014 and 57,595,479 issued and 57,476,192
 
 
 
 
outstanding at December 31, 2013, respectively
 
5,771

 
5,760

Paid-in capital
 
757,323

 
754,582

Accumulated distributions in excess of accumulated net income
 
(138,990
)
 
(213,275
)
Accumulated other comprehensive loss
 
(634
)
 
(702
)
Less: Treasury shares, at cost, 61,028 and 119,287 shares
 
 
 
 
at September 30, 2014 and December 31, 2013, respectively
 
(996
)
 
(1,915
)
Total shareholders' equity attributable to AERC
 
622,474

 
544,450

Noncontrolling interest
 
350

 
350

Total equity
 
622,824

 
544,800

Total liabilities and equity
 
$
1,421,831

 
$
1,422,497

 
 
 
 
 
The accompanying notes are an integral part of these consolidated financial statements.

3

ASSOCIATED ESTATES REALTY CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(UNAUDITED)
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
(In thousands, except per share amounts)
 
2014
 
2013
 
2014
 
2013
REVENUE
 
 
 
 
 
 
 
 
Property revenue
 
$
47,444

 
$
45,619

 
$
143,862

 
$
131,409

Office revenue
 
451

 
450

 
1,384

 
1,000

Property management and construction services revenue
 
312

 
—

 
578

 
—

Total revenue
 
48,207

 
46,069

 
145,824

 
132,409

EXPENSES
 
 
 
 
 
 
 
 
Property operating and maintenance
 
18,073

 
17,336

 
55,573

 
50,194

Depreciation and amortization
 
15,779

 
14,212

 
47,958

 
41,960

General and administrative
 
4,200

 
4,946

 
14,116

 
14,302

Development costs
 
162

 
220

 
690

 
662

Construction services
 
129

 
—

 
219

 
—

Costs associated with acquisitions
 
59

 
392

 
172

 
457

Total expenses
 
38,402

 
37,106

 
118,728

 
107,575

Operating income
 
9,805

 
8,963

 
27,096

 
24,834

Interest expense
 
(6,387
)
 
(7,633
)
 
(19,928
)
 
(22,449
)
Gain on disposition of properties
 
—

 
—

 
100,870

 
—

Income from continuing operations
 
3,418

 
1,330

 
108,038

 
2,385

Income from discontinued operations:
 
 
 
 
 
 
 
 
Operating income, net of interest expense
 
—

 
605

 
—

 
2,769

Gain on disposition of properties
 
—

 
18,072

 
—

 
26,868

Income from discontinued operations
 
—

 
18,677

 
—

 
29,637

Net income
 
3,418

 
20,007

 
108,038

 
32,022

Net income attributable to noncontrolling interests
 
—

 
(14
)
 
—

 
(45
)
Net income attributable to AERC
 
$
3,418

 
$
19,993

 
$
108,038

 
$
31,977

Allocation to participating securities
 
—

 
(85
)
 
(364
)
 
(136
)
Net income applicable to common shares
 
$
3,418

 
$
19,908

 
$
107,674

 
$
31,841

 
 
 
 
 
 
 
 
 
Earnings per common share - basic:
 
 
 
 
 
 
 
 
Income from continuing operations applicable to common shares
 
$
0.06

 
$
0.02

 
$
1.87

 
$
0.04

Income from discontinued operations
 
—

 
0.38

 
—

 
0.60

Net income applicable to common shares - basic
 
$
0.06

 
$
0.40

 
$
1.87

 
$
0.64

 
 
 
 
 
 
 
 
 
Earnings per common share - diluted:
 
 
 
 
 
 
 
 
Income from continuing operations applicable to common shares
 
$
0.06

 
$
0.02

 
$
1.86

 
$
0.04

Income from discontinued operations
 
—

 
0.38

 
—

 
0.59

Net income applicable to common shares - diluted
 
$
0.06

 
$
0.40

 
$
1.86

 
$
0.63

 
 
 
 
 
 
 
 
 
Comprehensive income:
 
 
 
 
 
 
 
 
Net income
 
$
3,418

 
$
20,007

 
$
108,038

 
$
32,022

Other comprehensive income:
 
 
 
 
 
 
 
 
Change in fair value and reclassification of hedge instruments
 
814

 
(622
)
 
68

 
1,687

Total comprehensive income
 
4,232

 
19,385

 
108,106

 
33,709

Comprehensive income attributable to noncontrolling interests
 
—

 
(14
)
 
—

 
(45
)
Total comprehensive income attributable to AERC
 
$
4,232

 
$
19,371

 
$
108,106

 
$
33,664

 
 
 
 
 
 
 
 
 
Dividends declared per common share
 
$
0.20

 
$
0.19

 
$
0.58

 
$
0.57

 
 
 
 
 
 
 
 
 
Weighted average shares outstanding - basic
 
57,531

 
49,949

 
57,456

 
49,816

 
 
 
 
 
 
 
 
 
Weighted average shares outstanding - diluted
 
58,033

 
50,267

 
57,928

 
50,376

 
 
 
 
 
 
 
 
 
The accompanying notes are an integral part of these consolidated financial statements.

4

ASSOCIATED ESTATES REALTY CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
 
 
Nine Months Ended
 
 
September 30,
(In thousands)
 
2014
 
2013
Cash flow from operating activities:
 
 
 
 
Net income
 
$
108,038

 
$
32,022

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
47,958

 
43,564

Gain on disposition of properties
 
(100,870
)
 
(26,868
)
Amortization of deferred financing costs and other
 
803

 
909

Share-based compensation expense
 
3,017

 
3,385

Net change in assets and liabilities:
 
 
 

Accounts receivable
 
(348
)
 
(464
)
Accounts payable and accrued expenses
 
(538
)
 
4,349

Other operating assets and liabilities
 
(671
)
 
452

Total adjustments
 
(50,649
)
 
25,327

Net cash flow provided by operating activities
 
57,389

 
57,349

Cash flow from investing activities:
 
 
 
 
Recurring fixed asset additions
 
(7,274
)
 
(8,310
)
Revenue enhancing/non-recurring fixed asset additions
 
(990
)
 
(1,322
)
Acquisition fixed asset additions
 
(47,584
)
 
(143,308
)
Development fixed asset additions
 
(46,224
)
 
(70,012
)
Net proceeds from disposition of operating properties
 
168,756

 
90,453

Contributions to joint ventures
 
(11,841
)
 
(8,874
)
Deposits on potential future acquisitions
 
3,193

 
(15,721
)
Cash proceeds from sale of equity interest in development property
 
24,075

 
—

Escrow deposits related to property sales
 
(72,292
)
 
—

Escrow disbursements related to property acquisition
 
52,414

 
—

Costs paid on behalf of joint venture
 
(6,016
)
 
—

Reimbursements of costs paid on behalf of joint venture
 
5,993

 
—

Other investing activity
 
(1,296
)
 
(1,667
)
Net cash flow provided by (used for) investing activities
 
60,914

 
(158,761
)
Cash flow from financing activities:
 
 
 
 
Principal amortization payments on mortgage notes payable
 
(1,577
)
 
(2,371
)
Principal repayments of mortgage notes payable
 
(20,038
)
 
—

Payment of debt procurement costs
 
(927
)
 
(2,453
)
Proceeds from secured construction loans
 
30,543

 
—

Proceeds from issuance of unsecured notes
 
—

 
150,000

Unsecured revolving credit facility borrowings
 
152,000

 
344,200

Unsecured revolving credit facility repayment
 
(244,000
)
 
(357,700
)
Common share dividends paid
 
(33,428
)
 
(28,170
)
Operating partnership distributions paid
 
—

 
(42
)
Exercise of stock options
 
733

 
1,550

Issuance of common shares
 
—

 
1,870

Purchase of treasury shares
 
(1,033
)
 
(704
)
Purchase of noncontrolling interest in partnership
 
—

 
(4,544
)
Other financing activities, net
 
166

 
361

Net cash flow (used for) provided by financing activities
 
(117,561
)
 
101,997

Increase in cash and cash equivalents
 
742

 
585

Cash and cash equivalents, beginning of period
 
4,586

 
4,740

Cash and cash equivalents, end of period
 
$
5,328

 
$
5,325

Supplemental disclosure of non-cash transactions:
 
 
 
 
Dividends declared but not paid
 
$
12,188

 
$
10,659

Net change in accounts payable related to fixed asset additions
 
7,651

 
6,770

Net change in accounts payable and security deposits
 
 
 
 
  related to disposition of operating properties
 
(486
)
 
(690
)
Deconsolidation of net assets
 
26,238

 
—

 
 
 
 
 
The accompanying notes are an integral part of these consolidated financial statements.

5

ASSOCIATED ESTATES REALTY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1.    BUSINESS
Except as the context otherwise requires, all references to "we," "our," "us," "AERC," "AEC" and the "Company" in this report collectively refer to Associated Estates Realty Corporation and its consolidated subsidiaries.
We are a fully-integrated, self-administered and self-managed equity real estate investment trust ("REIT") specializing in multifamily ownership, operation, acquisition, development, construction, disposition and property management activities. Our primary source of income is rental revenue. Additional income is derived from property management and construction services revenue. We own a taxable REIT subsidiary that performs construction services for our own account in connection with the development of multifamily properties that we own and operate, including consolidated and unconsolidated joint ventures. As of September 30, 2014, our operating portfolio consisted of 50 apartment communities containing 13,034 units in eight states that are owned, either directly or indirectly, through subsidiaries. In conjunction with our acquisition of land for development of an apartment community, we acquired a commercial building in Los Angeles, California containing approximately 78,800 total square feet of office and commercial space. Additionally, we provide property management services for three apartment communities that we expect to acquire pursuant to existing contracts.
2.    SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying unaudited consolidated financial statements have been prepared by management in accordance with accounting principles generally accepted in the United States of America ("GAAP") for interim financial information and applicable rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments consisting only of normal and recurring adjustments considered necessary for a fair statement have been included. The reported results of operations are not necessarily indicative of the results that may be expected for the full year. These financial statements should be read in conjunction with the audited financial statements and accompanying notes in our Annual Report on Form 10-K for the year ended December 31, 2013.
Segment Reporting
Substantially all of our properties are multifamily communities and, while the economic climate of the markets in which they are located may vary from time to time, the communities offer similar products and services and have similar economic characteristics. Management evaluates the performance of our properties and makes acquisition/disposition decisions on an individual basis. During the nine months ended September 30, 2014, substantially all of our consolidated revenue was provided by our multifamily properties. We have determined that, as of September 30, 2014, we have one reportable segment which is multifamily properties.
Derivative Instruments and Hedging Activities
We utilize interest rate swaps to add stability to interest expense and to manage our exposure to interest rate movements. Interest rate swaps designated as cash flow hedges involve the receipt of variable-rate amounts in exchange for fixed-rate payments over the life of the agreements without exchange of the underlying principal amount.

6

We do not use derivatives for trading or speculative purposes. Further, we have a policy of only entering into contracts with major financial institutions based upon their credit ratings and other factors. When viewed in conjunction with the underlying and offsetting exposure that the derivatives are designed to hedge, we have not sustained a material loss from these hedges.
We record all derivatives on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative and the resulting designation. Derivatives used to hedge the exposure to changes in the fair value of an asset, liability or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges. Derivatives used to hedge the exposure to variability in expected future cash flows or other types of forecasted transactions are considered cash flow hedges.
For derivatives designated as cash flow hedges, the effective portion of changes in the fair value of the derivative is initially reported in other comprehensive income (outside of earnings) and subsequently reclassified to earnings when the hedged transaction affects earnings, and the ineffective portion of changes in the fair value of the derivative is recognized directly in earnings. Hedge ineffectiveness is measured by comparing the changes in fair value or cash flows of the derivative hedging instrument with the changes in fair value or cash flows of the designated hedged item or transaction. For derivatives not designated as hedges, changes in fair value are recognized in earnings. See Note 11 for additional information related to our derivative and hedging activities.
Real Estate Capitalization Policies and Depreciation
Real estate assets are stated at cost less accumulated depreciation. Depreciation is provided on a straight-line basis over the estimated useful lives of the assets as follows:
Buildings and improvements
5 - 30 years
Furniture, fixtures and equipment
5 - 10 years
We capitalize replacements and improvements, such as HVAC equipment, structural replacements, windows, appliances, flooring, carpeting and kitchen/bath replacements and renovations. Ordinary repairs and maintenance, such as unit cleaning, painting and appliance repairs, are expensed when incurred.
We allocate the purchase price of acquired properties to net tangible and identified intangible assets and liabilities acquired based on their fair values. In making estimates of fair values for purposes of allocating the purchase price, we utilize a number of sources, including analysis provided by an advisor, independent appraisals that may be obtained in connection with the acquisition or financing of the respective property, our analysis of recently acquired and existing comparable properties in our portfolio and other market data. The intangible assets are amortized over the remaining lease terms, which is approximately 12 months. Due to the short-term nature of residential leases, we believe existing lease rates approximate market rates. Therefore, no allocation is made for above/below market leases. The intangible assets associated with one commercial lease are being amortized over the life of the lease, which is 60 months.

7

For properties under development, we capitalize interest costs on funds used in construction, real estate taxes and insurance from the commencement of development activity through the time the property is substantially complete and ready for leasing. For properties under development accounted for under the equity method, we capitalize interest costs on our investment through the time the venture commences planned principal operations. We also capitalize internal costs related to our consolidated and equity method ventures, which are primarily payroll, but may also include costs such as travel, lodging and temporary construction facilities that are directly attributable to the construction of a property or asset. Certain costs associated with the lease-up of development projects, such as signs and "grand openings" are capitalized and amortized over the estimated life of average tenant relationships, which are approximately 12 months. All other internal costs associated with the lease up of development properties are expensed as incurred. Revenue from incidental operations for properties under development are recognized as reductions of capitalized project costs. Capitalized payroll costs are allocated to projects based upon time incurred by the applicable personnel. Capitalized costs related to development and construction are transferred to buildings and improvements and/or furniture and fixtures, as applicable, upon substantial completion of the project. Total capitalized interest during the three and nine months ended September 30, 2014 was $1.2 million and $3.4 million, respectively. Total capitalized interest during the three and nine months ended September 30, 2013 was $1.1 million and $2.4 million, respectively. Total capitalized payroll costs during the three and nine months ended September 30, 2014 were $860,000 and $2.5 million, respectively. Total capitalized payroll costs during the three and nine months ended September 30, 2013 were $690,000 and $2.0 million, respectively.
We discontinue the depreciation of assets we have specifically identified as held for sale. There were no properties classified as held for sale at September 30, 2014 or December 31, 2013.
Classification of Fixed Asset Additions
We define recurring fixed asset additions to a property as capital expenditures made to replace worn out assets to maintain the property's value. Revenue enhancing/non-recurring fixed asset additions are defined as capital expenditures that increase the value of the property and enable us to increase rents. Acquisition/development fixed asset additions are defined as capital expenditures for the purchase or construction of new properties to be added to our portfolio, or fixed asset additions identified at the time of purchase that are not made until subsequent periods.
Discontinued Operations
In April 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-08, Presentation of Financial Statements (Topic 205) and Property, Plant and Equipment (Topic 360): Reporting of Discontinued Operations and Disclosures of Components of an Entity ("ASU 2014-08"). ASU 2014-08 states that only those disposals of components of an entity that represent a strategic shift that has (or will have) a major effect on an entity's operations and financial results should be reported as discontinued operations in the financial statements. Prior accounting guidance held that a component of an entity that is a reportable segment, an operating segment, a reporting unit, a subsidiary or an asset group was eligible for discontinued operations presentation. This led to many disposals, many of which were routine in nature and did not change an entity's strategy, to be reported as discontinued operations. The amendments in ASU 2014-08 require expanded disclosure for discontinued operations, which should provide financial statement users with more information about the assets, liabilities, revenues and expenses of discontinued operations. As such, our disposition of individual properties will generally no longer meet the guidance to be classified as discontinued operations. See Note 3 for additional information related to how ASU 2014-08 affects our current reporting. This updated guidance requires prospective application for all disposals of components of an entity that occur within annual periods beginning on or after December 15, 2014 and interim periods within those years, with early adoption permitted. We adopted this guidance effective January 1, 2014.

8

Revenue
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606) ("ASU 2014-09"). ASU 2014-09 is a comprehensive new revenue recognition model requiring a company to depict the transfer of goods or services to a customer at an amount reflecting the consideration it expects to receive in exchange for those goods or services. In adopting ASU 2014-09, companies may use either a full retrospective or a modified retrospective approach. Additionally, this guidance requires improved disclosures regarding the nature, amount, timing and uncertainty of revenue and cash flows arising from contracts with customers.  ASU 2014-09 is effective for the first interim period within annual reporting periods beginning after December 15, 2016, and early adoption is not permitted. The Company is currently evaluating the impact the adoption of ASU 2014-09 will have on the Company’s financial position or results of operations.
Going Concern
In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements - Going Concern (Subtopic 205-40) ("ASU 2014-15").  ASU 2014-15 was issued to give clarity to stakeholders when there are conditions or events that raise substantial doubt about an entity’s ability to continue as a going concern.  The guidance calls for, in connection with the preparation of financial statements for each annual and interim reporting period, an evaluation by management over whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the Company’s ability to continue as a going concern within one year after the date that the financial statements are issued (or within one year after the date that the financial statements are available to be issued, when applicable).  ASU 2014-15 is effective for the annual reporting periods ending after December 15, 2016.  ASU 2014-15 will become effective for the Company on January 1, 2016. At this time, the adoption of ASU 2014-15 is not expected to impact the Company's consolidated financial statements.
Reclassifications and Adjustments to Previously Issued Financial Statements
During the three months ended June 30, 2014, certain reclassifications were made to the 2014 financial statements to conform to Accounting Standards Codification No. 360-10-45-5, Impairment and Disposal of Long-Lived Assets, and include gains recognized on the sale of long-lived assets that are not discontinued operations in income from continuing operations.
In connection with the preparation of the financial statements as of June 30, 2014, we identified an adjustment related to the reporting of cash expenditures for development fixed asset additions and the related non-cash investing disclosure which impacted the Consolidated Statements of Cash Flows for the Year Ended December 31, 2013, by reducing cash flow from operating activities and cash used for investing activities. To correctly present cash flows expended for development fixed asset additions, the Consolidated Statements of Cash Flows for the Year Ended December 31, 2013 will include an adjustment of $8.3 million to increase net cash flow provided by operating activities, as well as a corresponding increase to net cash flow used for investing activities. We assessed the materiality of the foregoing adjustment on the prior period financial statements by examining and assessing the pertinent quantitative and qualitative criteria, and concluded that it was not material to the prior period. However, we determined it was appropriate to revise the applicable financial statements the next time such financial statements are included in a filing with the SEC. The following are selected line items from our Consolidated Statements of Cash Flows for the Year Ended December 31, 2013 illustrating the affect of the adjustment thereon:

9

(in thousands)
 
As Reported
 
Adjustment
 
As Revised
Cash flow from operating activities:
 
 
 
 
 
 
Net change in assets and liabilities:
 
 
 
 
 

Accounts payable and accrued expenses
 
$
(3,267
)
 
$
8,262

 
$
4,995

Total adjustments
 
$
12,268

 
$
8,262

 
$
20,530

Net cash flow provided by operating activities
 
$
73,563

 
$
8,262

 
$
81,825

 
 
 
 
 
 
 
Cash flow from investing activities:
 
 
 
 
 
 
Development fixed asset additions
 
$
(77,094
)
 
$
(8,262
)
 
$
(85,356
)
Net cash flow used for investing activities
 
$
(211,176
)
 
$
(8,262
)
 
$
(219,438
)
 
 
 
 
 
 
 
Supplemental disclosure of non-cash information:
 
 
 
 
 
 
Net change in accounts payable related to fixed asset additions
 
$
14,360

 
$
(8,262
)
 
$
6,098

There is no impact on these adjustments to the Consolidated Balance Sheets, Consolidated Statement of Shareholders’ Equity or Consolidated Statements of Operations and Comprehensive Income of the Company in any previously reported periods or any interim periods reported during the year ended December 31, 2013.
3.    ACQUISTION, DEVELOPMENT, AND DISPOSITION ACTIVITY
Acquisition Activity
On September 20, 2013, we entered into an agreement to acquire a portfolio of seven properties for a total purchase price of $323.9 million, including the assumption of $28.0 million of existing mortgage financing. During the year ended December 31, 2013, we closed on three of the seven properties: The Apartments at Blakeney, St. Mary's Square and Lofts at Weston Lakeside. During the nine months ended September 30, 2014, we closed on an additional two properties: Alpha Mill Phase I and Alpha Mill Phase II, which we will operate as one property. We expect to acquire the remaining two properties based on the closing periods set forth in the following table. Each of these remaining closings is contingent upon the completed construction of the property. Our obligation to purchase these properties is subject to certain closing conditions specified in the agreement. If we choose not to purchase one or more of the properties, despite the closing conditions having been satisfied within the time period contemplated by the purchase agreement, we would forfeit the then-remaining balance of our earnest money deposits, which was, as of September 30, 2014, an aggregate of $10.0 million. This remaining balance of earnest money deposits represents our maximum exposure to loss until the closing of the remaining portfolio properties. We consider our deposits allocated to the entities developing the properties under construction to be variable interests and the development entities to be variable interest entities for which we are not the primary beneficiary as of this reporting date. Although we intend to acquire the remaining two properties, and regard our acquisition of each property as probable, there can be no assurance that we will acquire such properties.
The table below provides details for the two remaining properties we plan to acquire:
(Dollar amounts in thousands)
Property
 
Location
 
Units
 
Estimated Closing Period
 
Purchase Price Allocation
1160 Hammond
 
Atlanta, GA
 
345

 
Q4 2014
 
$
80,350

Varela
 
Tampa, FL
 
350

 
Q1 2015
 
79,450

 
 
 
 
695

 
 
 
$
159,800


10

During the year ended December 31, 2012, we entered into an agreement to acquire for a purchase price of $80.2 million a 331-unit property that is being developed in Ft. Lauderdale, Florida. Our purchase obligation is conditioned upon the successful completion of the property in accordance with agreed upon plans and specifications and up to an 18-month period to allow for lease up of the property. Closing will not occur unless the conditions are satisfied, which is currently expected to occur in mid 2015. The developer may elect to terminate our agreement to purchase by agreeing to the release of our $4.0 million earnest money deposit from escrow and paying us an $8.0 million termination fee.  If we choose not to purchase the property, despite the closing conditions having been satisfied within the time period contemplated by the purchase agreement, we would forfeit our $4.0 million earnest money deposit.  This earnest money deposit represents our maximum exposure to loss until the closing of the property. We consider our deposit to be a variable interest and the development entity to be a variable interest entity for which we are not the primary beneficiary as of this reporting date.
On June 10, 2014, we acquired Alpha Mill Phase I and Phase II, a combined 267 units, located in Charlotte, North Carolina, for a total purchase price of $45.1 million. We paid cash for this acquisition, which was funded from proceeds from the sale of Vista Germantown.
During the nine months ended September 30, 2013, we acquired a 388-unit property located in Doral, Florida for a purchase price of $93.5 million, as well as a 152-unit property located in Dallas, Texas for a purchase price of $48.9 million.
The following table represents the purchase price allocation for the properties acquired during the nine months ended September 30, 2014 and September 30, 2013, respectively.
 
 
Nine Months Ended
 
 
September 30,
 
 
2014
 
2013
(In thousands)
 
 
Land
 
$
8,055

 
$
15,971

Buildings and improvements
 
36,139

 
123,193

Furniture and fixtures
 
463

 
1,154

Existing leases (Other assets)
 
418

 
2,082

Total
 
$
45,075

 
$
142,400

The following table presents actual and pro forma information related to the properties acquired during the three and nine months ended September 30, 2014 and 2013, respectively. The pro forma information is presented as if the properties were acquired on January 1, 2013. We recognized acquisition costs during the nine months ended September 30, 2014 totaling $57,000, which are included in "Costs associated with acquisitions" in the Consolidated Statements of Operations and Comprehensive Income. Additionally, we recognized acquisition costs totaling $78,000 related to the current year acquisition during the last half of 2013. The pro forma presentation is presented for informational purposes only, and is not necessarily indicative of what our actual results of operations would have been had the acquisitions occurred at such time.

11

 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
(In thousands, except per share amounts)
 
2014
 
2013
 
2014
 
2013
 
 
 
 
 
 
 
 
 
Actual revenue from acquisitions
 
$
813

 
$
1,732

 
$
974

 
$
1,732

Actual net (loss) income from acquisitions
 
(48
)
 
139

 
(93
)
 
139

Pro forma revenue
 
48,207

 
49,022

 
146,885

 
143,393

Pro forma net income applicable to common shares
 
3,673

 
20,929

 
108,238

 
33,931

 
 
 
 
 
 
 
 
 
Pro forma earnings per common share - basic:
 
 
 
 
 
 
 
 
Pro forma net income applicable to common shares
 
$
0.06

 
$
0.42

 
$
1.88

 
$
0.68

 
 
 
 
 
 
 
 
 
Pro forma earnings per common share - diluted:
 
 
 
 
 
 
 
 
Pro forma net income applicable to common shares
 
$
0.06

 
$
0.42

 
$
1.87

 
$
0.67

Development Activity
On May 28, 2013, we acquired a 3.36-acre parcel of land in the South of Market neighborhood of San Francisco, California for $46.6 million. On February 3, 2014, we entered into a 50/50 partnership with AIG Global Real Estate ("AIG") to develop and own this site known as 350 8th. The partnership is developing a 410-unit apartment community with commercial space and underground parking. See Note 6 for additional information related to this development.
The following table identifies our consolidated development activity on which construction has commenced:
 
 
 
 
 
 
 
 
Total
 
 
 
 
 
 
 
 
(Dollar amounts in thousands)
 
 
Estimated
 
 
 
 
 
Actual
 
Estimated
Under
 
 
 
Ownership
 
Total
 
Capital
 
Cost to
 
Total
 
Construction
 
Construction
Construction
 
Location
 
%
 
Units
 
Cost (1)
 
Date
 
Debt
 
Start
 
Completion
Cantabria at Turtle Creek
 
Dallas, TX
 
100.0%
 
249

 
$
56,800

 
$
46,436

 
$
25,688

 
Q2 2013
 
Q1 2015
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
7001 Arlington at Bethesda
 
Bethesda, MD
 
98.1%
(2) 
140

 
$
53,400

 
$
40,725

 
$
12,954

 
Q4 2012
 
Q2 2015
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
The Desmond on Wilshire
 
Los Angeles, CA
 
100.0%
 
175

 
$
76,300

 
$
40,528

 
$
—

 
Q2 2013
 
Q4 2015
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total
 
 
 
 
 
564

 
$
186,500

 
$
127,689

 
$
38,642

 
 
 
 
(1)
Total capital costs are calculated as if owned 100% by AEC and represent estimated costs for projects under development inclusive of all capitalized costs in accordance with GAAP. Based on current projections as of October 28, 2014.
(2)
Ownership percentage is based on current equity of the joint venture and is subject to change based on changes in total equity. Costs are shown at 100%. Joint venture partner contribution is $350.

12

The following table identifies our unconsolidated development activity on which construction has commenced:
 
 
 
 
 
 
 
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
(Dollar amounts in thousands)
 
 
 
Estimated
 
Cost
 
AEC
 
 
 
AEC
 
Actual
 
Estimated
Under
 
 
 
Ownership
 
Total
 
Capital
 
to
 
Investment
 
Total
 
Share
 
Construction
 
Construction
Construction
 
Location
 
%
 
Units
 
Cost (1)
 
Date
 
to Date
 
Debt
 
of Debt
 
Start
 
Completion
350 8th
 
San Francisco, CA
 
50.0%
 
410

 
$
245,000

 
$
72,500

 
$
33,609

 
$
—

 
$
—

(2 
) 
Q2 2014
 
Q4 2016
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
950 East Third
 
Los Angeles, CA
 
50.0%
 
472

 
$
164,000

 
$
35,566

 
$
4,547

 
$
—

 
$
—

 
Q3 2014
 
Q1 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total
 
 
 
 
 
882

 
$
409,000

 
$
108,066

 
$
38,156

 
$
—

 
$
—

 
 
 
 
(1)
Total capital costs are calculated as if owned 100% by AEC and represent estimated costs for projects under development inclusive of all capitalized costs in accordance with GAAP. Based on current projections as of October 28, 2014.
(2)
AEC has guaranteed 100% of a $143.6 million construction loan which had no outstanding balance as of September 30, 2014.
The following table identifies our unconsolidated development activity that is in the planning phase:
(Dollar amounts in thousands)
 
 
 
Estimated
 
 
 
AEC
 
 
 
AEC
 
 
 
 
Ownership
 
Number
 
Cost to
 
Investment
 
Total
 
Share of
Name
 
Location
 
%
 
Total Units (1)
 
Date
 
to Date
 
Debt
 
Debt
5th and Huntington
 
Monrovia, CA
 
50.0%
 
154

 
$
15,223

 
$
7,765

 
$
—

 
$
—

(1)
Based on current projections as of October 28, 2014.
Disposition Activity
The results of operations and gains related to the sale of operating properties for the current period presented are reported in income from continuing operations in the accompanying Consolidated Statements of Operations and Comprehensive Income. Prior to adoption of ASU 2014-08, and in all prior periods presented, these results were reported in "Income from discontinued operations" in the accompanying Consolidated Statements of Operations and Comprehensive Income. Furthermore, the results of properties classified as held for sale are now reported in income from continuing operations. See Note 2 for additional information related to how ASU 2014-08 affects our current reporting.
During the nine months ended September 30, 2014, we completed the sale of four properties for an aggregate total sales price of $172.2 million and recognized aggregate gains of $100.9 million. Three of the properties were located in Maryland and one in Tennessee.
"Income from discontinued operations" in the accompanying Consolidated Statements of Operations and Comprehensive Income for the three and nine months ended September 30, 2013 includes the operating results for four properties sold in 2013, as well as the recognized gain related to the two properties sold during the nine months ended September 30, 2013. The following table summarizes "Income from discontinued operations":

13

 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
(In thousands)
 
2013
 
2013
Revenue
 
 
 
 
Property revenue
 
$
1,904

 
$
8,144

 
 
 
 
 
Expenses
 
 
 
 
Property operating and maintenance
 
865

 
3,771

Depreciation and amortization
 
434

 
1,604

Total expenses
 
1,299

 
5,375

Operating income
 
605

 
2,769

Interest expense
 
—

 
—

Operating income, net of interest expense
 
605

 
2,769

Gain on disposition of properties
 
18,072

 
26,868

Income from discontinued operations
 
$
18,677

 
$
29,637

We have, on occasion, engaged Hancock Real Estate Strategies ("HRES"), a full service investment real estate brokerage and advisory firm, to provide certain real estate brokerage services. HRES is owned by Matthew E. Friedman, a son of our Chief Executive Officer ("CEO"). For the nine months ended September 30, 2014, in conjunction with the sale of one property in Nashville, Tennessee for $53.3 million on April 2, 2014, HRES was paid a commission totaling $244,000. For the nine months ended September 30, 2013, in conjunction with the sale of two properties and our joint venture to develop the 950 East Third land, HRES received commissions totaling $1.1 million. The aggregate value of those transactions was $122.7 million. These transactions were approved by the Company's independent directors in compliance with Company policy.
4.    DEBT
The following table identifies our total debt outstanding and weighted average interest rates:
 
September 30, 2014
 
December 31, 2013
 
 
 
Weighted
 
 
 
Weighted
 
Balance
 
Average Interest
 
Balance
 
Average Interest
(Dollar amounts in thousands)
Outstanding
 
Rate
 
Outstanding
 
Rate
Fixed Rate Debt:
 
 
 
 
 
 
 
Secured
$
249,182

 
4.9
%
 
$
271,374

 
4.9
%
Unsecured - notes
250,000

 
4.4
%
 
250,000

 
4.4
%
Total Fixed Rate Debt
499,182

 
4.6
%
 
521,374

 
4.7
%
 
 
 
 
 
 
 
 
Variable Rate Debt Swapped to Fixed:
 
 
 
 
 
 
 
Unsecured - term loan
125,000

 
2.7
%
 
125,000

 
3.0
%
Total Variable Rate Debt Swapped to Fixed
125,000

 
2.7
%
 
125,000

 
3.0
%
 
 
 
 
 
 
 
 
Variable Rate Debt Unhedged:
 
 
 
 
 
 
 
Secured
38,642

 
1.5
%
 
8,100

 
1.5
%
Unsecured - revolver
41,500

 
1.5
%
 
133,500

 
1.5
%
Unsecured - term loan
25,000

 
1.6
%
 
25,000

 
1.9
%
Total Variable Rate Debt Unhedged
105,142

 
1.5
%
 
166,600

 
1.5
%
Total Debt
$
729,324

 
3.9
%
 
$
812,974

 
3.8
%

14

Unsecured Debt
On July 25, 2014, we amended and restated our $150.0 million term loan. Among other modifications, the amendment extended the maturity date from January 3, 2018 to January 3, 2020, and reduced the interest rate spread across the pricing grid. The term loan currently bears interest at LIBOR plus a spread of 140 basis points. The interest rate spread over LIBOR is based on the Company's credit ratings and may range from 90 to 190 basis points for LIBOR-based loans. We also entered into an amendment to our unsecured revolving credit facility to implement corresponding financial covenant modifications to our unsecured revolving credit facility.
Mortgage Notes Payable
The following table provides information on mortgage loans repaid during the nine months ended September 30, 2014:
(Dollar amounts in thousands)
 
Loans Repaid
 
Property
 
Amount
 
 Interest Rate
 
Residence at White River
 
$
9,221

 
5.4%
 
Spring Valley
 
10,817

 
5.4%
 
Total/weighted average rate
 
$
20,038

 
5.4%
(1) 
(1)
Represents weighted average interest rate for the loans listed.
On April 25, 2014, the 350 8th partnership, which is accounted for under the equity method of accounting, entered into a construction loan agreement for $143.6 million with a five-year term and, based on our current credit ratings, has a per annum interest rate of LIBOR plus 160 basis points. There were no borrowings on this loan at September 30, 2014. We have guaranteed the payment of all future borrowings from this loan and the completion of construction in connection with the partnership's development. Additionally, we have drawn $25.7 million on the Cantabria at Turtle Creek construction loan and $13.0 million on the 7001 Arlington at Bethesda construction loan as of September 30, 2014. Cash paid for interest net of capitalized interest was $19.3 million and $19.8 million for the nine months ended September 30, 2014 and 2013, respectively.
5.    GOODWILL AND OTHER INTANGIBLE ASSETS
Goodwill
Our goodwill was allocated to our properties on a relative fair value basis. Upon disposition of properties, the goodwill allocated is included in the calculation of the gain or loss on disposal and subsequently written off. During the nine months ended September 30, 2014, we wrote off $150,000 of our goodwill as a result of property dispositions. The carrying value of our goodwill as of September 30, 2014 and December 31, 2013 was $1.4 million and $1.5 million, respectively. Our annual review of goodwill impairment is completed during the first quarter of each year (and more frequently if events or changes in circumstances indicate the carrying value may not be recoverable). The review, completed during the three months ended March 31, 2014, determined that goodwill was not impaired, and no other events have occurred that would require goodwill to be reevaluated. In performing this analysis, we compare the net assets of each property on which goodwill has been allocated, including the amount of allocated goodwill, to its estimated fair market value. Should the estimates used to determine the fair value of the properties change, impairment may result, which could materially impact our results of operations for the period in which it is recorded.

15

Intangible Assets
We allocate a portion of the total purchase price of a property acquisition to any intangible assets identified, such as existing leases. The intangible assets are amortized over the remaining lease terms, which is approximately 12 months. Due to the short-term nature of residential leases, we believe existing lease rates approximate market rates. Therefore, no allocation is made for above/below market leases. The intangible assets associated with one commercial lease are being amortized over the life of the lease, which is 60 months. See Note 13 for additional information related to this lease.
6.    INVESTMENT IN UNCONSOLIDATED ENTITIES
350 8th
On February 3, 2014, we entered into a partnership agreement with AIG, an unrelated third-party, for the development and operation of 350 8th, a 410-unit apartment community with commercial space and underground parking located in San Francisco, California. See Note 3 for more information related to this development. We are a 50.01% partner in this partnership. Our partner, AIG, has contributed $33.9 million to the partnership. The land upon which the partnership is developing was purchased by us for $46.6 million on May 28, 2013. As of December 31, 2013, this land was included in our consolidated financial statements. Upon the formation of our partnership with AIG, the land and improvements to date, with a carrying value of $50.3 million, were deconsolidated. Any future equity capital needs will be funded according to the partners' percentage interests in the partnership. Both partners have equal voting rights with respect to all major decisions, and all such decisions must be unanimous, including, among other things, development planning, budgeting and operational budgets. We perform construction management and property management services in accordance with the approved budgets for which we receive fees. As of September 30, 2014, we have recognized $262,500 of the construction management fee. As the partnership is not sufficiently funded to finance the activities of the entity, and not all of the capital will be funded up front, the partnership is not deemed to have sufficient equity, and has therefore been determined to be a variable interest entity. It has also been determined that we do not control the decisions that most significantly affect the economics of the entity, and that we do not hold a controlling financial interest in the entity. As such, our investment in the entity is accounted for in our consolidated financial statements using the equity method. At September 30, 2014, we have a cumulative basis difference in the partnership of $880,000 due to capitalization of interest on our investment and internal payroll and overhead costs directly related to the development of this property. This excess of our investment over our equity in the underlying net assets of the joint venture is included in "Investment in unconsolidated entities" in our Consolidated Balance Sheets, and will be amortized as a reduction to earnings on a straight-line basis over the lives of the related assets. On April 25, 2014, the partnership entered into a construction loan agreement for $143.6 million with a five-year term. There were no borrowings on this loan at September 30, 2014. We have guaranteed the payment of all future borrowings from this loan and the completion of construction in connection with the partnership's development. See Note 4 for more information related to this loan and Note 13 for more information related to the guarantees. Our maximum exposure to loss, as a result of our involvement in this entity, is the carrying value of our investment, which was $33.6 million as of September 30, 2014.
950 East Third
During the year ended December 31, 2013, we entered into a partnership agreement with Legendary Investors Group No. 1 LLC ("Legendary"), an unrelated third-party, for the development and operation of 950 East Third, a 472-unit apartment community located in Los Angeles, California. We are a 50.0% partner with Legendary, who contributed the land at a value of $30.0 million to the partnership. As of September 30, 2014, we have contributed $4.5 million to the partnership. We expect to fund the remaining portion of our capital contribution during the development and construction process. Both partners have equal voting rights with respect to all major decisions, and all such decisions must be unanimous, including, among other things, development planning, budgeting and operational budgets. We perform construction management and property management services in accordance with the approved budgets for which we receive fees. As of September 30, 2014, we have recognized $125,000 of the construction management fee. As the partnership is not sufficiently funded to finance the activities of the entity, and not all of the capital will be funded up front, the partnership is not deemed to have sufficient equity, and has therefore been determined to be a variable interest entity. It has also been determined that we do not control the decisions that most

16

significantly affect the economics of the entity, and that we do not hold a controlling financial interest in the entity. As such, our investment in the entity is included in our consolidated financial statements using the equity method. At September 30, 2014, we have a cumulative basis difference in the partnership of $470,000 due to the capitalization of interest on our investment and internal payroll and overhead costs directly related to the development of this property. This excess of our investment over our equity in the underlying net assets of the partnership is included in "Investment in unconsolidated entities" in our Consolidated Balance Sheets, and will be amortized as a reduction to earnings on a straight-line basis over the lives of the related assets. Our maximum exposure to loss, as a result of our involvement in this entity, is the carrying value of our investment, which was $4.5 million as of September 30, 2014. See Note 3 for more information related to this development.
5th and Huntington
During the year ended December 31, 2013, we entered into a partnership agreement with LPC MM Monrovia, LLC ("Lincoln"), an unrelated third-party, for the limited purpose of acquiring a property in Monrovia, California, and to produce construction drawings for improvements to the property. The land, upon which the partnership plans to develop a 154-unit multifamily apartment community, was purchased by the partnership on August 9, 2013 for $13.1 million. We are a 50.0% partner with Lincoln, who has contributed $7.5 million to the partnership. As of September 30, 2014, we have contributed $7.8 million to the partnership. Any future equity capital needs will be funded on a 50/50 basis by the partners. Both partners have equal voting rights with respect to all major decisions, and all such decisions must be unanimous, including, among other things, development planning, budgeting and operational budgets. Lincoln will perform the day-to-day activities on behalf of the partnership. As the partnership is not sufficiently funded to finance the activities of the entity, and not all of the capital will be funded up front, the partnership is not deemed to have sufficient equity, and has therefore been determined to be a variable interest entity. It has also been determined that we do not control the decisions that most significantly affect the economics of the entity, and that we do not hold a controlling financial interest in the entity. As such, our investment in the entity is included in our consolidated financial statements using the equity method. At September 30, 2014, we have a cumulative basis difference in the partnership of $370,000 due to the capitalization of interest on our investment and internal payroll and overhead costs directly related to the development of this property. This excess of our investment over our equity in the underlying net assets of the partnership is included in "Investment in unconsolidated entities" in our Consolidated Balance Sheets, and will be amortized as a reduction to earnings on a straight-line basis over the lives of the related assets. Our maximum exposure to loss, as a result of our involvement in this entity, is the carrying value of our investment, which was $7.8 million as of September 30, 2014. See Note 3 for more information related to this development.
7.    NONCONTROLLING INTERESTS
Noncontrolling Redeemable Interest
In 1998, in conjunction with the acquisition of an operating partnership that owned two apartment communities, one of which was sold in October 2005, we issued a total of 522,032 operating partnership units ("OP units"). Holders of OP units were entitled to receive cumulative distributions per OP unit equal to the per share distributions on our common shares. When the OP units were presented for redemption, we were obligated to redeem those OP units for either common shares exchangeable on a one-for-one basis, or the cash equivalent amount, determined as the average closing price for our common shares over the 20-day period preceding the redemption, at our option. On October 23, 2013, we consummated a subsidiary merger transaction that had the effect of converting the remaining 74,083 OP units into a right to receive cash merger consideration, pursuant to which we paid $1.4 million on November 6, 2013. As of December 31, 2013, there were no remaining OP units as all remaining units had been redeemed for cash or canceled in the merger. No OP units were redeemed during the three and nine months ended September 30, 2013.

17


Activity related to the noncontrolling redeemable interest is as follows:
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
(In thousands)
 
2013
 
2013
Balance at beginning of period
 
$
1,734

 
$
1,734

Net income attributable to noncontrolling redeemable interest
 
14

 
42

Distribution to noncontrolling redeemable interest
 
(14
)
 
(42
)
Balance at end of period
 
$
1,734

 
$
1,734

Noncontrolling Interests
On July 14, 2011, we entered into a partnership agreement with Keating Project Development, Inc., an unrelated third-party, pursuant to which we hold a 98.1% equity interest in the partnership. In March 2012, the partnership acquired a 2.5-acre parcel of land in Bethesda, Maryland for $12.2 million on which it is developing 140 apartment units and 7,000 square feet of commercial space. We have determined that this entity is not a variable interest entity and that we hold a controlling interest in the entity. As such, this entity is included in our consolidated financial statements. We have also determined that the noncontrolling interest in this entity meets the criteria to be classified as a component of permanent equity.
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 held a 90.0% equity interest in the partnership. In February 2013, we funded the redemption of the interest of the minority 10.0% partner of this partnership for $4.5 million, as a result of which we owned a 100% interest in Vista Germantown as of February 2013. On April 2, 2014, we disposed of Vista Germantown for a sales price of $53.3 million.
The following table provides details of the activity related to the noncontrolling interests:
 
 
Nine Months Ended
 
 
September 30,
(In thousands)
 
2014
 
2013
Balance at beginning of period
 
$
350

 
$
1,344

Net income
 
—

 
3

Purchase of noncontrolling interest
 
—

 
(997
)
Balance at end of period
 
$
350

 
$
350

The following table provides details of the activity related to changes in ownership of noncontrolling interests:
 
 
Nine Months Ended
 
 
September 30,
 
 
2014
 
2013
Net income attributable to AERC
 
$
108,038

 
$
31,977

Decrease in equity for purchase of noncontrolling interest
 
—

 
(3,547
)
Change from net income attributable to AERC and net
 
 
 
 
transfers to noncontrolling interest
 
$
108,038

 
$
28,430


18

8.    EQUITY
The following table provides a reconciliation of significant activity in equity accounts:
 
 
Nine Months Ended September 30, 2014
 
 
Common
 
 
 
Accumulated
 
 
 
 
 
 
 
 
Shares
 
 
 
Distributions
 
Accumulated
 
 
 
 
 
 
(at $.10
 
 
 
in Excess of
 
Other
 
Treasury
 
 
 
 
stated
 
Paid-In
 
Accumulated
 
Comprehensive
 
Shares
 
Noncontrolling
(In thousands)
 
value)
 
Capital
 
Net Income
 
Loss
 
(at Cost)
 
Interest
Balance, December 31, 2013
 
$
5,760

 
$
754,582

 
$
(213,275
)
 
$
(702
)
 
$
(1,915
)
 
$
350

Net income attributable to AERC
 
—

 
—

 
108,038

 
—

 
—

 
—

Other comprehensive income:
 

 

 

 

 

 

Changes in fair value of hedge
 
 
 
 
 
 
 
 
 
 
 
 
instruments
 
—

 
—

 
—

 
68

 
—

 
—

Share-based compensation
 
—

 
2,016

 
1

 
—

 
1,952

 
—

Purchase of common shares
 
—

 
—

 
—

 
—

 
(1,033
)
 
—

Option exercises
 
8

 
725

 
—

 
—

 
—

 
—

Issuance of common shares
 
3

 
—

 
—

 
—

 
—

 
—

Common share dividends declared
 
—

 
—

 
(33,754
)
 
—

 
—

 
—

Balance, September 30, 2014
 
$
5,771

 
$
757,323

 
$
(138,990
)
 
$
(634
)
 
$
(996
)
 
$
350

9.    EARNINGS PER SHARE
The following table presents a reconciliation of basic and diluted earnings per common share:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
(In thousands, except per share amounts)
2014
 
2013
 
2014
 
2013
Numerator - basic and diluted:
 
 
 
 
 
 
 
Income from continuing operations
$
3,418

 
$
1,330

 
$
108,038

 
$
2,385

Net income attributable to noncontrolling interests
—

 
(14
)
 
—

 
(45
)
Allocation to participating securities
—

 
(85
)
 
(364
)
 
(136
)
Income from continuing operations applicable to common shares
$
3,418

 
$
1,231

 
$
107,674

 
$
2,204

 
 
 
 
 
 
 
 
Income from discontinued operations applicable to common shares
$
—

 
$
18,677

 
$
—

 
$
29,637

 
 
 
 
 
 
 
 
Denominator - basic:
57,531

 
49,949

 
57,456

 
49,816

Effect of dilutive securities (1)
502

 
318

 
472

 
560

Denominator - diluted:
58,033

 
50,267

 
57,928

 
50,376

 
 
 
 
 
 
 
 
Net income applicable to common shares - basic:
 
 
 
 
 
 
 
Income from continuing operations applicable to common shares
$
0.06

 
$
0.02

 
$
1.87

 
$
0.04

Income from discontinued operations
—

 
0.38

 
—

 
0.60

Net income attributable to common shares - basic
$
0.06

 
$
0.40

 
$
1.87

 
$
0.64

 
 
 
 
 
 
 
 
Net income applicable to common shares - diluted:
 
 
 
 
 
 
 
Income from continuing operations applicable to common shares
$
0.06

 
$
0.02

 
$
1.86

 
$
0.04

Income from discontinued operations
—

 
0.38

 
—

 
0.59

Net income attributable to common shares - diluted
$
0.06

 
$
0.40

 
$
1.86

 
$
0.63

(1)
The Company has excluded 93 stock options for the three and nine months ended September 30, 2013, as their inclusion would be anti-dilutive.

19

10.    EQUITY BASED AWARD PLANS
During the three and nine months ended September 30, 2014, we recognized share-based compensation cost of $850,000 and $3.0 million, respectively, in "General and administrative expense" in the Consolidated Statements of Operations and Comprehensive Income. During the three and nine months ended September 30, 2013, we recognized share-based compensation cost of $980,000 and $3.4 million, respectively, in "General and administrative expense" in the Consolidated Statements of Operations and Comprehensive Income. Additionally, during the three and nine months ended September 30, 2014, we capitalized $120,000 and $340,000, respectively, of share-based compensation related to time incurred on development projects. During the three and nine months ended September 30, 2013, we capitalized $90,000 and $300,000, respectively, of share-based compensation related to time incurred on development projects. See Note 2 for additional information related to capitalized payroll.
Restricted Shares. Restricted shares generally have the same rights as our common shares, except for transfer restrictions and forfeiture provisions. We have two compensation plans under which our officers and directors may elect to defer the receipt of restricted shares. Restricted share awards deferred under these plans are reflected as deferred restricted share equivalent units ("DRSUs") in an individual bookkeeping account maintained for each participant. The vesting of DRSUs occurs on the same schedule as the restricted shares made subject to the deferral election, and the valuation and attribution of cost in our consolidated financial statements are also the same as the restricted shares subject to the deferral election. DRSUs are not included in the number of issued and outstanding common shares reflected in the "Equity" section of our Consolidated Balance Sheets. DRSUs with non-forfeitable dividend rights are included in the allocation to participating securities using the two-class method. DRSUs with forfeitable dividend rights do not qualify as participating securities, and are included in the calculation of diluted earnings per share to the extent they are not anti-dilutive for the period presented.
The following table represents restricted share and DRSU activity for the nine months ended September 30, 2014:
 
 
 
 
Weighted
 
 
 
Weighted
 
 
Number of
 
Average
 
 
 
Average
 
 
Restricted
 
Grant-Date
 
Number of
 
Grant-Date
 
 
Shares
 
Fair Value
 
DRSUs
 
Fair Value
Nonvested at beginning of period
 
735,184

 
$
10.52

 
34,797

 
$
17.15

Granted
 
161,267

 
$
16.11

 
39,526

 
$
16.14

Vested
 
171,381

 
$
16.36

 
26,603

 
$
17.38

Forfeited
 
16,280

 
$
10.63

 
8,194

 
$
16.38

Nonvested at end of period
 
708,790

 
$
10.37

 
39,526

 
$
16.14

The weighted average grant-date fair value of restricted shares granted during the nine months ended September 30, 2013 was $10.44. The total fair value of restricted shares vested during the nine months ended September 30, 2014 and 2013 was $3.2 million and $2.7 million, respectively. The total fair value of DRSUs vested during the nine months ended September 30, 2014 and 2013 was $460,000 and $590,000, respectively, recognized as "Paid-in-capital." At September 30, 2014, there was a total of $5.5 million of unrecognized compensation cost related to non-vested restricted share awards and DRSUs that we expect to recognize over a weighted average period of 2.0 years.
During 2014 and 2013, we issued restricted share awards in which the number of shares that will ultimately vest is subject to market conditions over a three-year period and service conditions over a four-year period. The total estimated grant-date fair value of these awards, including the awards that were deferred, were $90,000 during 2014 and $4.3 million during 2013. We used the Monte Carlo method to estimate the fair value of these awards. The Monte Carlo method, which is similar to the binomial analysis, evaluates the award for changing stock prices over the term of vesting, and uses random situations that are averaged based on past stock characteristics. There were one million simulation paths used to estimate the fair value of these awards. The expected volatility for the awards granted in 2014 and 2013 was based upon a 50/50 blend of historical and implied volatility. The historical volatility was based upon changes in the weekly closing prices of our shares over a period equal to the expected life of the restricted shares

20

granted. The implied volatility was the trailing month average of daily implied volatilities calculated by interpolating between the volatilities implied by stock call option contracts that were closest to both the expected life and the exercise price of the restricted shares. The risk-free interest rate used was based on a yield curve derived from U.S. Treasury zero-coupon bonds on the date of grant with a maturity equal to the market condition performance periods. The expected life used was the market condition performance period.
The following table represents the assumption ranges used in the Monte Carlo method for the multi-year restricted share awards:
 
 
2014
 
2013
Expected volatility - AERC
 
22.3% to 24.2%
 
18.1% to 22.5%
Expected volatility - peer group
 
16.9% to 24.7%
 
14.7% to 29.5%
Risk-free interest rate
 
0.02% to 0.8%
 
0.08% to 0.5%
Expected life (performance period)
 
3 years
 
3 years
Stock Options. We use the Black-Scholes option pricing model to estimate the fair value of stock options awarded. There were no options awarded, 80,930 options exercised and 5,000 options forfeited during the nine months ended September 30, 2014. There were no options awarded, 169,164 options exercised and no options forfeited during the nine months ended September 30, 2013.
The following table represents stock option activity for the nine months ended September 30, 2014:
 
 
 
 
 
 
Weighted-Average
 
 
Number of
 
Weighted-Average
 
Remaining
 
 
Stock Options
 
Exercise Price
 
Contract Life
Outstanding at beginning of period
 
510,020

 
$
11.47

 
 
Exercised
 
80,930

 
$
9.07

 
 
Forfeited
 
5,000

 
$
14.00

 
 
Outstanding at end of period
 
424,090

 
$
11.89

 
3.1
 
 
 
 
 
 
 
Exercisable at end of period
 
382,424

 
$
11.52

 
2.6
The aggregate intrinsic value of stock options outstanding and stock options exercisable at September 30, 2014 and 2013 was $2.3 million and $2.2 million, respectively.
11.    DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
We utilize interest rate swaps, from time to time, to add stability to interest risk and to manage our exposure to interest rate movements. See Note 2 for additional information related to our derivative instruments and hedging policy.
As of September 30, 2014, the Company had the following outstanding interest rate derivatives that were designated as cash flow hedges:
Interest Rate Derivative
 
Number of Instruments
 
Notional Amount
Interest Rate Swaps
 
2
 
$125.0 million
    

21

On April 2, 2013, we entered into a forward starting interest rate swap on $125.0 million of our $150.0 million unsecured term loan, fixing the rate beginning June 2, 2016 at a rate of 1.55% per annum plus the credit spread, which was 1.40% per annum as of September 30, 2014, or an all-in rate of 2.95% per annum until January 2018. The credit spread is subject to change, from time to time, from a minimum of 0.90% per annum to a maximum of 1.90% per annum over LIBOR based upon our qualified ratings as defined in the agreement. See Note 12 for additional information.
On December 19, 2011, we entered into a forward starting interest rate swap effective June 7, 2013. This swap hedges the future cash flows of interest payments on $125.0 million of our $150.0 million unsecured term loan by fixing the rate until June 2016 at a rate of 1.26% per annum plus the credit spread, which was 1.40% per annum at September 30, 2014, or an all-in rate of 2.66% per annum. The credit spread is subject to change, from time to time, from a minimum of 0.90% per annum to a maximum of 1.90% per annum over LIBOR based upon our qualified ratings as defined in the agreement. See Note 12 for additional information.
The following table presents the fair value of our derivative financial instruments as well as the classification on the Consolidated Balance Sheets (see Note 12 for additional information regarding the fair value of these derivative instruments):
Fair Value of Derivative Instruments
 
Asset Derivatives
 
As of September 30, 2014
 
As of December 31, 2013
(In thousands)
Balance Sheet Location
 
Fair Value
 
Balance Sheet Location
 
Fair Value
Derivatives designated
 
 
 
 
 
 
 
as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Interest rate swap
Other assets, net
 
$
890

 
Other assets, net
 
$
1,573

Fair Value of Derivative Instruments
 
Liability Derivatives
 
As of September 30, 2014
 
As of December 31, 2013
(In thousands)
Balance Sheet Location
 
Fair Value
 
Balance Sheet Location
 
Fair Value
Derivatives designated
 
 
 
 
 
 
 
as hedging instruments:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Accounts payable and
 
 
 
Accounts payable and
 
 
Interest rate swap
other liabilities
 
$
1,524

 
other liabilities
 
$
2,275

The following table presents the effect of our derivative financial instruments on the Consolidated Statements of Operations and Comprehensive Income:
The Effect of Derivative Instruments on the Consolidated Statements of Operations and Comprehensive Income
 
 
Location of Gain or
 
 
 
 
 
 
 
 
(In thousands)
 
(Loss) Recognized
 
Three Months Ended
 
Nine Months Ended
Derivatives in Cash Flow Hedging
 
in Income
 
September 30,
 
September 30,
Relationships (Interest Rate Swaps)
 
on Derivative
 
2014
 
2013
 
2014
 
2013
Amount of gain/(loss)
 
 
 
 
 
 
 
 
 
 
recognized in OCI on derivative
 
 
 
$
462

 
$
(964
)
 
$
(977
)
 
$
1,257

 
 
 
 
 
 
 
 
 
 
 
Amount of loss reclassified from accumulated
 
 
 
 
 
 
 
 
 
 
OCI into interest expense
 
Interest expense
 
$
(352
)
 
$
(342
)
 
$
(1,045
)
 
$
(430
)
 
 
 
 
 
 
 
 
 
 
 
Amount of gain/(loss) recognized in
 
 
 
 
 
 
 
 
 
 
income on derivative (ineffective portion and
 
 
 
 
 
 
 
 
 
 
amount excluded from effectiveness testing)
 
Other expense
 
$
—

 
$
—

 
$
—

 
$
—


22

The following table presents the effect of offsetting financial assets and liabilities on the Consolidated Balance Sheets:
Offsetting of Derivative Assets and Liabilities
 
 
 
 
 
 
 
 
Gross Amounts Not Offset in
 
 
 
 
 
 
 
 
 
 
the Balance Sheets
 
 
 
 
 
 
 
 
Net Amounts of
 
 
 
 
 
 
 
 
Gross Amounts
 
Gross Amounts
 
Assets/Liabilities
 
 
 
Cash
 
 
 
 
of Recognized
 
Offset in the
 
Presented in the
 
Financial
 
Collateral
 
Net
(In thousands)
 
Assets/Liabilities
 
Balance Sheets
 
Balance Sheets
 
Instruments
 
Received
 
Amount
September 30, 2014
 
 
 
 
 
 
 
 
 
 
 
 
Offsetting Derivative
 
 
 
 
 
 
 
 
 
 
 
 
Assets
 
$
890

 
$
—

 
$
890

 
$
—

 
$
—

 
$
890