Equity Residential - 10-Q quarterly report FY

FORM 10-Q

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C.  20549

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 whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act).  Yes  ý   No o

The number of Common Shares of Beneficial Interest, $0.01 par value, outstanding on October 31, 2003 was 275,461,073.

EQUITY RESIDENTIAL
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands except for share amounts)
(Unaudited)

See accompanying notes

2

EQUITY RESIDENTIAL
CONSOLIDATED STATEMENTS OF OPERATIONS
(Amounts in thousands except per share data)
(Unaudited)

See accompanying notes

3

EQUITY RESIDENTIAL
CONSOLIDATED STATEMENTS OF OPERATIONS (Continued)
(Amounts in thousands except per share data)
(Unaudited)

See accompanying notes

4

EQUITY RESIDENTIAL
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
(Unaudited)

See accompanying notes

5

EQUITY RESIDENTIAL
CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Amounts in thousands)
(Unaudited)

See accompanying notes

6

EQUITY RESIDENTIAL
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1.                                      Business

Equity Residential (“EQR”), formed in March 1993, is a fully integrated real estate company engaged in the acquisition, ownership, management and operation of multifamily properties.  EQR has elected to be taxed as a real estate investment trust (“REIT”).

EQR is the general partner of, and as of September 30, 2003 owned an approximate 92.6% ownership interest in, ERP Operating Limited Partnership, an Illinois limited partnership (the “Operating Partnership”). The Operating Partnership is, 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 EQR, the Operating Partnership and each of the partnerships, limited liability companies and corporations controlled by the Operating Partnership and/or EQR.

As of September 30, 2003, the Company owned or had investments in 990 properties in 34 states consisting of 212,147 units.  An ownership breakdown includes:

2.                                      Summary of Significant Accounting Policies

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.  In the opinion of management, all adjustments (consisting of normal recurring accruals) and certain reclassifications considered necessary for a fair presentation have been included.  Certain reclassifications have been made to the prior period financial statements in order to conform to the current year presentation.  Operating results for the nine months ended September 30, 2003 are not necessarily indicative of the results that may be expected for the year ending December 31, 2003.

The balance sheet at December 31, 2002 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements.

For further information, including definition of capitalized terms not defined herein, refer to the consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2002.

7

Stock-Based Compensation

Prior to 2003, the Company had chosen to account for its stock-based compensation in accordance with APB No. 25, Accounting for Stock Issued to Employees, which resulted in no compensation expense for options issued with an exercise price equal to or exceeding the market value of the Company’s Common Shares on the date of grant (intrinsic method).  The Company has elected to expense its stock-based compensation in accordance with SFAS No. 123 and its amendment (SFAS No. 148), Accounting for Stock Based Compensation, effective in the first quarter of 2003, which resulted in compensation expense being recorded based on the fair value of the stock compensation granted or modified.

SFAS No. 148 provides three transition methods for entities that adopt the fair value recognition provisions of SFAS No. 123.  The Company has chosen to use the “Prospective Method”.  This method requires that companies apply the recognition provisions of SFAS No. 123 to only employee awards granted or modified after the beginning of the fiscal year in which the recognition provisions are first applied, or January 1, 2003.  Compensation expense under all of the Company’s plans is generally recognized over periods ranging from three months to five years.  Therefore, the cost related to stock-based employee compensation included in the determination of net income for the nine months and quarter ended September 30, 2003 is less than that which would have been recognized if the fair value based method had been applied to all awards since the original effective date of SFAS No. 123.

The following table illustrates the effect on net income and earnings per share if the fair value based method had been applied to all outstanding and unvested awards in each period presented:

(1)       Share options for the nine months ended September 30, 2003 included $1.4 million of expense recognition related to options granted in the first quarter of 2003 to the Company’s former chief executive officer.  These options vested immediately upon grant.

8

Other

In April 2002, the FASB issued SFAS No. 145, Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections.  SFAS No. 145, among other items, rescinds the automatic classification of costs incurred on debt extinguishment as extraordinary charges.  Instead, gains and losses from debt extinguishment should only be classified as extraordinary if they meet the “unusual and infrequently occurring” criteria outlined in APB No. 30.  SFAS No. 145 is effective for fiscal years beginning after May 15, 2002.  The Company adopted the standard effective January 1, 2003.

In January 2003, the FASB issued Interpretation (“FIN”) No. 46, Consolidation of Variable Interest Entities.  FIN No. 46 requires a variable interest entity to be consolidated if a company is subject to a majority of the risk of loss from the variable interest entity’s activities or entitled to receive a majority of the entity’s residual returns or both.  The Company will adopt FIN No. 46 as required effective December 31, 2003.  FASB Staff Position (“FSP”) No. FIN 46-6 deferred the effective date for applying the provisions of FIN No. 46 (for entities created before February 1, 2003) from July 1, 2003 to December 31, 2003.  The Company has preliminarily determined that its unconsolidated stabilized development projects and projects under development (see Note 7) are variable interest entities in which the Company is the primary beneficiary as of the date of the original formation of the respective joint ventures.  On such respective formation dates, the fair value of the assets, liabilities and non-controlling interests of these development projects approximates carryover basis.  If these development projects had been consolidated as of September 30, 2003, the Company’s investment in real estate and mortgage notes payable would have increased by $1.4 billion and $890.3 million, respectively, and investments in unconsolidated entities would have decreased by $514.6 million.  The Company does not anticipate that the adoption of FIN No. 46 will have any material effect on net income.

In May 2003, the FASB issued SFAS No. 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.  SFAS No. 150 establishes standards for classifying and measuring as liabilities certain financial instruments that embody obligations of the issuer and have characteristics of both liabilities and equity.  On November 7, 2003, the FASB issued FSP No. FAS 150-3, which deferred for an indefinite period the classification and measurement provisions, but not the disclosure provisions (see discussion below), of SFAS No. 150 as it relates to noncontrolling interests that are classified as equity in the financial statements of a subsidiary but would be classified as a liability in the parent’s financial statements under SFAS No. 150 (e.g., minority interests in consolidated limited-life subsidiaries).  The Company does not have any mandatorily redeemable preferred shares/units that fall within the scope of SFAS No. 150.

With regards to the aforementioned disclosure provisions, the Company is presently the controlling partner in various consolidated partnerships consisting of 36 properties and 6,931 units.  These partnerships contain provisions that require the partnerships to be liquidated through the sale of its assets upon reaching a date specified in each respective partnership agreement.  The Company, as controlling partner, has an obligation to cause the property owning partnerships to distribute proceeds of liquidation to the Minority Interests in these Partially Owned Properties only to the extent that the net proceeds received by the partnerships from the sale of its assets warrant a distribution based on the partnership agreements.  As of September 30, 2003, the Company estimates the value of Minority Interest distributions would have been approximately $100 million (“Settlement Value”) had the partnerships been liquidated.  This Settlement Value is based on estimated third party consideration realized by the partnerships upon disposition of the Partially Owned Properties and is net of all other assets and liabilities including yield maintenance on the mortgages encumbering the properties that would have been due on September 30, 2003 had those mortgages been prepaid.  Due to, among other things, the inherent uncertainty in the sale of real estate assets, the amount of any potential distribution to the Minority Interests in the Company’s Partially Owned Properties is subject to change.  To the extent that the partnerships’ underlying assets are worth less than the underlying liabilities, the Company has no obligation to remit any consideration to the Minority Interests in Partially Owned Properties.

On July 31, 2003, the SEC clarified its position with respect to Emerging Issues Task Force (“EITF”) Topic D-42, The Effect on the Calculation of Earnings per Share for the Redemption or Induced Conversion of Preferred Stock.  Under the SEC’s revised interpretation, in connection with the redemption of preferred shares/units, the original issuance costs of these shares/units must be treated in a manner similar to preferred distributions and deducted from net income in arriving at net income available to Common Shares.  The clarification of EITF Topic D-42 was required to be adopted effective July 1, 2003 on a retroactive basis by restating prior periods included in the current financial statements.  The adoption of the clarification of EITF Topic D-42 did not have any impact on the Company’s consolidated financial position or cash flows nor did it impact the reported consolidated results of operations for the periods presented herein.

3.             Shareholders’ Equity and Minority Interests

The following table presents the changes in the Company’s issued and outstanding Common Shares for the nine months ended September 30, 2003:

9

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”.  The Minority Interests – Operating Partnership held 22,093,940 units of limited partnership interest (“OP Units”), representing a 7.4% interest in the Operating Partnership, at September 30, 2003.  Assuming conversion of all OP Units into Common Shares, total Common Shares outstanding at September 30, 2003 would have been 297,291,121.  Subject to applicable securities law restrictions, the Minority Interests – Operating Partnership may exchange their OP Units for EQR Common Shares on a one-for-one basis.

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 those contributions, EQR receives a number of OP Units in the Operating Partnership equal to the number of Common Shares it has issued in the equity offering (or in the case of a preferred equity offering, a number of preference units in the Operating Partnership equal in number and having the same terms as the Preferred Shares issued in the equity offering).  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.

During the nine months ended September 30, 2003, the Operating Partnership issued 159,427 OP Units to various limited partners at an average price of $27.48 per unit.  These OP Units are classified as Minority Interests – Operating Partnership in the accompanying consolidated balance sheets.

The Company’s declaration of trust authorizes the Company to 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.

The following table presents the Company’s issued and outstanding Preferred Shares as of September 30, 2003 and December 31, 2002:

10

(1)                      Dividends on all series of Preferred Shares are payable quarterly at various pay dates.  Dividend rates listed for Series B, C, D, G and N are Preferred Share rates and the equivalent Depositary Share annual dividend rates are $2.281252, $2.281252, $2.15, $1.8125 and $1.62, respectively.

(2)                      On June 19, 2003, the Company redeemed all of its outstanding Series L Cumulative Redeemable Preferred Shares at liquidation value for total cash consideration of $100.0 million.  The Company did not incur any original issuance costs as these shares were issued by Merry Land and Investment Company, Inc. prior to its merger with the Company.

(3)                      On June 19, 2003, the Company issued 600,000 Series N Cumulative Redeemable Preferred Shares in a public offering.  The Company received $145.3 million in net proceeds from this offering after payment of the underwriters’ fee.

11

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.

The following table presents the issued and outstanding Preference Interests as of September 30, 2003 and December 31, 2002:

(1)                      Dividends on all series of Preference Interests are payable quarterly on March 25^th, June 25^th, September 25^th, and December 25^th of each year.

The following table presents the Operating Partnership’s issued and outstanding Junior Convertible Preference Units (the “Junior Preference Units”) as of September 30, 2003 and December 31, 2002:

12

(1)                                  Dividends on both series of Junior Preference Units are payable quarterly at various pay dates.

4.             Real Estate Acquisitions

During the nine months ended September 30, 2003, the Company acquired the entire equity interest in the eight properties listed below from unaffiliated parties, and two additional units at an existing property, for a total purchase price of $389.7 million.

(1)           Includes 8,167 square feet of retail space.

(2)           Includes 36,326 square feet of office space and a 324-space parking garage.

During the nine months ended September 30, 2003, the Company acquired the remaining third party equity interests it did not previously own in the following three properties:

•                  Liberty Park, a 202-unit property located in Braintree, Massachusetts;

•                  Hickory Mill II, a 44-unit property located in Hurricane, West Virginia (property was subsequently sold — see Note 5); and

•                  Winter Woods II, a 44-unit property located in Winter Garden, Florida.

These properties were accounted for under the equity method of accounting and subsequent to each purchase were consolidated.  The Company recorded $34.9 million in investment in real estate at carryover basis and the following:

•      Assumed $28.1 million in mortgage debt;

•      Issued 153,851 OP Units having a value of $4.2 million;

•      Reduced investments in unconsolidated entities by $1.2 million;

13

•      Paid cash of $0.8 million; and

•      Assumed $0.6 million of other liabilities net of other assets acquired.

5.              Real Estate Dispositions

During the nine months ended September 30, 2003, the Company disposed of the sixty-three properties and various individual condominium units listed below to unaffiliated parties.  The Company recognized a net gain on sales of discontinued operations of approximately $219.0 million and a net gain on sales of unconsolidated entities of approximately $4.7 million.

14

6.             Commitments to Acquire/Dispose of Real Estate

As of November 4, 2003, in addition to the properties that were subsequently acquired as discussed in Note 18, the Company had entered into separate agreements to acquire seven multifamily properties containing 2,265 units from unaffiliated parties.  The Company expects a combined purchase price of approximately $220.4 million, including the assumption of mortgage debt of approximately $21.5 million.

As of November 4, 2003, in addition to the properties that were subsequently disposed of as discussed in Note 18, the Company had entered into separate agreements to dispose of thirty-three multifamily properties containing 8,404 units to unaffiliated parties.  The Company expects a combined disposition price of approximately $456.9 million.

15

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.

7.              Investments in Unconsolidated Entities

The Company has co-invested in various properties with unrelated third parties.  The following table summarizes the Company’s investments in unconsolidated entities as of September 30, 2003 (amounts in thousands except for project and unit amounts):

(1)          The Company determines a project to be stabilized once it has maintained an average physical occupancy of 90% or more for a three-month period or one year from the cessation of major development activities, whichever is earlier.

(2)          Includes nine projects under development containing 2,356 units, which are not included in the Company’s property/unit counts at September 30, 2003.   Totals exclude Fort Lewis Military Housing consisting of one property and 3,799 units, which is not accounted for under the equity method of accounting.  The Fort Lewis Military Housing is included in the Company’s property/unit counts at September 30, 2003.

(3)          A total of $706.3 million is available for funding under this construction debt, of which $559.2 million was funded and outstanding at September 30, 2003.

(4)          As of November 4, 2003, the Company has funded $44.0 million as additional collateral on selected debt (see Note 8).  All remaining debt is non-recourse to the Company.

Investments in unconsolidated entities include the Unconsolidated Properties as well as various development properties under construction or pending construction.  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 capitalizes 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 nine months ended September 30, 2003 and 2002, the Company capitalized $16.0 million and $12.5 million, respectively, in interest cost related to its unconsolidated development projects (which reduced interest expense incurred in the consolidated statements of operations).

The Company generally contributes between 25% and 35% of the project cost of the unconsolidated projects under development (constituting 100% of the equity), with the remaining cost financed through third-party construction mortgages.  Voting rights are shared equally between the Company and its respective development partners.

16

See Note 2 for further discussion regarding FIN No. 46 and its anticipated effect on the Company’s unconsolidated development projects.

8.              Deposits - - Restricted

As of September 30, 2003, deposits-restricted totaled $287.8 million and primarily included the following:

•                  Deposits in the amount of $51.0 million held in third party escrow accounts to provide collateral for third party construction financing in connection with unconsolidated development projects;

•                  Approximately $169.5 million in tax-deferred (1031) exchange proceeds; and

•                  Approximately $67.3 million for resident security, utility, and other deposits.

9.              Mortgage Notes Payable

As of September 30, 2003, the Company had outstanding mortgage indebtedness of approximately $2.8 billion.

During the nine months ended September 30, 2003, the Company:

•                  Repaid $235.2 million of mortgage loans;

•                  Assumed $109.1 million of mortgage debt on certain properties in connection with their acquisitions and/or consolidation;

•                  Obtained $48.7 million of mortgage loans on certain properties; and

•                  Relinquished $31.7 million of mortgage debt assumed by the purchaser on disposed properties.

As of September 30, 2003, scheduled maturities for the Company’s outstanding mortgage indebtedness were at various dates through October 1, 2033.  At September 30, 2003, the interest rate range on the Company’s mortgage debt was 1.04% to 12.465%.  During the nine months ended September 30, 2003, the weighted average interest rate on the Company’s mortgage debt was 5.84%.

10.       Notes

As of September 30, 2003, the Company had outstanding unsecured notes of approximately $2.7 billion.

On June 5, 2003, the Operating Partnership filed a Form S-3 registration statement with the SEC to register $2.0 billion of debt securities.  The SEC declared this registration statement effective on June 11, 2003.  In addition, the Operating Partnership carried over $280.0 million related to the registration statement effective on September 8, 2000.  As of September 30, 2003, $2.28 billion remained available for issuance under this registration statement.

During the nine months ended September 30, 2003, the Company:

•                  Issued $400.0 million of ten-year 5.20% fixed-rate public notes, receiving net proceeds of $397.5 million;

•                  Repaid $100.0 million of floating rate public notes at maturity; and

•                  Repaid $4.5 million of other unsecured notes.

As of September 30, 2003, scheduled maturities for the Company’s outstanding notes were at various dates through 2029.  At September 30, 2003, the interest rate range on the Company’s notes was 4.75% to 7.75%. During the nine months ended September 30, 2003, the weighted average interest rate on the Company’s notes was 6.48%.

17

11.       Line of Credit

The Company has a revolving credit facility with potential borrowings of up to $700.0 million.  As of September 30, 2003, no amounts were outstanding and $57.0 million was restricted (dedicated to support letters of credit and not available for borrowing) on the line of credit.  During the nine months ended September 30, 2003, the weighted average interest rate was 1.85%.  EQR has guaranteed the Operating Partnership’s line of credit up to the maximum amount and for the full term of the facility.

12.       Derivative Instruments

The following table summarizes the consolidated derivative instruments at September 30, 2003 (dollar amounts are in thousands):