FORM 10-KSECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
For the Fiscal Year Ended DECEMBER 31, 2001
OR
Commission file number 1-12252
EQUITY RESIDENTIAL PROPERTIES TRUST (Exact Name of Registrant as Specified in Its Charter)
(312) 474-1300 (Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: None
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 ý No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
The aggregate market value of voting and non-voting shares held by non-affiliates of the Registrant was approximately $7.5 billion based upon the closing price on January 15, 2002 of $27.74 using beneficial ownership of shares rules adopted pursuant to Section 13 of the Securities Exchange Act of 1934 to exclude voting shares owned by Trustees and Executive Officers, some of whom may not be held to be affiliates upon judicial determination.
At January 15, 2002, 271,918,700 of the Registrant's Common Shares of Beneficial Interest were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Part III incorporates by reference information to be contained in the Company's definitive proxy statement, which the Company anticipates will be filed no later than April 30, 2002, and thus these items have been omitted in accordance with General Instruction G (3) to Form 10-K.
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EQUITY RESIDENTIAL PROPERTIES TRUST
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PART I
Item 1. Business
General
Equity Residential Properties Trust ("EQR") is a self-administered and self-managed equity real estate investment trust ("REIT"). EQR was organized in March 1993 and commenced operations on August 18, 1993 upon completion of its initial public offering (the "EQR IPO") of 26,450,000 common shares of beneficial interest, $0.01 par value per share ("Common Shares"). EQR was formed to continue the multifamily property business objectives and acquisition strategies of certain affiliated entities controlled by Mr. Samuel Zell, Chairman of the Board of Trustees of EQR. These entities had been engaged in the acquisition, ownership and operation of multifamily residential properties since 1969. As used herein, the term "Company" includes EQR and those entities owned or controlled by it, as the survivor of the mergers between EQR and each of Wellsford Residential Property Trust, Evans Withycombe Residential, Inc., Merry Land & Investment Company, Inc. and Lexford Residential Trust (collectively, the "Mergers"). The term "Company" also includes Globe Business Resources, Inc. ("Globe") and Grove Property Trust ("Grove"). The Company completed the sale of its Globe furniture rental business on January 11, 2002. The Company has elected to be taxed as a REIT under Section 856(c) of the Internal Revenue Code of 1986, as amended (the "Code"). Certain capitalized terms are defined in the Notes to the Company's Consolidated Financial Statements.
EQR is the general partner of, and as of December 31, 2001, owned an approximate 92.1% ownership interest in, ERP Operating Limited Partnership (the "Operating Partnership"). The Company conducts substantially all of its business and owns substantially all of its assets through the Operating Partnership. The Operating Partnership is, in turn, directly or indirectly, a partner, member or shareholder of numerous partnerships, limited liability companies and corporations which have been established primarily to own fee simple title to multifamily properties or to conduct property management activities and other businesses related to the ownership and operation of multifamily residential real estate. References to the "Company" include the Operating Partnership and each of the partnerships, limited liability companies and corporations controlled by the Operating Partnership or EQR.
The Company is engaged in the acquisition, ownership, management, operation and disposition of multifamily properties. As of December 31, 2001, the Company owned or had interests in a portfolio of 1,076 multifamily properties (individually a "Property" and collectively the "Properties") containing 224,801 apartment units consisting of the following:
The Company accounts for its ownership interest in the 955 "Wholly Owned Properties" under the consolidation method of accounting. The Company beneficially owns 100% fee simple title to 948 of the 955 Wholly Owned Properties. The Company has a leasehold estate ownership interest in one Property. As such, the Company owns the real estate building and improvements and leases the land underlying the improvements under a long-term ground lease that expires in 2066. This one Property is consolidated and reflected as a real estate asset while the ground lease is accounted for as an operating lease in accordance with Statement of Financial Accounting Standards ("SFAS") No. 13, Accounting for Leases. The Company owns the debt collateralized by two Properties and owns an interest in the debt
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collateralized by the remaining four Properties. The Company consolidates its interest in these six Properties in accordance with the accounting standards outlined in the AcSEC guidance for real estate acquisition, development and construction arrangements issued in the CPA letter dated February 10, 1986, and as such, reflects these assets as real estate in the consolidated financial statements.
The "Partially Owned Properties" are controlled and partially owned by the Company but have partners with minority interests and are accounted for under the consolidation method of accounting. The "Unconsolidated Properties" are partially owned but not controlled by the Company and consist of investments in partnership interests and/or subordinated mortgages that are accounted for under the equity method of accounting. The above table does not include various uncompleted development properties.
The Company is one of the largest publicly traded REIT's (based on the aggregate market value of its outstanding Common Shares) and is the largest publicly traded REIT owner of multifamily properties (based on the number of apartment units wholly owned and total revenues earned). The Company's Properties are located in 36 states with its corporate headquarters located in Chicago, Illinois. The Company also leases (under operating leases) over thirty-five divisional, regional and area property management offices throughout the United States.
Direct fee simple title for certain of the Properties is owned by single-purpose nominee corporations, limited partnerships and limited liability companies or land trusts that engage in no business other than holding title to the Property for the benefit of the Company. Holding title in such a manner is expected to make it less costly to transfer such Property in the future in the event of a sale and should facilitate financing, since lenders often require title to a Property to be held in a single purpose entity in order to isolate that Property from potential liabilities of other Properties.
The Company has approximately 6,400 employees as of March 1, 2002. An on-site manager, who supervises the on-site employees and is responsible for the day-to-day operations of the Property, directs each of the Company's Properties. An assistant manager and/or leasing staff generally assist the manager. In addition, a maintenance director at each Property supervises a maintenance staff whose responsibilities include a variety of tasks, including responding to service requests, preparing vacant apartments for the next resident and performing preventive maintenance procedures year-round.
Business Objectives and Operating Strategies
The Company seeks to maximize both current income and long-term growth in income, thereby increasing:
The Company's strategies for accomplishing these objectives are:
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The Company is committed to resident satisfaction by striving to anticipate industry trends and implementing strategies and policies consistent with providing quality resident services. In addition, the Company continuously surveys rental rates of competing properties and conducts resident satisfaction surveys to determine the factors they consider most important in choosing a particular apartment unit and/or Property.
Acquisition and Development Strategies
The Company anticipates that future property acquisitions and developments will occur within the continental United States. Management will continue to use market information to evaluate opportunities. The Company's market database allows it to review the primary economic indicators of the markets where the Company currently owns and manages Properties and where it expects to expand its operations. Acquisitions and developments may be financed from various sources of capital, which may include retained cash flow, issuance of additional equity securities, sales of Properties, joint venture agreements and collateralized and uncollateralized borrowings. In addition, the Company may acquire additional properties in transactions that include the issuance of limited partnership interests in the Operating Partnership ("OP Units") as consideration for the acquired properties. Such transactions may, in certain circumstances, enable the sellers to defer, in part, the recognition of taxable income or gain, which might otherwise result from the sales.
When evaluating potential acquisitions and developments, the Company will consider:
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Financing Strategies
On October 11, 2001, the Company effected a two-for-one split of its Common Shares and OP Units to shareholders and unit holders of record as of September 21, 2001. All Common Shares and OP Units presented have been retroactively adjusted to reflect the Common Share and OP Unit split.
The Company's "Consolidated Debt-to-Total Market Capitalization Ratio" as of December 31, 2001 is presented in the following table. The Company calculates the equity component of its market capitalization as the sum of (i) the total outstanding Common Shares and assumed conversion of all OP Units at the equivalent market value of the closing price of the Company's Common Shares on the New York Stock Exchange; (ii) the "Common Share Equivalent" of all convertible preferred shares and preference interests/units; and (iii) the liquidation value of all perpetual preferred shares and preference interests outstanding.
Capitalization as of December 31, 2001
Convertible Preferred Shares, Preference Interests and UnitsAs of December 31, 2001
The Company's policy is to maintain a ratio of consolidated debt-to-total market capitalization of less than 50%.
It is also the Company's policy that all unsecured indebtedness (other than short-term trade, employee compensation or similar indebtedness that will be paid in the ordinary course of business) be
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incurred by the Operating Partnership to the extent necessary to fund the business activities conducted by the Operating Partnership and its subsidiaries.
Equity Offerings For the Years Ended December 31, 2001, 2000 and 1999
During 2001, the Company:
During 2000, the Company:
During 1999, the Company:
The Company filed with the SEC on February 3, 1998 a Form S-3 Registration Statement to register $1 billion of equity securities. The SEC declared this registration statement effective on February 27, 1998. In addition, the Company carried over $272 million related to the registration statement that was declared effective on August 4, 1997. As of December 31, 2001, $1.1 billion in equity securities remained available for issuance under this registration statement.
During 2001, 2000 and 1999, the Company, through a subsidiary of the Operating Partnership, issued various Preference Interests series (the "Preference Interests") with an equity value of
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$246.0 million receiving net proceeds of $239.9 million. The following table presents the issued and outstanding Preference Interests as of December 31, 2001 and December 31, 2000:
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Debt Offerings For the Years Ended December 31, 2001, 2000 and 1999
During 2001:
During 2000:
During 1999:
The Operating Partnership filed a Form S-3 Registration Statement on August 25, 2000 to register $1 billion of debt securities. The SEC declared this registration statement effective on September 8, 2000. In addition, the Operating Partnership carried over $430 million related to the registration statement effective on February 27, 1998. As of December 31, 2001, $1.13 billion in debt securities remained available for issuance under this registration statement.
Disposition Strategies
Management will use market information to evaluate dispositions. Factors the Company considers in deciding whether to dispose of its Properties include the following:
The Company will reinvest the proceeds received from property dispositions primarily to fund property acquisitions as well as fund development activities. In addition, when feasible, the Company may structure these transactions as tax deferred exchanges.
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Credit Facilities
The Company has a revolving credit facility to provide the Operating Partnership with potential borrowings of up to $700 million. This line of credit is scheduled to expire in August 2002 and the Company has begun negotiations to have a new line of credit in place by the end of the second quarter of 2002. As of February 28, 2002, $262.0 million was outstanding under this facility at a weighted average interest rate of 2.38%.
In connection with its acquisition of Globe, the Company assumed a revolving credit facility with potential borrowings of up to $55.0 million. On May 31, 2001, this credit facility was terminated.
Business Combinations
On October 1, 1999, the Company completed the acquisition of the multifamily property business of Lexford Residential Trust ("LFT") through the LFT Merger. The transaction was valued at approximately $738 million and included 402 LFT Properties containing 36,609 units. The purchase price consisted of:
On July 11, 2000, the Company acquired Globe in an all cash and debt transaction valued at approximately $163.2 million. Globe provided fully furnished short-term housing through an inventory of leased housing units to transferring or temporarily assigned corporate personnel, new hires, trainees, consultants and individual customers throughout the United States. Additionally, Globe rents and sells furniture to a diversified base of commercial and residential customers throughout the United States. Shareholders of Globe received $13.00 per share, which approximated $58.7 million in cash based on the 4.5 million Globe shares outstanding. In addition, the Company:
On July 21, 2000, the Company, through its Globe subsidiary, acquired Temporary Quarters, Inc., the leading corporate housing provider in Atlanta, Georgia, in a $3.3 million all cash transaction.
As of September 30, 2001, the Company recorded $60.0 million of asset impairment charges related to its furniture rental business. These charges were the result of a review of the existing intangible and tangible assets reflected on the consolidated balance sheet as of September 30, 2001. The impairment loss is reflected on the income statement in total expenses and includes the write-down of the following assets: a) goodwill of approximately $26.0 million; b) rental furniture, net of approximately $28.6 million; c) property and equipment, net of approximately $4.5 million; and d) other assets of approximately $0.9 million.
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On January 11, 2002, the Company sold the former Globe furniture rental business for approximately $30.0 million in cash, which approximated the net book value at the sale date. The Company has retained ownership of the former Globe short-term furnished housing business, which is now known as Equity Corporate Housing.
On October 31, 2000 the Company acquired Grove, which included 60 properties containing 7,308 units for a total purchase price of $463.2 million. The Company:
The Company accounted for these business combinations as purchases in accordance with Accounting Principles Board ("APB") Opinion No. 16. The fair value of the consideration given by the Company was used as the valuation basis for each of the combinations.
Competition
All of the Properties are located in developed areas that include other multifamily properties. The number of competitive multifamily properties in a particular area could have a material effect on the Company's ability to lease units at the Properties or at any newly acquired properties and on the rents charged. The Company may be competing with other entities that have greater resources than the Company and whose managers have more experience than the Company's managers. In addition, other forms of rental properties, including multifamily properties and manufactured housing, some of which may be controlled by Mr. Zell, and single-family housing, provide housing alternatives to potential residents of multifamily properties.
Risk Factors
The following Risk Factors may contain defined terms that are different from those used in the other sections of this report. Unless otherwise indicated, when used in this section, the terms "we" and "us" refer to Equity Residential Properties Trust and its subsidiaries, including ERP Operating Limited Partnership.
Set forth below are the risks that we believe are important to investors who purchase or own our common shares of beneficial interest or preferred shares of beneficial interest (which we refer to collectively as "Shares"); preference interests ("Interests") of a subsidiary of ERP Operating Limited Partnership; preference units ("Units"); or units of limited partnership interest ("OP Units") of ERP Operating Limited Partnership, our operating partnership, which are redeemable on a one-for-one basis for common shares or their cash equivalent. In this section, we refer to the Shares, Interests, Units and
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the OP Units together as our "securities," and the investors who own Shares, Interests, Units and/or OP Units as our "security holders."
Debt Financing, Preferred Shares and Preference Interests and Units Could Adversely Affect Our Performance
The Company's total debt summary, as of December 31, 2001, included:
Debt Summary as of December 31, 2001
In addition to debt, we have issued and outstanding $1.2 billion of liquidation value for the preferred shares of beneficial interest and preference interests and units combined, with a weighted average dividend preference of 8.06% per annum. Our use of debt and preferred equity financing creates certain risks, including the following.
Scheduled Debt Payments Could Adversely Affect Our Financial Condition
In the future, our cash flow could be insufficient to meet required payments of principal and interest or to pay distributions on our securities at expected levels.
We may not be able to refinance existing debt (which in virtually all cases requires substantial principal payments at maturity) and, if we can, the terms of such refinancing might not be as favorable as the terms of existing indebtedness. If principal payments due at maturity cannot be refinanced, extended or paid with proceeds of other capital transactions, such as new equity capital, our cash flow will not be sufficient in all years to repay all maturing debt. As a result, we may be forced to postpone capital expenditures necessary for the maintenance of our properties and may have to dispose of one or
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more properties on terms that would otherwise be unacceptable to us. The Company's debt maturity schedule as of December 31, 2001 is as follows:
Debt Maturity ScheduleAs of December 31, 2001
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Financial Covenants Could Adversely Affect the Company's Financial Condition
If a property we own is mortgaged to secure payment of indebtedness and we are unable to meet the mortgage payments, the holder of the mortgage could foreclose on the property, resulting in loss of income and asset value. Foreclosure on mortgaged properties or an inability to refinance existing indebtedness would likely have a negative impact on our financial condition and results of operations. A foreclosure could also result in our recognition of taxable income without our actually receiving cash proceeds from the disposition of the property with which to pay the tax. This could adversely affect our cash flow and could make it more difficult for us to meet our distribution requirements as a real estate investment trust (a "REIT").
The mortgages on our properties may contain customary negative covenants that, among other things, limit our ability, without the prior consent of the lender, to further mortgage the property and to reduce or change insurance coverage. In addition, our credit facilities contain certain customary restrictions, requirements and other limitations on our ability to incur indebtedness. Our current $700 million revolving credit facility matures in August 2002 and we will negotiate new covenants when we enter into the new credit facility which we expect will be no more restrictive than those contained in our existing credit facility, although there can be no assurance that our expectations will prove to be accurate. The indentures under which a substantial portion of our debt was issued also contain certain financial and operating covenants including, among other things, maintenance of certain financial ratios, as well as limitations on our ability to incur secured and unsecured indebtedness (including acquisition financing), and to sell all or substantially all of our assets. Our credit facility and indentures are cross-defaulted and also contain cross default provisions with other material indebtedness.
Some of the properties were financed with tax-exempt bonds that contain certain restrictive covenants or deed restrictions. We have retained an independent outside consultant to monitor compliance with the restrictive covenants and deed restrictions that affect these properties. If these bond compliance requirements restrict our ability to increase our rental rates to attract low or moderate-income tenants, or eligible/qualified tenants, then our income from these properties may be limited.
Our Degree of Leverage Could Limit Our Ability to Obtain Additional Financing
Our Consolidated Debt-to-Total Market Capitalization Ratio was approximately 37.20% as of December 31, 2001. We have a policy of incurring indebtedness for borrowed money only through the Operating Partnership and its subsidiaries and only if upon such incurrence our debt to market capitalization ratio would be approximately 50% or less. Our degree of leverage could have important consequences to security holders. For example, the degree of leverage could affect our ability to obtain additional financing in the future for working capital, capital expenditures, acquisitions, development or other general corporate purposes, making us more vulnerable to a downturn in business or the economy generally.
Rising Interest Rates Could Adversely Affect Cash Flow
Advances under our credit facility bear interest at variable rates based upon LIBOR available at various interest periods, plus a certain spread dependent upon the Company's credit rating. Certain public issuances of our senior unsecured debt instruments also, from time to time, bear interest at floating rates. We may also borrow additional money with variable interest rates in the future. Increases in interest rates would increase our interest expenses under these debt instruments and would increase the costs of refinancing existing indebtedness and of issuing new debt. Accordingly, higher interest rates could adversely affect cash flow and our ability to service our debt and to make distributions to security holders.
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Control and Influence by Significant Shareholders Could be Exercised in a Manner Adverse to Other Shareholders
As of January 15, 2002, (1) Samuel Zell, the Chairman of the Board of the Company, and certain of the current holders of Units issued to affiliates of Mr. Zell owned in the aggregate approximately 3.1% of our common shares (Mr. Zell and these affiliates are described herein as the "Zell Original Owners"); and (2) our executive officers and trustees, excluding Mr. Zell (see disclosure above), owned approximately 5.7% of our common shares. These percentages assume all options are exercised for common shares and all Units are converted to common shares. In addition, the consent of certain affiliates of Mr. Zell is required for certain amendments to the Fifth Amended and Restated ERP Operating Limited Partnership Agreement of Limited Partnership (the "Partnership Agreement"). As a result of their security ownership and rights concerning amendments to the Partnership Agreement, Mr. Zell may have substantial influence over the Company. Although these security holders have not agreed to act together on any matter, they would be in a position to exercise even more influence over the Company's affairs if they were to act together in the future. This influence might be exercised in a manner that is inconsistent with the interests of other security holders.
Environmental Problems are Possible and can be Costly
Federal, state and local laws and regulations relating to the protection of the environment may require a current or previous owner or operator of real estate to investigate and clean up hazardous or toxic substances or petroleum product releases at such property. The owner or operator may have to pay a governmental entity or third parties for property damage and for investigation and clean-up costs incurred by such parties in connection with the contamination. These laws typically impose clean-up responsibility and liability without regard to whether the owner or operator knew of or caused the presence of the contaminants. Even if more than one person may have been responsible for the contamination each person covered by the environmental laws may be held responsible for all of the clean-up costs incurred. In addition, third parties may sue the owner or operator of a site for damages and costs resulting from environmental contamination emanating from that site.
Environmental laws also govern the presence, maintenance and removal of asbestos. These laws require that owners or operators of buildings containing asbestos properly manage and maintain the asbestos, that they notify and train those who may come into contact with asbestos and that they undertake special precautions, including removal or other abatement, if asbestos would be disturbed during renovation or demolition of a building. These laws may impose fines and penalties on building owners or operators who fail to comply with these requirements and may allow third parties to seek recovery from owners or operators for personal injury associated with exposure to asbestos fibers.
Substantially all of our properties have been the subject of environmental assessments completed by qualified independent environmental consultant companies. These environmental assessments have not revealed, nor are we aware of, any environmental liability that our management believes would have a material adverse effect on our business, results of operations, financial condition or liquidity.
Recently there has been an increasing number of lawsuits against owners and managers of multifamily properties other than the Company alleging personal injury and property damage caused by the presence of mold in residential real estate. Some of these lawsuits have resulted in substantial monetary judgments or settlements. Insurance carriers have reacted to these liability awards by excluding mold related claims from standard policies and pricing mold endorsements at prohibitively high rates. We have adopted programs designed to minimize the existence of mold in any of our properties as well as guidelines for promptly addressing and resolving reports of mold to minimize any impact mold might have on residents or the property.
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We cannot be assured that existing environmental assessments of our properties reveal all environmental liabilities, that any prior owner of any of our properties did not create a material environmental condition not known to us, or that a material environmental condition does not otherwise exist as to any one or more of our properties.
Our Performance and Share Value are Subject to Risks Associated with the Real Estate Industry
Real property investments are subject to varying degrees of risk and are relatively illiquid. Several factors may adversely affect the economic performance and value of our properties. These factors include changes in the national, regional and local economic climate, local conditions such as an oversupply of multifamily properties or a reduction in demand for our multifamily properties, the attractiveness of our properties to tenants, competition from other available multifamily property owners and changes in market rental rates. Our performance also depends on our ability to collect rent from tenants and to pay for adequate maintenance, insurance and other operating costs, including real estate taxes, which could increase over time. Also, the expenses of owning and operating a property are not necessarily reduced when circumstances such as market factors and competition cause a reduction in income from the property.
We May be Unable to Renew Leases or Relet Units as Leases Expire
When our residents decide not to renew their leases upon expiration, we may not be able to relet their units. Even if the residents do renew or we can relet the units, the terms of renewal or reletting may be less favorable than current lease terms. Because virtually all of our leases are for apartments, they are generally for terms of no more than one year. If we are unable to promptly renew the leases or relet the units, or if the rental rates upon renewal or reletting are significantly lower than expected rates, then our results of operations and financial condition will be adversely affected. Consequently, our cash flow and ability to service debt and make distributions to security holders would be reduced.
New Acquisitions or Developments May Fail to Perform as Expected and Competition for Acquisitions May Result in Increased Prices for Properties
We intend to continue to actively acquire and develop multifamily properties. Newly acquired or developed properties may fail to perform as expected. We may underestimate the costs necessary to bring an acquired property up to standards established for its intended market position or to develop a property. Additionally, we expect that other major real estate investors with significant capital will compete with us for attractive investment opportunities or may also develop properties in markets where we focus our development efforts. This competition may increase prices for multifamily properties. We may not be in a position or have the opportunity in the future to make suitable property acquisitions on favorable terms.
Because Real Estate Investments Are Illiquid, We May Not Be Able To Sell Properties When Appropriate
Real estate investments generally cannot be sold quickly. We may not be able to change our portfolio promptly in response to economic or other conditions. This inability to respond promptly to changes in the performance of our investments could adversely affect our financial condition and ability to make distributions to our security holders.
Changes in Laws Could Affect Our Business
We are generally not able to pass through to our residents under existing leases real estate taxes, income taxes and service or other taxes. Consequently, any such tax increases may adversely affect our financial condition and limit our ability to make distributions to our security holders. Similarly, changes
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that increase our potential liability under environmental laws or our expenditures on environmental compliance would adversely affect our cash flow and ability to make distributions on our securities.
Shareholders' Ability to Effect Changes in Control of the Company is Limited
Provisions of Our Declaration of Trust and Bylaws Could Inhibit Changes in Control
Certain provisions of our Declaration of Trust and Bylaws may delay or prevent a change in control of the Company or other transactions that could provide the security holders with a premium over the then-prevailing market price of their securities or which might otherwise be in the best interest of our security holders. These include a staggered Board of Trustees and the 5% Ownership Limit described below. See "—We Have a Share Ownership Limit for REIT Tax Purposes." Also, any future series of preferred shares of beneficial interest may have certain voting provisions that could delay or prevent a change of control or other transactions that might otherwise be in the interest of our security holders.
We Have a Share Ownership Limit for REIT Tax Purposes
To remain qualified as a REIT for federal income tax purposes, not more than 50% in value of our outstanding Shares may be owned, directly or indirectly, by five or fewer individuals at any time during the last half of any year. To facilitate maintenance of our REIT qualification, our Declaration of Trust, subject to certain exceptions, prohibits ownership by any single shareholder of more than 5% of the lesser of the number or value of the outstanding class of common or preferred shares. We refer to this restriction as the "Ownership Limit." Absent any exemption or waiver granted by our Board of Trustees, securities acquired or held in violation of the Ownership Limit will be transferred to a trust for the exclusive benefit of a designated charitable beneficiary, and the security holder's rights to distributions and to vote would terminate. 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.
Our Preferred Shares of Beneficial Interest May Affect Changes in Control
Our Declaration of Trust authorizes the Board of Trustees to issue up to 100 million preferred shares of beneficial interest, and to establish the preferences and rights (including the right to vote and the right to convert into common shares) of any preferred shares issued. The Board of Trustees may use its powers to issue preferred shares and to set the terms of such securities to delay or prevent a change in control of the Company, even if a change in control were in the interest of security holders. As of December 31, 2001, 11,344,521 preferred shares were issued and outstanding.
Inapplicability of Maryland Law Limiting Certain Changes in Control
Certain provisions of Maryland law applicable to real estate investment trusts prohibit "business combinations" (including certain issuances of equity securities) with any person who beneficially owns ten percent or more of the voting power of outstanding securities, or with an affiliate who, at any time within the two-year period prior to the date in question, was the beneficial owner of ten percent or more of the voting power of the trust's outstanding voting securities (an "Interested Shareholder"), or with an affiliate of an Interested Shareholder. These prohibitions last for five years after the most recent date on which the Interested Shareholder became an Interested Shareholder. After the five-year period, a business combination with an Interested Shareholder must be approved by two super-majority shareholder votes unless, among other conditions, holders of common shares receive a minimum price for their shares and the consideration is received in cash or in the same form as previously paid by the Interested Shareholder for its common shares. As permitted by Maryland law, however, the Board of Trustees of the Company has opted out of these restrictions with respect to any business combination
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involving the Zell Original Owners and persons acting in concert with any of the Zell Original Owners. Consequently, the five-year prohibition and the super-majority vote requirements will not apply to a business combination involving us and/or any of them. Such business combinations may not be in the best interest of our security holders.
Our Success as a REIT is Dependent on Compliance With Federal Income Tax Requirements
Our Failure to Qualify as a REIT Would Have Serious Adverse Consequences to Our Security Holders
We believe that we have qualified for taxation as a REIT for federal income tax purposes since our taxable year ended December 31, 1992 based, in part, upon opinions of tax counsel received whenever we have issued equity securities or engaged in significant merger transactions. We plan to continue to meet the requirements for taxation as a REIT. Many of these 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, at least 95% of our gross income must come from sources that are itemized in the REIT tax laws. We are also required to distribute to security holders at least 90% of our REIT taxable income excluding capital gains. The fact that we hold our assets through ERP Operating Limited Partnership and its subsidiaries further complicates the application of the REIT requirements. Even a technical or inadvertent mistake could jeopardize our REIT status. Furthermore, Congress and the IRS might make changes to the tax laws and regulations, and the courts might issue new rulings that make it more difficult, or impossible, for us to remain qualified as a REIT. We do not believe, however, that any pending or proposed tax law changes would jeopardize our REIT status.
If we fail to qualify as a REIT, we would be subject to federal income tax at regular corporate rates. Also, unless the IRS granted us relief under certain statutory provisions, we would remain disqualified as a REIT for four years following the year we first failed to qualify. If we fail to qualify as a REIT, we would have to pay significant income taxes. We, therefore, would have less money available for investments or for distributions to security holders. This would likely have a significant adverse affect on the value of our securities. In addition, we would no longer be required to make any distributions to security holders.
We could be Disqualified as a REIT or Have to Pay Taxes if Our Merger Partners Did Not Qualify as REIT's
If any of our recent merger partners had failed to qualify as a REIT throughout the duration of their existence, then they might have had undistributed "C corporation earnings and profits" at the time of their merger with us. If that was the case and we did not distribute those earnings and profits prior to the end of the year in which the merger took place, we might not qualify as a REIT. We believe based upon opinions of legal counsel received pursuant to the terms of our merger agreements, among other things, that each of our merger partners qualified as a REIT and that, in any event, none of them had any undistributed "C corporation earnings and profits" at the time of their merger with us. If any of our merger partners failed to qualify as a REIT, an additional concern would be that they would have recognized taxable gain at the time they were merged with us. We would be liable for the tax on such gain. In this event, we would have to pay corporate income tax on any gain existing at the time of the applicable merger on assets acquired in the merger if the assets are sold within ten years of the merger. Finally, we could be precluded from electing REIT status for up to four years after the year in which the predecessor entity failed to qualify for REIT status.
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Other Tax Liabilities
Even if we qualify as a REIT, we will be subject to certain federal, state and local taxes on our income and property. In addition, our third-party management operations, which are conducted through subsidiaries, generally will be subject to federal income tax at regular corporate rates.
We Depend on Our Key Personnel
We depend on the efforts of the Chairman of our Board of Trustees, Samuel Zell, and our executive officers, particularly Douglas Crocker II and Gerald A. Spector. If they resign, our operations could be temporarily adversely effected. Mr. Zell and Mr. Crocker have entered into executive compensation agreements and retirement benefit agreements with the Company. Mr. Crocker and Mr. Spector have entered into Deferred Compensation Agreements with the Company that under certain conditions could provide both with a salary benefit after their respective termination of employment with the Company. In addition, Mr. Zell, Mr. Crocker and Mr. Spector have entered into Noncompetition Agreements with the Company. On August 23, 2001, the Company announced that it commenced an executive search for a new President as a part of its long-term succession planning effort.
Compliance with REIT Distribution Requirements May Affect Our Financial Condition
Distribution Requirements May Increase the Indebtedness of the Company
We may be required from time to time, under certain circumstances, to accrue as income for tax purposes interest and rent earned but not yet received. In such event, or upon our repayment of principal on debt, we could have taxable income without sufficient cash to enable us to meet the distribution requirements of a REIT. Accordingly, we could be required to borrow funds or liquidate investments on adverse terms in order to meet these distribution requirements.
Federal Income Tax Considerations
The following discussion summarizes the federal income tax considerations material to a holder of common shares. It is not exhaustive of all possible tax considerations. For example, it does not give a detailed discussion of any state, local or foreign tax considerations. The following discussion also does not address all tax matters that may be relevant to prospective shareholders in light of their particular circumstances. Moreover, it does not address all tax matters that may be relevant to shareholders who are subject to special treatment under the tax laws, such as insurance companies, tax-exempt entities, financial institutions or broker-dealers, foreign corporations and persons who are not citizens or residents of the United States.
The specific tax attributes of a particular shareholder could have a material impact on the tax considerations associated with the purchase, ownership and disposition of common shares. Therefore, it is essential that each prospective shareholder consult with his or her own tax advisors with regard to the application of the federal income tax laws to the shareholder's personal tax situation, as well as any tax consequences arising under the laws of any state, local or foreign taxing jurisdiction.
The information in this section is based on the current Internal Revenue Code, current, temporary and proposed Treasury regulations, the legislative history of the Internal Revenue Code, current administrative interpretations and practices of the Internal Revenue Service, including its practices and policies as set forth in private letter rulings, which are not binding on the Internal Revenue Service, and existing court decisions. Future legislation, regulations, administrative interpretations and court decisions could change current law or adversely affect existing interpretations of current law. Any change could apply retroactively. Thus, it is possible that the Internal Revenue Service could challenge
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the statements in this discussion, which do not bind the Internal Revenue Service or the courts, and that a court could agree with the Internal Revenue Service.
Our Taxation
We elected REIT status beginning with the year that ended December 31, 1992. In any year in which we qualify as a REIT, we generally will not be subject to federal income tax on the portion of our REIT taxable income or capital gain that we distribute to our shareholders. This treatment substantially eliminates the double taxation that applies to most corporations, which pay a tax on their income and then distribute dividends to shareholders who are in turn taxed on the amount they receive.
We will be subject, however, to federal income tax at regular corporate rates upon our REIT taxable income or capital gain that we do not distribute to our shareholders. In addition, we will be subject to a 4% excise tax if we do not satisfy specific REIT distribution requirements. We could also be subject to the "alternative minimum tax" on our items of tax preference. In addition, any net income from "prohibited transactions" (i.e., dispositions of property, other than property held by a taxable REIT subsidiary, held primarily for sale to customers in the ordinary course of business) will be subject to a 100% tax. We could also be subject to a 100% penalty tax on certain payments received from or on certain expenses deducted by a taxable REIT subsidiary if certain rules enacted as part of the REIT Modernization Act of 1999 are not complied with. Moreover, we may be subject to taxes in certain situations and on certain transactions that we do not presently contemplate.
We believe that we have qualified as a REIT for all of our taxable years beginning with 1992. We also believe that our current structure and method of operation is such that we will continue to qualify as a REIT. However, given the complexity of the REIT qualification requirements, we cannot provide any assurance that the actual results of our operations have satisfied or will satisfy the requirements under the Internal Revenue Code for a particular year.
If we fail to qualify for taxation as a REIT in any taxable year, we will be subject to tax on our taxable income at regular corporate rates. We also may be subject to the corporate "alternate minimum tax." As a result, our failure to qualify as a REIT would significantly reduce the cash we have available to distribute to our shareholders. Unless entitled to statutory relief, we would be disqualified from qualification as a REIT for the four taxable years following the year during which qualification was lost. It is not possible to state whether we would be entitled to statutory relief.
Tax legislation has recently been enacted which is intended to allow REITs to have greater flexibility in engaging in activities which previously had been prohibited by the REIT rules. Among these changes was the establishment of "taxable REIT subsidiaries" or "TRSs" which are corporations subject to tax as a regular "C" corporation. Generally, a taxable REIT subsidiary can own assets that cannot be owned by a REIT and can perform impermissible tenant services (discussed below) which would otherwise taint our rental income under the REIT income tests. In enacting the taxable REIT subsidiary rules, Congress intended that the arrangements between a REIT and its taxable REIT subsidiaries be structured to ensure that a taxable REIT subsidiary will be subject to an appropriate level of federal income taxation. As a result, the Act imposes certain limits on the ability of a taxable REIT subsidiary to deduct interest payments made to us. In addition, we will be obligated to pay a 100% penalty tax on some payments that we receive or on certain expenses deducted by the taxable REIT subsidiary if the economic arrangements between the REIT, the REIT's tenants and the taxable REIT subsidiary are not comparable to similar arrangements among unrelated parties.
Our qualification and taxation as a REIT depend on our ability to satisfy various requirements under the Internal Revenue Code. We are required to satisfy these requirements on a continuing basis through actual annual operating and other results.
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Share Ownership Test and Organizational Requirement. In order to qualify as a REIT, our shares of beneficial interest must be held by a minimum of 100 persons for at least 335 days of a taxable year that is 12 months, or during a proportionate part of a taxable year of less than 12 months. Also, not more than 50% in value of our shares of beneficial interest may be owned directly, or indirectly by applying certain constructive ownership rules, by five or fewer individuals during the last half of each taxable year. In addition, we must meet certain other organizational requirements, including, but not limited to, that (i) the beneficial ownership in us is evidenced by transferable shares and (ii) we are managed by one or more trustees. We believe that we have satisfied all of these tests and all other organizational requirements and that we will continue to do so in the future. In order to help comply with the 100 person test and the 50% share ownership test discussed above, we have placed certain restrictions on the transfer of our shares that are intended to prevent further concentration of share ownership. However, such restrictions may not prevent us from failing these requirements, and thereby failing to qualify as a REIT.
Gross Income Tests. To qualify as a REIT, we must satisfy two gross income tests. First, at least 75% of our gross income for each taxable year must be derived directly or indirectly from investments in real estate and/or real estate mortgage, dividends paid by another REIT and from some types of temporary investments. Second, at least 95% of our gross income for each taxable year must be derived from any combination of income qualifying under the 75% test and dividends, non-real estate mortgage interest, some payments under hedging instruments and gain from the sale or disposition of stock or securities. To qualify as rents from real property for the purpose of satisfying the gross income tests, rental payments must generally be received from unrelated persons and not be based on the net income of the tenant. Also, the rent attributable to personal property must not exceed 15% of the total rent. We may generally provide services to tenants without "tainting" our rental income only if such services are "usually or customarily rendered" in connection with the rental of real property and not otherwise considered "impermissible services". If such services are impermissible, then we may generally provide them only if they are considered de minimis in amount, or are provided through an independent contractor from whom we derive no revenue and that meets other requirements, or through a taxable REIT subsidiary. We believe that services provided to tenants by us either are usually or customarily rendered in connection with the rental of real property and not otherwise considered impermissible, or, if considered impermissible services, will meet the de minimis test or will be provided by an independent contractor or taxable REIT subsidiary. However, we cannot provide any assurance that the Internal Revenue Service will agree with these positions.
Asset Tests. In general, at the close of each quarter of our taxable year, we must satisfy four tests relating to the nature of our assets: (1) at least 75% of the value of our total assets must be represented by real estate assets (which include for this purpose shares in other real estate investment trusts) and certain cash related items; (2) not more than 25% of our total assets may be represented by securities other than those in the 75% asset class; (3) except for equity investments in other REITs, qualified REIT subsidiaries (i.e., corporations owned 100% by a REIT that are not TRSs or REITs), or taxable REIT subsidiaries: (a) the value of any one issuer's securities owned by us may not exceed 5% of the value of our total assets and (b) we may not own more than 10% of the value of or the voting securities of any one issuer; and (4) not more than 20% of our total assets may be represented by securities of one or more taxable REIT subsidiaries. Securities for purposes of the asset tests may include debt securities. We currently own equity interests in certain entities that have elected to be taxed as REITs for federal income tax purposes and are not publicly traded. If any such entity were to fail to qualify as a REIT, we would not meet the 10% voting stock limitation and the 10% value limitation and we would fail to qualify as a REIT. We believe that we and each of the REITs we own an interest in have and will comply with the foregoing asset tests for REIT qualification. However, we cannot provide any assurance that the Internal Revenue Service might not disagree with our determinations.
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Annual Distribution Requirements. To qualify as a REIT, we are generally required to distribute dividends, other than capital gain dividends, to our shareholders each year in an amount at least equal to 90% (95% for taxable years prior to 2001) of our REIT taxable income. These distributions must be paid either in the taxable year to which they relate, or in the following taxable year if declared before we timely file our tax return for the prior year and if paid with or before the first regular dividend payment date after the declaration is made. We intend to make timely distributions sufficient to satisfy our annual distribution requirements. To the extent that we do not distribute all of our net capital gain or distribute at least 90%, but less than 100% of our REIT taxable income, as adjusted, we are subject to tax on these amounts at regular corporate rates. We will be subject to a 4% excise tax on the excess of the required distribution over the sum of amounts actually distributed and amounts retained for which federal income tax was paid, if we fail to distribute during each calendar year at least the sum of: (1) 85% of our REIT ordinary income for the year; (2) 95% of our REIT capital gain net income for the year; and (3) any undistributed taxable income from prior taxable years. A REIT may elect to retain rather than distribute all or a portion of its net capital gains and pay the tax on the gains. In that case, a REIT may elect to have its shareholders include their proportionate share of the undistributed net capital gains in income as long-term capital gains and receive a credit for their share of the tax paid by the REIT. For purposes of the 4% excise tax described above, any retained amounts would be treated as having been distributed.
Ownership of Partnership Interests By Us. As a result of our ownership of the Operating Partnership, we will be considered to own and derive our proportionate share of the assets and items of income of the Operating Partnership, respectively, for purposes of the REIT asset and income tests, including its share of assets and items of income of any subsidiaries that are partnerships or limited liability companies, provided that the Operating Partnership is taxed as a partnership and not as a "C" corporation for federal tax purposes. Under the Internal Revenue Code, publicly traded partnerships are generally taxed as "C" corporations, unless at least 90% of their gross income consists of "qualifying income," such as interest, dividends, real property rents, and gains from the sale or other disposition of real property held for investment. If the Operating Partnership at any time were considered a publicly traded partnership and did not satisfy the 90% qualifying income test, then it would be taxed as a corporation for federal income tax purposes which would jeopardize our status as a REIT. A partnership is a "publicly traded partnership" if interests in such partnership are either traded on an established securities market or are "readily tradable on a secondary market." We believe that the Operating Partnership and all other partnerships in which we own an interest are not publicly traded partnerships. It is possible, however, that the IRS could successfully assert that the Operating Partnership is a publicly traded partnership as a result of the redemption right afforded to limited partners of the Operating Partnership. However, even if the Operating Partnership is classified as a publicly traded partnership, we believe that the Operating Partnership satisfies the 90% gross income test necessary to avoid taxation as a "C" corporation and, as a result, such determination would not adversely affect our REIT status.
Our Management Company and Other Subsidiaries. A small portion of the cash to be used by the Operating Partnership to fund distributions to us is expected to come from payments of dividends from management companies and other subsidiaries of the Company that have elected TRS status. These companies pay federal and state income tax at the full applicable corporate rates. They will attempt to minimize the amount of these taxes, but we cannot guarantee whether or the extent to, which measures taken to minimize these taxes, will be successful. To the extent that these companies are required to pay taxes, the cash available for distribution from these management companies by us to shareholders will be reduced accordingly.
State and Local Taxes. We may be subject to state or local taxation in various jurisdictions, including those in which we transact business or reside. Our state and local tax treatment may not conform to the federal income tax consequence discussed above. Consequently, prospective
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shareholders should consult their own tax advisors regarding the effect of state and local tax laws on an investment in common shares.
Taxation of Domestic Shareholders Subject to U.S. Tax
General. If we qualify as a REIT, distributions made to our taxable domestic shareholders with respect to their common shares, other than capital gain distributions, will be treated as ordinary income to the extent that the distributions come out of earnings and profits. These distributions will not be eligible for the dividends received deduction for shareholders that are corporations. In determining whether distributions are out of earnings and profits, we will allocate our earnings and profits first to preferred shares and second to the common shares.
To the extent we make distributions to our taxable domestic shareholders in excess of our earnings and profits, such distributions will be considered a return of capital. Such distributions will be treated as a tax free distribution and will reduce the tax basis of a shareholder's common shares by the amount of the distribution so treated. To the extent that such distributions cumulatively exceed a taxable domestic shareholder's tax basis, such distributions are taxable as a gain from the sale of his shares. Shareholders may not include in their individual income tax returns any of our net operating losses or capital losses.
Distributions made by us that we properly designate as capital gain dividends will be taxable to taxable domestic shareholders as gain from the sale or exchange of a capital asset held for more than one year. This treatment applies only to the extent that the designated distributions do not exceed our actual net capital gain for the taxable year. It applies regardless of the period for which a domestic shareholder has held his or her common shares. Despite this general rule, corporate shareholders may be required to treat up to 20% of certain capital gain dividends as ordinary income.
Generally, we will classify a portion of our designated capital gains dividend as a 20% rate gain distribution and the remaining portion as an unrecaptured Section 1250 gain distribution. As the names suggest, a 20% rate gain distribution would be taxable to taxable domestic shareholders that are individuals, estates or trusts at a maximum rate of 20%. An unrecaptured Section 1250 gain distribution would be taxable to taxable domestic shareholders that are individuals, estates or trusts at a maximum rate of 25%.
If, for any taxable year, we elect to designate as capital gain dividends any portion of the dividends paid or made available for the year to holders of all classes of shares of beneficial interest, then the portion of the capital gains dividends that will be allocable to the holders of common shares will be the total capital gain dividends multiplied by a fraction. The numerator of the fraction will be the total dividends paid or made available to the holders of the common shares for the year. The denominator of the fraction will be the total dividends paid or made available to holders of all classes of shares of beneficial interest.
In general, a shareholder will recognize gain or loss for federal income tax purposes on the sale or other disposition of common shares in an amount equal to the difference between:
The gain or loss will be capital gain or loss if the common shares were held as a capital asset. Generally, the capital gain or loss will be long-term capital gain or loss if the common shares were held for more than one year. The Taxpayer Relief Act of 1997 allows the IRS to issue regulations that would apply a capital gains tax rate of 25% to a portion of the capital gain realized by a noncorporate holder of REIT Shares. The IRS has not issued these regulations. However, if the IRS does issue these regulations, they could affect the taxation of gain and loss realized on the disposition of common
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shares. Shareholders are urged to consult with their own tax advisors with respect to the impact of such rules on their capital gains tax.
In general, a loss recognized by a shareholder upon the sale of common shares that were held for six months or less, determined after applying certain holding period rules, will be treated as long-term capital loss to the extent that the shareholder received distributions that were treated as long-term capital gains. For shareholders who are individuals, trusts and estates, the long-term capital loss will be apportioned among the applicable long-term capital gain rates to the extent that distributions received by the shareholder were previously so treated.
We may elect to retain (rather than distribute as is generally required) net capital gain for a taxable year and pay the income tax on that gain. If we make this election, shareholders must include in income, as long-term capital gain, their proportionate share of the undistributed net capital gain. Shareholders will be treated as having paid their proportionate share of the tax paid by us on these gains. Accordingly, they will receive a credit or refund for the amount. Shareholders will increase the basis in their common shares by the difference between the amount of capital gain included in their income and the amount of the tax they are treated as having paid. Our earnings and profits will be adjusted appropriately.
Taxation of Domestic Tax-Exempt Shareholders
Most tax-exempt organizations are not subject to federal income tax except to the extent of their unrelated business taxable income, which is often referred to as UBTI. Unless a tax-exempt shareholder holds its common shares as debt financed property or uses the common shares in an unrelated trade or business, distributions to the shareholder should not constitute UBTI. Similarly, if a tax-exempt shareholder sells common shares, the income from the sale should not constitute UBTI unless the shareholder held the shares as debt financed property or used the shares in a trade or business.
However, for tax-exempt shareholders that are social clubs, voluntary employee benefit associations, supplemental unemployment benefit trusts, and qualified group legal services plans, income from owning or selling common shares will constitute UBTI unless the organization is able to properly deduct amounts set aside or placed in reserve so as to offset the income generated by its investment in common shares. These shareholders should consult their own tax advisors concerning these set aside and reserve requirements which are set forth in the Internal Revenue Code.
In addition, certain pension trusts that own more than 10% of a "pension-held REIT" must report a portion of the distributions that they receive from the REIT as UBTI. We have not been and do not expect to be treated as a pension-held REIT for purposes of this rule.
Taxation of Foreign Shareholders
The following is a discussion of certain anticipated United States federal income tax consequences of the ownership and disposition of common shares applicable to a foreign shareholder. For purposes of this discussion, a "foreign shareholder" is any person other than:
Distributions by Us. Distributions by us to a foreign shareholder that are neither attributable to gain from sales or exchanges by us of United States real property interests nor designated by us as capital gains dividends will be treated as dividends of ordinary income to the extent that they are made out of our earnings and profits. These distributions ordinarily will be subject to withholding of United
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States federal income tax on a gross basis at a 30% rate, or a lower treaty rate, unless the dividends are treated as effectively connected with the conduct by the foreign shareholder of a United States trade or business. Please note that under certain treaties lower withholding rates generally applicable to dividends do not apply to dividends from REIT's. Dividends that are effectively connected with a United States trade or business will be subject to tax on a net basis at graduated rates, and are generally not subject to withholding. Certification and disclosure requirements must be satisfied before a dividend is exempt from withholding under this exemption. A foreign shareholder that is a corporation also may be subject to an additional branch profits tax at a 30% rate or a lower treaty rate.
We expect to withhold United States income tax at the rate of 30% on any distributions made to a foreign shareholder unless:
A distribution in excess of our current or accumulated earnings and profits will not be taxable to a foreign shareholder to the extent that the distribution does not exceed the adjusted basis of the shareholder's common shares. Instead, the distribution will reduce the adjusted basis of the common shares. To the extent that the distribution exceeds the adjusted basis of the common shares, it will give rise to gain from the sale or exchange of the shareholder's common shares. The tax treatment of this gain is described below.
As a result of a legislative change made by the Small Business Job Protection Act of 1996, we may be required to withhold 10% of any distribution in excess of our earnings and profits. Consequently, although we intend to withhold at a rate of 30%, or a lower applicable treaty rate, on the entire amount of any distribution, to the extent that we do not do so, distributions will be subject to withholding at a rate of 10%. However, a foreign shareholder may seek a refund of the withheld amount from the IRS if it subsequently determined that the distribution was, in fact, in excess of our earnings and profits, and the amount withheld exceeded the foreign shareholder's United States tax liability with respect to the distribution.
Distributions to a foreign shareholder that we designate at the time of the distributions as capital gain dividends, other than those arising from the disposition of a United States real property interest, generally will not be subject to United States federal income taxation unless:
Under the Foreign Investment in Real Property Tax Act, which is known as FIRPTA, distributions to a foreign shareholder that are attributable to gain from sales or exchanges of United States real property interests will cause the foreign shareholder to be treated as recognizing the gain as income effectively connected with a United States trade or business. This rule applies whether or not a distribution is designated as a capital gain dividend. Accordingly, foreign shareholders generally would be taxed on these distributions at the same rates applicable to U.S. shareholders, subject to a special alternative minimum tax in the case of nonresident alien individuals. In addition, a foreign corporate shareholder might be subject to the branch profits tax discussed above. We are required to withhold
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35% of these distributions. The withheld amount can be credited against the foreign shareholder's United States federal income tax liability.
Although the law is not entirely clear on the matter, it appears that amounts we designate as undistributed capital gains in respect of the common shares held by U.S. shareholders would be treated with respect to foreign shareholders in the same manner as actual distributions of capital gain dividends. Under that approach, foreign shareholders would be able to offset as a credit against the United States federal income tax liability their proportionate share of the tax paid by us on these undistributed capital gains. In addition, foreign shareholders would be able to receive from the IRS a refund to the extent their proportionate share of the tax paid by us were to exceed their actual United States federal income tax liability.
Sales of Common Shares. Gain recognized by a foreign shareholder upon the sale or exchange of common shares generally will not be subject to United States taxation unless the shares constitute a "United States real property interest" within the meaning of FIRPTA. The common shares will not constitute a United States real property interest so long as we are a domestically controlled REIT. A domestically controlled REIT is a REIT in which at all times during a specified testing period less than 50% in value of its stock is held directly or indirectly by foreign shareholders. We believe that we are a domestically controlled REIT. Therefore, we believe that the sale of common shares will not be subject to taxation under FIRPTA. However, because common shares and preferred shares are publicly traded, we cannot guarantee that we will continue to be a domestically controlled REIT. In any event, gain from the sale or exchange of common shares not otherwise subject to FIRPTA will be subject to U.S. tax, if either:
Even if we do not qualify as or cease to be a domestically controlled REIT, gain arising from the sale or exchange by a foreign shareholder of common shares still would not be subject to United States taxation under FIRPTA as a sale of a United States real property interest if:
If gain on the sale or exchange of common shares were subject to taxation under FIRPTA, the foreign shareholder would be subject to regular United States income tax with respect to the gain in the same manner as a taxable U.S. shareholder, subject to any applicable alternative minimum tax, a special alternative minimum tax in the case of nonresident alien individuals and the possible application of the branch profits tax in the case of foreign corporations. The purchaser of the common shares would be required to withhold and remit to the IRS 10% of the purchase price.
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Item 2. The Properties
As of December 31, 2001, the Company owned or had interests in a portfolio of 1,076 multifamily Properties located in 36 states containing 224,801 apartment units. The Company's Properties are more fully described as follows:
Resident leases are generally for twelve months in length and typically require security deposits. The garden-style properties are generally defined as properties with two and/or three story buildings while the mid-rise/high-rise are defined as properties greater than three story buildings. These two property types typically provide residents with amenities, which may include a clubhouse, swimming pool, laundry facilities and cable television access. Certain of these properties offer additional amenities such as saunas, whirlpools, spas, sports courts and exercise rooms or other amenities. The ranch-style properties are defined as single story properties, which do not provide additional amenities for residents other than common laundry facilities and cable television access.
It is management's role to monitor compliance with Property policies and to provide preventive maintenance of the Properties including common areas, facilities and amenities. The Company has a dedicated training and education department that creates and coordinates training and strategic implementation for the Company's property management personnel. The Company believes that, due in part to its emphasis on training and employee quality, the Properties historically have had high occupancy rates.
The distribution of the Properties throughout the United States reflects the Company's belief that geographic diversification helps insulate the portfolio from regional and economic influences. At the same time, the Company has sought to create clusters of Properties within each of its primary markets in order to achieve economies of scale in management and operation. The Company may nevertheless acquire additional multifamily properties located anywhere in the continental United States.
The following tables set forth certain information by type and state relating to the Properties at December 31, 2001:
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GARDEN — STYLE PROPERTIES
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MID-RISE/HIGH-RISE PROPERTIES
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The properties currently under development are included in the following table.
DEVELOPMENT PROJECTS
Item 3. Legal Proceedings
Only ordinary routine litigation incidental to the business, which is not deemed material, was initiated during the year ended December 31, 2001. As of December 31, 2001, the Company is not aware of any other litigation threatened against the Company other than routine litigation arising out of the ordinary course of business, some of which is expected to be covered by liability insurance, none of which is expected to have a material adverse effect on the consolidated financial statements of the Company.
Item 4. Submission of Matters to a Vote of Security Holders
At a Special Meeting of Shareholders of the Company held on December 12, 2001, the Company's common shareholders approved a proposal to increase the number of authorized Common Shares from 350.0 million to 1.0 billion. Of the 241,190,136 Common Shares represented at the meeting (being
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89.07% of the total Common Shares outstanding and entitled to vote at the record date for the meeting), 214,301,620 Common Shares (79.14% of the total Common Shares outstanding and 88.85% of the Common Shares represented at the meeting) voted for the increase, 26,588,117 Common Shares voted against the increase and 300,399 Common shares abstained from the vote.
PART II
Item 5. Market for Registrant's Common Equity and Related Shareholder Matters
The following table sets forth, for the years indicated, the high and low sales prices for and the distributions paid on the Company's Common Shares, which trade on the New York Stock Exchange under the trading symbol EQR.
The number of beneficial holders of Common Shares at January 15, 2002, was approximately 63,900. The number of outstanding Common Shares as of January 15, 2002 was 271,918,700.
Item 6. Selected Financial Data
The following table sets forth selected financial and operating information on a historical basis for the Company. The following information should be read in conjunction with all of the financial statements and notes thereto included elsewhere in this Form 10-K. The historical operating and balance sheet data have been derived from the historical Financial Statements of the Company audited by Ernst & Young LLP, independent auditors. Certain capitalized terms as used herein, are defined in the Notes to the Consolidated Financial Statements.
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EQUITY RESIDENTIAL PROPERTIES TRUSTCONSOLIDATED HISTORICAL FINANCIAL INFORMATION(Financial information in thousands except for per share and property data)
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Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Overview
The following discussion and analysis of the results of operations and financial condition of the Company should be read in connection with the Consolidated Financial Statements and Notes thereto. Due to the Company's ability to control the Operating Partnership and its subsidiaries other than entities owning interests in the Unconsolidated Properties and certain other entities in which the
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Company has investments, the Operating Partnership and each such subsidiary entity has been consolidated with the Company for financial reporting purposes. Capitalized terms used herein and not defined are as defined elsewhere in this Annual Report on Form 10-K for the year ended December 31, 2001.
Forward-looking statements in this Item 7 as well as Item 1 of this Annual Report on Form 10-K are intended to be made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. The words "believes", "expects" and "anticipates" and other similar expressions that are predictions of or indicate future events and trends and which do not relate solely to historical matters identify forward-looking statements. Such forward-looking statements are subject to risks and uncertainties, which could cause actual results, performance, or achievements of the Company to differ materially from anticipated future results, performance or achievements expressed or implied by such forward-looking statements. Factors that might cause such differences include, but are not limited to, the following:
Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The Company undertakes no obligation to publicly release any revisions to these forward-looking statements, which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.
Results of Operations
The following table summarizes the number of Properties and related units for the year-to-date periods presented:
The Company's acquisition and disposition activity has impacted overall results of operations for the years ended December 31, 2001 and 2000. Significant changes in revenues and expenses have resulted primarily from the consolidation of previously Unconsolidated Properties and the acquisition of Globe in July 2000, as well as the 2001 and the 2000 Acquired Properties, which have been partially offset by the disposition of the 2001 and the 2000 Disposed Properties. Significant change in expenses has also resulted from impairment charges (furniture rental and unconsolidated technology investments) recorded in 2001. This impact is discussed in greater detail in the following paragraphs.
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Properties that the Company owned for all of both 2001 and 2000 (the "2001 Same Store Properties"), which represented 181,951 units, impacted the Company's results of operations. Properties that the Company owned for all of both 2000 and 1999 (the "2000 Same Store Properties"), which represented 155,910 units, also impacted the Company's results of operations. Both the 2001 Same Store Properties and 2000 Same Store Properties are discussed in the following paragraphs.
Comparison of the year ended December 31, 2001 to the year ended December 31, 2000
For the year ended December 31, 2001, income before allocation to Minority Interests, income from investments in unconsolidated entities, net gain on sales of real estate, extraordinary items and cumulative effect of change in accounting principle decreased by approximately $39.5 million when compared to the year ended December 31, 2000.
Revenues from the 2001 Same Store Properties increased primarily as a result of higher rental rates charged to new residents and resident renewals and an increase in income from billing residents for their share of utility costs as well as other ancillary services provided to residents. Property operating expenses from the 2001 Same Store Properties, which include property and maintenance, real estate taxes and insurance and an allocation of property management expenses, increased primarily attributable to a $5.4 million, or 5.6%, increase in utilities and an $8.2 million, or 5.5%, increase in payroll costs. The following tables provide comparative revenue, expenses, net operating income and weighted average occupancy for the 2001 Same Store Properties:
Same Store Net Operating Income ("NOI")
Same Store Occupancy Statistics
For 2002 Properties which the Company acquired prior to December 31, 2000 and will continue to own through December 31, 2002, the Company expects to see revenue growth within a range of being slightly lower by 1.25% to slightly higher by as much as 0.5%; to maintain expense growth between a range of 1.0% to 1.5%; and expects NOI within a range of being slightly lower by 2.9% to slightly higher by 0.2%. These estimated changes are subject to certain risks and uncertainties including, but not limited to, maintaining an overall average occupancy rate of 93.0%.
Rental income from properties other than 2001 Same Store Properties increased by approximately $57.4 million primarily as a result of revenue from the Company's 2001 and 2000 Acquired Properties, additional 2001 Partially Owned Properties, and the 2001 Disposition Properties.
Interest income-investment in mortgage notes decreased by approximately $2.4 million as a result of the Company consolidating these previously Unconsolidated Properties in July 2001. The Company anticipates no additional interest income will be recognized on these mortgage notes in future years as the Company now consolidates the results related to these previously Unconsolidated Properties.
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Interest and other income decreased by approximately $3.4 million, primarily as a result of lower balances available for investment and related interest rates being earned on the Company's short-term investment accounts.
Property management expenses include off-site expenses associated with the self-management of the Company's Properties. These expenses increased by approximately $0.7 million or less than 1%. The Company continues to acquire properties in major metropolitan areas and dispose of assets in smaller multi-family rental markets where the Company does not have a significant management presence. As a result, the Company was able to maintain off-site management expenses at a constant level between the two reporting periods.
Fee and asset management revenues and fee and asset management expenses increased as a result of the Company continuing to manage Properties that were sold and/or contributed to various unconsolidated joint venture entities. As of December 31, 2001, the Company managed 16,539 units for third parties and the unconsolidated joint venture entities.
Furniture income and furniture expenses are associated with the operation of the furniture rental business assumed in connection with the Globe acquisition, which occurred in July 2000. Furniture expenses include a depreciation charge on furniture held in inventory and property and equipment directly related to the furniture business. The Company sold its furniture rental business for approximately $30.0 million on January 11, 2002.
The Company recorded impairment charges in 2001 totaling approximately $71.8 million, of which $60.0 million is related to the furniture rental business and approximately $11.8 million is related to certain investments in technology entities. See Footnote 20 in the Notes to the Consolidated Financial Statements for further discussion.
Interest expense, including amortization of deferred financing costs, decreased approximately $11.0 million. During 2001, the Company capitalized interest costs of approximately $28.2 million as compared to $17.7 million for the year ended 2000. This capitalization of interest primarily related to equity investments in unconsolidated entities engaged in development activities. The effective interest cost on all of the Company's indebtedness for the year ended December 31, 2001 was 6.90% as compared to 7.25% for the year ended December 31, 2000. For 2002, the Company expects to refinance approximately $550 million of indebtedness and to incur interest costs ranging from 6.5% to 7.0% per annum.
General and administrative expenses, which include corporate operating expenses, increased approximately $9.0 million between the years under comparison. This increase was primarily due to the addition of corporate personnel, recruiting fees for the new President, retirement plan expenses for certain key executives, and higher overall compensation expenses including a current year expense associated with the vesting of restricted shares/awards to key employees earned over the past three years.
Net gain on sales of real estate decreased approximately $49.1 million between the periods under comparison. This decrease is primarily the result of a fewer number of units sold during the year ended December 31, 2001 (11,818 units including the joint venture Properties) as compared to the year ended December 31, 2000 (20,648 units including the joint venture Properties).
Comparison of the year ended December 31, 2000 to the year ended December 31, 1999
For the year ended December 31, 2000, income before allocation to Minority Interests, income from investments in unconsolidated entities, net gain on sales of real estate, extraordinary items and cumulative effect of change in accounting principle increased by $69.5 million, or 21.3%, when compared to the year ended December 31, 1999.
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Revenues from the 2000 Same Store Properties increased primarily as a result of higher rental rates charged to new residents and resident renewals and an increase in income from billing residents for their share of utility costs as well as other ancillary services provided to residents. Property operating expenses from the 2000 Same Store Properties, which include property and maintenance, real estate taxes and insurance and an allocation of property management expenses, increased primarily attributable to a $1.8 million, or 2.1%, increase in utilities and a $9.1 million, or 7.4% increase in payroll costs. The following tables provide comparative revenue, expenses, net operating income and weighted average occupancy for the 2000 Same Store Properties:
Same Store Net Operating Income
$ in Millions — 155,910 Same Store Units
Rental income from properties other than 2000 Same Store Properties increased by approximately $178.3 million primarily as a result of revenue from the Company's corporate housing business and the acquisition of Properties during 2000, including the consolidation of previously Unconsolidated Properties.
Interest and other income increased by approximately $12.0 million, primarily as a result of disposition proceeds earning interest in various tax deferred 1031 exchange accounts. These proceeds are invested in money market investments until the Company purchases additional multi-family properties.
Property management expenses include expenses associated with the self-management of the Company's Properties. These expenses increased by approximately $14.8 million primarily due to the continued expansion of the Company's property management business and higher overall compensation expenses. During 2000, the Company incurred the full year impact of assuming the property management business of LFT and also assumed management offices in Cincinnati, Ohio and Norwood, Massachusetts related to the acquisition of Globe and Grove, respectively. Also included in compensation expense is the current year expense associated with the vesting of restricted shares/awards to key employees earned over the past year.
Fee and asset management revenues and fee and asset management expenses increased as a result of the Company continuing to manage Properties that were either sold and/or contributed to various joint venture entities.
Furniture income and furniture expenses are associated with the operation of the furniture rental business assumed in connection with the Globe acquisition, which occurred in July 2000. Furniture expenses include a depreciation charge on furniture held in inventory and property and equipment directly related to the furniture business.
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The Company recorded impairment charges in 2000 totaling approximately $1.0 million related to certain investments in technology entities.
Interest expense, including amortization of deferred financing costs, increased by approximately $37.5 million. During 2000, the Company capitalized interest costs of approximately $17.7 million as compared to $8.1 million for the year ended 1999. This capitalization of interest primarily related to equity investments in unconsolidated entities engaged in development activities. The effective interest cost on all of the Company's indebtedness for the year ended December 31, 2000 was 7.25% as compared to 7.05% for the year ended December 31, 1999.
General and administrative expenses, which include corporate operating expenses, increased approximately $4.1 million between the periods under comparison. This increase was primarily due to the addition of corporate personnel and higher overall compensation expenses including a current year expense associated with the awarding of restricted shares to key employees in 2000.
Net gain on sales of real estate increased approximately $104.9 million between the periods under comparison. This increase is primarily the result of a larger number of units sold during the year ended December 31, 2000 (20,648 units, including the joint venture Properties) as compared to the year ended December 31, 1999 (9,183 units).
Net loss from extraordinary items increased approximately $5.1 million related primarily to pre-payment penalties incurred on the refinancing of $208 million in mortgage debt.
Liquidity and Capital Resources
For the Year Ended December 31, 2001
As of January 1, 2001, the Company had approximately $23.8 million of cash and cash equivalents and $399.5 million available under its lines of credit, of which $53.5 million was restricted (not available to be drawn). After taking into effect the various transactions discussed in the following paragraphs and the net cash provided by operating activities, the Company's cash and cash equivalents balance at December 31, 2001 was approximately $51.6 million and the amount available on the Company's line of credit was $505.0 million, of which $59.0 million was restricted (not available to be drawn).
Part of the Company's acquisition and development funding strategy and the funding of the Company's investment in various joint ventures is to utilize its lines of credit and to subsequently repay the lines of credit from the disposition of Properties, retained cash flows or the issuance of additional equity or debt securities. Continuing to utilize this strategy during the year ended 2001, the Company:
All of these proceeds were utilized to either:
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During the year ended December 31, 2001, the Company:
From January 1, 2002 through February 5, 2002, the Company:
During 2002, the Company expects to fund approximately $33.5 million related to wholly owned developments and joint venture projects under development. In connection with one joint venture agreement, the Company has an obligation to fund up to an additional $6.5 million to guarantee third party construction financing. As of December 31, 2001, the Company has 22 projects under development with estimated completion dates ranging from March 31, 2002 through December 31, 2003.
For one joint venture agreement, the Company's joint venture partner has the right, at any time following completion of a project, to stipulate a value for such project and offer to sell its interest in
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the project to the Company based on such value. If the Company chooses not to purchase the interest, it must agree to a sale of the project to an unrelated third party at such value. The Company's joint venture partner must exercise this right as to all projects within five years after the receipt of the final certificate of occupancy on the last developed property.
For the second joint venture agreement, the Company's joint venture partner has the right, at any time following completion of a project, to require the Company to purchase the joint venture partners' interest in that project at a mutually agreeable price. If the Company and the joint venture partner are unable to agree on a price, both parties will obtain appraisals. If the appraised values vary by more than 10%, both the Company and the joint venture partner will agree on a third appraiser to determine which original appraisal is closest to its determination of value. The Company may elect at that time not to purchase the property and instead, authorize the joint venture partner to sell the project at or above the agreed-upon value to an unrelated third party. Five years following the receipt of the final certificate of occupancy on the last developed property, any projects remaining unsold must be purchased by the Company at the agreed-upon price.
The Company has a policy of capitalizing expenditures made for new assets, including newly acquired Properties, and the costs associated with placing these assets into service. Expenditures for improvements and renovations that significantly enhance the value of existing assets or substantially extend the useful life of an asset are also capitalized. Expenditures for in-the-unit replacement-type items such as appliances, draperies, carpeting and floor coverings, mechanical equipment and certain furniture and fixtures are also capitalized. Expenditures for ordinary maintenance and repairs are expensed to operations as incurred. With respect to acquired Properties, the Company has determined that it generally spends $1,000 per unit during its first three years of ownership to fully improve and enhance these Properties to meet the Company's standards. In regard to replacement-type items described above, the Company generally expects to spend $250 per unit on an annual recurring basis.
During the year ended December 31, 2001, the Company's total improvements to real estate approximated $150.9 million. Replacements, which include new carpeting, appliances, mechanical equipment, fixtures, vinyl floors and blinds inside the unit approximated $56.0 million, or $276 per unit. Building improvements for the 1999, 2000 and 2001 Acquired Properties approximated $26.4 million, or $496 per unit. Building improvements for all of the Company's pre-1999 Acquired Properties approximated $57.2 million or $383 per unit. In addition, approximately $7.2 million was spent on twelve specific assets related to major renovations and repositioning of these assets. Also included in total improvements to real estate was approximately $4.1 million on commercial/other assets and Partially Owned Properties. Such improvements to real estate were primarily funded from net cash provided by operating activities. Total improvements to real estate for 2002 are estimated at $135.0 million.
During the year ended December 31, 2001, the Company's total non-real estate capital additions, such as computer software, computer equipment, and furniture and fixtures and leasehold improvements to the Company's property management offices and its corporate offices, was approximately $6.9 million. Such additions to non-real estate property were funded from net cash provided by operating activities. Total additions to non-real estate property for 2002 are estimated at $6.8 million.
The Company has a policy of capitalizing expenditures made for rental furniture and related property and equipment. The Company, prior to the sale of its furniture rental business, purchased furniture to replace furniture that had been sold and to maintain adequate levels of rental furniture to meet existing and new customer needs. Expenditures for property and equipment that significantly enhance the value of existing assets or substantially extend the useful life of an asset are also capitalized. Expenditures for ordinary maintenance and repairs related to property and equipment are expensed as incurred. For the year ended December 31, 2001, total additions to rental furniture
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approximated $18.6 million and property and equipment approximated $2.5 million. The furniture rental business was sold on January 11, 2002.
Minority Interests as of December 31, 2001 increased by $23.2 million when compared to December 31, 2000 principally as a result of the consolidation of twenty-one former Unconsolidated Properties and the issuance of $60.0 million of Preference Interests, partially offset by the conversions of OP Units into Common Shares. The primary factors that impacted this account in the Company's consolidated statements of operations and balance sheets during the year were:
Total distributions paid in 2001 amounted to $475.8 million (excluding distributions on Partially Owned Properties), which included certain distributions declared in the fourth quarter of 2001 and paid in 2002.
The Company expects to meet its short-term liquidity requirements, including capital expenditures related to maintaining its existing Properties and certain scheduled unsecured note and mortgage note repayments, generally through its working capital, net cash provided by operating activities and borrowings under its line of credit. The Company considers its cash provided by operating activities to be adequate to meet operating requirements and payments of distributions. The Company also expects to meet its long-term liquidity requirements, such as scheduled unsecured note and mortgage debt maturities, property acquisitions, financing of construction and development activities and capital improvements through the issuance of unsecured notes and equity securities, including additional OP Units, and proceeds received from the disposition of certain Properties. During March 2002, the Company anticipates the issuance of unsecured notes in the amount of approximately $300.0 million. In addition, the Company has certain unencumbered Properties available to secure additional mortgage borrowings in the event that the public capital markets are unavailable to the Company or the cost of alternative sources of capital to the Company is too high. These unencumbered Properties are in excess of the value of unencumbered Properties the Company must maintain in order to comply with covenants under its unsecured notes and line of credit.
The Company has a revolving credit facility to provide the Operating Partnership with potential borrowings of up to $700 million. As of February 28, 2002, $262.0 million was outstanding under this facility. This credit Facility is scheduled to expire in August 2002 and the Company has begun the process of replacing its line of credit with a new line of credit, which it believes will be on at least as favorable terms.
In connection with the Globe acquisition, the Company assumed a revolving credit facility with potential borrowings of up to $55.0 million. This credit facility was terminated on May 31, 2001.
In connection with the Wellsford Merger, the Company provided a credit enhancement with respect to certain tax-exempt bonds issued to finance certain public improvements at a multifamily development project. As of February 28, 2002, this enhancement was still in effect at a commitment amount of $12.7 million.
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Derivative Instruments and Hedging Activities
In the normal course of business, the Company is exposed to the effect of interest rate changes. The Company limits these risks by following established risk management policies and procedures including the use of derivatives to hedge interest rate risk on debt instruments.
The Company has 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, the Company has not sustained a material loss from those instruments nor does it anticipate any material adverse effect on its net income or financial position in the future from the use of derivatives to hedge interest rate risk on debt instruments.
On January 1, 2001, the Company adopted SFAS No. 133 and its amendments (SFAS Nos. 137 and 138), Accounting for Derivative Instruments and Hedging Activities, which requires an entity to recognize all derivatives as either assets or liabilities in the statement of financial position and to measure those instruments at fair value. Additionally, the fair value adjustments will affect either shareholders' equity or net income depending on whether the derivative instruments qualify as a hedge for accounting purposes and, if so, the nature of the hedging activity. When the terms of an underlying transaction are modified, or when the underlying transaction is terminated or completed, all changes in the fair value of the instrument are marked-to-market with changes in value included in net income each period until the instrument matures. Any derivative instrument used for risk management that does not meet the hedging criteria of SFAS No. 133 is marked-to-market each period.
As of January 1, 2001, the adoption of the new standard resulted in derivative instruments reported on the balance sheet as liabilities of approximately $6.6 million; an adjustment of approximately $5.3 million to accumulated other comprehensive loss, which are gains and losses not affecting retained earnings in the consolidated statement of shareholders' equity; and a charge of approximately $1.3 million as a cumulative effect of change in accounting principle in the consolidated statement of operations.
At December 31, 2001, the Company had entered into swaps which have been designated as cash flow hedges with an aggregate notional amount of $626.4 million at interest rates ranging from 3.65% to 6.15% maturing at various dates ranging from 2003 to 2007 with a net liability fair value of $23.3 million; and swaps which have been designated as fair value hedges with an aggregate notional amount of $396.4 million at interest rates ranging from 4.46% to 7.25% maturing at various dates ranging from 2003 to 2011 with a net asset fair value of $4.6 million.
At December 31, 2001, the Company's joint venture development partners had entered into swaps to hedge the interest rate risk exposure on unconsolidated floating rate construction mortgage loans. The Company has recorded its proportionate share of these qualifying hedges on its consolidated balance sheet. These swaps have been designated as cash flow hedges with a current aggregate notional amount of $302.5 million (notional amounts range from $139.7 million to $525.1 million over the terms of the swaps) at interest rates ranging from 4.13% to 7.35% maturing at various dates ranging from 2002 to 2005 with a net liability fair value of $10.4 million.
As of December 31, 2001, there were approximately $32.6 million in deferred losses, net, included in accumulated other comprehensive loss. On December 31, 2001, the net derivative instruments were reported at their fair value as other liabilities of approximately $18.7 million and as a reduction to investment in unconsolidated entities of approximately $10.4 million. The Company expects to recognize an estimated $14.3 million of accumulated other comprehensive loss as additional interest expense during the twelve months ending December 31, 2002, of which $6.5 million is related to the development joint venture swaps.
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For the Year Ended December 31, 2000
As of January 1, 2000, the Company had approximately $29.1 million of cash and cash equivalents and $400 million available on its lines of credit, of which $65.8 million was restricted (not available to be drawn). After taking into effect the various transactions discussed in the following paragraphs, the Company's cash and cash equivalents balance at December 31, 2000 was approximately $23.8 million and the amount available on the Company's line of credit was $399.5 million, of which $53.5 million was restricted (not available to be drawn).
Part of the Company's strategy in funding the purchase of multifamily properties, funding its Properties in the development stage and the funding of the Company's investment in joint ventures is to utilize its line of credit and to subsequently repay the line of credit from the issuance of additional equity or debt securities or the net proceeds from the disposition of Properties. Utilizing this strategy during 2000, the Company:
During the year ended December 31, 2000, the Company:
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The Company's total debt summary, as of December 31, 2000, included:
Debt Summary as of December 31, 2000
Critical Accounting Policies and Estimates
The Company's consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States, which require the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosures. The Company believes that the following critical accounting policies, among others, affect its more significant judgments and estimates used in the preparation of its consolidated financial statements.
Impairment of Long-Lived Assets, Including Goodwill
The Company periodically evaluates its long-lived assets, including its investments in real estate and goodwill, for impairment indicators. The judgments regarding the existence of impairment indicators are based on factors such as operational performance, market conditions and legal factors. Future events could occur which would cause the Company to conclude that impairment indicators exist and an impairment loss is warranted.
Depreciation of Investment in Real Estate
The Company depreciates the building component of its investment in real estate over a 30-year estimated useful life and both the furniture, fixtures and equipment and replacements components over a 5-year estimated useful life, all of which are judgmental determinations.
Fair Value of Financial Instruments, Including Derivative Instruments
The valuation of financial instruments under SFAS No. 107 and SFAS No. 133 requires the Company to make estimates and judgments that affect the fair value of the instruments. The Company, where possible, bases the fair values of its financial instruments, including its derivative instruments, on listed market prices and third party quotes. Where these are not available, the Company bases its estimates on other factors relevant to the financial instruments.
Stock-Based Compensation
The Company has chosen to account for its stock-based compensation in accordance with APB No. 25, which results in no compensation expense for options issued with an exercise price equal to or exceeding market value of the Company's Common Shares on the date of grant, instead of Statement
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No. 123, which would result in compensation expense being recorded based on the fair value of the stock-based compensation issued.
Adjusted Net Income
For the year ended December 31, 2001, Adjusted Net Income ("ANI") available to Common Shares and OP units decreased $18.3 million as compared to the year ended December 31, 2000. For the year ended December 31, 2000, ANI available to Common Shares and OP Units increased $110.0 million, as compared to the year ended December 31, 1999.
The following is a reconciliation of net income available to Common Shares to ANI available to Common Shares and OP Units for the years ended December 31, 2001, 2000 and 1999:
Adjusted Net Income (Amounts in thousands)
The Company believes that ANI is helpful to investors as a supplemental measure of the operating performance of a real estate company because, along with cash flows from operating activities, financing activities and investing activities, it provides investors an understanding of the ability of the Company to incur and service debt and to make capital expenditures. ANI in and of itself does not represent cash generated from operating activities in accordance with GAAP and therefore should not be considered an alternative to net income as an indication of the Company's performance or to net cash flows from operating activities as determined by GAAP as a measure of liquidity and is not necessarily indicative of cash available to fund cash needs. The Company's calculation of ANI may differ from the methodology for calculating ANI utilized by other real estate companies and may differ, for example, due to variations among the Company's and other real estate companies' accounting policies for replacement type items and, accordingly, may not be comparable to such other real estate companies.
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Funds From Operations
For the year ended December 31, 2001, Funds From Operations ("FFO") available to Common Shares and OP Units increased $60.5 million, or 8.3%, as compared to the year ended December 31, 2000. For the year ended December 31, 2000, FFO available to Common Shares and OP Units increased $106.6 million, or 17.2%, as compared to the year ended December 31, 1999.
The following is a reconciliation of net income available to Common Shares to FFO available to Common Shares and OP Units for the years ended December 31, 2001, 2000 and 1999:
Funds From Operations (Amounts in thousands)
FFO represents net income (loss) (computed in accordance with accounting principles generally accepted in the United States (("GAAP")), excluding gains or losses from sales of property, plus depreciation and amortization (after adjustments for Partially Owned Properties and Unconsolidated Properties), plus/minus extraordinary items, and plus the cumulative effect of change in accounting principle and impairment charges. Adjustments for unconsolidated partnerships and joint ventures will be calculated to reflect funds from operations on the same basis.
The Company believes that FFO is helpful to investors as a supplemental measure of the operating performance of a real estate company because, along with cash flows from operating activities, financing activities and investing activities, it provides investors an understanding of the ability of the Company to incur and service debt and to make capital expenditures. FFO in and of itself does not represent cash generated from operating activities in accordance with GAAP and therefore should not be considered an alternative to net income as an indication of the Company's performance or to net cash flows from operating activities as determined by GAAP as a measure of liquidity and is not necessarily indicative of cash available to fund cash needs. The Company's calculation of FFO may differ from the methodology for calculating FFO utilized by other real estate companies and may differ, for example, due to variations among the Company's and other real estate companies' accounting policies for replacement type items and, accordingly, may not be comparable to such other real estate companies.
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Item 7A. Quantitative and Qualitative Disclosure about Market Risk
Market risks relating to the Company's operations result primarily from changes in short-term LIBOR interest rates. The Company does not have any direct foreign exchange or other significant market risk.
The Company's exposure to market risk for changes in interest rates relates primarily to the Company's unsecured line of credit. The Company typically incurs fixed rate debt obligations to finance acquisitions and capital expenditures, while it typically incurs floating rate debt obligations to finance working capital needs and as a temporary measure in advance of securing long-term fixed rate financing. The Company continuously evaluates its level of floating rate debt with respect to total debt and other factors, including its assessment of the current and future economic environment.
The Company also utilizes certain derivative financial instruments to limit market risk. Interest rate protection agreements are used to convert floating rate debt to a fixed rate basis or vice versa. Derivatives are used for hedging purposes rather than speculation. The Company does not enter into financial instruments for trading purposes.
The fair values of the Company's financial instruments (including such items in the financial statement captions as cash and cash equivalents, other assets, lines of credit, accounts payable and accrued expenses, rents received in advance and other liabilities) approximate their carrying or contract values based on their nature, terms and interest rates that approximate current market rates. The fair value of the Company's mortgage notes payable and unsecured notes approximates their carrying value at December 31, 2001.
The Company had total outstanding floating rate debt of approximately $896.0 million, or 15.6% of the Company's total debt at December 31, 2001, including the effects of any interest rate protection agreements. If market rates of interest on all of the Company's floating rate debt permanently increased by 32 basis points (a 10% increase), the increase in interest expense on the Company's floating rate debt would decrease future earnings and cash flows by approximately $2.9 million. If market rates of interest on all of the Company's floating rate debt permanently decreased by 32 basis points (a 10% decrease), the decrease in interest expense on the Company's floating rate debt would increase future earnings and cash flows by approximately $2.9 million.
These amounts were determined by considering the impact of hypothetical interest rates on the Company's financial instruments. The foregoing assumptions apply to the entire amount of the Company's floating rate debt and does not differentiate among maturities. These analyses do not consider the effects of the changes in overall economic activity that could exist in such an environment. Further, in the event of a change of such magnitude, management would likely take actions to further mitigate its exposure to the change. However, due to the uncertainty of the specific actions that would be taken and their possible effects, this analysis assumes no changes in the Company's financial structure or results other than interest expense.
The Company cannot predict the effect of adverse changes in interest rates on its floating rate debt and, therefore, its exposure to market risk, nor can there be any assurance that fixed rate, long term debt will be available to the Company at advantageous pricing. Consequently, future results may differ materially from the estimated adverse changes discussed above.
Item 8. Financial Statements and Supplementary Data
See Index to Consolidated Financial Statements on page F-1 of this Form 10-K.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
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PART III
Items 10, 11, 12 and 13.
Trustees and Executive Officers of the Registrant, Executive Compensation, Security Ownership of Certain Beneficial Owners and Management and Certain Relationship and Related Transactions.
The information required by Item 10, Item 11, Item 12 and Item 13 are incorporated by reference to, and will be contained in, the Company's definitive proxy statement, which the Company anticipates will be filed no later than April 30, 2002, and thus these items have been omitted in accordance with General Instruction G(3) to Form 10-K.
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PART IV
Item 14. Exhibits, Financial Statements, Schedules and Reports on Form 8-K
(a)
(1 & 2) See Index to Financial Statements and Schedules on page F-1 of this Form 10-K.
(3) Exhibits:
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(b) Reports on Form 8-K: None.
(c) Exhibits: See Item 14(a)(3) above.
(d) Financial Statement Schedules: See Index to Financial Statements attached hereto on page F-1 of this Form 10-K.
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SIGNATURES
Pursuant to the requirements of the Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on behalf by the undersigned thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, the following persons on behalf of the registrant and in the capacities and on the dates indicated have signed this report below.
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INDEX TO FINANCIAL STATEMENTS AND SCHEDULE EQUITY RESIDENTIAL PROPERTIES TRUST
F-1
REPORT OF INDEPENDENT AUDITORS
To the Board of Trustees and ShareholdersEquity Residential Properties Trust
We have audited the accompanying consolidated balance sheets of Equity Residential Properties Trust (the "Company") as of December 31, 2001 and 2000 and the related consolidated statements of operations, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 2001. Our audits also included the financial statement schedule listed in the accompanying index to financial statements and schedule. These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Equity Residential Properties Trust at December 31, 2001 and 2000, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
As discussed in Note 2 to the consolidated financial statements, in 2001 the Company changed its method of accounting for derivative instruments and hedging activities.
/s/ ERNST & YOUNG LLP
Chicago, IllinoisFebruary 5, 2002
F-2
EQUITY RESIDENTIAL PROPERTIES TRUST CONSOLIDATED BALANCE SHEETS (Amounts in thousands except for share amounts)
See accompanying notes
F-3
EQUITY RESIDENTIAL PROPERTIES TRUST CONSOLIDATED STATEMENTS OF OPERATIONS (Amounts in thousands except per share data)
F-4
EQUITY RESIDENTIAL PROPERTIES TRUST CONSOLIDATED STATEMENTS OF OPERATIONS (Continued) (Amounts in thousands except per share data)
F-5
EQUITY RESIDENTIAL PROPERTIES TRUST CONSOLIDATED STATEMENTS OF CASH FLOWS (Amounts in thousands)
F-6
EQUITY RESIDENTIAL PROPERTIES TRUST CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued) (Amounts in thousands)
F-7
F-8
EQUITY RESIDENTIAL PROPERTIES TRUST CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (Amounts in thousands)
F-9
EQUITY RESIDENTIAL PROPERTIES TRUSTCONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (Continued)(Amounts in thousands)
F-10
EQUITY RESIDENTIAL PROPERTIES TRUST NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Business and Formation of the Company
Equity Residential Properties Trust, formed in March 1993 ("EQR"), is a self-administered and self-managed equity real estate investment trust ("REIT"). As used herein, the term "Company" means EQR, and its subsidiaries, as the survivor of the mergers between EQR and each of Wellsford Residential Property Trust, Evans Withycombe Residential, Inc., Merry Land & Investment Company, Inc. and Lexford Residential Trust (collectively, the "Mergers"). The Company also includes the businesses formerly operated by Globe Business Resources, Inc. ("Globe") and Grove Property Trust ("Grove"). The Company completed the sale of its Globe furniture rental business on January 11, 2002. The Company has elected to be taxed as a REIT under Section 856(c) of the Internal Revenue Code 1986, as amended (the "Code").
EQR is the general partner of, and as of December 31, 2001, owned an approximate 92.1% ownership interest in, ERP Operating Limited Partnership (the "Operating Partnership"). The Company conducts substantially all of its business and owns substantially all of its assets through the Operating Partnership. The Operating Partnership is, in turn, directly or indirectly, a partner, member or shareholder of numerous partnerships, limited liability companies and corporations which have been established primarily to own fee simple title to multifamily properties or to conduct property management activities and other businesses related to the ownership and operation of multifamily residential real estate. References to the Company include the Operating Partnership and each of the partnerships, limited liability companies and corporations controlled by the Operating Partnership or EQR.
The Company is engaged in the acquisition, ownership, management, operation and disposition of multifamily properties. As of December 31, 2001, the Company owned or had interests in a portfolio of 1,076 multifamily properties (individually a "Property" and collectively the "Properties") containing 224,801 apartment units located in 36 states consisting of the following:
The Company accounts for its ownership interest in the 955 "Wholly Owned Properties" under the consolidation method of accounting. The Company beneficially owns 100% fee simple title to 948 of the 955 Wholly Owned Properties. The Company has a leasehold estate ownership interest in one Property. As such, the Company owns the real estate building and improvements and leases the land underlying the improvements under a long-term ground lease that expires in 2066. This one Property is consolidated and reflected as a real estate asset while the ground lease is accounted for as an operating lease in accordance with Statement of Financial Accounting Standards ("SFAS") No. 13, Accounting for Leases. The Company owns the debt collateralized by two Properties and owns an interest in the debt collateralized by the remaining four Properties. The Company consolidates its interest in these six Properties in accordance with the accounting standards outlined in the AcSEC guidance for real estate acquisition, development and construction arrangements issued in the CPA letter dated February 10, 1986, and as such, reflects these assets as real estate in the consolidated financial statements.
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The "Partially Owned Properties" are controlled and partially owned by the Company but have partners with minority interests and are accounted for under the consolidation method of accounting. The "Unconsolidated Properties" are partially owned but not controlled by the Company and consist of investments in partnership interests and/or subordinated mortgages that are accounted for under the equity method of accounting.
2. Summary of Significant Accounting Policies
Basis of Presentation
The Mergers and acquisitions were accounted for as purchases in accordance with Accounting Principles Board Opinion No. 16. The fair value of the consideration given by the Company in the Mergers was used as the valuation basis for each of the combinations. The accompanying consolidated statements of operations and cash flows include the results of the Properties purchased through the Mergers and through acquisitions from their respective closing dates.
Due to the Company's ability as general partner to control either through ownership or by contract the Operating Partnership and its subsidiaries, other than entities owning interests in the Unconsolidated Properties and certain other entities in which the Company has investments, the Operating Partnership and each such subsidiary has been consolidated with the Company for financial reporting purposes. In July 2001, the Company acquired 100% of a management company entity, which had a controlling ownership interest in a portfolio of 21 previously Unconsolidated Properties. Subsequent to this transaction, the Company consolidated these 21 Properties. In September 2001, the Company acquired the remaining 5% of the preferred stock it did not own and 100% of the voting common stock in two other management company entities. As a result, the Company now wholly-owns these two entities. The Company consolidated the results of these two entities prior to this transaction despite not having legal control, the effects of which were immaterial.
Real Estate Assets and Depreciation
Real estate is recorded at cost less accumulated depreciation less an adjustment, if any, for impairment. A land value is assigned based on the purchase price if land is acquired separately or based on market research if acquired in a merger or in a single or portfolio acquisition.
Depreciation is computed on a straight-line basis over the estimated useful lives of the assets. The Company uses a 30-year estimated life for buildings and a five-year estimated life for initial furniture, fixtures and equipment. Replacements inside a unit such as appliances and carpeting, are depreciated over a five-year estimated life. Expenditures for ordinary maintenance and repairs are expensed to operations as incurred and significant renovations and improvements that improve and/or extend the useful life of the asset are capitalized over their estimated useful life, generally five to ten years. Initial direct leasing costs are expensed as incurred as such expense approximates the deferral and amortization of initial direct leasing costs over the lease terms. Property sales or dispositions are recorded when title transfers and sufficient consideration has been received by the Company. Upon disposition, the related costs and accumulated depreciation are removed from the respective accounts. Any gain or loss on sale of disposition is recognized in accordance with accounting principles generally accepted in the United States.
The Company classifies real estate assets as real estate held for disposition when it is certain a property will be disposed.
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The Company classifies Properties under development and/or expansion and properties in the lease up phase as construction in progress until construction has been completed and all certificates of occupancy permits have been obtained. The Company also classifies land relating to construction in progress as land on its balance sheet.
Asset Impairment
For real estate properties held for use, the Company follows the guidance in SFAS No. 121, Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of, in determining whether an impairment loss exists. The Company first determines whether any indicators of impairment exist. If indicators exist, the Company compares the expected future undiscounted cash flows for an operating property against the carrying amount of that property. If the sum of the estimated undiscounted cash flows is less than the carrying amount of the property, an impairment loss would be recorded for the difference between the estimated fair value and the carrying amount of the property.
For real estate properties to be disposed of, an impairment loss is recognized when the estimated fair value of the real estate, less the estimated cost to sell, is less than the carrying amount of the real estate measured at the time it is certain that the Company will sell the property. Real estate held for disposition is reported at the lower of its carrying amount or its estimated fair value, less its cost to sell.
For all other assets, including property and equipment and goodwill, the Company also follows the guidance in SFAS No. 121 in determining whether an impairment loss exists. The Company reviews the current net book value taking into consideration existing business and economic conditions as well as projected operating cash flows. See Note 20 for further discussion.
In August 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, which is effective for fiscal years beginning after December 15, 2001. The Company adopted the standard effective January 1, 2002, which did not have any impact on the Company's financial condition and results of operations.
Cash and Cash Equivalents
The Company considers all demand deposits, money market accounts and investments in certificates of deposit and repurchase agreements purchased with a maturity of three months or less, at the date of purchase, to be cash equivalents. The Company maintains its cash and cash equivalents at financial institutions. The combined account balances at each institution periodically exceed the Federal Depository Insurance Corporation ("FDIC") insurance coverage, and, as a result, there is a concentration of credit risk related to amounts on deposit in excess of FDIC insurance coverage. The Company believes that the risk is not significant, as the Company does not anticipate their non-performance.
Deferred Financing Costs
Deferred financing costs include fees and costs incurred to obtain the Company's lines of credit, long-term financings and costs for certain interest rate protection agreements. These costs are amortized over the terms of the related debt. Unamortized financing costs are written-off when debt is
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retired before the maturity date. The accumulated amortization of such deferred financing costs was $22.9 million and $17.7 million at December 31, 2001 and 2000, respectively.
Rental Furniture
Rental furniture is stated at cost and depreciated on a straight-line basis at a rate of 1% per month, which is designed to approximate an estimated useful life of four years with provision for a 50% residual value. The accumulated depreciation of rental furniture was $419,000 and $725,000 at December 31, 2001 and 2000, respectively.
Property and Equipment
Property and equipment is stated at cost. Depreciation expense is provided on a straight-line basis over estimated useful lives of three to ten years. The accumulated depreciation of property and equipment was $2.6 million and $1.1 million at December 31, 2001 and 2000, respectively.
Goodwill
Goodwill is amortized on a straight-line basis over a period of 20 years. The Company periodically reviews goodwill for impairment and if a permanent decline in value has occurred, the Company would reduce its goodwill balance to fair value. The accumulated amortization of goodwill was $5.5 million and $1.8 million at December 31, 2001 and 2000, respectively.
In June 2001, the FASB issued SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 142 requires companies to eliminate the amortization of goodwill in favor of a periodic impairment based approach. SFAS No. 142 is effective for fiscal years beginning after December 15, 2001. The Company adopted the standard effective January 1, 2002, which did not have a material impact on the Company's financial condition and results of operations.
The Company has 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, the Company has not sustained a material loss from those instruments nor does it anticipate any material adverse effect on its net income or financial position in the future from the use of derivatives.
On January 1, 2001, the Company adopted SFAS No. 133 and its amendments (SFAS Nos. 137 and 138), Accounting for Derivative Instruments and Hedging Activities, which requires an entity to recognize all derivatives as either assets or liabilities in the statement of financial position and to measure those instruments at fair value. Additionally, the fair value adjustments will affect either shareholders' equity or net income depending on whether the derivative instruments qualify as a hedge for accounting purposes and, if so, the nature of the hedging activity. When the terms of an underlying transaction are modified, or when the underlying transaction is terminated or completed, all changes in the fair value of the instrument are marked-to-market with changes in value included in net income each period until
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the instrument matures. Any derivative instrument used for risk management that does not meet the hedging criteria of SFAS No. 133 is marked-to-market each period.
At December 31, 2001, the Company had entered into swaps which have been designated as cash flow hedges with an aggregate notional amount of $626.4 million at interest rates ranging from 3.65125% to 6.15% maturing at various dates ranging from 2003 to 2007 with a net liability fair value of $23.3 million; and swaps which have been designated as fair value hedges with an aggregate notional amount of $396.4 million at interest rates ranging from 4.458% to 7.25% maturing at various dates ranging from 2003 to 2011 with a net asset fair value of $4.6 million.
Fair Value of Financial Instruments
The fair values of the Company's financial instruments (excluding the Company's investment in mortgage notes—see Note 8), including cash and cash equivalents, mortgage notes payable, other notes payable, lines of credit and other financial instruments, approximate their carrying or contract values.
Revenue Recognition
Rental income attributable to leases is recorded when due from residents and is recognized monthly as it is earned, which is not materially different than on a straight-line basis. Interest income is recorded on an accrual basis. Leases entered into between a resident and a Property for the rental of an apartment unit are year-to-year, renewable upon consent of both parties on a year-to-year or month-to-month basis.
Leases of furniture generally have an initial term of three to six months in duration and can be extended by the customer on a month-to-month basis. Furniture rentals are accounted for as operating leases, and revenue is recorded in the month earned. For sales of furniture, as well as rental buyouts,
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revenue and related cost of sales are recorded when the furniture is delivered or taken off lease. Revenues from both furniture rentals and sales are included in furniture income while the associated costs of those rentals and sales are included in furniture operating expenses in the consolidated statements of operations.
The Company adopted the provisions of Staff Accounting Bulletin ("SAB") No. 101, Revenue Recognition, effective October 1, 2000. SAB No. 101 provides guidance on the recognition, presentation and disclosure of revenue in financial statements. The adoption of SAB No. 101 did not have a material impact on the Company's financial condition and results of operations.
Income Taxes
Due to the structure of the Company as a REIT and the nature of the operations of the Properties and management business, the results of operations generally contain no provision for federal income taxes. The Company is subject to certain state and local income, excise and franchise taxes. The aggregate cost of land and depreciable property for federal income tax purposes as of December 31, 2001 and 2000 was approximately $8.6 billion and $9.0 billion, respectively.
Effective in 2001, the Company has elected Taxable REIT Subsidiary ("TRS") status for certain of its corporate subsidiaries. The provisions for federal income taxes for these TRS entities were not material during 2001 and were recognized as general and administrative expenses in the consolidated statements of operations.
During the years ended December 31, 2001, 2000 and 1999, the Company's tax treatment of distributions were as follows:
Minority Interests
Operating Partnership: Net income is allocated to minority interests based on their respective ownership percentage of the Operating Partnership. The ownership percentage is calculated by dividing the number of Operating Partnership Units ("OP Units") held by the minority interests by the total OP Units held by the minority interests and the Company. Issuance of additional common shares of beneficial interest, $0.01 par value per share (the "Common Shares"), and OP Units changes the ownership interests of both the minority interests and the Company. Such transactions and the proceeds therefrom are treated as capital transactions.
Partially Owned Properties: The Company reflects minority interests in partially owned properties on the balance sheet for the portion of properties consolidated by the Company that are not wholly owned by the Company. The earnings or losses from those properties attributable to the minority
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interests are reflected as minority interests in partially owned properties in the consolidated statements of operations.
Use of Estimates
In preparation of the Company's financial statements in conformity with accounting principles generally accepted in the United States, management makes estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.
Reclassifications
Certain reclassifications have been made to the previously reported financial statements in order to provide comparability with the 2001 statements reported herein. These reclassifications have not changed the results of operations or shareholders' equity.
Reportable Segments
The Company has one primary reportable business segment, which consists of investment in rental real estate. The Company's primary business is owning, managing and operating multifamily residential properties, which includes the generation of rental and other related income through the leasing of apartment units to residents.
The primary financial measure for the Company's rental real estate segment is net operating income ("NOI"), which represents rental income less: 1) property and maintenance expense; 2) real estate taxes and insurance expense; and 3) property management expense (all as reflected in the accompanying statements of operations). Current year NOI is compared to prior year NOI and current year budgeted NOI as a measure of financial performance.
During the acquisition, development and/or disposition of real estate, the NOI return on total capitalized costs is the primary measure of financial performance (capitalization rate) the Company considers.
The Company's fee and asset management activity and furniture rental/sales activities are immaterial and do not meet the threshold requirements of a reportable segment as provided for in SFAS No. 131.
All revenues are from external customers and there is no customer who contributed 10% or more of the Company's total revenues during 2001, 2000 or 1999.
Other
In June 2001, the FASB issued SFAS No. 141, Business Combinations. SFAS No. 141 requires companies to account for all business combinations using the purchase method of accounting. SFAS No. 141 is effective for fiscal years beginning after December 15, 2001. The Company adopted the standard effective January 1, 2002, which did not have any impact on the Company's financial condition and results of operations.
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3. Business Combinations
On October 1, 1999, the Company acquired Lexford Residential Trust ("LFT")(the "LFT Merger"), which included 402 Properties containing 36,609 units and other related assets for a total purchase price of approximately $738 million. In connection with the LFT Merger, each outstanding common share of beneficial interest of LFT was converted into 0.926 of a Common Share of the Company. The purchase price consisted of 8.0 million Common Shares issued by the Company with a market value of $181.1 million, the assumption of mortgage indebtedness, a term loan and a line of credit in the amount of $528.3 million, the acquisition of other assets of approximately $40.9 million, the assumption of other liabilities of approximately $25.3 million and other merger related costs of approximately $24.5 million.
On July 11, 2000, the Company acquired Globe in an all cash and debt transaction valued at $163.2 million. Globe provided fully furnished short-term housing through an inventory of leased housing units to transferring or temporarily assigned corporate personnel, new hires, trainees, consultants and individual customers throughout the United States. Additionally, Globe rents and sells furniture to a diversified base of commercial and residential customers throughout the United States. Shareholders of Globe received $13.00 per share, which approximated $58.7 million in cash based on the 4.5 million Globe shares outstanding. In addition, the Company:
During 2001 and prior to the one-year anniversary of the Globe acquisition, the Company recorded net increases to goodwill of $9.5 million to reallocate the original purchase price recorded at the acquisition date. Also during 2001, the Company recorded a $60.0 million asset impairment charge related to its furniture rental business. See Note 20.
On October 31, 2000, the Company acquired Grove, which included 60 properties containing 7,308 units for a total purchase price of $463.2 million. The Company:
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All of the amounts stated above related to these business combinations were based on management's best estimates, which were subject to adjustment within one year of the respective closing dates.
4. Shareholders' Equity and Minority Interests
The following table presents the changes in the Company's issued and outstanding Common Shares for the years ended December 31, 2001, 2000 and 1999:
On December 12, 2001, the Company's shareholders approved an amendment to the Company's Declaration of Trust to increase the total number of authorized Common Shares from 350.0 million to 1.0 billion.
On February 3, 1998, the Company filed with the SEC a Form S-3 Registration Statement to register $1 billion of equity securities. The SEC declared this registration statement effective on
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February 27, 1998. In addition, the Company carried over $272 million related to the registration statement effective on August 4, 1997. As of December 31, 2001, $1.1 billion remained available for issuance under this registration statement.
The equity positions of various individuals and entities that contributed their properties to the Operating Partnership in exchange for a partnership interest are collectively referred to as the "Minority Interests—Operating Partnership". As of December 31, 2001 and 2000, the Minority Interests—Operating Partnership held 23,197,192 and 24,857,502 OP Units, respectively. As a result, the Minority Interests had a 7.87% and 8.57% interest in the Operating Partnership at December 31, 2001 and 2000, respectively. Assuming conversion of all OP Units into Common Shares, total Common Shares outstanding at December 31, 2001 and 2000 would have been 294,818,566 and 290,090,252, respectively.
Net proceeds from the Company's Common Share and Preferred Share (see definition below) offerings are contributed by the Company to the Operating Partnership in return for an increased ownership percentage and are treated as capital transactions in the Company's consolidated financial statements. As a result, the net offering proceeds from Common Shares are allocated between shareholders' equity and Minority Interests—Operating Partnership to account for the change in their respective percentage ownership of the underlying equity of the Operating Partnership.
The declaration of trust of the Company provides that the Company may issue up to 100,000,000 preferred shares of beneficial interest, $0.01 par value per share (the "Preferred Shares"), with specific rights, preferences and other attributes as the Board of Trustees may determine, which may include preferences, powers and rights that are senior to the rights of holders of the Company's Common Shares.
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The following table presents the Company's issued and outstanding Preferred Shares as of December 31, 2001 and 2000:
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The liquidation value of the Preference Interests and the Junior Preference Units (both as defined below) are included as separate components of Minority Interests in the consolidated balance sheets and the distributions incurred are included in preferred distributions in the consolidated statements of operations.
During 2001, 2000 and 1999, the Company, through a subsidiary of the Operating Partnership, issued various Preference Interest series with an equity value of $246.0 million receiving net proceeds of $239.9 million. The following table presents the issued and outstanding Preference Interests as of December 31, 2001 and December 31, 2000:
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The following table presents the Operating Partnership's issued and outstanding Junior Convertible Preference Units (the "Junior Preference Units") as of December 31, 2001 and December 31, 2000:
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5. Real Estate
The following table summarizes the carrying amounts for investment in real estate as of December 31, 2001 and 2000 (Amounts are in thousands):
The following table summarizes the carrying amounts for the real estate held for disposition as of December 31, 2001 and 2000 (Amounts are in thousands):
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During the year ended December 31, 2001, the Company acquired the fourteen properties and one parcel of land listed below from unaffiliated parties for a total purchase price of $387.8 million:
On July 2, 2001, the Company acquired an additional ownership interest in 21 previously Unconsolidated Properties containing 3,896 units. Prior to July 2, 2001, the Company accounted for this portfolio as an investment in mortgage notes (see Note 8). As a result of this additional ownership acquisition, the Company acquired a controlling interest, and as such, now consolidates these properties for financial reporting purposes. The Company recorded additional investments in real estate totaling $258.9 million in connection with this transaction.
During the year ended December 31, 2000, the Company acquired 29 Properties and three parcels of land containing 5,952 units for a total purchase price of $743.4 million, and the acquisition of the Grove portfolio. In addition, the Company paid $6.5 million to acquire interests in 25 Properties containing 3,820 units, which previously were accounted for under the equity method of accounting and subsequent to these purchases were consolidated. Accordingly, the Company recorded an additional $90.7 million in investments in real estate.
6. Real Estate Dispositions
During the year ended December 31, 2001, the Company disposed of the forty-seven properties and two vacant parcels of land listed below to unaffiliated parties. When combined with gains from the
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joint venture and unconsolidated property sales discussed below, the Company recognized a net gain of approximately $149.3 million on these sales.
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On February 23, 2001, the Company entered into a joint venture with an unaffiliated joint venture partner ("JVP"). At closing, the Company sold and/or contributed eleven wholly owned properties containing 3,011 units valued at $202.5 million to the joint venture encumbered with $20.2 million in mortgage loans obtained on February 16, 2001. An additional $123.6 million of mortgage loans was obtained by the joint venture. The JVP contributed cash in an amount equal to 75% of the equity in the joint venture, which was then distributed to the Company. The Company retained a 25% interest in the joint venture along with the right to manage the properties. In accordance with the respective joint venture organization documents, the Company and the JVP both shall have the right, but not the obligation, to infuse additional cash into the joint venture. There are no other agreements that require the Company or the JVP to infuse cash into the joint venture. In addition, the Company and the JVP have not guaranteed the mortgage indebtedness of the joint venture. As a result, the Company recognized 75% of the gain on the sales and/or contributions of property to the joint venture, which totaled approximately $36.2 million. The Company has classified its initial $3.4 million 25% interest in the joint venture (at carryover basis) as investments in unconsolidated entities and accounted for it under the equity method of accounting.
During 2001, the Company sold its entire interest in two Unconsolidated Properties containing 135 units for approximately $0.7 million.
During the year ended December 31, 2000, the Company sold fifty properties containing 12,436 units to unaffiliated parties for a total sales price of $626.7 million. Including the joint venture sales discussed below, the Company recognized a net gain of approximately $198.4 million.
During 2000, the Company entered into three separate joint ventures with an unaffiliated JVP. At closing, the Company sold and/or contributed thirty-four wholly owned properties containing 7,835 units valued at $473.4 million to the joint ventures encumbered with $341.0 million in mortgage loans. The JVP contributed cash in an amount equal to 75% of the equity in the joint ventures, which was then distributed to the Company. The Company retained a 25% interest in the joint venture along with the right to manage the properties. In accordance with the respective joint venture organization documents, the Company and the JVP both shall have the right, but not the obligation, to infuse additional cash into each joint venture. There are no other agreements that require the Company or the JVP to infuse cash into each joint venture. In addition, the Company and the JVP have not guaranteed the mortgage
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indebtedness of each joint venture. As a result, the Company recognized 75% of the gain on the sales and/or contributions of property to the joint ventures, which totaled approximately $70.2 million. The Company has classified its initial $10.7 million 25% interest in the joint ventures (at carryover basis) as investments in unconsolidated entities and accounted for them under the equity method of accounting.
During 2000, the Company also sold its entire interest in three Unconsolidated Properties containing 377 units for approximately $4.6 million.
7. Commitments to Acquire/Dispose of Real Estate
As of December 31, 2001, the Company has not entered into any separate agreements to acquire additional multifamily properties.
As of December 31, 2001, in addition to the Properties that were subsequently disposed of as discussed in Note 22, the Company entered into separate agreements to dispose of twenty-eight multifamily properties containing 5,685 units to unaffiliated parties. The Company expects a combined disposition price of approximately $317.2 million.
The closings of these pending transactions are subject to certain contingencies and conditions, therefore, there can be no assurance that these transactions will be consummated or that the final terms thereof will not differ in material respects from those summarized in the preceding paragraphs.
8. Investment in Mortgage Notes, Net
In 1995, the Company invested $89 million in various partnership interests and subordinated mortgages collateralized by 21 Properties consisting of 3,896 units. Prior to the consolidation of these Properties, the Company received $61.4 million in cash during 2001 as partial repayment of its investment in these mortgage notes.
On July 2, 2001, the Company acquired an additional ownership interest in the 21 entities that own the Unconsolidated Properties. As a result of this additional ownership interest, the Company now has a controlling interest, and as such, consolidates these properties for financial reporting purposes.
The unamortized balance of the discount on the notes at December 31, 2001 and 2000 was zero and $3.6 million, respectively. During 2001 and 2000, the Company amortized $2.3 million and $1.2 million, respectively. This discount was being amortized utilizing the effective yield method based on the expected life of the investment.
The fair value of the mortgage notes as of December 31, 2001 and 2000 was estimated to be approximately zero and $80.8 million, respectively, compared to the Company's carrying value of zero and $77.2 million, respectively.
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9. Investments in Unconsolidated Entities
The Company has entered into various joint venture agreements with third party companies. The following table summarizes the Company's investments in unconsolidated entities as of December 31, 2001 (amounts in thousands except for project and unit amounts):
Investments in unconsolidated entities includes the Unconsolidated Properties as well as various uncompleted development joint venture properties. The Company does not consolidate these entities, as it does not have the ability to exercise unilateral control over the major decisions (such as sale and/or financing/refinancing) regarding these entities. The Company's legal ownership interests in these entities range from 1.5% to 57.0% at December 31, 2001.
These investments are accounted for utilizing the equity method of accounting. Under the equity method of accounting, the net equity investment of the Company is reflected on the consolidated balance sheets and after the project is completed, the consolidated statements of operations include the Company's share of net income or loss from the unconsolidated entity. Prior to the project being completed, the Company capitalized interest on its equity contribution in accordance with the provisions of SFAS No. 58, Capitalization of Interest Cost in Financial Statements That Include Investments Accounted for by the Equity Method. During the years ended December 31, 2001, 2000 and 1999, the Company capitalized $19.9 million, $16.2 million, and $6.6 million, respectively, in interest cost related to its unconsolidated joint venture development projects (which reduced interest expense incurred in the consolidated statements of operations).
The Company generally contributes between 25% and 30% of the construction cost of the development joint venture projects, with the remaining cost financed through third-party construction mortgages.
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10. Deposits—Restricted
As of December 31, 2001, deposits-restricted totaled $218.6 million and primarily included the following:
As of December 31, 2000, deposits-restricted totaled $231.6 million and primarily included the following:
11. Mortgage Notes Payable
As of December 31, 2001, the Company had outstanding mortgage indebtedness of approximately $3.3 billion.
As of December 31, 2001, scheduled maturities for the Company's outstanding mortgage indebtedness were at various dates through October 1, 2033. The interest rate range on the Company's mortgage debt was 1.50% to 12.465% at December 31, 2001. During the year ended December 31, 2001, the weighted average interest rate on the Company's mortgage debt was 6.54%.
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Aggregate payments of principal on mortgage notes payable for each of the next five years and thereafter are as follows (amounts in thousands):
As of December 31, 2000, the Company had outstanding mortgage indebtedness of approximately $3.2 billion.
As of December 31, 2000, scheduled maturities for the Company's outstanding mortgage indebtedness were at various dates through October 1, 2033. The interest rate range on the Company's mortgage debt was 3.95% to 12.465% at December 31, 2000. During the year ended December 31, 2000, the weighted average interest rate on the Company's mortgage debt was 6.89%.
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12. Notes
The following tables summarize the Company's unsecured note balances and certain interest rate and maturity date information as of and for the years ended December 31, 2001 and 2000, respectively:
As of December 31, 2001, the Company had outstanding unsecured notes of approximately $2.3 billion net of a $3.8 million discount and including a $2.9 million premium.
As of December 31, 2000, the Company had outstanding unsecured notes of approximately $2.1 billion net of a $3.7 million discount and including a $5.0 million premium.
On August 25, 2000, the Operating Partnership filed with the SEC a Form S-3 Registration Statement to register $1.0 billion of debt securities. The SEC declared this registration statement effective on September 8, 2000. In addition, the Operating Partnership carried over $430 million related to the registration statement effective on February 27, 1998. As of December 31, 2001, $1.13 billion remained available for issuance under this registration statement.
During the year ended December 31, 2001, the Company and/or the Operating Partnership:
During the year ended December 31, 2000, the Company and/or the Operating Partnership:
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Aggregate payments of principal on unsecured notes payable for each of the next five years and thereafter are as follows (amounts in thousands):
*Includes $300 million with a final maturity of 2015 that is putable/callable in 2005.
13. Lines of Credit
The Company has a revolving credit facility to provide the Operating Partnership with potential borrowings of up to $700.0 million. This line of credit matures in August 2002. Advances under the credit facility bear interest at variable rates based upon LIBOR at various interest periods, plus a spread dependent upon the Company's credit rating. As of February 5, 2002, $320.0 million was outstanding under this facility at a weighted average interest rate of 2.43%.
As of December 31, 2001 and 2000, $195.0 million and $355.5 million, respectively, was outstanding and $59.0 million and $53.5 million, respectively, was restricted (not available to be drawn) on the lines of credit. During the years ended December 31, 2001 and 2000, the weighted average interest rate was 5.03% and 7.52%, respectively.
In connection with the Globe acquisition, the Company assumed a revolving credit facility with potential borrowings of up to $55.0 million. On May 31, 2001, this credit facility was terminated.
In connection with the Grove acquisition, the Company assumed a line of credit that had an outstanding balance of approximately $38.0 million. On October 31, 2000, the Company repaid this outstanding balance and terminated this facility.
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14. Calculation of Net Income Per Weighted Average Common Share
The following tables set forth the computation of net income per share—basic and net income per share—diluted:
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Convertible preferred shares/units that could be converted into 15,122,162, 13,138,716 and 24,046,102 weighted average Common Shares for the years ended December 31, 2001, 2000 and 1999, respectively, were outstanding but were not included in the computation of diluted earnings per share because the effects would be anti-dilutive.
On October 11, 2001, the Company effected a two-for-one split of its Common Shares to shareholders of record as of September 21, 2001. All per share data and numbers of Common Shares have been retroactively adjusted to reflect the Common Share split.
For additional disclosures regarding the employee share options and restricted shares, see Note 15.
15. Share Option and Share Award Plan
Pursuant to the Company's Fifth Amended and Restated 1993 Share Option and Share Award Plan (the "Fifth Amended Option and Award Plan"), officers, directors, key employees and consultants of the Company may be offered the opportunity to acquire Common Shares through the grant of share options ("Options") including non-qualified share options ("NQSOs"), incentive share options ("ISOs") and share appreciation rights ("SARs") or may be granted restricted or non-restricted shares. Additionally, under the Fifth Amended Option and Award Plan, officers and key employees of the Company may be awarded Common Shares, subject to conditions and restrictions as described in the Fifth Amended Option and Award Plan. Finally, certain executive officers of the Company are subject to the Company's performance based restricted share grant agreement. Options and SARs are sometimes referred to herein as "Awards".
The Company has reserved 25,000,000 Common Shares for issuance under the Fifth Amended Option and Award Plan. The Options generally are granted at the fair market value of the Company's Common Shares at the date of grant, vest over a three year period, are exercisable upon vesting and expire ten years from the date of grant. The exercise price for all Options under the Fifth Amended
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Option and Award Plan shall not be less than the fair market value of the underlying Common Shares at the time the Option is granted. The Fifth Amended Option and Award Plan will terminate at such time as no further Common Shares are available for issuance upon the exercise of Options and all outstanding Options have expired or been exercised. The Board of Trustees may at any time amend or terminate the Fifth Amended Option and Award Plan, but termination will not affect Awards previously granted. Any Options, which had vested prior to such a termination, would remain exercisable by the holder thereof.
As to the Options that have been granted through December 31, 2001, generally, one-third are exercisable one year after the initial grant, one-third are exercisable two years following the date such Options were granted and the remaining one-third are exercisable three years following the date such Options were granted.
As to the restricted shares that have been awarded through December 31, 2001, these shares generally vest three years from the award date. During the three-year period of restriction, the employee receives quarterly dividend payments on their shares. If employment is terminated prior to the lapsing of the restriction, the shares are canceled. During the years ended December 31, 2001 and 2000, the Company issued 470,028 and 520,962 restricted shares. The performance-based awards generally vest over a five-year period.
The Company has elected to apply the provisions of Accounting Principles Board ("APB") Opinion No. 25, Accounting for Stock Issued to Employees ("APB No. 25"), in the computation of compensation expense. Under APB No. 25's intrinsic value method, compensation expense is determined by computing the excess of the market price of the shares over the exercise price on the measurement date. For the Company's share options, the intrinsic value on the measurement date (or grant date) is zero, and no compensation expense is recognized. For the Company's restricted shares, the Company determines the intrinsic value on the measurement date and accordingly recognizes a compensation expense for such shares. SFAS No. 123, Accounting for Stock-Based Compensation ("Statement No. 123"), requires the Company to disclose pro forma net income and income per share as if a fair value based accounting method had been used in the computation of compensation expense. The fair value of the options computed under Statement No. 123 would be recognized over the vesting period of the options. The fair value for the Company's options was estimated at the time the options were granted using the Black Scholes option pricing model with the following weighted-average assumptions for 2001, 2000 and 1999, respectively: risk-free interest rates of 4.43%, 6.22% and 5.84%; dividend yields of 6.17%, 6.83% and 6.89%; volatility factors of the expected market price of the Company's Common Shares of 0.204, 0.207 and 0.209; and a weighted-average expected life of the options of seven years.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's Options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its Options.
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For purposes of pro forma disclosures, the estimated fair value of the Options is amortized to expense over the Options' vesting period. The following is the pro forma information for the three years ended December 31, 2001, 2000 and 1999:
The table below summarizes the Option activity of the Fifth Amended Option and Award Plan and options assumed in connection with Mergers (the "Merger Options") for the three years ended December 31, 2001, 2000 and 1999:
As of December 31, 2001, 2000 and 1999, 7,295,314 shares (with a weighted average exercise price of $21.62), 7,897,038 shares (with a weighted average exercise price of $20.76) and 6,313,751 shares (with a weighted average exercise price of $19.18) were exercisable, respectively. Exercise prices for Options outstanding as of December 31, 2001 ranged from $13.00 to $27.60 for the Fifth Amended Option and Award Plan and $2.76 to $24.84 for the Merger Options.
16. Employee Plans
The Company has established an Employee Share Purchase Plan whereby trustees and employees of the Company may annually acquire up to $100,000 of Common Shares of the Company. The aggregate number of Common Shares available under the Employee Share Purchase Plan shall not exceed 2,000,000, subject to adjustment by the Board of Trustees. The Common Shares may be
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purchased quarterly at a price equal to 85% of the lesser of: (a) the closing price for a share on the last day of such quarter; and (b) the greater of: (i) the closing price for a share on the first day of such quarter, and (ii) the average closing price for a share for all the business days in the quarter. During 2001, the Company issued 310,261 Common Shares at net prices that ranged from $21.76 per share to $23.69 per share and raised approximately $6.9 million in connection therewith. During 2000, the Company issued 299,580 Common Shares at net prices that ranged from $17.06 per share to $20.51 per share and raised approximately $5.4 million in connection therewith. During 1999, the Company issued 295,770 Common Shares at net prices that ranged from $17.19 per share to $18.36 per share and raised approximately $5.2 million in connection therewith.
The Company has established a defined contribution plan (the "401(k) Plan") that provides retirement benefits for employees that meet minimum employment criteria. The Company contributes 100% of the first 4% of eligible compensation that a participant contributes to the 401(k) Plan. Participants are vested in the Company's contributions over five years. The Company made contributions in the amount of $2.3 million and $2.3 million for the years ended December 31, 1999 and 2000, respectively, and expects to make contributions in the amount of approximately $3.4 million for the year ended December 31, 2001.
17. Distribution Reinvestment and Share Purchase Plan
On November 3, 1997, the Company filed with the SEC a Form S-3 Registration Statement to register 14,000,000 Common Shares pursuant to a Distribution Reinvestment and Share Purchase Plan (the "DRIP Plan"). The registration statement was declared effective on November 25, 1997.
The DRIP Plan of the Company provides holders of record and beneficial owners of Common Shares, Preferred Shares, and limited partnership interests in the Operating Partnership with a simple and convenient method of investing cash distributions in additional Common Shares (which is referred to herein as the "Dividend Reinvestment—DRIP Plan"). Common Shares may also be purchased on a monthly basis with optional cash payments made by participants in the DRIP Plan and interested new investors, not currently shareholders of the Company, at the market price of the Common Shares less a discount ranging between 0% and 5%, as determined in accordance with the DRIP Plan (which is referred to herein as the "Share Purchase—DRIP Plan").
18. Transactions with Related Parties
Certain officers of the Company purchased Common Shares in prior years which were financed with loans made by the Company at various rates ranging from 6.15% to 7.93% per annum and at one month LIBOR plus 2.0% per annum. Scheduled maturities are at various dates through 2005. The amounts outstanding at December 31, 2001 and 2000 are $4.0 million and $4.3 million, respectively.
The Company also entered into executive compensation, deferred compensation and share distribution agreements with certain officers of the Company that resulted in the Company recognizing compensation expense of $3.7 million, $0.9 million and $1.1 million for the years ended December 31, 2001, 2000 and 1999, respectively.
In connection with certain Mergers, the Company agreed to make consulting payments to certain individuals who had been employees of the companies acquired and who became trustees of the Company subsequent to the applicable merger dates. During the years ended December 31, 2001, 2000 and 1999, the Company made payments pursuant to these agreements of $400,000, $400,000 and $625,000, respectively. The remaining future payments to be made under these agreements as of December 31, 2001 are approximately $167,000.
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The Company occupies office space at various office buildings that are owned and/or managed by Equity Office Properties Trust, a company of which EQR's chairman of the board is also chairman of the board. Amounts incurred for such office space for the years ended December 31, 2001, 2000 and 1999, respectively, were $1,935,013, $1,781,069 and $1,466,569.
Artery Property Management, Inc., a real estate property management company ("APMI") in which a trustee of the Company is a two-thirds owner and chairman of the board of directors, provided the Company consulting services with regard to property acquisitions and additional business opportunities. In connection with the acquisition of certain Properties from this trustee and his affiliates during 1995, the Company made a loan to this trustee and APMI of $15,212,000 evidenced by two notes and secured by 931,090 OP Units. At December 31, 2000, no amounts were outstanding under these notes and all OP Units were released from their pledges.
During 1999, the Company acquired eight Properties and the related management agreements from affiliates of the aforementioned trustee for an aggregate purchase price of approximately $110.2 million, including the assumption of approximately $44.3 million of mortgage indebtedness. The purchase price also included the issuance of 28,795 Series A Junior Convertible Preference Units in the Operating Partnership, which have a liquidation value of $100 per unit and are exchangeable for OP Units under certain circumstances. On June 29, 1999, this trustee received 8,462 of these units with a liquidation value of approximately $0.8 million.
The Company paid legal fees to a law firm of which one of the Company's trustees is a partner, in the amounts of $1.7 million, $3.6 million and $1.6 million for the years ended December 31, 2001, 2000 and 1999, respectively.
In addition, the Company has provided acquisition, asset and property management services to certain related entities for properties not owned by the Company. Fees received for providing such services were approximately $0.8 million, $1.7 million and $2.5 million for the years ended December 31, 2001, 2000 and 1999, respectively.
19. Commitments and Contingencies
The Company, as an owner of real estate, is subject to various environmental laws of Federal and local governments. Compliance by the Company with existing laws has not had a material adverse effect on the Company's financial condition and results of operations. However, the Company cannot predict the impact of new or changed laws or regulations on its current Properties or on properties that it may acquire in the future.
The Company does not believe there is any litigation threatened against the Company other than routine litigation arising out of the ordinary course of business, some of which is expected to be covered by liability insurance, none of which is expected to have a material adverse effect on the consolidated financial statements of the Company.
In regards to the funding of Properties in the development and/or earnout stage and the joint venture agreements with multifamily residential real estate developers, the Company funded a net total of $174.6 million during the year ended December 31, 2001. The Company expects to fund approximately $33.5 million in connection with these Properties beyond 2001. In connection with one joint venture agreement, the Company has an obligation to fund up to an additional $6.5 million to guarantee third party construction financing. As of December 31, 2001, the Company has 22 projects under development with estimated completion dates ranging from March 31, 2002 through December 31, 2003.
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For one joint venture agreement, the Company's joint venture partner has the right, at any time following completion of a project, to stipulate a value for such project and offer to sell its interest in the project to the Company based on such value. If the Company chooses not to purchase the interest, it must agree to a sale of the project to an unrelated third party at such value. The Company's joint venture partner must exercise this right as to all projects within five years after the receipt of the final certificate of occupancy on the last developed property.
In connection with the Wellsford Merger, the Company provided a credit enhancement with respect to certain tax-exempt bonds issued to finance certain public improvements at a multifamily development project. As of December 31, 2001, this enhancement was still in effect at a commitment amount of $12.7 million.
During the years ended December 31, 2001, 2000 and 1999, total lease payments incurred, including a portion of real estate taxes, insurance, repairs and utilities, aggregated $4,929,018, $4,074,672 and $3,271,513 respectively.
The minimum basic aggregate rental commitment under the Company's leases in years following December 31, 2001 is as follows:
20. Asset Impairment
For the year ended December 31, 2001, the Company recorded $60.0 million of asset impairment charges related to its Globe furniture rental business. These charges were the result of a review of the existing intangible and tangible assets reflected on the consolidated balance sheet as of September 30, 2001. The impairment loss is reflected on the statement of operations in total expenses and includes the write-down of the following assets: a) goodwill of approximately $26.0 million; b) rental furniture, net of approximately $28.6 million; c) property and equipment, net of approximately $4.5 million; and d) other assets of approximately $0.9 million.
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For the years ended December 31, 2001 and 2000 the Company recorded approximately $11.8 million and $1.0 million, respectively, of asset impairment charges related to its technology investments. These charges were the result of review of the existing investments reflected on the consolidated balance sheet. The Company reviewed the current relative value of each investment based on existing economic conditions and current events. These impairment losses are reflected on the statement of operations in total expenses and include the write-down of assets classified as other assets and investments in unconsolidated entities.
21. Reportable Segments
Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by senior management. Senior management decides how resources are allocated and assesses performance on a monthly basis.
The Company's primary business is owning, managing, and operating multifamily residential properties, which includes the generation of rental and other related income through the leasing of apartment units to residents. Senior management evaluates the performance of each of our apartment communities on an individual basis, however, each of our apartment communities has similar economic characteristics, residents, and products and services so they have been aggregated into one reportable segment. The Company's rental real estate segment comprises approximately 95.6%, 96.3% and 98.2% of total revenues for the years ended December 31, 2001, 2000 and 1999, respectively. The Company's rental real estate segment comprises approximately 99.8% and 98.7% of total assets at December 31, 2001 and 2000, respectively.
The primary financial measure for the Company's rental real estate segment is net operating income ("NOI"), which represents rental income less: 1) property and maintenance expense; 2) real estate taxes and insurance expense; and 3) property management expense (all as reflected in the accompanying statements of operations). Current year NOI is compared to prior year NOI and current year budgeted NOI as a measure of financial performance. NOI from our rental real estate totaled approximately $1.3 billion, $1.2 billion and $1.1 billion for the years ended December 31, 2001, 2000 and 1999, respectively.
22. Subsequent Events
Subsequent to December 31, 2001 and through February 5, 2002, the Company:
23. Quarterly Financial Data (Unaudited)
The following unaudited quarterly data has been prepared on the basis of a December 31 year-end. All per share and weighted average Common Shares outstanding amounts have been restated as a result of the Company's two-for-one split of its Common Shares. Amounts are in thousands, except for per share amounts.
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EQUITY RESIDENTIAL PROPERTIES TRUSTSchedule III — Real Estate and Accumulated DepreciationDecember 31, 2001
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EQUITY RESIDENTIAL PROPERTIES TRUST Schedule III — Real Estate and Accumulated Depreciation December 31, 2001
NOTES:
Note 1: Mortgage debt includes $1,245,848.19 collateralized by a warehouse owned by the Company's furniture rental subsidiary.
Note 2: The following letters have not been used: (I), (J), (K), (Q), (S), (V), (W), and (X)
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EQUITY RESIDENTIAL PROPERTIES TRUST Schedule III—Real Estate and Accumulated Depreciation (continued) (Amounts in thousands)
The changes in total real estate for the years ended December 31, 2001, 2000 and 1999 are as follows:
The changes in accumulated depreciation for the years ended December 31, 2001, 2000, and 1999 are as follows:
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