filings.toolsItem 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
56K characters. Original on sec.gov · Markdown
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 96.5% limited partner interest as of December 31, 2018. 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 located in the Southeast, Southwest and Mid-Atlantic regions of the United States. As of December 31, 2018, we owned and operated 303 apartment communities through the Operating Partnership and its subsidiaries, and we had an ownership interest in one apartment community through an unconsolidated real estate joint venture. In addition, as of December 31, 2018, we owned four commercial properties, and 30 of our apartment communities included retail components. Our multifamily and commercial properties are located across 17 states and the District of Columbia.
We report in two segments, Same Store communities and Non-Same Store and Other. Our Same Store segment represents those communities that have been owned and stabilized for at least 12 months as of the first day of the calendar year. Our Non-Same Store and Other segment includes recently acquired communities, communities being developed or in lease-up, communities undergoing extensive renovations, communities identified for disposition, and communities that have incurred a significant casualty loss. Also included in our Non-Same Store and Other segment are non-multifamily activities.
Effective January 1, 2018, we revised our reportable segment presentation. The revision eliminated the prior distinction between large and secondary same store markets and combined the two previously reportable segments into the Same Store reportable segment referred to above. Additional information regarding the composition of our segments is included in Note 14 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
Overview
For the year ended December 31, 2018, net income available for MAA common shareholders was $219.2 million compared to $324.7 million for the year ended December 31, 2017. Results for the year ended December 31, 2018 included $2.6 million of expense related to the mark-to-market adjustment of the bifurcated embedded derivative related to the MAA Series I preferred stock issued in the merger with Post Properties and $4.5 million of gains related to the sale of real estate assets. Results for the year ended December 31, 2017 included $8.8 million of income related to the adjustment of the bifurcated embedded derivative and $127.4 million of gains related to the sale of real estate assets. Revenues for the year ended December 31, 2018 increased 2.8% compared to the year ended December 31, 2017, driven by a 1.9% increase in our Same Store segment and a 13.5% increase in our Non-Same Store and Other segment. Property operating expenses, excluding depreciation and amortization, for the year ended December 31, 2018 increased by 3.1% compared to the year ended December 31, 2017, due to a 2.0% increase in our Same Store segment and to a 14.6% increase in our Non-Same Store and Other segment. The drivers of these increases are discussed below in the "Results of Operations" section.
Over the past three years, our growth has been driven by our acquisition strategy to invest in growing markets in the Southeast, Southwest and Mid-Atlantic regions of the United States. As a result of the merger with Post Properties, we acquired 61 apartment communities in 2016. We acquired one apartment community in 2018, two in 2017, and five in 2016 apart from the merger with Post Properties. No apartment communities were disposed in 2018. We disposed of five apartment communities in 2017 and 12 in 2016.
Trends
During the year ended December 31, 2018, demand for apartments continued to be relatively strong, as it was during the year ended December 31, 2017. Average daily physical occupancy for our Same Store portfolio was 96.1% for the year ended December 31, 2018, in line with the 96.1% average daily physical occupancy achieved during the year ended December 31, 2017. Average effective rent per unit from our Same Store portfolio continued to increase, up 1.9% for the year ended December 31, 2018 as compared to the year ended December 31, 2017.
An important part of our portfolio strategy is to maintain diversity of markets, submarkets, product types and price points in the Southeast, Southwest and Mid-Atlantic 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 38 defined Metropolitan Statistical Areas, we are diversified across markets, urban and suburban submarkets, and a variety of monthly rent pricing points.
Though overall demand continues to be strong, the current elevated supply levels are impacting rent growth for our portfolio, particularly for apartment communities located in urban submarkets. Properties in suburban submarkets have been impacted somewhat less by supply, primarily because less new development has occurred in those submarkets. Multifamily permitting is typically a leading indicator of future supply levels. While multifamily permitting across our markets was down in 2017 as compared to 2016, to date, the U.S. Census Bureau's data for 2018 suggested multifamily permitting across our markets was up as compared to 2017. It is difficult to project supply levels based on this data because not all permitted projects are ultimately built. However, given the current supply level and the 2018 permitting data, it is possible that supply in some of our markets could remain elevated over the next couple of years.
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 economic conditions continue to support increased job growth, 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 apartment communities. Furthermore, rental competition from single family homes has not been a major competitive factor impacting our portfolio. For the year ended December 31, 2018, total move outs attributable to single family home rentals for our portfolio represented less than 7% of total move outs, as it did in the year ended December 31, 2017. 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, Southwest and Mid-Atlantic 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, 2018, we had approximately $4.5 billion of debt, of which 25% had variable rate interest and 75% 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.
Our focus is on maintaining strong physical occupancy while increasing pricing where possible through our revenue management system. As noted above, average daily physical occupancy for the year ended December 31, 2018 was sustained at 96.1%. As we continue through the typically slower winter leasing season, we believe that the current level of physical occupancy and continued strong job growth in our markets position us well for this period and sets us up to achieve modestly improved pricing growth in 2019.
Results of Operations
Comparison of the Year Ended December 31, 2018 to the Year Ended December 31, 2017
For the year ended December 31, 2018, we achieved net income available for MAA common shareholders of $219.2 million, a 32.5% decrease as compared to the year ended December 31, 2017, and total revenue growth of $42.4 million, representing a 2.8% increase in property revenues as compared to the year ended December 31, 2017. The following discussion describes the primary drivers of the decrease in net income available for MAA common shareholders for the year ended December 31, 2018 as compared to the year ended December 31, 2017.
Property Revenues
The following table reflects our property revenues by segment for the years ended December 31, 2018 and December 31, 2017 (dollars in thousands):
| December 31, 2018 | December 31, 2017 | Increase | % Increase | |||||||||||
| Same Store | $ | 1,441,811 | $ | 1,414,839 | $ | 26,972 | 1.9 | % | ||||||
| Non-Same Store and Other | 129,535 | 114,148 | 15,387 | 13.5 | % | |||||||||
| Total | $ | 1,571,346 | $ | 1,528,987 | $ | 42,359 | 2.8 | % |
The increase in property revenues for our Same Store segment as compared to the year ended December 31, 2017 was the primary driver of total property revenue growth. The Same Store segment generated a 1.9% increase in revenues for the year ended December 31, 2018, primarily a result of average effective rent per unit growth of 1.9% and stable occupancy as compared to the year ended December 31, 2017. The increase in property revenues from the Non-Same Store and Other segment for the year ended December 31, 2018 as compared to year ended December 31, 2017 was primarily the result of recent property acquisitions and continued lease-up of recent development communities.
Property Operating Expenses
Property operating expenses include costs for property personnel, building repairs and maintenance, real estate taxes and insurance, utilities, landscaping, and other operating expenses. The following table reflects our property operating expenses by segment for the years ended December 31, 2018 and December 31, 2017 (dollars in thousands):
| December 31, 2018 | December 31, 2017 | Increase | % Increase | |||||||||||
| Same Store | $ | 536,055 | $ | 525,663 | $ | 10,392 | 2.0 | % | ||||||
| Non-Same Store and Other | 58,533 | 51,068 | 7,465 | 14.6 | % | |||||||||
| Total | $ | 594,588 | $ | 576,731 | $ | 17,857 | 3.1 | % |
The increase in property operating expenses for our Same Store segment as compared to the year ended December 31, 2017 was primarily driven by increases in real estate tax expense of $7.7 million and personnel expenses of $4.4 million, partially offset by a decrease in building repairs and maintenance expense of $2.5 million. The increase in property operating expenses from our Non-Same Store and Other segment was primarily the result of increases in real estate tax expense of $4.2 million driven by recently completed communities previously in our development pipeline and other operating expense of $3.0 million.
Depreciation and Amortization
Depreciation and amortization expense for the year ended December 31, 2018 was $489.8 million, a decrease of $3.9 million as compared to the year ended December 31, 2017. The decrease was primarily due to a $25.8 million decrease in amortization expense, which was driven by certain intangible assets acquired as a result of the merger with Post Properties becoming fully amortized in the second quarter of 2017. As a result, we recognized no amortization expense for those assets in the year ended December 31, 2018. The decrease in amortization expense was partially offset by a $21.9 million increase to depreciation expense for the year ended December 31, 2018 as compared to the year ended December 31, 2017. The increase in depreciation expense was primarily driven by the recognition of depreciation expense associated with our capital asset spend during the year ended December 31, 2018, which was related to our development and redevelopment activities made in the normal course of business as well as property acquisitions during the year ended December 31, 2018.
Other Income and Expenses
Property management expenses for the year ended December 31, 2018 were $47.6 million, an increase of $4.0 million as compared to the year ended December 31, 2017. The increase was primarily due to increases in personnel costs. General and administrative expenses for the year ended December 31, 2018 were $34.8 million, a decrease of $5.4 million as compared to the year ended December 31, 2017, primarily due to decreases in legal expense. Merger and integration expenses for the year ended December 31, 2018 were $9.1 million, a decrease of $10.9 million as compared to the year ended December 31, 2017, primarily due to declining year-over-year integration activities related to the merger with Post Properties.
Interest expense for the year ended December 31, 2018 was $173.6 million, an increase of $18.8 million as compared to the year ended December 31, 2017. The increase was primarily due to an increase of approximately 18 basis points in our effective interest rate during the year ended December 31, 2018 compared to the year ended December 31, 2017 combined with a decrease in interest capitalized from our development pipeline during the year ended December 31, 2018 compared to the year ended December 31, 2017.
We did not dispose of any apartment communities during the year ended December 31, 2018. For the year ended December 31, 2017, we disposed of five apartment communities, resulting in gains on sale of depreciable real estate assets of $127.4 million. Gain on sale of non-depreciable assets for the year ended December 31, 2018 was $4.5 million, an increase of $4.5 million as compared to the year ended December 31, 2017. Although we disposed of only one land parcel more in the year ended December 31, 2018 as compared to the year ended December 31, 2017, the gain on sale of non-depreciable assets increased primarily due to the nature of the real estate assets sold.
Other non-operating income for the year ended December 31, 2018 was $5.4 million, a decrease of $8.9 million as compared to the year ended December 31, 2017. The decrease was primarily due to the recognition of $2.6 million of expense from the net mark-to-market adjustment of the bifurcated embedded derivative related to the MAA Series I preferred stock during the year ended December 31, 2018 as compared to the recognition of $8.8 million of income from the net mark-to-market adjustment of the bifurcated embedded derivative during the year ended December 31, 2017.
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, as compared to $211.9 million for the year ended December 31, 2016. Total revenue grew $403.6 million for the year ended December 31, 2017 as compared to the year ended December 31, 2016, representing a 35.9% increase in property revenues. The following discussion describes the primary drivers of the increase in net income available for MAA common shareholders for the year ended December 31, 2017 as compared to the year ended December 31, 2016. The comparison of the year ended December 31, 2017 to the year ended December 31, 2016 shows the segment break down based on our Same Store portfolio for the year ended December 31, 2017. A comparison using our 2018 Same Store portfolio would not be comparative due to the nature of the classifications.
Property Revenues
The following table reflects 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 | |||||||||||
| Same Store | $ | 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 Same Store segment generated a 2.9% increase in revenues for the year ended December 31, 2017, primarily a result of average effective rent per unit growth of 3.0% as compared to the year ended December 31, 2016. The increase in property revenues for the year ended December 31, 2017 as compared to the year ended December 31, 2016 from our Non-Same Store and Other segment was primarily the result of the merger with Post Properties, as we classified the properties we acquired in the merger in our Non-Same Store and Other segment.
Property Operating Expenses
Property operating expenses include costs for property personnel, building repairs and maintenance, real estate taxes and insurance, utilities, landscaping and other operating expenses. The following table reflects our property operating expenses by segment for the years ended December 31, 2017 and December 31, 2016 (dollars in thousands):
| December 31, 2017 | December 31, 2016 | Increase | % Increase | |||||||||||
| Same Store | $ | 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 Same Store segment as compared to the year ended December 31, 2016 was primarily driven by increases in real estate tax expense of $6.2 million and personnel expenses of $2.3 million. The increase in property operating expenses for our Non-Same Store and Other segment was primarily due to the merger with Post Properties.
Depreciation and Amortization
Depreciation and amortization expense for the year ended December 31, 2017 was $493.7 million, an increase of $170.8 million as compared to the year ended December 31, 2016. The increase was primarily driven by the full year of depreciation and amortization expense resulting from the merger with Post Properties compared to only one month of comparable depreciation and amortization in 2016. As a result of the merger with Post Properties, depreciation expense and amortization expense increased $138.2 million and $23.2 million, respectively, for the year ended December 31, 2017 as compared to the year ended December 31, 2016. The remaining increase was primarily driven by our capital asset spend and other asset acquisition activity.
Other Income and Expenses
Property management expenses for the year ended December 31, 2017 were $43.6 million, an increase of $9.5 million as 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 with Post Properties. General and administrative expenses for the year ended December 31, 2017 were $40.2 million, an increase of $11.2 million as compared to the year ended December 31, 2016, primarily due to increases in legal expense. Merger and integration expenses for the year ended December 31, 2017 were $20.0 million, a decrease of $20.8 million as compared to the year ended December 31, 2016, as we incurred significant merger related expenses in 2016 to complete the merger with Post Properties on December 1, 2016.
Interest expense for the year ended December 31, 2017 was $154.8 million, an increase of $24.8 million as compared to 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 with Post Properties, 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 also entered into a new $300.0 million term loan on the closing date of the merger with Post Properties. Interest expense for the year ended December 31, 2017 increased $16.0 million due to these borrowings resulting from the merger with Post Properties.
Gains on sale of depreciable assets totaled $127.4 million for the year ended December 31, 2017, an increase of $47.0 million as compared to 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 $16.2 million as compared to the year ended December 31, 2016. The increase was primarily due to an $8.8 million increase in income from the net mark-to-market adjustment of the bifurcated embedded derivative related to the MAA Series I preferred stock issued in the merger with Post Properties. The increase in other non-operating income was also driven by a $3.3 million net gain on debt extinguishment.
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 with Post Properties 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.
Funds from Operations
Funds from operations, or FFO, a non-GAAP financial measure, represent 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 operating properties, plus net income attributable to noncontrolling interests, depreciation and amortization of real estate, and adjustments for joint ventures. 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, as an indicator of operating performance or as an alternative to cash flow 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 the National Association of Real Estate Trust's, or 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, 2018, 2017 and 2016, as we believe net income available for MAA common shareholders is the most directly comparable GAAP measure (dollars in thousands):
| Year ended December 31, | |||||||||||
| 2018 | 2017 | 2016 | |||||||||
| Net income available for MAA common shareholders | $ | 219,211 | $ | 324,691 | $ | 211,915 | |||||
| Depreciation and amortization of real estate assets | 484,722 | 489,503 | 319,528 | ||||||||
| Loss (gain) on sale of depreciable real estate assets | 39 | (127,386 | ) | (80,397 | ) | ||||||
| Loss on disposition within unconsolidated entities | — | — | 98 | ||||||||
| Depreciation and amortization of real estate assets of real estate joint venture | 595 | 596 | 61 | ||||||||
| Net income attributable to noncontrolling interests | 8,123 | 12,157 | 12,180 | ||||||||
| Funds from operations attributable to the Company | $ | 712,690 | $ | 699,561 | $ | 463,385 |
FFO for the year ended December 31, 2018 were $712.7 million, an increase of $13.1 million as compared to the year ended December 31, 2017, primarily as a result of increases in property revenues of $42.4 million and gain on sale of non-depreciable assets of $4.5 million, in addition to a decrease in merger and integration expenses of $10.9 million. The increases to FFO were offset by increases in interest expense of $18.8 million and property operating expenses, excluding depreciation and amortization, of $17.9 million, in addition to a decrease in other non-operating income of $8.9 million.
FFO for the year ended December 31, 2017 were $699.6 million, an increase of $236.2 million as compared to the year ended December 31, 2016, primarily as a result of increases in property revenues of $403.6 million and other non-operating income of $16.2 million, in addition to a decrease in merger and integration expenses of $20.8 million. The increases to FFO were offset by 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.
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 provided by operating activities was $734.3 million for the year ended December 31, 2018, as compared to $660.8 million for the year ended December 31, 2017. The increase in operating cash flows was primarily driven by our operating performance as well as the timing of cash payments.
Investing Activities
Net cash used in investing activities was $366.4 million for the year ended December 31, 2018, as compared to net cash used in investing activities of $294.2 million for the year ended December 31, 2017. The primary drivers of the change were as follows (dollars in thousands):
| Primary drivers of cash (outflow) inflow | Increase (Decrease) in Net Cash | ||||||||||
| during the year ended December 31, | |||||||||||
| 2018 | 2017 | ||||||||||
| Purchases of real estate and other assets | $ | (129,487 | ) | $ | (136,065 | ) | $ | 6,578 | |||
| Capital improvements, development and other | (254,715 | ) | (343,890 | ) | 89,175 | ||||||
| Proceeds from disposition of real estate assets | 19,982 | 187,245 | (167,263 | ) |
The decrease in cash outflows for purchases of real estate and other assets was driven by the acquisition activity during the year ended December 31, 2018 as compared to the year ended December 31, 2017. The decrease in cash outflows for capital improvements, development and other as compared to the prior year was primarily due to the decrease in activity in our development pipeline during the year ended December 31, 2018 as compared to the prior year. The decrease in cash inflows related to proceeds from disposition of real estate assets was primarily due to the sale of five land parcels during the year ended December 31, 2018, as compared to the sale of five apartment communities and four land parcels during the prior year.
Financing Activities
Net cash used in financing activities was $405.1 million for the year ended December 31, 2018, as compared to net cash used in financing activities of $399.5 million for the year ended December 31, 2017. The primary drivers of the change were as follows (dollars in thousands):
| Primary drivers of cash inflow (outflow) | Increase (Decrease) in Net Cash | ||||||||||
| during the year ended December 31, | |||||||||||
| 2018 | 2017 | ||||||||||
| Net change in credit lines | $ | 50,000 | $ | (160,000 | ) | $ | 210,000 | ||||
| Proceeds from notes payable | 869,630 | 597,480 | 272,150 | ||||||||
| Principal payments on notes payable | (878,610 | ) | (413,557 | ) | (465,053 | ) | |||||
| Dividends paid on common shares | (419,849 | ) | (395,294 | ) | (24,555 | ) |
The increase in cash inflow related to the net change in credit lines resulted from the increase in net borrowings of $50.0 million on our unsecured revolving credit facility during the year ended December 31, 2018, as compared to the decrease in net borrowings of $160.0 million on the unsecured revolving credit facility during the year ended December 31, 2017. The increase in cash inflows from proceeds from notes payable primarily resulted from the issuances of $400.0 million of senior unsecured notes, $172.0 million of secured property mortgages and a $300.0 million unsecured term loan during the year ended December 31, 2018, compared to the issuance of $600.0 million of senior unsecured notes during the year ended December 31, 2017. The increase in cash outflows from principal payments on notes payable primarily resulted from the retirement of $568.0 million of secured property mortgages and an $80.0 million secured credit facility during the year ended December 31, 2018, as compared to the retirement of $233.6 million of secured property mortgages and $168.0 million of senior unsecured notes during the year ended December 31, 2017. The increase in cash outflows from dividends paid on common shares primarily resulted from the increase in the annual dividend rate to $3.69 per share during the year ended December 31, 2018, as compared to the annual dividend rate of $3.48 per share during the year ended December 31, 2017.
Equity
As of December 31, 2018, MAA owned 113,844,267 OP Units, comprising a 96.5% limited partnership interest in MAALP, while the remaining 4,111,301 outstanding OP Units were held by limited partners of MAALP other than MAA and its subsidiaries. Holders of OP Units (other than MAA and its subsidiaries) 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 4,111,301 shares of its common stock that, as of December 31, 2018, were issuable upon redemption of OP Units, in order for those shares to 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 reflects our fixed and variable rate debt, including the impact of our interest rate swaps, outstanding as of December 31, 2018 (dollars in thousands):
| Principal Balance | Average Years to Rate Maturity | Effective Rate | |||||||
| Unsecured debt | |||||||||
| Fixed rate or swapped | $ | 2,942,000 | 6.0 | 3.8 | % | ||||
| Variable rate | 1,140,000 | 0.1 | 3.4 | % | |||||
| Fair market value adjustments, debt issuance costs and discounts | (28,698 | ) | |||||||
| Total unsecured rate maturity | $ | 4,053,302 | 4.3 | 3.7 | % | ||||
| Secured debt | |||||||||
| Conventional - fixed rate | $ | 476,161 | 12.2 | 4.6 | % | ||||
| Fair market value adjustments and debt issuance costs | (1,135 | ) | |||||||
| Total secured rate maturity | $ | 475,026 | 12.2 | 4.6 | % | ||||
| Total debt | $ | 4,528,328 | 5.1 | 3.8 | % | ||||
| Total fixed or hedged debt | $ | 3,389,249 | 6.8 | 3.9 | % |
As of December 31, 2018, we had entered into interest rate swaps totaling a notional amount of $600.0 million, of which $300.0 million related to issued debt, while the remaining $300.0 million hedges the first 10 years of interest payments on debt we anticipate will be issued in 2019. To date, we believe the interest rate swaps have proven to be highly effective hedges.
The following schedule presents the contractual maturity dates of our outstanding debt, net of fair market value adjustments, debt issuance costs and discounts, as of December 31, 2018 (dollars in thousands):
| Unsecured Revolving Credit Facility | Public Bonds | Other Unsecured | Secured | Total | |||||||||||||||
| 2019 | $ | — | $ | — | $ | 319,508 | $ | 13,524 | $ | 333,032 | |||||||||
| 2020 | 540,000 | — | 149,883 | 159,097 | 848,980 | ||||||||||||||
| 2021 | — | — | 222,294 | 122,837 | 345,131 | ||||||||||||||
| 2022 | — | 248,522 | 416,075 | — | 664,597 | ||||||||||||||
| 2023 | — | 346,826 | 12,217 | — | 359,043 | ||||||||||||||
| Thereafter | — | 1,778,037 | 19,940 | 179,568 | 1,977,545 | ||||||||||||||
| Total | $ | 540,000 | $ | 2,373,385 | $ | 1,139,917 | $ | 475,026 | $ | 4,528,328 |
The following schedule reflects 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, 2018 (dollars in thousands):
| Fixed Rate Debt | Interest Rate Swaps | Total Fixed Rate Balances | Contract Rate | ||||||||||||
| 2019 | $ | 33,508 | $ | — | $ | 33,508 | 4.4 | % | |||||||
| 2020 | 159,097 | 299,353 | 458,450 | 3.2 | % | ||||||||||
| 2021 | 195,459 | — | 195,459 | 5.2 | % | ||||||||||
| 2022 | 365,244 | — | 365,244 | 3.6 | % | ||||||||||
| 2023 | 359,043 | — | 359,043 | 4.3 | % | ||||||||||
| Thereafter | 1,977,545 | — | 1,977,545 | 3.9 | % | ||||||||||
| Total | $ | 3,089,896 | $ | 299,353 | $ | 3,389,249 | 3.9 | % |
Unsecured Revolving Credit Facility
In October 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 fifteen other banks, which we refer to as the KeyBank Facility. The KeyBank Facility replaced the 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%. In December 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, 2018, we had $540.0 million borrowed under the KeyBank Facility, bearing interest at a rate of one month 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. The KeyBank Facility matures in April 2020, with an option to extend for an additional six months.
Senior Unsecured Notes
We have issued both public and private unsecured notes. As of December 31, 2018, we had approximately $2.4 billion (face value) of publicly issued unsecured notes and $242.0 million of unsecured notes issued in two private placements. In October 2013, we publicly issued $350.0 million of senior unsecured notes due October 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 June 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 November 2025 with a coupon of 4.00%, paid semi-annually on May 15 and November 15. As a result of the merger with Post Properties in December 2016, we assumed $250.0 million of senior unsecured notes due December 2022 with a coupon of 3.38%, paid semi-annually on June 1 and December 1. In May 2017, we publicly issued $600.0 million of senior unsecured notes due June 2027 with a coupon of 3.60%, paid semi-annually on June 1 and December 1. In May 2018, we publicly issued $400.0 million of senior unsecured notes due June 2028 with a coupon of 4.20%, paid semi-annually on June 15 and December 15. The proceeds from the senior unsecured notes issued in May 2018 were used to pay down outstanding amounts under the Key Bank Facility. As of December 31, 2018, all of these amounts 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 in July 2018, $72.8 million at 5.4% maturing in July 2021; and $12.3 million at 5.6% maturing in July 2023. The $50.0 million tranche was paid off on its maturity date. In August 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 in November 2017; $20.0 million at 3.61% maturing in November 2019; $117.0 million at 4.17% maturing in November 2022; and $20.0 million at 4.33% maturing in November 2024. The $18.0 million tranche was paid off on its maturity date. The remaining tranches were outstanding as of December 31, 2018.
Unsecured Term Loans
In addition to the KeyBank Facility and senior unsecured notes, we maintain four unsecured term loans. We had total borrowings of $900.0 million outstanding under these term loan agreements as of December 31, 2018, comprised of:
A $300.0 million term loan with Wells Fargo, N.A., or Wells Fargo, that bears interest at a rate of LIBOR plus a spread of 0.75% to 1.65% based on the credit ratings of our unsecured debt. We entered into the six month term loan in December 2018, and the loan matures in June 2019, with an option to extend for an additional six months. As of December 31, 2018, this loan was bearing interest at a rate of one month LIBOR plus 0.90%.
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 in March 2020. As of December 31, 2018, this loan was bearing interest at a rate of one month LIBOR plus 0.98%.
A $150.0 million term loan with KeyBank 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 in February 2021. As of December 31, 2018, this loan was bearing interest at a rate of one month 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 in March 2022. As of December 31, 2018, this loan was bearing interest at a rate of one month LIBOR plus 0.95%.
We retired a $250.0 million unsecured term loan with Wells Fargo on its maturity date in August 2018.
Secured Property Mortgages
We 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 30 years in maturity. As of December 31, 2018, we had $476.2 million of secured property mortgages. In December 2018, we issued $172.0 million in secured property mortgages with a fixed rate of 4.44%. During the year ended December 31, 2018, we retired $568.0 million of secured property mortgages.
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, 2018, which consist of principal and interest on our long-term debt as well as operating leases (dollars in thousands):
| Contractual Obligations | 2019 | 2020 | 2021 | 2022 | 2023 | Thereafter | Total | |||||||||||||||||||||
| Long-term debt obligations (1) | $ | 340,446 | $ | 848,281 | $ | 342,903 | $ | 668,401 | $ | 363,731 | $ | 1,994,399 | $ | 4,558,161 | ||||||||||||||
| Fixed rate or swapped interest (2) | 130,639 | 122,459 | 113,892 | 107,209 | 93,756 | 394,048 | 962,003 | |||||||||||||||||||||
| Variable rate interest (3) | 32,992 | 20,755 | 10,681 | 1,650 | — | — | 66,078 | |||||||||||||||||||||
| Operating lease obligations (4) | 2,729 | 2,744 | 2,771 | 2,767 | 2,761 | 68,516 | 82,288 | |||||||||||||||||||||
| Total | $ | 506,806 | $ | 994,239 | $ | 470,247 | $ | 780,027 | $ | 460,248 | $ | 2,456,963 | $ | 5,668,530 |
(1) Represents principal payments gross of discounts, debt issuance costs and fair market value adjustments of debt assumed.
(2) 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.
(3) Interest payments on variable rate debt instruments not subject to interest rate swaps are based on each debt instrument's respective interest rate as of December 31, 2018, which is assumed to be in effect through the maturity date of the respective debt instrument.
(4) Primarily comprised of a ground lease underlying one apartment community we own and the lease for our corporate headquarters.
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. As of December 31, 2018, we had committed to make additional capital contributions totaling up to $13.6 million if and when called by the general partner of the limited partnership and until September 2022.
Off-Balance Sheet Arrangements
As of December 31, 2018 and 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 20.7% ownership interest in a limited partnership as of December 31, 2018. Our interests in these investments are unconsolidated and are recorded using the equity method as we do not have a controlling interest.
As of December 31, 2018 and 2017, 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. 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 apartment 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 any property, including loss of rental income during the reconstruction period.
We renegotiated our insurance programs effective July 1, 2018. 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 operations.
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. The majority of our leases are for approximately 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 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 analyzes 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. Management periodically evaluates 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. Management calculates the fair value of an asset by dividing historical operating cash flows by a market capitalization rate. Management estimates 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, 2018, 2017, and 2016.
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. Management records an accrual for loss contingencies when a loss is probable and the amount of the loss can be reasonably estimated. We also accrue an estimate of defense costs expected to be incurred in connection with legal matters. Management reviews these accruals quarterly and makes 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 management discloses 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. Management's 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, management believes 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.
Previous: Item 6. Selected Financial Data. · Next: Item 7A. Quantitative and Qualitative Disclosures About Market Risk.