filings.toolsItem 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
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Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following discussion analyzes the financial condition and results of operations of both MAA and the Operating Partnership, of which MAA is the sole general partner and in which MAA owned a 96.4% limited partner interest as of December 31, 2017. MAA conducts all of its business through the Operating Partnership and its various subsidiaries. This discussion should be read in conjunction with the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
MAA is a multifamily focused, self-administered and self-managed real estate investment trust, or REIT. We own, operate, acquire and selectively develop apartment communities primarily located in the Southeast and Southwest regions of the United States. As of December 31, 2017, activities include full ownership and operation of 301 multifamily properties, which includes commercial space at certain properties, four additional commercial properties, and a partial ownership in one multifamily property. These properties are located in Alabama, Arizona, Arkansas, Colorado, Florida, Georgia, Kansas, Kentucky, Maryland, Mississippi, Missouri, Nevada, North Carolina, South Carolina, Tennessee, Texas, Virginia and Washington, D.C.
Our primary business objectives are to protect and grow existing property values, to maintain a stable and increasing cash flow that will fund our dividends and distributions through all parts of the real estate investment cycle, and to create shareholder value by growing in a disciplined manner. To achieve these objectives, we intend to continue to pursue the following goals and strategies:
| • | effectively and efficiently operate our existing properties with an intense property and asset management focus and a decentralized structure; |
| • | manage real estate cycles by taking an opportunistic approach to buying, selling, renovating and developing apartment communities; |
| • | diversify investment capital across markets in which we operate to achieve a balanced portfolio with less volatile operating performance; and |
| • | actively manage our capital structure to enhance predictability of earnings to fund our dividends and distributions. |
OVERVIEW
We experienced an increase in net income available for MAA common shareholders for the year ended December 31, 2017 as the growth in revenues outpaced increases in our property operating expenses. The increase in revenues was primarily driven by a 3.0% increase in our Large Market Same Store segment, a 2.6% increase in our Secondary Market Same Store segment and a $375.2 million increase in our Non-Same Store and Other segment, which was primarily a result of the Merger. The increase in property operating expenses was primarily due to a 2.0% increase in our Large Market Same Store segment, a 2.7% increase in our Secondary Market Same Store segment and a $145.1 million increase in our Non-Same Store and Other segment, which was primarily the result of the Merger. The drivers of these increases are discussed below in the "Results of Operations" section.
On December 1, 2016, we consummated the Merger and acquired all of Post Properties' consolidated net assets. The consolidated net assets and results of operations of Post Properties are included in our consolidated financial statements from the closing date of the Merger going forward. All properties acquired from Post Properties are included in our Non-Same Store and Other operating segment, as the properties are recent acquisitions and had not been owned and stabilized for at least twelve months as of January 1, 2017.
Over the past three years, our growth has been driven by our acquisition strategy to invest in large and mid-sized growing markets in the Southeast and Southwest region of the United States. As a result of the Merger, we acquired 61 apartment communities in 2016. We acquired two apartment communities in 2017, five in 2016 apart from the Merger, and seven in 2015. We disposed of five apartment communities in 2017, 12 in 2016, and 21 in 2015.
TRENDS
During the year ended December 31, 2017, demand for apartments continued to be relatively strong, as it was during the year ended December 31, 2016. This strength was evident on two fronts: occupancy and effective rent per unit. Same store physical occupancy at December 31, 2017 was 97%. Average physical occupancy for the same store portfolio was 96.2% for the year ended December 31, 2017, consistent with the year ended December 31, 2016. Same store average effective rent per unit continued to increase, and was up 3.0% for the year ended December 31, 2017 as compared to the year ended December 31, 2016. As we move through the remainder of the typically slower winter leasing season and into the typically stronger spring leasing season, we believe the current level of physical occupancy puts us in a good position to capture solid pricing in the first half of 2018.
An important part of our portfolio strategy is to maintain a diversity of markets, submarkets, product types and price points across the Southeast and Southwest regions of the United States. This diversity tends to mitigate exposure to economic issues in any one geographic market or area. We believe that a well-balanced portfolio, including inner loop, suburban, and downtown/central business district locations and various monthly rent price points, will perform well in "up" cycles as well as weather "down" cycles better. Through our investment in 37 defined Metropolitan Statistical Areas, or MSAs, we are diversified across markets, urban and suburban submarkets, and a variety of monthly rent pricing points.
Current supply levels are impacting our total portfolio from a demand standpoint, particularly properties located in urban submarkets, the majority of which were acquired in the Merger. Properties in our same store portfolio have been impacted somewhat less by supply, primarily because less new development has occurred in those submarkets. Encouragingly, according to U.S. Census Bureau data, full year 2017 multifamily permitting across our markets was down 5% as compared to the prior year. This activity should result in relatively lower supply in our markets in the future as compared to the current environment.
Demand for our apartments is primarily driven by general economic conditions in our markets. In particular, job growth relative to new supply is a critical factor in our ability to maintain occupancy and increase rents. To the extent that the Tax Cuts and Jobs Act results in improving economic conditions such as increased job growth or more disposable income, we believe that we may be able to maintain occupancy more effectively and increase rents.
Also, we believe that more disciplined credit terms for residential mortgages should continue to favor rental demand at existing multifamily properties. Furthermore, rental competition from single family homes has not been a major competitive factor impacting our portfolio. For the year ended December 31, 2017, total move outs attributable to single family home
rentals for our combined portfolio represented about 6% of total move outs, in line with the year ended December 31, 2016. We have seen significant rental competition from single family homes in only a few of our submarkets. Long term, we expect demographic trends (including the growth of prime age groups for rentals and immigration and population movement to the Southeast and Southwest regions) will continue to support apartment rental demand in our markets.
Rising interest rates may have a significant impact on our business and results of operations. As of December 31, 2017, we had approximately $4.5 billion of debt, of which 17% had variable rate interest and 83% had fixed or hedged interest rates. To the extent interest rates rise, our net interest expense on variable rate debt will increase as will potentially our net interest expense on any debt refinancing. Given the short-term nature of our leases, to the extent interest rates rise due to general economic growth, we would expect increases in interest expense to be somewhat offset by positive leasing trends.
RESULTS OF OPERATIONS
Comparison of the Year Ended December 31, 2017 to the Year Ended December 31, 2016
For the year ended December 31, 2017, we achieved net income available for MAA common shareholders of $324.7 million, a 53.2% increase over the prior year, and total revenue growth of $403.6 million, a 35.9% increase over the prior year. The following discussion describes the primary drivers of the increase in net income for MAA common shareholders for the year ended December 31, 2017.
Property Revenues
The following table presents our property revenues by segment for the years ended December 31, 2017 and December 31, 2016 (dollars in thousands):
| December 31, 2017 | December 31, 2016 | Increase | % Increase | |||||||||||
| Large Market Same Store | $ | 672,131 | $ | 652,560 | $ | 19,571 | 3.0 | % | ||||||
| Secondary Market Same Store | 349,007 | 340,161 | 8,846 | 2.6 | % | |||||||||
| Same Store Portfolio | 1,021,138 | 992,721 | 28,417 | 2.9 | % | |||||||||
| Non-Same Store and Other | 507,849 | 132,627 | 375,222 | 282.9 | % | |||||||||
| Total | $ | 1,528,987 | $ | 1,125,348 | $ | 403,639 | 35.9 | % |
The increases in property revenues from our Large Market Same Store and Secondary Market Same Store portfolio were primarily a result of increased effective rent per unit of 3.1% and 2.7%, respectively, as compared to the year ended December 31, 2016. The increase in property revenues from our Non-Same Store and Other portfolio was primarily the result of the Merger, as we classified the properties we acquired as Non-Same Store.
Property Operating Expenses
Property operating expenses include costs for property personnel, building repairs and maintenance, real estate taxes and insurance, utilities, landscaping, other operating expenses and depreciation and amortization. The following table reflects our property operating expenses by segment excluding depreciation and amortization for the years ended December 31, 2017 and December 31, 2016 (dollars in thousands):
| December 31, 2017 | December 31, 2016 | Increase | % Increase | |||||||||||
| Large Market Same Store | $ | 250,056 | $ | 245,266 | $ | 4,790 | 2.0 | % | ||||||
| Secondary Market Same Store | 130,334 | 126,888 | 3,446 | 2.7 | % | |||||||||
| Same Store Portfolio | 380,390 | 372,154 | 8,236 | 2.2 | % | |||||||||
| Non-Same Store and Other | 196,341 | 51,202 | 145,139 | 283.5 | % | |||||||||
| Total | $ | 576,731 | $ | 423,356 | $ | 153,375 | 36.2 | % |
The increase in property operating expenses for our Large Market Same Store segment was primarily the result of increases in real estate taxes of $4.7 million, personnel expenses of $1.0 million, and utilities expense of $0.7 million, partially offset by a decrease in insurance expense of $1.5 million. The increase in property operating expenses for our Secondary Market Same Store segment was primarily driven by increases in real estate taxes of $1.5 million, personnel expenses of $1.3 million, and utilities expense of $0.9 million, partially offset by a decrease in insurance expense of $0.3 million. The increase in property operating expenses for our Non-Same Store and Other portfolio was primarily due to the Merger.
Depreciation and Amortization
Depreciation and amortization expense for the year ended December 31, 2017 was approximately $493.7 million, an increase of $170.8 million from the year ended December 31, 2016. In addition to asset acquisitions made in the normal course of business, the increase was primarily driven by the full year of depreciation and amortization expense resulting from the Merger compared to only one month of comparable depreciation and amortization in 2016. As a result of the Merger, depreciation expense and amortization expense increased $138.2 million and $23.2 million, respectively, for year ended December 31, 2017 compared to the year ended December 31, 2016.
Other Operating Expenses
Property management expenses for the year ended December 31, 2017 were approximately $43.6 million, an increase of $9.5 million compared to the year ended December 31, 2016. The increase was primarily due to the growth in our portfolio as a result of the Merger.
Merger and integration expenses for the year ended December 31, 2017 were primarily comprised of $16.0 million of systems and professional costs and $4.0 million of legal costs, as we integrated Post Properties into our consolidated operations. Merger and integration expenses for the year ended December 31, 2017 were approximately $20.8 million less than merger and integration expenses for the year ended December 31, 2016, as we incurred significant merger related expenses in 2016 to complete the Merger on December 1, 2016.
General and administrative expenses for the year ended December 31, 2017 were approximately $40.2 million, an increase of $11.2 million compared to the year ended December 31, 2016. The increase was primarily driven by legal expenses.
Non-Operating Expenses and Other
Interest expense for the year ended December 31, 2017 was approximately $154.8 million, an increase of $24.8 million from the year ended December 31, 2016. The increase was primarily due to increased borrowing as we assumed several loans as a result of the Merger, including a secured loan with a face value of $186.0 million and two unsecured loans with face values of $150.0 million and $250.0 million, respectively. We entered into a new $300.0 million term loan on the closing date of the Merger. Interest expense for the year ended December 31, 2017 increased $16.0 million due to these borrowings resulting from the Merger. In addition, in May 2017, we publicly issued senior unsecured notes with a face value of $600.0 million, bearing interest at 3.60% per annum, which resulted in additional interest expense of approximately $14.0 million for the year ended December 31, 2017. Such increases were offset by a slight decreases in interest expense as a result of retirements of secured property mortgages and unsecured notes during the year ended December 31, 2017; the notes were scheduled to mature in October 2017.
Gains on sale of depreciable assets totaled $127.4 million for the year ended December 31, 2017, an increase of approximately $47.0 million from the year ended December 31, 2016. Although disposition activity decreased year-over-year, the gain on sale of depreciable assets increased primarily due to the nature of the real estate assets sold.
Other non-operating income for the year ended December 31, 2017 was $14.4 million, an increase of approximately $16.2 million compared to the year ended December 31, 2016. The year-over-year increase was primarily due to an $8.8 million increase in the net mark-to-market adjustments of the bifurcated embedded derivative related to the MAA Series I preferred stock issued in the Merger. The year-over-year increase was also driven by the $3.3 million increase in the net gain on debt extinguishment, primarily due to gains of $4.8 million from the write-offs of mark-to-market debt adjustments related to the retirement of secured mortgages and a term loan, partially offset by a cash prepayment penalty of $1.6 million.
During the year ended December 31, 2017 we recorded quarterly dividend distributions to holders of MAA's Series I preferred stock totaling $3.7 million. As there were no shares of MAA Series I preferred stock issued and outstanding until completion of the Merger on December 1, 2016, preferred dividends only impacted our results of operations for one month totaling $0.3 million for the year ended December 31, 2016.
Comparison of the Year Ended December 31, 2016 to the Year Ended December 31, 2015
For the year ended December 31, 2016, we achieved net income available for MAA common shareholders of $211.9 million, a 36.2% decrease over the prior year, and total revenue growth of $82.6 million, a 7.9% increase over the prior year.
The following discussion describes the primary drivers of the decrease in net income for MAA common shareholders for the year ended December 31, 2016.
The comparison of the year ended December 31, 2016 to the year ended December 31, 2015 shows the segment break down based on the 2016 same store portfolios. A comparison using the 2017 same store portfolio would not be comparative due to the nature of the classifications.
Property Revenues
The following table presents our property revenues by segment for the years ended December 31, 2016 and December 31, 2015 (dollars in thousands):
| December 31, 2016 | December 31, 2015 | Increase | % Increase | |||||||||||
| Large Market Same Store | $ | 642,679 | $ | 612,934 | $ | 29,745 | 4.9 | % | ||||||
| Secondary Market Same Store | 337,883 | 327,700 | 10,183 | 3.1 | % | |||||||||
| Same Store Portfolio | 980,562 | 940,634 | 39,928 | 4.2 | % | |||||||||
| Non-Same Store and Other | 144,786 | 102,145 | 42,641 | 41.7 | % | |||||||||
| Total | $ | 1,125,348 | $ | 1,042,779 | $ | 82,569 | 7.9 | % |
The increase in property revenues from our same store portfolio was primarily a result of increased effective rent per unit of 4.9% and 2.9% for our large and secondary markets, respectively. The increase in property revenues from our Non-Same Store and Other segment was due to the Merger.
Property Operating Expenses
Property operating expenses include costs for property personnel, building repairs and maintenance, real estate taxes and insurance, utilities, landscaping, other operating expenses and depreciation and amortization. The following table reflects our property operating expenses excluding depreciation and amortization by segment for the years ended December 31, 2016 and December 31, 2015 (dollars in thousands):
| December 31, 2016 | December 31, 2015 | Increase | % Increase | |||||||||||
| Large Market Same Store | $ | 243,392 | $ | 235,909 | $ | 7,483 | 3.2 | % | ||||||
| Secondary Market Same Store | 125,830 | 123,318 | 2,512 | 2.0 | % | |||||||||
| Same Store Portfolio | 369,222 | 359,227 | 9,995 | 2.8 | % | |||||||||
| Non-Same Store and Other | 54,134 | 41,418 | 12,716 | 30.7 | % | |||||||||
| Total | $ | 423,356 | $ | 400,645 | $ | 22,711 | 5.7 | % |
The increase in property operating expenses from our Large Market Same Store segment was primarily the result of increases in real estate taxes of $5.3 million, personnel expenses of $1.5 million and utilities expenses of $1.2 million. The increase in property operating expenses from our Secondary Market Same Store segment was primarily driven by increases in real estate taxes of $1.3 million. The increase in property operating expenses from our Non-Same Store and Other segment was due to the Merger.
Depreciation and Amortization
Depreciation and amortization expense for the year ended December 31, 2016 was $323.0 million, an increase of $28.4 million, from the year ended December 31, 2015. The increase was primarily driven by depreciation expense of $17.4 million related to the Merger. Additionally, the amortization of the fair market value of in-place leases related to the Merger began in December 2016, and totaled $4.9 million for the year ended December 31, 2016.
Other Operating Expenses
Merger and integration expenses for the year ended December 31, 2016 were $40.8 million as a result of the expenses associated with the Merger, which closed on December 1, 2016. There were no merger and integration expenses for the year ended December 31, 2015 as no merger occurred in that year.
Interest expense for the year ended December 31, 2016 was approximately $129.9 million, an increase of $7.6 million from the year ended December 31, 2015. The increase was due in part to decreased amortization of the fair market value of
debt adjustments related to debt acquired and increased interest rates towards the end of 2016. Additionally, we assumed additional debt as a result of the Merger, including a secured loan in the principal amount of $186.0 million and two series of unsecured senior notes with face values of $150.0 million and $250.0 million, respectively. Additionally, we entered into a new $300.0 million term loan on the closing date of the Merger.
We recorded a gain on sale of depreciable assets of $80.4 million for the year ended December 31, 2016, a decrease of approximately $109.6 million from the year ended December 31, 2015. The decrease was primarily the result of a decline in disposition activity year-over-year. Dispositions decreased from 21 multifamily properties for the year ended December 31, 2015, to 12 multifamily properties for the year ended December 31, 2016.
Non-Operating Expenses and Other
Other non-operating expense for the year ended December 31, 2016 was $1.8 million, a decrease of approximately $4.4 million compared to the year ended December 31, 2015. The year-over-year decrease was primarily due to the $3.5 million decrease in loss on debt extinguishment due to the 2015 removal of properties from a secured tax-free debt facility; there was an immaterial loss on debt extinguishment activity for the year ended December 31, 2016.
Funds from Operations
Funds from operations, or FFO, a non-GAAP financial measure, represents net income available for MAA common shareholders (computed in accordance with the United States generally accepted accounting principles, or GAAP) excluding extraordinary items, asset impairment and gains or losses on disposition of real estate assets, plus net income attributable to noncontrolling interests, depreciation and amortization of real estate, and adjustments for joint ventures to reflect FFO on the same basis. Because noncontrolling interest is added back, FFO, when used in this Annual Report on Form 10-K, represents FFO attributable to the Company.
FFO should not be considered as an alternative to net income or any other GAAP measurement of performance, as an indicator of operating performance or as an alternative to cash flows from operating, investing, and financing activities as a measure of liquidity. Management believes that FFO is helpful to investors in understanding our operating performance primarily because its calculation excludes depreciation and amortization expense on real estate assets. We believe that GAAP historical cost depreciation of real estate assets is generally not correlated with changes in the value of those assets, whose value does not diminish predictably over time, as historical cost depreciation implies. While our calculation of FFO is in accordance with NAREIT's definition, it may differ from the methodology for calculating FFO utilized by other REITs and, accordingly, may not be comparable to such other REITs.
The following table presents a reconciliation of net income available for MAA common shareholders to FFO for the years ended December 31, 2017, 2016, and 2015, as we believe net income available for MAA common shareholders is the closest corresponding GAAP measure (dollars in thousands):
| Year ended December 31, | |||||||||||
| 2017 | 2016 | 2015 | |||||||||
| Net income available for MAA common shareholders | $ | 324,691 | $ | 211,915 | $ | 332,287 | |||||
| Depreciation and amortization of real estate assets | 489,503 | 319,528 | 291,572 | ||||||||
| Gain on sale of depreciable real estate assets | (127,386 | ) | (80,397 | ) | (189,958 | ) | |||||
| Loss (gain) on disposition within unconsolidated entities | — | 98 | (12 | ) | |||||||
| Depreciation and amortization of real estate assets of real estate joint ventures | 596 | 61 | 25 | ||||||||
| Net income attributable to noncontrolling interests | 12,157 | 12,180 | 18,458 | ||||||||
| Funds from operations attributable to the Company | $ | 699,561 | $ | 463,385 | $ | 452,372 |
FFO for the year ended December 31, 2017 increased by approximately $236.2 million from the year ended December 31, 2016 primarily as a result of the increases in property revenues of $403.6 million and other non-operating income of $16.2 million, in addition to decreased merger and integration expenses of $20.8 million. The increases to FFO were offset by the impact of increases in property operating expenses, excluding depreciation and amortization, of $153.4 million, interest expense of $24.8 million, general and administrative expenses of $11.2 million, property management expenses of $9.5 million and preferred dividends of $3.4 million.
FFO for the year ended December 31, 2016 increased by approximately $11.0 million from the year ended December 31, 2015 primarily as a result of the increase in property revenues of $82.6 million, which was offset by increases in merger and integration expenses of $40.8 million, property operating expenses, excluding depreciation and amortization, of $22.7 million, general and administrative expenses of $3.3 million and property management expenses of $3.1 million.
LIQUIDITY AND CAPITAL RESOURCES
Our cash flows from operating, investing, and financing activities, as well as general economic and market conditions, are the principal factors affecting our liquidity and capital resources.
Operating Activities
Net cash flow provided by operating activities increased to $658.5 million for the year ended December 31, 2017 from $484.0 million for the year ended December 31, 2016. The increase was primarily driven by the inclusion of twelve months of operating results of Post Properties for the year ended December 31, 2017 as compared to one month of operating results for the year ended December 31, 2016.
Investing Activities
Net cash used in investing activities for the year ended December 31, 2017 was $283.4 million compared to net cash used in investing activities for the year ended December 31, 2016 of $710.5 million. The primary drivers of the change were as follows:
| Primary drivers of cash inflow (outflow) | Increase (Decrease) in Net Cash | Percentage Increase (Decrease) in Net Cash | ||||||||||||
| during the year ended December 31, | ||||||||||||||
| 2017 | 2016 | |||||||||||||
| Purchases of real estate and other assets | $ | (136,065 | ) | $ | (339,186 | ) | $ | 203,121 | 59.9 | % | ||||
| Capital improvements, development and other | (343,890 | ) | (183,977 | ) | (159,913 | ) | (86.9 | )% | ||||||
| Proceeds from disposition of real estate assets | 187,429 | 296,700 | (109,271 | ) | (36.8 | )% | ||||||||
| Return (funding) of escrow for future acquisitions | 10,591 | (58,259 | ) | 68,850 | 118.2 | % | ||||||||
| Acquisition of Post Properties, net of cash acquired | — | (427,764 | ) | 427,764 | (100.0 | )% |
The decrease in cash outflows for purchases of real estate and other assets resulted from the acquisition of two apartment communities during the year ended December 31, 2017 compared to the acquisition of five apartment communities during the year ended December 31, 2016. The increase in cash outflows for capital improvements, development and other during the year ended December 31, 2017 compared to the prior year resulted from the property portfolio increase and development pipeline increase as a result of the Merger. The decrease in proceeds from the disposition of real estate assets primarily resulted from the sale of five apartment communities and four land parcels during the year ended December 31, 2017 compared to the sale of 12 apartment communities, one commercial property, and three land parcels during the year ended December 31, 2016. The increase in cash inflows from the funding of escrow for future acquisitions resulted from the funding of three anticipated future 1031(b) transactions offset by the release of three 1031(b) transactions that never occurred during the year ended December 31, 2017 compared to the funding of one anticipated future 1031(b) transaction during the year ended December 31, 2016. The decrease in cash outflows for the acquisition of Post Properties, net of cash acquired, compared to prior year resulted from the completion of the Merger; there were no mergers during the year ended December 31, 2017.
Financing Activities
Net cash used by financing activities was $397.9 million for the year ended December 31, 2017 compared to net cash provided by financing activities of $222.4 million for the year ended December 31, 2016. The primary drivers of the change were as follows:
| Primary drivers of cash inflow (outflow) | Increase (Decrease) in Net Cash | Percentage Increase (Decrease) in Net Cash | ||||||||||||
| during the year ended December 31, | ||||||||||||||
| 2017 | 2016 | |||||||||||||
| Net change in credit lines | $ | (160,000 | ) | $ | 335,000 | $ | (495,000 | ) | (147.8 | )% | ||||
| Proceeds from notes payable | 597,480 | 300,000 | 297,480 | 99.2 | % | |||||||||
| Principal payments on notes payable | (413,557 | ) | (146,026 | ) | (267,531 | ) | (183.2 | )% | ||||||
| Dividends paid on common shares | (395,294 | ) | (247,652 | ) | (147,642 | ) | (59.6 | )% |
The decrease in cash outflows related to the net change in credit lines resulted from the decrease in net borrowings of $80.0 million on our unsecured revolving credit facility and $80.0 million on our secured credit facility during the year ended December 31, 2017, compared to an increase in net borrowings of $415.0 million on the unsecured revolving credit facility and a decrease of $80.0 million on the secured credit facility during the year ended December 31, 2016. The increase in proceeds from notes payable during the year ended December 31, 2017 related to the May 2017 issuance of $600.0 million senior unsecured notes, as discussed in Note 6, compared to the 2016 issuance of the unsecured term loan in the amount of $300.0 million. The increase in cash outflows from principal payments on notes payable primarily resulted from paying off approximately $233.6 million of secured property mortgages and $168.0 million of senior unsecured notes during the year ended December 31, 2017 compared to paying off the $140.0 million legacy Post Properties' line of credit facility during the year ended December 31, 2016. The increase in cash outflows from dividends paid on common shares primarily resulted from the increased number of common shares outstanding as a result of the Merger and the increase in the annual dividend rate to $3.48 per share during the year ended December 31, 2017 compared to the dividend rate of $3.28 per share during the year ended December 31, 2016.
Equity
As of December 31, 2017, MAA owned 113,643,166 OP Units, comprising a 96.4% limited partnership interest in the Operating Partnership, while the remaining 4,191,586 outstanding OP Units were held by third party limited partners of the Operating Partnership. Holders of OP Units (other than MAA and its corporate affiliates) may require us to redeem their OP Units from time to time, in which case MAA may, at its option, pay the redemption price either in cash (in an amount per OP Unit equal, in general, to the average closing price of MAA's common stock on the NYSE over a specified period prior to the redemption date) or by delivering one share of MAA's common stock (subject to adjustment under specified circumstances) for each OP Unit so redeemed. In addition, MAA has registered under the Securities Act the 4,191,586 shares of its common stock, that as of December 31, 2017, were issuable upon redemption of OP Units, so that those shares can be sold freely in the public markets.
For more information regarding our equity capital resources, see Note 9 and Note 10 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
Debt
The following schedule outlines our fixed and variable rate debt, including the impact of our interest rate swaps and cap, outstanding as of December 31, 2017 (dollars in thousands):
| Principal Balance | Average Years to Maturity | Effective Rate | |||||||
| Unsecured debt | |||||||||
| Fixed rate or swapped | $ | 2,842,000 | 5.5 | 3.8 | % | ||||
| Variable rate | 710,000 | 0.1 | 2.4 | % | |||||
| Fair market value adjustments, debt issuance costs and discounts | (26,235 | ) | |||||||
| Total unsecured rate maturity | $ | 3,525,765 | 4.9 | 3.5 | % | ||||
| Secured debt | |||||||||
| Conventional - fixed rate or swapped | $ | 882,752 | 1.8 | 4.0 | % | ||||
| Conventional - variable rate - capped (1) | 25,000 | 0.1 | 1.8 | % | |||||
| Total fixed or hedged rate maturity | $ | 907,752 | 1.7 | 3.9 | % | ||||
| Conventional - variable rate | 55,000 | 0.1 | 1.8 | % | |||||
| Fair market value adjustments and debt issuance costs | 13,540 | ||||||||
| Total secured rate maturity | $ | 976,292 | 1.6 | 3.8 | % | ||||
| Total debt | $ | 4,502,057 | 3.9 | 3.6 | % | ||||
| Total fixed or hedged debt | $ | 3,737,763 | 4.7 | 3.8 | % |
| (1) | The effective rate represents the average rate on the underlying variable debt unless the cap rate of 4.5% of the London Interbank Offered Rate, or LIBOR, is reached. |
As of December 31, 2017, we had entered into interest rate swaps totaling a notional amount of $550.0 million related to issued debt. To date, these swaps have proven to be highly effective hedges. We had also entered into an interest rate cap agreement totaling a notional amount of $25.0 million as of December 31, 2017.
The following schedule outlines the contractual maturity dates of our outstanding debt, net of fair market value adjustments, debt issuance costs and discounts, as of December 31, 2017 (dollars in thousands):
| Key Bank Unsecured Credit Facility | Public Bonds | Other Unsecured | Secured | Total | |||||||||||||||
| 2018 | $ | — | $ | — | $ | 300,261 | $ | 118,658 | $ | 418,919 | |||||||||
| 2019 | — | — | 19,967 | 559,378 | 579,345 | ||||||||||||||
| 2020 | 410,000 | — | 149,773 | 163,054 | 722,827 | ||||||||||||||
| 2021 | — | — | 222,091 | 124,711 | 346,802 | ||||||||||||||
| 2022 | — | 248,144 | 415,798 | — | 663,942 | ||||||||||||||
| Thereafter | — | 1,727,590 | 32,141 | 10,491 | 1,770,222 | ||||||||||||||
| Total | $ | 410,000 | $ | 1,975,734 | $ | 1,140,031 | $ | 976,292 | $ | 4,502,057 |
The following schedule outlines the interest rate maturities of our outstanding fixed or hedged debt, net of fair market value adjustments, debt issuance costs and discounts, as of December 31, 2017 (dollars in thousands):
| Fixed Rate Debt | Interest Rate Swaps | Total Fixed Rate Balances | Contract Rate | Interest Rate Cap | Total Fixed or Hedged | ||||||||||||||||||
| 2018 | $ | 88,633 | $ | 250,286 | $ | 338,919 | 3.1 | % | $ | 25,000 | $ | 363,919 | |||||||||||
| 2019 | 579,345 | — | 579,345 | 5.9 | % | — | 579,345 | ||||||||||||||||
| 2020 | 163,054 | 299,148 | 462,202 | 3.7 | % | — | 462,202 | ||||||||||||||||
| 2021 | 197,281 | — | 197,281 | 5.2 | % | — | 197,281 | ||||||||||||||||
| 2022 | 364,794 | — | 364,794 | 3.6 | % | — | 364,794 | ||||||||||||||||
| Thereafter | 1,770,222 | — | 1,770,222 | 3.7 | % | — | 1,770,222 | ||||||||||||||||
| Total | $ | 3,163,329 | $ | 549,434 | $ | 3,712,763 | 4.0 | % | $ | 25,000 | $ | 3,737,763 |
Unsecured Revolving Credit Facility
On October 15, 2015, the Operating Partnership entered into an unsecured revolving credit facility agreement with a syndicate of banks led by KeyBank National Association, or KeyBank, and fourteen other banks, the KeyBank Facility. The KeyBank Facility replaced our Operating Partnership's previous unsecured credit facility with KeyBank. The interest rate is determined using an investment grade pricing grid using LIBOR plus a spread of 0.85% to 1.55%. On December 1, 2016, the Operating Partnership amended the KeyBank Facility by increasing the borrowing capacity from $750.0 million to $1.0 billion. As of December 31, 2017, we had $410.0 million borrowed under the KeyBank Facility, bearing interest at a rate of LIBOR plus 0.90%. The KeyBank Facility serves as our primary source of short-term liquidity and has an accordion feature that we may use to expand its capacity to $1.5 billion. This facility matures on April 15, 2020, with an option to extend for an additional six months.
Senior Unsecured Notes
We have also issued both public and private unsecured notes. As of December 31, 2017, we had approximately $2.0 billion (face value) of publicly issued notes and $292.0 million of unsecured notes issued in two private placements. In October 2013, we publicly issued $350.0 million of senior unsecured notes due 2023 with a coupon of 4.30%, paid semi-annually on April 15 and October 15. In June 2014, we publicly issued $400.0 million of senior unsecured notes due 2024 with a coupon of 3.75%, paid semi-annually on June 15 and December 15. In November 2015, we publicly issued $400.0 million senior unsecured notes due 2025 with a coupon of 4.00%, paid semi-annually on May 15 and November 15. As a result of the Merger in December 2016, we assumed two series of publicly issued senior notes totaling $400.0 million. One series of senior notes assumed as a result of the Merger has a face value of $250.0 million, is due 2022, and has a coupon of 3.38% paid semi-annually on June 1 and December 1. The other series of senior notes assumed as a result of the Merger had a face value of $150.0 million and was due in October 2017, but was paid off in July 2017. In May 2017, we publicly issued $600.0 million of senior unsecured notes due June 1, 2027 with a coupon of 3.60%, paid semi-annually on June 1 and December 1. The proceeds from the senior unsecured notes issued in May 2017 were used to pay down outstanding amounts of the Key Bank Facility. As of December 31, 2017, all of these amounts, with the exception of the series of senior unsecured notes assumed in the Merger with a face value of $150.0 million that was paid off in July 2017, remained outstanding.
In July 2011, we issued $135.0 million of senior unsecured notes. The notes were offered and sold in a private placement with three maturity tranches: $50.0 million at 4.7% maturing on July 29, 2018, $72.8 million at 5.4% maturing on July 29, 2021; and $12.3 million at 5.6% maturing on July 29, 2023; all of which were outstanding at December 31, 2017. On August 31, 2012, we issued $175.0 million of senior unsecured notes. The notes were offered and sold in a private placement with four tranches: $18.0 million at 3.15% maturing on November 30, 2017; $20.0 million at 3.61% maturing on November 30, 2019; $117.0 million at 4.17% maturing on November 30, 2022; and $20.0 million at 4.33% maturing on November 30, 2024. The $18 million tranche was paid off on its maturity date. The remaining tranches were outstanding as of December 31, 2017.
Unsecured Term Loans
In addition to the KeyBank Facility, we maintain four unsecured term loans. We had total borrowings of $850.0 million outstanding under these term loan agreements at December 31, 2017, comprised of:
A $250.0 million term loan with Wells Fargo, N.A., or Wells Fargo, that bears interest at a rate of LIBOR plus a spread of 0.90% to 1.90% based on the credit ratings of our unsecured debt. The loan matures on August 1, 2018. As of December 31, 2017, this loan was bearing interest at a rate of LIBOR plus 0.98%.
A $150.0 million term loan with U.S. Bank National Association, or U.S. Bank, that bears interest at a rate of LIBOR plus a spread of 0.90% to 1.90% based on the credit ratings of our unsecured debt. The loan matures on March 1, 2020. As of December 31, 2017, this loan was bearing interest at a rate of LIBOR plus 0.98%.
A $150.0 million term loan with Key Bank that bears interest at a rate of LIBOR plus a spread of 0.90% to 1.75% based on the credit ratings of our unsecured debt. The loan matures on March 1, 2021. As of December 31, 2017, this loan was bearing interest at a rate of LIBOR plus 0.95%.
A $300.0 million term loan with Wells Fargo that bears interest at a rate of LIBOR plus a spread of 0.90% to 1.75% based on the credit ratings of our unsecured debt. The loan matures on March 1, 2022. As of December 31, 2017, this loan was bearing interest at a rate of LIBOR plus 0.95%.
Secured Property Mortgages
We also maintain secured property mortgages with Fannie Mae, Freddie Mac and various life insurance companies. These mortgages are usually fixed rate and can range from five to ten years in maturity. As of December 31, 2017, we had $882.8 million of secured property mortgages.
Secured Credit Facility
Approximately 1.8% of our outstanding obligations at December 31, 2017 were borrowed through a credit facility with Prudential Mortgage Capital, which is credit enhanced by Fannie Mae, or the Fannie Mae Facility. The Fannie Mae Facility has a combined line limit of $80.0 million, of which $80.0 million was collateralized, available to borrow, and borrowed, at December 31, 2017. The Fannie Mae Facility matures in 2018.
For more information regarding our debt capital resources, see Note 6 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
Contractual Obligations
The following table reflects our total contractual cash obligations as of December 31, 2017, which consist of our long-term debt, development fees and operating leases (dollars in thousands):
| Contractual Obligations (1) | 2018 | 2019 | 2020 | 2021 | 2022 | Thereafter | Total | |||||||||||||||||||||
| Long-term debt obligations (2) | $ | 428,942 | $ | 570,114 | $ | 718,281 | $ | 342,903 | $ | 668,401 | $ | 1,786,111 | $ | 4,514,752 | ||||||||||||||
| Fixed rate or swapped interest (3) | 145,867 | 113,339 | 98,021 | 89,454 | 82,771 | 196,190 | 725,642 | |||||||||||||||||||||
| Purchase obligations (4) | 672 | — | — | — | — | — | 672 | |||||||||||||||||||||
| Operating lease obligations (5) | 882 | 724 | 708 | 718 | 733 | 62,788 | 66,553 | |||||||||||||||||||||
| Total | $ | 576,363 | $ | 684,177 | $ | 817,010 | $ | 433,075 | $ | 751,905 | $ | 2,045,089 | $ | 5,307,619 |
(1) Fixed rate and swapped interest are reflected in this table. The average interest rates of variable rate debt are presented in preceding tables.
(2) Represents principal payments gross of discounts, debt issuance costs and fair market value adjustments of debt assumed.
(3) Swapped interest is subject to the ineffective portion of cash flow hedges as described in Note 7 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
(4) Represents development fees.
(5) Primarily comprised of a ground lease underlying one apartment community we own.
We have a commitment, which is not reflected in the table above, to make additional capital contributions to a limited partnership in which we hold an equity interest. The capital contributions may be called by the general partner at any time until September 2022 after giving appropriate notice. At December 31, 2017, we had committed to make additional capital contributions totaling up to $13.5 million if and when called by the general partner of the limited partnership and prior to September 2022.
Off-Balance Sheet Arrangements
At December 31, 2017, and 2016, we did not have any relationships, including those with unconsolidated entities or financial partnerships, for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
As of December 31, 2017, we had a 35.0% ownership interest in a limited liability company, which owns one apartment community comprised of 269 units, located in Washington, D.C. We also had a 31.0% ownership interest in a limited partnership. Our interests in these investments are unconsolidated and are recorded using the equity method for the investments as we do not have a controlling interest.
In addition, we do not engage in trading activities involving non-exchange traded contracts. As such, we are not materially exposed to any financing, liquidity, market, or credit risk that could arise if we had engaged in such relationships. We do not have any relationships or transactions with persons or entities that derive benefits from their non-independent relationships with us or our related parties other than those disclosed in Note 13 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
INSURANCE
We carry comprehensive general liability coverage on our communities, with limits of liability we believe are customary within the multifamily apartment industry, to insure against liability claims and related defense costs. We also maintain insurance against the risk of direct physical damage to reimburse us on a replacement cost basis for costs incurred to repair or rebuild each property, including loss of rental income during the reconstruction period.
We renegotiated our primary insurance programs effective July 1, 2017. We believe that the current property and casualty insurance program in place provides appropriate insurance coverage for financial protection against insurable risks such that any insurable loss experienced that can be reasonably anticipated would not have a significant impact on our liquidity, financial position or results of operation.
INFLATION
Our resident leases at our apartment communities allow, at the time of renewal, for adjustments in the rent payable thereunder, and thus may enable us to seek rent increases. Almost all leases are for one year or less. The short-term nature of these leases generally serves to reduce our risk to adverse effects of inflation.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
A critical accounting policy is one that is both important to our financial condition and results of operations and that involves some degree of uncertainty. The preceding discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements and the notes thereto, which have been prepared in accordance with GAAP. The preparation of financial statements in conformity with GAAP requires management to make a number of estimates and assumptions that affect the reported amounts and disclosures in the consolidated financial statements. On an ongoing basis, we evaluate our estimates and assumptions based upon historical experience and various other factors and circumstances. We believe that our estimates and assumptions are reasonable under the circumstances; however, actual results may differ from these estimates and assumptions.
We believe that the estimates and assumptions listed below are most important to the portrayal of our financial condition and results of operations because they require the greatest subjective determinations and form the basis of accounting policies deemed to be most critical.
Acquisition of real estate assets
We account for our acquisitions of investments in real estate as asset acquisitions in accordance with ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business, which requires the cost of the of the real estate acquired to be allocated to the individual acquired tangible assets, consisting of land, buildings and improvements and other, and identified intangible assets, consisting of the value of in-place leases and other contracts, on a relative fair value basis. In calculating the total asset value of acquired tangible assets, management uses stabilized net operating income, or NOI, and market specific capitalization and discount rates. Management analyzed historical stabilized NOI to determine its estimate for forecasted NOI. Management estimates the market capitalization rate by analyzing the market capitalization rates for properties with comparable ages in similarly sized markets. Management then allocates the purchase price of the asset acquisition based on the relative fair value of the individual components as a proportion of the total assets acquired.
Impairment of long-lived assets
We account for long-lived assets in accordance with the provisions of accounting standards for the impairment or disposal of long-lived assets. We periodically evaluate long-lived assets, including investments in real estate, for indicators that would suggest that the carrying amount of the assets may not be recoverable. The judgments regarding the existence of such indicators are based on factors such as operating performance, market conditions and legal factors. Long-lived assets, such as real estate assets, equipment and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset, which is estimated by analyzing historical cash flows of the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized for the amount by which the carrying amount of the asset exceeds the fair value of the asset. We calculate the fair value of an asset by dividing historical operating cash flows by a market capitalization rate. We estimate the market capitalization rate by analyzing the market capitalization rates for properties with comparable ages in similarly sized markets. No material impairment losses have been recognized
during the years ended December 31, 2017, 2016, and 2015.
Cost capitalization
In conformity with GAAP, we capitalize those expenditures that materially enhance the value of an existing asset or substantially extend the useful life of an existing asset. Expenditures necessary to maintain an existing property in ordinary operating condition are expensed as incurred. Therefore, repairs and maintenance costs are expensed as incurred while significant improvements, renovations, and replacements are capitalized. The cost to complete any deferred repairs and maintenance at properties acquired by us in order to elevate the condition of the property to our standards are capitalized as incurred. The carrying costs related to development projects, including interest, property taxes, insurance and allocated direct development salary cost during the construction period, are capitalized. Management uses judgment in determining whether costs should be expensed or capitalized. See Note 1 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K for additional detail.
Loss contingencies
The outcomes of claims, disputes and legal proceedings are subject to significant uncertainty. We record an accrual for loss contingencies when a loss is probable and the amount of the loss can be reasonably estimated. We review these accruals quarterly and make revisions based on changes in facts and circumstances. When a loss contingency is not both probable and reasonably estimable, then we do not accrue the loss. However, for material loss contingencies, if the unrecorded loss (or an additional loss in excess of the accrual) is at least a reasonable possibility and material, then we disclose a reasonable estimate of the possible loss, or range of loss, if such reasonable estimate can be made. If we cannot make a reasonable estimate of the possible loss, or range of loss, then that is disclosed.
The assessment of whether a loss is probable or a reasonable possibility, and whether the loss or range of loss is reasonably estimable, often involves a series of complex judgments about future events. Among the factors that we consider in this assessment, including with respect to the matters disclosed in this Annual Report on Form 10-K, are the nature of existing legal proceedings and claims, the asserted or possible damages or loss contingency (if reasonably estimable), the progress of the matter, existing law and precedent, the opinions or views of legal counsel and other advisers, our experience in similar matters, the facts available to us at the time of assessment, and how we intend to respond, or have responded, to the proceeding or claim. Our assessment of these factors may change over time as individual proceedings or claims progress. For matters where we are not currently able to reasonably estimate a range of reasonably possible loss, the factors that have contributed to this determination include the following: (i) the damages sought are indeterminate; (ii) the proceedings are in the early stages; (iii) the matters involve novel or unsettled legal theories or a large or uncertain number of actual or potential cases or parties; and/or (iv) discussions with the parties in matters that are expected ultimately to be resolved through negotiation and settlement have not reached the point where we believe a reasonable estimate of loss, or range of loss, can be made. In such instances, we believe that there is considerable uncertainty regarding the timing or ultimate resolution of such matters, including a possible eventual loss or business impact, if any.
For more information regarding our significant accounting policies, including a brief description of recent accounting pronouncements that could have a material impact on our financial statements, see Note 1 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
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