Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of the results of operations and financial condition of the Company and the Operating Partnership should be read in connection with the Consolidated Financial Statements and Notes thereto. Due to the Company’s ability to control the Operating Partnership and its subsidiaries, the Operating Partnership and each such subsidiary entity has been consolidated with the Company for financial reporting purposes, except for our unconsolidated properties/entities. Capitalized terms used herein and not defined are as defined elsewhere in this Annual Report on Form 10-K for the year ended December 31, 2018.

Forward-Looking Statements

Forward-looking statements in this Item 7 as well as elsewhere in this Annual Report on Form 10-K are intended to be made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are based on current expectations, estimates, projections and assumptions made by management. While the Company’s management believes the assumptions underlying its forward-looking statements are reasonable, such information is inherently subject to uncertainties and may involve certain risks, which could cause actual results, performance or achievements of the Company to differ materially from anticipated future results, performance or achievements expressed or implied by such forward-looking statements. Many of these uncertainties and risks are difficult to predict and beyond management’s control. Forward-looking statements are not guarantees of future performance, results or events. The forward-looking statements contained herein are made as of the date hereof and the Company undertakes no obligation to update or supplement these forward-looking statements. Factors that might cause such differences include, but are not limited to, the following:

	•	We intend to actively acquire, develop and renovate multifamily operating properties as market conditions dictate. We may also acquire multifamily properties that are unoccupied or in the early stages of lease-up. We may be unable to lease these apartment properties on schedule, resulting in decreases in expected rental revenues and/or lower yields due to lower occupancy and rental rates as well as higher than expected concessions or higher than expected operating expenses. We may not be able to achieve rents that are consistent with expectations for acquired, developed or renovated properties. We may underestimate the costs necessary to bring an acquired property up to standards established for its intended market position, to complete a development property or to complete a renovation. Additionally, we expect that other real estate investors with capital will compete with us for attractive investment opportunities or may also develop properties in markets where we focus our development and acquisition efforts. This competition (or lack thereof) may increase (or depress) prices for multifamily properties. We may not be in a position or have the opportunity in the future to make suitable property acquisitions on favorable terms. We have acquired in the past and intend to continue to pursue the acquisition of properties, including large portfolios of properties, that could increase our size and result in alterations to our capital structure. The total number of apartment units under development, costs of labor and construction materials and estimated completion dates are subject to uncertainties arising from changing economic conditions, competition, tariffs and other trade disruptions and local government regulation;

	•	Debt financing and other capital required by the Company may not be available or may only be available on adverse terms;

	•	Labor and materials required for maintenance, repair, capital expenditure or development may be more expensive than anticipated;

	•	Occupancy levels and market rents may be adversely affected by national and local political, economic and market conditions including, without limitation, new construction and excess inventory of multifamily and owned housing/condominiums, increasing portions of owned housing/condominium stock being converted to rental use, rental housing subsidized by the government, other government programs that favor single family rental housing or owner occupied housing over multifamily rental housing, slow or negative employment growth and household formation, the availability of low-interest mortgages or the availability of mortgages requiring little or no down payment for single family home buyers, changes in social preferences, governmental regulations including rent control or rent stabilization laws and regulations and the potential for geopolitical instability, all of which are beyond the Company’s control; and

	•	Additional factors as discussed in Part I of this Annual Report on Form 10-K, particularly those under Item 1A, Risk Factors.

Forward-looking statements and related uncertainties are also included in the Notes to Consolidated Financial Statements in this report.

Overview

See Item 1, Business, for discussion regarding the Company’s overview.

Business Objectives and Operating and Investing Strategies

See Item 1, Business, for discussion regarding the Company’s business objectives and operating and investing strategies.

Results of Operations

2018 and 2017 Transactions

During the years ended December 31, 2018 and 2017, in conjunction with our business objectives and operating strategy, the Company continued to invest in apartment properties located primarily in our urban and high-density suburban markets and sell apartment properties located primarily in the less dense portion of suburban markets and/or properties that we believe will have inferior long-term returns as follows:

Year Ended December 31, 2018:

	•	Acquired five consolidated apartment properties, located in the Seattle, New York, Denver (two properties) and Boston markets, consisting of 1,461 apartment units, along with the remaining 17 apartment units of an existing consolidated apartment property located in the Washington D.C. market, for approximately $707.0 million at a weighted average Acquisition Cap Rate (see Definitions section below) of 4.4%;

	•	Sold five consolidated apartment properties, located in the Seattle, Los Angeles and New York (three properties) markets, consisting of 1,292 apartment units for approximately $706.1 million at a weighted average Disposition Yield (see Definitions section below) of 4.1% and generating an Unlevered IRR (see Definitions section below) of 8.7%;

	•	Sold one land parcel located in the Washington D.C. market for a sale price of approximately $2.7 million;

	•	Started construction on one project, located in the Boston market, consisting of 469 apartment units totaling approximately $409.7 million of expected development costs; and

	•	Substantially completed construction on two projects, located in the San Francisco and Washington D.C. markets, consisting of 671 apartment units totaling approximately $410.3 million of development costs at a weighted average Development Yield (see Definitions section below) of 5.2% and stabilized four projects, located in the Washington D.C., San Francisco and Seattle (two properties) markets, consisting of 1,498 apartment units totaling approximately $794.8 million of development costs at a weighted average Development Yield of 5.2%.

Year Ended December 31, 2017:

	•	Acquired four consolidated apartment properties, located in the Seattle (two properties), Boston and Los Angeles markets, consisting of 947 apartment units for approximately $468.0 million at a weighted average Acquisition Cap Rate of 4.8%;

	•	Sold five consolidated apartment properties, located in the Boston (three properties), New York and San Diego markets, consisting of 1,194 apartment units for approximately $355.0 million at a weighted average Disposition Yield of 5.1% and generating an Unlevered IRR of 12.4%;

	•	Started construction on two projects, located in the Boston and Seattle markets, consisting of 221 apartment units totaling approximately $113.8 million of expected development costs; and

	•	Substantially completed construction on four projects, located in the Orange County, Washington D.C. and Seattle (two properties) markets, consisting of 1,393 apartment units totaling approximately $579.9 million of development costs and stabilized five development projects, located in the San Francisco (three properties), Los Angeles and Orange County markets, consisting of 1,931 apartment units totaling approximately $983.1 million of development costs.

See also Note 4 in the Notes to Consolidated Financial Statements for additional discussion regarding the Company’s real estate transactions.

Same Store Results

Properties that the Company owned and were stabilized (see definition below) for all of both 2018 and 2017 (the “2018 Same Store Properties”), which represented 71,721 apartment units, impacted the Company’s results of operations. The 2018 Same Store Properties are discussed in the following paragraphs.

The Company’s primary financial measure for evaluating each of its apartment communities is net operating income (“NOI”). NOI represents rental income less direct property operating expenses (including real estate taxes and insurance). The Company believes that NOI is helpful to investors as a supplemental measure of its operating performance because it is a direct measure of the actual operating results of the Company’s apartment properties.

The following tables provide a rollforward of the apartment units included in Same Store Properties and a reconciliation of apartment units included in Same Store Properties to those included in Total Properties for the year ended December 31, 2018:

		Year Ended December 31, 2018
		Properties				Apartment Units
Same Store Properties at December 31, 2017			275				70,117
2016 acquisitions			4				573
2018 dispositions			(5	)			(1,292	)
Lease-up properties stabilized			7				2,292
Other			—				31
Same Store Properties at December 31, 2018			281				71,721

		Year Ended December 31, 2018
		Properties				Apartment Units
Same Store			281				71,721
Non-Same Store:
2018 acquisitions			5				1,461
2017 acquisitions – stabilized			2				437
2017 acquisitions – not stabilized			2				510
Properties removed from same store (1)			2				356
Master-Leased property (2)			1				162
Lease-up properties not yet stabilized (3)			11				3,889
Other			1				1
Total Non-Same Store			24				6,816
Unconsolidated properties			2				945
Total Properties and Apartment Units			307				79,482

Note: Properties are considered “stabilized” when they have achieved 90% occupancy for three consecutive months. Properties are included in Same Store when they are stabilized for all of the current and comparable periods presented.

Note: During the year ended December 31, 2018, the Company closed down a garage (CRP Sports Garage in Boston, Massachusetts) and began its demolition as it starts the development of West End Tower on the site. As a result, the garage was removed from the same store portfolio, which had no impact on the apartment unit or property count for the year ended December 31, 2018.

(1)	Consists of two properties which were removed from the same store portfolio as discussed further below:

	a.	Playa Pacifica in Hermosa Beach, California containing 285 apartment units was removed from the same store portfolio in the first quarter of 2015 due to a major renovation in which significant portions of the property were taken offline for extended time periods. As of December 31, 2018 and 2017, Playa Pacifica had an occupancy of 97.9% and 94.4%, respectively. Playa Pacifica remains in non-same store for the year ended December 31, 2018 as the property did not achieve greater than 90% occupancy for all of the current and comparable periods presented.

	b.	Acton Courtyard in Berkeley, California containing 71 apartment units was removed from the same store portfolio in the third quarter of 2016 due to an affordable housing dispute which required significant portions of the property to be vacant for an extended re-leasing period. As of December 31, 2018 and 2017, Acton Courtyard had an occupancy of 90.1% and 91.5%, respectively. Acton Courtyard remains in non-same store for the year ended December 31, 2018 as the property did not achieve greater than 90% occupancy for all of the current and comparable periods presented.

(2)

Consists of one property containing 162 apartment units that is wholly owned by the Company where the entire project is master leased to a third party corporate housing provider. Effective February 1, 2018, the Company took over management of one of its master-leased properties containing 94 apartment units located in the Boston market. Also, effective April 2, 2018, the Company took over management of one of its other master-leased properties containing 597 apartment units located in the Los Angeles market.

(3)	Consists of properties in various stages of lease-up and properties where lease-up has been completed but the properties were not stabilized for the comparable periods presented. Also includes the two master-leased properties noted above.

The following table provides comparative same store results and statistics for the 2018 Same Store Properties:

2018 vs. 2017

Same Store Results/Statistics for 71,721 Same Store Apartment Units

$ in thousands (except for Average Rental Rate)

		Results												Statistics
Description		Revenues				Expenses				NOI				Average Rental Rate (1)				Physical Occupancy (2)				Turnover (3)
2018		$	2,363,491			$	705,890			$	1,657,601			$	2,748				96.2	%			51.1	%
2017		$	2,311,240			$	681,198			$	1,630,042			$	2,693				96.0	%			53.4	%
Change		$	52,251			$	24,692			$	27,559			$	55				0.2	%			(2.3	%)
Change			2.3	%			3.6	%			1.7	%			2.0	%

Note: Same store revenues for all leases are reflected on a straight line basis in accordance with GAAP for the current and comparable periods.

(1)	Average Rental Rate – Total residential rental revenues reflected on a straight-line basis in accordance with GAAP divided by the weighted average occupied apartment units for the reporting period presented.

(2)	Physical Occupancy – The weighted average occupied apartment units for the reporting period divided by the average of total apartment units available for rent for the reporting period.

(3)	Turnover – Total residential move-outs (including inter-property and intra-property transfers) divided by total residential apartment units.

The following tables present reconciliations of operating income per the consolidated statements of operations to NOI, along with rental income, operating expenses and NOI per the consolidated statements of operations allocated between same store and non-same store results for the 2018 Same Store Properties (amounts in thousands):

		Year Ended December 31,
		2018				2017
Operating income		$	858,560			$	847,471
Adjustments:
Fee and asset management revenue			(753	)			(717	)
Property management			92,485				85,493
General and administrative			53,813				52,224
Depreciation			785,725				743,749
Impairment			702				1,693
Total NOI		$	1,790,532			$	1,729,913
Rental income:
Same store		$	2,363,491			$	2,311,240
Non-same store/other			214,190				159,449
Total rental income			2,577,681				2,470,689
Operating expenses:
Same store			705,890				681,198
Non-same store/other			81,259				59,578
Total operating expenses			787,149				740,776
NOI:
Same store			1,657,601				1,630,042
Non-same store/other			132,931				99,871
Total NOI		$	1,790,532			$	1,729,913

The Company anticipates the following same store results for the full year ending December 31, 2019, which assumptions are based on current expectations and are forward-looking:

2019 Same Store Assumptions
Physical Occupancy		96.2%
Revenue change		2.2% to 3.2%
Expense change		3.5% to 4.5%
NOI change		1.5% to 3.0%

Same store revenues increased 2.3% during the year ended December 31, 2018 as compared to the same period in 2017, which was ahead of our original expectations and consistent with our most recent guidance that was provided in October 2018, due to gains in occupancy of 0.2%, continued low turnover and strong renewals. The Company’s primary goal in 2018 was to focus on providing exceptional customer service in order to retain existing residents to drive strong occupancy and renewal rate growth which it achieved at 4.9% for the year ended December 31, 2018 as compared to the same period in 2017. Same store turnover declined by 2.3% for the year ended December 31, 2018 as compared to the same period in 2017. The Company’s primary focus for 2019 will continue to be retaining existing residents and maintaining strong occupancy. Additionally, in many markets we expect to achieve improved new lease growth, albeit only modestly better relative to 2018. We currently estimate same store revenues to increase in a range from 2.2% to 3.2% for 2019 as compared to 2018. Our outlook for 2019 is based on an expectation that continued economic growth will create the demand to absorb the elevated levels of new supply in many of our markets. All of our markets, with the exception of Seattle and Orange County, are projected to deliver better same store revenue growth in 2019 as compared to 2018.

Washington D.C. showed above average job growth at the end of 2018, which aided the absorption of elevated new supply, and occupancy rates remained high throughout the year. However, same store revenues increased 1.0% during the year ended December 31, 2018 compared to the same period in 2017, which was consistent with our original expectations but slightly below our most recent guidance that was provided in October 2018. In 2019, we expect to see a slight decline in occupancy rates and consistent new lease and renewal rates. We expect to produce same store revenue growth of approximately 1.4% in this market in 2019. This expected 0.40% improvement over 2018 is almost entirely driven by growth already in place from existing residents given less ability to raise rents due to elevated levels of supply.

In the New York market, we anticipated that elevated deliveries of new luxury supply would have an impact on our ability to raise rents and would require us to issue meaningful rent concessions. While we were impacted by new supply, stronger demand for our properties led to increased same store occupancy levels and significantly fewer rent concessions for the year ended December 31, 2018 than we expected. As a result, same store revenues increased 0.8% for the year ended December 31, 2018 as compared to the same period in 2017, which was higher than both our original expectations and our most recent guidance that was provided in October 2018. With new competitive supply expected to be lower in 2019, similar occupancy rates, strong renewal and new lease rates and continued strong demand anticipated in the market, we expect to produce same store revenue growth of approximately 1.8% in this market in 2019.

Boston continues to steadily absorb new supply as a result of strong job growth in the biotechnology and business sectors. Same store revenues increased 2.5% for the year ended December 31, 2018 as compared to the same period in 2017, which was higher than our original guidance and slightly higher than our most recent guidance provided in October 2018, due to stronger occupancy rates and renewal increases. With supply pressures easing in the near-term, we expect to produce same store revenue growth of approximately 2.8% in this market in 2019.

We have a continued cautious outlook for Seattle as the market has decelerated as anticipated due to significant supply in the urban core. Same store revenues increased 2.8% for the year ended December 31, 2018 as compared to the same period in 2017, which was below both our original expectations and our most recent guidance provided in October 2018. Job growth is expected to be strong in 2019 and we expect a slight improvement in occupancy and new lease rates, offset by lower renewal rate growth. We also expect new supply to remain elevated in this market in 2019. We therefore expect to produce same store revenue growth of approximately 2.0% in this market in 2019.

San Francisco continues to perform better than expected as a result of solid job growth and strong demand driving occupancy, new lease growth and renewal rates. The market showed positive trends and is producing wage growth driven by technology company expansions and investments. As a result, same store revenues increased 2.9% for the year ended December 31, 2018 as compared to the same period in 2017, which was above our original expectations and consistent with our most recent guidance provided in October 2018. In 2019, we expect the elevated supply levels to continue to be absorbed due to economic and job expansion in this market. We expect to produce same store revenue growth of approximately 3.4% in this market in 2019.

Los Angeles continues to experience new supply, but the impact of this supply has been somewhat delayed due to labor shortages pushing deliveries of new units into 2019. Strong demand and, to some extent, these delays in deliveries have led to occupancy, renewals and new lease rates that exceeded our original expectations. Same store revenues increased 3.6% for the year ended December 31, 2018 as compared to the same period in 2017, which was above our original expectations and consistent with our most recent guidance provided in October 2018. We believe job growth will continue to be strong and absorb the incoming new supply in 2019. We therefore expect to produce same store revenue growth of approximately 3.8% in this market in 2019.

During the first half of the year, Orange County experienced pressure on average rental rates and occupancy due to elevated supply within the Irvine area which was offset by strong renewal rates. Same store revenues increased 3.5% for the year ended December 31, 2018 as compared to the same period in 2017, which was below our original expectations and slightly below our most recent guidance provided in October 2018. Job growth has been slowing in this market, but the overall outlook for 2019 remains positive. We believe renewal increases will be slightly lower and therefore expect to produce same store revenue growth of approximately 3.1% in this market in 2019.

In the San Diego market, we experienced supply pressure in the downtown area, but military spending remains strong. Same store revenues increased 3.9% for the year ended December 31, 2018 as compared to the same period in 2017, which was slightly below both our original expectations and our most recent guidance provided in October 2018. We believe occupancy and new lease rates will remain similar in 2019. We therefore expect to produce same store revenue growth of approximately 3.9% in this market in 2019.

During the second half of 2018, the Company acquired two apartment properties in Denver. While these properties are not currently within our same store portfolio, these properties are performing consistent with our expectations.

The following table provides comparative same store operating expenses for the 2018 Same Store Properties:

2018 vs. 2017

Same Store Operating Expenses for 71,721 Same Store Apartment Units

$ in thousands

																		% of Actual
																		2018
		Actual				Actual				$				%				Operating
		2018				2017				Change				Change				Expenses
Real estate taxes		$	297,734			$	287,999			$	9,735				3.4	%			42.2	%
On-site payroll (1)			156,859				150,924				5,935				3.9	%			22.2	%
Utilities (2)			95,761				91,630				4,131				4.5	%			13.6	%
Repairs and maintenance (3)			90,424				85,685				4,739				5.5	%			12.8	%
Insurance			18,272				17,359				913				5.3	%			2.6	%
Leasing and advertising			9,959				9,726				233				2.4	%			1.4	%
Other on-site operating expenses (4)			36,881				37,875				(994	)			(2.6	%)			5.2	%
Same store operating expenses		$	705,890			$	681,198			$	24,692				3.6	%			100.0	%

(1)	On-site payroll – Includes payroll and related expenses for on-site personnel including property managers, leasing consultants and maintenance staff.

(2)	Utilities – Represents gross expenses prior to any recoveries under the Resident Utility Billing System (“RUBS”). Recoveries are reflected in rental income.

(3)	Repairs and maintenance – Includes general maintenance costs, apartment unit turnover costs including interior painting, routine landscaping, security, exterminating, fire protection, snow removal, elevator, roof and parking lot repairs and other miscellaneous building repair and maintenance costs.

(4)	Other on-site operating expenses – Includes ground lease costs and administrative costs such as office supplies, telephone and data charges and association and business licensing fees.

Same store expenses increased 3.6% during the year ended December 31, 2018 as compared to the same period in 2017, which was near the low end of our original expectations and slightly lower than our most recent guidance provided in October 2018. The full year 2018 results were primarily due to the following items:

	•	Real estate taxes increased 3.4% for the full year 2018 as compared to the same period in 2017, which was significantly lower than our original expectations and lower than our most recent expectations provided in October 2018, due primarily to better than anticipated appeal results;

	•	Payroll costs increased 3.9% for the full year 2018 as compared to the same period in 2017, which was significantly lower than our original expectations but slightly higher than our most recent expectations provided in October 2018. Wage pressures, particularly with maintenance staff, was partially offset by favorable medical reserve adjustments in the current year;

	•	Utilities increased 4.5% for the full year 2018 as compared to the same period in 2017, which was higher than our original expectations but slightly lower than our most recent expectations provided in October 2018. Increases were due primarily to higher commodity costs for electricity, natural gas and heating oil in 2018, after enjoying several years of declining rates, as well as adverse winter weather in the Northeast in the first quarter of 2018; and

	•	Repairs and maintenance increased 5.5% for the full year 2018 as compared to the same period in 2017, which was higher than our expectations, due primarily to wage pressure on contract labor throughout the year, particularly in Los Angeles, and higher than usual repairs stemming from adverse weather in the fourth quarter of 2018.

We anticipate same store expenses to increase in a range from 3.5% to 4.5% for 2019 as compared to 2018 primarily due to the following items:

	•	Real estate taxes are estimated to increase between 3.75% and 4.75% due primarily to lower anticipated refunds from appeals in 2019 compared to 2018 and the 421-a tax abatement benefits continuing to burn-off in New York;

	•	Payroll costs are estimated to increase approximately 4.0% to 5.0% primarily due to expected higher on-site wages due to competition from new supply and a continued focus on retaining our current skilled employees; and

	•	Utilities are estimated to increase between 1.0% and 3.0% primarily due to the anticipated normalization of commodity costs for electricity, natural gas and heating oil as compared to 2018 and continued sustainability investments in lighting and co-generation.

Same store NOI increased 1.7% for the full year 2018 as compared to the same period in 2017, which was higher than our original expectations and consistent with our most recent guidance provided in October 2018. The Company anticipates same store NOI growth of approximately 1.5% to 3.0% for the full year 2019 as a result of the above same store revenue and expense expectations.

See also Note 17 in the Notes to Consolidated Financial Statements for additional discussion regarding the Company’s segment disclosures.

Non-Same Store/Other Results

Non-same store/other NOI results for the year ended December 31, 2018 increased approximately $33.1 million compared to the same period of 2017 and consist primarily of properties acquired in calendar years 2017 and 2018, operations from the Company’s development properties and operations prior to disposition from 2017 and 2018 sold properties. This difference is due primarily to:

	•	A positive impact of higher NOI from development and newly stabilized development properties in lease-up of $35.1 million;

	•	A positive impact of higher NOI from properties acquired in 2017 and 2018 of $28.1 million;

	•	A positive impact of higher NOI from other non-same store properties (including one current and two former master leased properties) of $1.1 million; and

	•	A negative impact of lost NOI from 2017 and 2018 dispositions of $31.6 million.

The Company’s guidance assumes consolidated rental acquisitions of $700.0 million and consolidated rental dispositions of $700.0 million and assumes that the Acquisition Cap Rate will be 0.25% lower than the Disposition Yield for the full year ending December 31, 2019. The Company did not budget any development starts during the year ending December 31, 2019. We currently

budget spending approximately $165.0 million on development costs during the year ending December 31, 2019, primarily for projects currently under construction. We assume that this capital will be primarily sourced with excess operating cash flow, future debt offerings and borrowings on our revolving credit facility and/or commercial paper program. These 2019 assumptions are based on current expectations and are forward-looking.

Comparison of the year ended December 31, 2018 to the year ended December 31, 2017 and the year ended December 31, 2017 to the year ended December 31, 2016

For the year ended December 31, 2018, the Company reported diluted earnings per share/unit of $1.77 compared to $1.63 per share/unit for the year ended December 31, 2017. The difference is primarily due to approximately $0.26 per share/unit in higher gains on property sales and $0.16 per share/unit in higher property NOI in 2018 as compared to 2017, partially offset by $0.08 per share/unit in higher debt extinguishment costs, $0.05 per share/unit in lower gains on sales of non-operating assets and $0.11 per share/unit in higher depreciation expense in 2018 compared to 2017. For the year ended December 31, 2017, the Company reported diluted earnings per share/unit of $1.63 compared to $11.68 per share/unit for the year ended December 31, 2016. The difference is primarily due to approximately $10.16 per share/unit in higher gains on property sales and $0.14 per share/unit in higher gains on sales of non-operating assets in 2016 compared to 2017 as a direct result of the significant sales activity in 2016 compared to 2017, partially offset by $0.29 per share/unit in higher debt extinguishment costs incurred in 2016 as compared to 2017.

For the year ended December 31, 2018, consolidated rental income increased 4.3%, consolidated operating expenses (comprised of property and maintenance and real estate taxes and insurance) increased 6.3% and consolidated NOI increased 3.5% when compared to the year ended December 31, 2017. The increase in NOI is primarily a result of the Company’s improved NOI from same store and lease-up properties. For the year ended December 31, 2017, consolidated rental income increased 2.0%, consolidated operating expenses (comprised of property and maintenance and real estate taxes and insurance) increased 2.3% and consolidated NOI increased 1.9% when compared to the year ended December 31, 2016. The increase in NOI is primarily a result of the Company’s improved NOI from same store and lease-up properties, partially offset by dilution from disposition activity.

Fee and asset management revenues decreased approximately $2.9 million or 79.9% during the year ended December 31, 2017 as compared to 2016, primarily as a result of lower revenue earned on management of the Company’s military housing ventures at Joint Base Lewis McChord due to the sale of the Company’s entire interest in the management contracts and related rights associated with these ventures in the second quarter of 2016.

Property management expenses include off-site expenses associated with the self-management of the Company’s properties as well as management fees paid to any third party management companies. These expenses increased approximately $7.0 million or 8.2% and approximately $3.5 million or 4.2% during the year ended December 31, 2018 as compared to 2017 and the year ended December 31, 2017 as compared to 2016, respectively. The increase is primarily attributable to increases in payroll-related costs, legal and professional fees and computer operations. The Company anticipates that property management expenses will approximate $96.0 million to $98.0 million for the year ending December 31, 2019.

General and administrative expenses, which include corporate operating expenses, increased approximately $1.6 million or 3.0% during the year ended December 31, 2018 as compared to 2017 primarily due to an increase in payroll-related costs. These expenses decreased $5.6 million or 9.7% during the year ended December 31, 2017 as compared to 2016 primarily due to a decrease in payroll-related costs. The Company anticipates that general and administrative expenses will approximate $49.0 million to $51.0 million for the year ending December 31, 2019.

Depreciation expense, which includes depreciation on non-real estate assets, increased approximately $42.0 million or 5.6% and approximately $38.1 million or 5.4% during the year ended December 31, 2018 as compared to 2017 and the year ended December 31, 2017 as compared to 2016, respectively. The increase from the year ended December 31, 2018 as compared to 2017 is primarily a result of additional depreciation expense on properties acquired in 2017 and 2018 and development properties placed in service in 2017 and 2018, partially offset by lower depreciation from properties sold in 2017 and 2018. The increase from the year ended December 31, 2017 as compared to 2016 is primarily due to additional depreciation expense on properties acquired in 2017 and development properties placed in service in 2016 and 2017, partially offset by lower depreciation from properties sold in 2016 and 2017.

Interest and other income increased approximately $9.2 million during the year ended December 31, 2018 as compared to 2017, primarily due to an $8.4 million increase in insurance/litigation settlement proceeds during 2018 compared to the prior year. Interest and other income decreased approximately $59.6 million or 90.7% during the year ended December 31, 2017 as compared to 2016, primarily due to the approximate $52.4 million gain from the sale of the Company’s entire interest in the management contracts and related rights associated with the military housing ventures at Joint Base Lewis McChord and approximate $6.0 million gain from the sale of 421-a real estate tax certificates during the year ended December 31, 2016, which did not occur in 2017. The Company anticipates that interest and other income will approximate $1.2 million to $1.7 million for the year ending December 31, 2019, excluding certain non-comparable insurance/litigation settlement proceeds.

Other expenses increased approximately $12.1 million during the year ended December 31, 2018 as compared to 2017, primarily due to an increase in expenses related to insurance, litigation and environmental settlements and advocacy contributions in 2018 as compared to 2017. Other expenses decreased approximately $5.2 million or 50.0% during the year ended December 31, 2017 as compared to 2016, primarily due to higher litigation/environmental reserve and/or settlement costs in 2016, which did not occur at the same levels in 2017, as well as a decrease in annual transaction costs of approximately $1.5 million in 2017.

Interest expense, including amortization of deferred financing costs, increased approximately $32.3 million or 8.2% during the year ended December 31, 2018 as compared to 2017, primarily as a result of $29.5 million in higher debt extinguishment costs in 2018 as compared to 2017. Interest expense, including amortization of deferred financing costs, decreased approximately $102.5 million or 20.7% during the year ended December 31, 2017 as compared to 2016, primarily as a result of $109.9 million in lower debt extinguishment costs in 2017 as compared to 2016. The effective interest cost on all indebtedness, excluding debt extinguishment costs/prepayment penalties, was 4.32%, 4.44% and 4.68% for the years ended December 31, 2018, 2017 and 2016, respectively. The Company capitalized interest of approximately $6.3 million, $26.3 million and $51.5 million for the years ended December 31, 2018, 2017 and 2016, respectively. The Company anticipates that interest expense, excluding debt extinguishment costs/prepayment penalties, will approximate $374.0 million to $382.5 million and capitalized interest will approximate $4.5 million to $8.5 million for the year ending December 31, 2019.

The 2019 guidance/projections provided above are based on current projections and are forward-looking.

Income (loss) from investments in unconsolidated entities decreased approximately $8.2 million during the year ended December 31, 2017 as compared to 2016, primarily due to a gain on the sale of one unconsolidated apartment property totaling $8.8 million in 2016 that did not occur in 2017.

Net gain on sales of real estate properties increased approximately $99.8 million or 63.5% during the year ended December 31, 2018 as compared to 2017, primarily as a result of the sale of five consolidated apartment properties for a sales price of approximately $706.1 million during the year ended December 31, 2018 as compared to five consolidated apartment properties for a sales price of approximately $355.0 million sold during the year ended December 31, 2017. Net gain on sales of real estate properties decreased approximately $3.9 billion or 96.1% during the year ended December 31, 2017 as compared to 2016, primarily as a result of 98 consolidated property sales during the year ended December 31, 2016 (including the Starwood Portfolio), all of which did not meet the criteria for reporting discontinued operations.

Net gain on sales of land parcels decreased approximately $18.2 million or 94.9% as compared to 2017 due to the gain on sale of one land parcel with a low basis in the prior year compared to the gain on sale of one land parcel in the current year. Net gain on sales of land parcels increased approximately $3.4 million or 21.8% due to the gain on sale of one land parcel with a low basis during the year ended December 31, 2017 as compared to the gain on sales of four land parcels during the year ended December 31, 2016.

Liquidity and Capital Resources

Short-Term Liquidity and Cash Proceeds

The Company generally expects to meet its short-term liquidity requirements, including capital expenditures related to maintaining its existing properties and scheduled unsecured note and mortgage note repayments, through its working capital, net cash provided by operating activities and borrowings under the Company’s revolving credit facility and commercial paper program. Under normal operating conditions, the Company considers its cash provided by operating activities to be adequate to meet operating requirements and payments of distributions.

As of January 1, 2018, the Company had approximately $50.6 million of cash and cash equivalents, approximately $50.1 million of restricted deposits and the amount available on its revolving credit facility was $1.69 billion. After taking into effect the various transactions discussed in the following paragraphs and the net cash provided by operating activities, at December 31, 2018, the Company’s cash and cash equivalents balance was approximately $47.4 million, the restricted deposits balance was approximately $68.9 million and the amount available on its revolving credit facility was $1.40 billion. See Note 8 in the Notes to Consolidated Financial Statements for further discussion of the availability on the Company’s revolving credit facility.

During the year ended December 31, 2018, the Company generated proceeds from various transactions, which included the following:

	•	Disposed of five consolidated rental properties and one land parcel, receiving net proceeds of approximately $691.5 million;

	•	Issued $500.0 million of ten-year 3.50% unsecured notes, receiving net proceeds of approximately $497.0 million before underwriting fees, hedge termination costs and other expenses;

	•	Issued $400.0 million of ten-year 4.15% unsecured notes, receiving net proceeds of approximately $399.3 million before underwriting fees, hedge termination costs and other expenses;

	•	Reissued $96.9 million of floating rate tax-exempt mortgage bonds; and

	•	Issued approximately 1.1 million Common Shares related to share option exercises and ESPP purchases and received net proceeds of $34.5 million, which were contributed to the capital of the Operating Partnership in exchange for additional OP Units (on a one-for-one Common Share per OP Unit basis).

During the year ended December 31, 2018, the above proceeds along with net cash flow from operations and borrowings from the Company’s revolving line of credit and commercial paper program were primarily utilized to:

	•	Acquire five consolidated rental properties for approximately $708.1 million in cash;

	•	Invest $154.4 million primarily in development projects; and

	•	Repay $1.4 billion of mortgage loans (inclusive of scheduled principal repayments) and incur prepayment penalties of approximately $22.1 million;

Credit Facility and Commercial Paper Program

In November 2016, the Company replaced its existing $2.5 billion facility with a $2.0 billion unsecured revolving credit facility maturing January 10, 2022. The Company has the ability to increase available borrowings by an additional $750.0 million by adding additional banks to the facility or obtaining the agreement of existing banks to increase their commitments. The interest rate on advances under the facility will generally be LIBOR plus a spread (currently 0.825%), or based on bids received from the lending group, and the Company pays an annual facility fee (currently 0.125%). Both the spread and the facility fee are dependent on the Company’s senior unsecured credit rating.

In February 2015, the Company entered into an unsecured commercial paper note program in the United States. The Company may borrow up to a maximum of $500.0 million under this program subject to market conditions. The notes will be sold under customary terms in the United States commercial paper note market and will rank pari passu with all of the Company’s other unsecured senior indebtedness. As of February 15, 2019, there was a balance of $500.0 million in principal outstanding on the commercial paper program.

As of February 15, 2019, $250.0 million was outstanding under the revolving credit facility and $6.7 million was restricted/dedicated to support letters of credit. In addition, the Company limits its utilization of the facility in order to maintain liquidity to support its $500.0 million commercial paper program along with certain other obligations. As a result, the Company had approximately $1.15 billion available under the facility at February 15, 2019. This facility may, among other potential uses, be used to fund property acquisitions, costs for certain properties under development and short-term liquidity requirements.

Dividend Policy

Beginning in 2018, the Company no longer determines its dividends/distributions as a fixed percentage of estimated Normalized FFO but instead adopted a more conventional policy based on actual and projected financial conditions, the Company’s actual and projected liquidity and operating results, the Company’s projected cash needs for capital expenditures and other investment activities and such other factors as the Company’s Board of Trustees deems relevant. The Company declared a dividend/distribution for each quarter in 2018 of $0.54 per share/unit, an annualized increase of 7.2% over the amount paid in 2017. This policy change is supported by the Company’s strong growth in property operations since the recent economic downturn and a significant reduction in its development activity resulting in a material increase in available cash flow. All future dividends/distributions remain subject to the discretion of the Company’s Board of Trustees. The Company‘s 2018 operating cash flow was sufficient to cover capital expenditures and regular dividends/distributions.

Total dividends/distributions paid in January 2019 amounted to $206.6 million (excluding distributions on Partially Owned Properties), which included certain distributions declared during the fourth quarter ended December 31, 2018.

Long-Term Financing and Capital Needs

The Company expects to meet its long-term liquidity requirements, such as lump sum unsecured note and mortgage debt maturities, property acquisitions, financing of construction and development activities through the issuance of secured and unsecured debt and equity securities, including additional OP Units, proceeds received from the disposition of certain properties and joint ventures and cash generated from operations after all distributions. In addition, the Company has significant unencumbered properties available to secure additional mortgage borrowings in the event that unsecured capital is unavailable or the cost of alternative sources of capital is too high. The fair value of and cash flow from these unencumbered properties are in excess of the requirements the Company must maintain in order to comply with covenants under its unsecured notes and line of credit. Of the $26.5 billion in investment in real estate on the Company’s balance sheet at December 31, 2018, $22.1 billion or 83.5% was unencumbered. However, there can be no assurances that these sources of capital will be available to the Company in the future on acceptable terms or otherwise.

EQR issues public equity from time to time and guarantees certain debt of the Operating Partnership. EQR does not have any indebtedness as all debt is incurred by the Operating Partnership.

The Company’s total debt summary and debt maturity schedules as of December 31, 2018 are as follows:

Debt Summary as of December 31, 2018

($ in thousands)

		Amounts (1)				% of Total				Weighted Average Rates (1)				Weighted Average Maturities (years)
Secured		$	2,385,470				27.1	%			4.15	%			6.7
Unsecured			6,432,469				72.9	%			4.10	%			9.3
Total		$	8,817,939				100	%			4.12	%			8.6
Fixed Rate Debt:
Secured – Conventional		$	1,885,407				21.4	%			4.61	%			4.3
Unsecured – Public			5,485,884				62.2	%			4.37	%			10.9
Fixed Rate Debt			7,371,291				83.6	%			4.45	%			9.2
Floating Rate Debt:
Secured – Conventional			6,357				0.1	%			1.93	%			5.6
Secured – Tax Exempt			493,706				5.6	%			2.14	%			15.6
Unsecured – Public (2)			447,402				5.1	%			2.84	%			0.5
Unsecured – Revolving Credit Facility			—				—				2.97	%			3.0
Unsecured – Commercial Paper Program			499,183				5.6	%			2.35	%			—
Floating Rate Debt			1,446,648				16.4	%			2.46	%			5.8
Total		$	8,817,939				100.0	%			4.12	%			8.6

(1)	Net of the effect of any derivative instruments. Weighted average rates are for the year ended December 31, 2018.

(2)	Fair value interest rate swaps convert the $450.0 million 2.375% notes due July 1, 2019 to a floating interest rate of 90-Day LIBOR plus 0.61%.

Debt Maturity Schedule as of December 31, 2018

($ in thousands)

Year		Fixed Rate (1)				Floating Rate (1)				Total				% of Total				Weighted Average Rates on Fixed Rate Debt (1)				Weighted Average Rates on Total Debt (1)
2019		$	6,731			$	968,223		(2)	$	974,954				10.9	%			3.73	%			2.86	%
2020			1,128,592		(3)		700				1,129,292				12.7	%			5.20	%			5.20	%
2021			927,506				600				928,106				10.4	%			4.64	%			4.64	%
2022			265,341				800				266,141				3.0	%			3.26	%			3.26	%
2023			1,326,800				4,800				1,331,600				14.9	%			3.74	%			3.73	%
2024			1,272				10,900				12,172				0.1	%			4.79	%			2.13	%
2025			451,334				13,200				464,534				5.2	%			3.38	%			3.33	%
2026			593,424				14,500				607,924				6.8	%			3.59	%			3.54	%
2027			401,468				15,600				417,068				4.7	%			3.26	%			3.20	%
2028			901,540				48,580				950,120				10.7	%			3.79	%			3.69	%
2029+			1,423,430				407,420				1,830,850				20.6	%			4.41	%			3.83	%
Subtotal			7,427,438				1,485,323				8,912,761				100.0	%			4.11	%			3.86	%
Deferred Financing Costs and Unamortized (Discount)			(56,147	)			(38,675	)			(94,822	)		N/A				N/A				N/A
Total		$	7,371,291			$	1,446,648			$	8,817,939				100.0	%			4.11	%			3.86	%

(1)	Net of the effect of any derivative instruments. Weighted average rates are as of December 31, 2018.

(2)	Includes $500.0 million in principal outstanding on the Company’s commercial paper program.

(3)	Includes a $500.0 million 5.78% mortgage loan with a maturity date of July 1, 2020 that can be prepaid at par beginning July 1, 2019. The Company currently intends to prepay this mortgage loan on July 1, 2019.

See Note 8 in the Notes to Consolidated Financial Statements for additional discussion of debt at December 31, 2018.

The Company’s “Consolidated Debt-to-Total Market Capitalization Ratio” as of December 31, 2018 is presented in the following table. The Company calculates the equity component of its market capitalization as the sum of (i) the total outstanding Common Shares and assumed conversion of all Units at the equivalent market value of the closing price of the Company’s Common Shares on the New York Stock Exchange and (ii) the liquidation value of all perpetual preferred shares outstanding.

Equity Residential

Capital Structure as of December 31, 2018

(Amounts in thousands except for share/unit and per share amounts)

Secured Debt										$	2,385,470				27.1	%
Unsecured Debt											6,432,469				72.9	%
Total Debt											8,817,939				100.0	%			25.8	%
Common Shares (includes Restricted Shares)			369,405,161				96.4	%
Units (includes OP Units and Restricted Units)			13,904,035				3.6	%
Total Shares and Units			383,309,196				100.0	%
Common Share Price at December 31, 2018		$	66.01
											25,302,240				99.9	%
Perpetual Preferred Equity											37,280				0.1	%
Total Equity											25,339,520				100.0	%			74.2	%
Total Market Capitalization										$	34,157,459								100.0	%

The Operating Partnership’s “Consolidated Debt-to-Total Market Capitalization Ratio” as of December 31, 2018 is presented in the following table. The Operating Partnership calculates the equity component of its market capitalization as the sum of (i) the total outstanding Units at the equivalent market value of the closing price of the Company’s Common Shares on the New York Stock Exchange and (ii) the liquidation value of all perpetual preference units outstanding.

ERP Operating Limited Partnership

Capital Structure as of December 31, 2018

(Amounts in thousands except for unit and per unit amounts)

Secured Debt							$	2,385,470				27.1	%
Unsecured Debt								6,432,469				72.9	%
Total Debt								8,817,939				100.0	%			25.8	%
Total Outstanding Units			383,309,196
Common Share Price at December 31, 2018		$	66.01
								25,302,240				99.9	%
Perpetual Preference Units								37,280				0.1	%
Total Equity								25,339,520				100.0	%			74.2	%
Total Market Capitalization							$	34,157,459								100.0	%

In September 2009, EQR announced the establishment of an At-The-Market (“ATM”) share offering program which would allow EQR to sell Common Shares from time to time into the existing trading market at current market prices as well as through negotiated transactions. Per the terms of ERPOP’s partnership agreement, EQR contributes the net proceeds from all equity offerings to the capital of ERPOP in exchange for additional OP Units (on a one-for-one Common Share per OP Unit basis). EQR may, but shall have no obligation to, sell Common Shares through the ATM share offering program in amounts and at times to be determined by EQR. Actual sales will depend on a variety of factors to be determined by EQR from time to time, including (among others) market conditions, the trading price of EQR’s Common Shares and determinations of the appropriate sources of funding for EQR. The program currently has a maturity of June 28, 2019. EQR has the authority to issue 13.0 million shares but has not issued any shares under this program since September 2012. Through February 15, 2019, EQR has cumulatively issued approximately 16.7 million Common Shares at an average price of $48.53 per share for total consideration of approximately $809.9 million.

Depending on its analysis of market prices, economic conditions and other opportunities for the investment of available capital, EQR may repurchase its Common Shares pursuant to its existing share repurchase program authorized by the Board of Trustees. The Company may repurchase up to 13.0 million Common Shares under this program. No open market repurchases have occurred since 2008 and no repurchases of any kind have occurred since February 2014. As of February 15, 2019, EQR has remaining authorization to repurchase up to 13.0 million of its shares.

EQR and ERPOP currently have an active universal shelf registration statement for the issuance of equity and debt securities that automatically became effective upon filing with the SEC on June 28, 2016 and expires on June 28, 2019. Per the terms of ERPOP’s partnership agreement, EQR contributes the net proceeds of all equity offerings to the capital of ERPOP in exchange for additional OP Units (on a one-for-one Common Share per OP Unit basis) or preference units (on a one-for-one preferred share per preference unit basis).

ERPOP’s long-term senior debt ratings and short-term commercial paper ratings as well as EQR’s long-term preferred equity ratings, which all have a stable outlook, as of February 15, 2019 are as follows:

		Standard & Poor’s		Moody’s		Fitch
ERPOP’s long-term senior debt rating		A-		A3		A
ERPOP’s short-term commercial paper rating		A-2		P-2		F-1
EQR’s long-term preferred equity rating		BBB		Baa1		BBB+

See Note 18 in the Notes to Consolidated Financial Statements for discussion of the events, if any, which occurred subsequent to December 31, 2018.

Capitalization of Fixed Assets and Improvements to Real Estate

Our policy with respect to capital expenditures is generally to capitalize expenditures that improve the value of the property or extend the useful life of the component asset of the property. We track improvements to real estate in three major categories and several subcategories:

	▪	Replacements (inside the apartment unit). These include:

	•	flooring such as carpets, hardwood, vinyl or tile;

	•	appliances;

	•	mechanical equipment such as individual furnace/air units, hot water heaters, etc;

	•	furniture and fixtures such as kitchen/bath cabinets, light fixtures, ceiling fans, sinks, tubs, toilets, mirrors, countertops, etc; and

	•	blinds.

All replacements are depreciated over a five to ten-year estimated useful life. We expense as incurred all make-ready maintenance and turnover costs such as cleaning, interior painting of individual apartment units and the repair of any replacement item noted above.

	▪	Building improvements (outside the apartment unit). These include:

	•	roof replacement and major repairs;

	•	paving or major resurfacing of parking lots, curbs and sidewalks;

	•	amenities and common areas such as pools, exterior sports and playground equipment, lobbies, clubhouses, laundry rooms, alarm and security systems and offices;

	•	major building mechanical equipment systems;

	•	interior and exterior structural repair and exterior painting and siding;

	•	major landscaping and grounds improvement; and

	•	vehicles and office and maintenance equipment.

All building improvements are depreciated over a five to fifteen-year estimated useful life. We capitalize building improvements and upgrades only if the item: (i) exceeds $2,500 (selected projects must exceed $10,000); (ii) extends the useful life of the asset; and (iii) improves the value of the asset.

The third major category is renovations, which primarily consists of expenditures for kitchens and baths designed to reposition the apartment units/properties for higher rental levels in their respective markets. All renovation expenditures are depreciated over a ten-year estimated useful life.

For the year ended December 31, 2018, our actual capital expenditures to real estate included the following (amounts in thousands except for apartment unit and per apartment unit amounts):

Capital Expenditures to Real Estate

For the Year Ended December 31, 2018

		Same Stores Properties (5)				Non-Same Store Properties/Other (6)				Total				Same Store Avg. Per Apartment Unit
Total Apartment Units (1)			71,721				6,816				78,537
Building Improvements (2)		$	100,382			$	3,830			$	104,212			$	1,399
Renovation Expenditures (3)			39,431				1,922				41,353				550
Replacements (4)			41,746				1,190				42,936				582
Total Capital Expenditures		$	181,559			$	6,942			$	188,501			$	2,531

(1)	Total Apartment Units – Excludes 945 unconsolidated apartment units for which capital expenditures to real estate are self-funded and do not consolidate into the Company’s results.

(2)	Building Improvements – Includes roof replacement, paving, building mechanical equipment systems, exterior siding and painting, major landscaping, furniture, fixtures and equipment for amenities and common areas, vehicles and office and maintenance equipment.

(3)	Renovation Expenditures – Apartment unit renovation costs (primarily kitchens and baths) designed to reposition these units for higher rental levels in their respective markets. Amounts for 2,850 same store apartment units approximated $13,800 per apartment unit renovated.

(4)	Replacements – Includes appliances, mechanical equipment, fixtures and flooring (including hardwood and carpeting).

(5)	Same Store Properties – Primarily includes all properties acquired or completed that are stabilized prior to January 1, 2017, less properties subsequently sold.

(6)	Non-Same Store Properties/Other – Primarily includes all properties acquired during 2017 and 2018, plus any properties in lease-up and not stabilized as of January 1, 2017. Also includes capital expenditures for properties sold.

For the year ended December 31, 2017, our actual capital expenditures to real estate included the following (amounts in thousands except for apartment unit and per apartment unit amounts):

Capital Expenditures to Real Estate

For the Year Ended December 31, 2017

		Same Stores Properties (5)				Non-Same Store Properties/Other (6)				Total				Same Store Avg. Per Apartment Unit
Total Apartment Units (1)			70,117				7,549				77,666
Building Improvements (2)		$	114,162			$	3,966			$	118,128			$	1,628
Renovation Expenditures (3)			44,418				888				45,306				634
Replacements (4)			38,560				613				39,173				550
Total Capital Expenditures		$	197,140			$	5,467			$	202,607			$	2,812

(1)	Total Apartment Units – Excludes 945 unconsolidated apartment units for which capital expenditures to real estate are self-funded and do not consolidate into the Company’s results.

(2)	Building Improvements – Includes roof replacement, paving, building mechanical equipment systems, exterior siding and painting, major landscaping, furniture, fixtures and equipment for amenities and common areas, vehicles and office and maintenance equipment.

(3)	Renovation Expenditures – Apartment unit renovation costs (primarily kitchens and baths) designed to reposition these units for higher rental levels in their respective markets. Amounts for 3,371 same store apartment units approximated $13,200 per apartment unit renovated.

(4)	Replacements – Includes appliances, mechanical equipment, fixtures and flooring (including hardwood and carpeting).

(5)	Same Store Properties – Primarily includes all properties acquired or completed that are stabilized prior to January 1, 2016, less properties subsequently sold.

(6)	Non-Same Store Properties/Other – Primarily includes all properties acquired during 2016 and 2017, plus any properties in lease-up and not stabilized as of January 1, 2016. Also includes capital expenditures for properties sold.

The Company estimates that during 2019 it will spend approximately $2,600 per same store apartment unit or $190.0 million of total capital expenditures to real estate for same store properties. During 2019, the Company expects to spend approximately $40.0 million for apartment unit renovation expenditures on approximately 3,000 same store apartment units at an average cost of approximately $13,300 per apartment unit renovated. The anticipated total capital expenditures to real estate for same store properties represent approximately the same percentage of same store revenues and a slightly higher cost per unit and absolute dollar amount as compared to 2018. The Company plans to continue the capital expenditures for investment in customer-facing building improvements (leasing offices, fitness centers, common areas, etc.) to enhance the quality of our properties and to protect our competitive position given the new luxury supply opening in many of our markets. We also expect to maintain our elevated spending on sustainability projects and renovation expenditures during 2019. The above assumptions are based on current expectations and are forward-looking.

During the year ended December 31, 2018, the Company’s total non-real estate capital additions, such as computer software, computer equipment, and furniture and fixtures and leasehold improvements to the Company’s property management offices and its corporate offices, were approximately $4.5 million. The Company expects to fund approximately $4.1 million in total non-real estate capital additions in 2019. These anticipated fundings are slightly lower than 2018 and are primarily driven by anticipated hardware and software upgrades to various existing systems during 2019. The above assumption is based on current expectations and is forward-looking.

Capital expenditures to real estate and non-real estate capital additions are generally funded from net cash provided by operating activities and from investment cash flow.

Derivative Instruments

In the normal course of business, the Company is exposed to the effect of interest rate changes. The Company seeks to manage these risks by following established risk management policies and procedures including the use of derivatives to hedge interest rate risk on debt instruments. The Company may also use derivatives to manage commodity prices in the daily operations of the business.

The Company has a policy of only entering into contracts with major financial institutions based upon their credit ratings and other factors. When viewed in conjunction with the underlying and offsetting exposure that the derivatives are designed to hedge, the Company has not sustained a material loss from these instruments nor does it anticipate any material adverse effect on its net income or financial position in the future from the use of derivatives it currently has in place.

See Note 9 in the Notes to Consolidated Financial Statements for additional discussion of derivative instruments at December 31, 2018.

Definitions

The definition of certain terms described above or below are as follows:

	•	Acquisition Cap Rate – NOI that the Company anticipates receiving in the next 12 months (or the year two or three stabilized NOI for properties that are in lease-up at acquisition) less an estimate of property management costs/management fees allocated to the project (generally ranging from 2.0% to 4.0% of revenues depending on the size and income streams of the asset) and less an estimate for in-the-unit replacement capital expenditures (generally ranging from $100-$450 per apartment unit depending on the age and condition of the asset) divided by the gross purchase price of the asset. The weighted average Acquisition Cap Rate for acquired properties is weighted based on the projected NOI streams and the relative purchase price for each respective property.

	•	Development Yield – NOI that the Company anticipates receiving in the next 12 months following stabilization less an estimate of property management costs/management fees allocated to the project (generally ranging from 2.0% to 4.0% of revenues depending on the size and income streams of the asset) and less an estimate for in-the-unit replacement capital expenditures (generally ranging from $50-$150 per apartment unit depending on the type of asset) divided by the Total Budgeted Capital Cost of the asset. The weighted average Development Yield for development properties is weighted based on the projected NOI streams and the relative Total Budgeted Capital Cost for each respective property.

	•	Disposition Yield – NOI that the Company anticipates giving up in the next 12 months less an estimate of property management costs/management fees allocated to the project (generally ranging from 2.0% to 4.0% of revenues depending on the size and income streams of the asset) and less an estimate for in-the-unit replacement capital expenditures (generally ranging from $100-$450 per apartment unit depending on the age and condition of the asset) divided by the gross sale price of the asset. The weighted average Disposition Yield for sold properties is weighted based on the projected NOI streams and the relative sales price for each respective property.

	•	Unlevered Internal Rate of Return (“IRR”) – The Unlevered IRR on sold properties is the compound annual rate of return calculated by the Company based on the timing and amount of: (i) the gross purchase price of the property plus any direct acquisition costs incurred by the Company; (ii) total revenues earned during the Company’s ownership period; (iii) total direct property operating expenses (including real estate taxes and insurance) incurred during the Company’s ownership period; (iv) capital expenditures incurred during the Company’s ownership period; and (v) the gross sales price of the property net of selling costs.

Off-Balance Sheet Arrangements and Contractual Obligations

The Company has various unconsolidated interests in certain joint ventures. The Company does not believe that these unconsolidated investments have a materially different impact on its liquidity, cash flows, capital resources, credit or market risk than its consolidated operating and/or other activities. See also Note 6 in the Notes to Consolidated Financial Statements for additional discussion regarding the Company’s investments in partially owned entities. See also Note 16 in the Notes to Consolidated Financial Statements for discussion regarding the Company’s development projects.

The following table summarizes the Company’s contractual obligations for the next five years and thereafter as of December 31, 2018:

Payments Due by Year (in thousands)
Contractual Obligations		2019				2020				2021				2022				2023				Thereafter				Unamortized Cost/Discounts				Total
Debt:
Principal (a)		$	974,954			$	1,129,292			$	928,106			$	266,141			$	1,331,600			$	4,282,668			$	(94,822	)		$	8,817,939
Interest (b)			320,384				284,381				248,509				209,014				187,251				1,700,743				—				2,950,282
Operating Leases:
Minimum Rent Payments (c)			16,718				16,726				16,665				14,500				14,339				953,001				—				1,031,949
Other Long-Term Liabilities:
Deferred Compensation (d)			803				1,100				1,100				1,100				975				3,810				—				8,888
Total		$	1,312,859			$	1,431,499			$	1,194,380			$	490,755			$	1,534,165			$	6,940,222			$	(94,822	)		$	12,809,058

(a)	Amounts include aggregate principal payments only.

(b)	Amounts include interest expected to be incurred on the Company’s secured and unsecured debt based on obligations outstanding at December 31, 2018 and inclusive of capitalized interest. For floating rate debt, the current rate in effect for the most recent payment through December 31, 2018 is assumed to be in effect through the respective maturity date of each instrument.

(c)	Minimum basic rent due for various office space the Company leases and fixed base rent due on ground leases for 12 properties.

(d)	Estimated payments to the Company’s Chairman, Vice Chairman and one former CEO based on actual and estimated retirement dates.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to use judgment in the application of accounting policies, including making estimates and assumptions. If our judgment or interpretation of the facts and circumstances relating to various transactions had been different or different assumptions were made, it is possible that different accounting policies would have been applied, resulting in different financial results or different presentation of our financial statements.

The Company’s significant accounting policies are described in Note 2 in the Notes to Consolidated Financial Statements. These policies were followed in preparing the consolidated financial statements at and for the year ended December 31, 2018.

The Company has identified five significant accounting policies as critical accounting policies. These critical accounting policies are those that have the most impact on the reporting of our financial condition and those requiring significant judgments and estimates. With respect to these critical accounting policies, management believes that the application of judgments and estimates is consistently applied and produces financial information that fairly presents the results of operations for all periods presented. The five critical accounting policies are:

Acquisition of Investment Properties

The Company allocates the purchase price of properties that meet the definition of an asset acquisition to net tangible and identified intangible assets acquired based on their relative fair values. In making estimates of relative fair values for purposes of allocating purchase price, the Company utilizes a number of sources, including independent appraisals that may be obtained in connection with the acquisition or financing of the respective property, our own analysis of recently acquired and existing comparable properties in our portfolio and other market data. The Company also considers information obtained about each property as a result of its pre-acquisition due diligence, marketing and leasing activities in estimating the relative fair value of the tangible and intangible assets acquired.

Impairment of Long-Lived Assets

The Company periodically evaluates its long-lived assets, including its investments in real estate, for indicators of impairment. The judgments regarding the existence of impairment indicators are based on factors such as operational performance, market conditions and legal and environmental concerns, as well as the Company’s ability to hold and its intent with regard to each asset. Future events could occur which would cause the Company to conclude that impairment indicators exist and an impairment loss is warranted.

Depreciation of Investment in Real Estate

The Company depreciates the building component of its investment in real estate over a 30-year estimated useful life, building improvements over a 5-year to 15-year estimated useful life, both the furniture, fixtures and equipment and replacement components

over a 5-year to 10-year estimated useful life and the renovations component over a 10-year estimated useful life, all of which are judgmental determinations.

Cost Capitalization

See the Capitalization of Fixed Assets and Improvements to Real Estate section for a discussion of the Company’s policy with respect to capitalization vs. expensing of fixed asset/repair and maintenance costs. In addition, the Company capitalizes an allocation of the payroll and associated costs of employees directly responsible for and who spend their time on the execution and supervision of major capital and/or renovation projects. These costs are reflected on the balance sheets as increases to depreciable property.

For all development projects, the Company uses its professional judgment in determining whether such costs meet the criteria for capitalization or must be expensed as incurred. The Company capitalizes interest, real estate taxes and insurance and payroll and associated costs for those individuals directly responsible for and who spend their time on development activities, with capitalization ceasing no later than 90 days following issuance of the certificate of occupancy. These costs are reflected on the balance sheets as construction-in-progress for each specific property. The Company expenses as incurred all payroll costs of on-site employees working directly at our properties, except as noted above on our development properties prior to certificate of occupancy issuance and on specific major renovations at selected properties when additional incremental employees are hired.

During the years ended December 31, 2018, 2017 and 2016, the Company capitalized $13.2 million, $14.7 million and $18.7 million, respectively, of payroll and associated costs of employees directly responsible for and who spend their time on the execution and supervision of development activities as well as major capital and/or renovation projects.

Fair Value of Financial Instruments, Including Derivative Instruments

The valuation of financial instruments requires the Company to make estimates and judgments that affect the fair value of the instruments. The Company, where possible, bases the fair values of its financial instruments, including its derivative instruments, on listed market prices and third party quotes. Where these are not available, the Company bases its estimates on current instruments with similar terms and maturities or on other factors relevant to the financial instruments.

Funds From Operations and Normalized Funds From Operations

The following is the Company’s and the Operating Partnership’s reconciliation of net income to FFO available to Common Shares and Units / Units and Normalized FFO available to Common Shares and Units / Units for each of the five years ended December 31, 2018:

Funds From Operations and Normalized Funds From Operations

(Amounts in thousands)

		Year Ended December 31,
		2018				2017				2016				2015				2014
Net income		$	685,192			$	628,381			$	4,480,104			$	908,018			$	658,683
Net (income) loss attributable to Noncontrolling Interests – Partially Owned Properties			(2,718	)			(2,323	)			(16,430	)			(3,657	)			(2,544	)
Preferred/preference distributions			(3,090	)			(3,091	)			(3,091	)			(3,357	)			(4,145	)
Premium on redemption of Preferred Shares/Preference Units			—				—				—				(3,486	)			—
Net income available to Common Shares and Units / Units			679,384				622,967				4,460,583				897,518				651,994
Adjustments:
Depreciation			785,725				743,749				705,649				765,895				758,861
Depreciation – Non-real estate additions			(4,561	)			(5,023	)			(5,224	)			(4,981	)			(4,643	)
Depreciation – Partially Owned Properties			(3,740	)			(4,526	)			(3,805	)			(4,332	)			(4,285	)
Depreciation – Unconsolidated Properties			4,451				4,577				4,745				4,920				6,754
Net (gain) loss on sales of unconsolidated entities – operating assets			—				(73	)			(8,841	)			(100	)			(4,902	)
Net (gain) loss on sales of real estate properties			(256,810	)			(157,057	)			(4,044,055	)			(335,134	)			(212,685	)
Noncontrolling Interests share of gain (loss) on sales of real estate properties			(284	)			290				14,521				—				—
Discontinued operations:
Net (gain) loss on sales of discontinued operations			—				—				(43	)			—				(179	)
Impairment – operating assets			702				—				—				—				—
FFO available to Common Shares and Units / Units (1) (3) (4)			1,204,867				1,204,904				1,123,530				1,323,786				1,190,915
Adjustments:
Impairment – non-operating assets			—				1,693				—				—				—
Write-off of pursuit costs			4,450				3,106				4,092				3,208				3,607
Debt extinguishment and preferred share redemption (gains) losses			41,335				11,789				121,694				5,704				(1,110	)
Non-operating asset (gains) losses			(161	)			(18,884	)			(73,301	)			(18,805	)			2,421
Other miscellaneous items			(1,781	)			(3,371	)			3,635				3,909				613
Normalized FFO available to Common Shares and Units / Units (2) (3) (4)		$	1,248,710			$	1,199,237			$	1,179,650			$	1,317,802			$	1,196,446
FFO (1) (3)		$	1,207,957			$	1,207,995			$	1,126,621			$	1,330,629			$	1,195,060
Preferred/preference distributions			(3,090	)			(3,091	)			(3,091	)			(3,357	)			(4,145	)
Premium on redemption of Preferred Shares/Preference Units			—				—				—				(3,486	)			—
FFO available to Common Shares and Units / Units (1) (3) (4)		$	1,204,867			$	1,204,904			$	1,123,530			$	1,323,786			$	1,190,915
Normalized FFO (2) (3)		$	1,251,800			$	1,202,328			$	1,182,741			$	1,321,159			$	1,200,591
Preferred/preference distributions			(3,090	)			(3,091	)			(3,091	)			(3,357	)			(4,145	)
Normalized FFO available to Common Shares and Units / Units (2) (3) (4)		$	1,248,710			$	1,199,237			$	1,179,650			$	1,317,802			$	1,196,446

(1)

The National Association of Real Estate Investment Trusts (“Nareit”) defines funds from operations (“FFO”) (April 2002 White Paper) as net income (computed in accordance with accounting principles generally accepted in the United States (“GAAP”)), excluding gains (or losses) from sales and impairment write-downs of depreciated operating properties, plus depreciation and amortization expense, and after adjustments for unconsolidated partnerships and joint ventures. Adjustments for unconsolidated partnerships and joint ventures will be calculated to reflect funds from operations on the same basis. The April 2002 White Paper states that gain or loss on sales of property is excluded from FFO for previously depreciated operating properties only.

(2)	Normalized funds from operations (“Normalized FFO”) begins with FFO and excludes:

	•	the impact of any expenses relating to non-operating asset impairment;

	•	pursuit cost write-offs;

	•	gains and losses from early debt extinguishment and preferred share redemptions;

	•	gains and losses from non-operating assets; and

	•	other miscellaneous items.

(3)

The Company believes that FFO and FFO available to Common Shares and Units / Units are helpful to investors as supplemental measures of the operating performance of a real estate company because they are recognized measures of performance by the real estate industry and by excluding gains or losses related to sales of depreciated operating properties and excluding real estate depreciation (which can vary among owners of identical assets in similar condition based on historical cost accounting and useful life estimates), FFO and FFO available to Common Shares and Units / Units can help compare the operating performance of a company’s real estate between periods or as compared to different companies. The Company also believes that Normalized FFO and Normalized FFO available to Common Shares and Units / Units are helpful to investors as supplemental measures of the operating performance of a real estate company because they allow investors to compare the Company’s operating performance to its performance in prior reporting periods and to the operating performance of other real estate companies without the effect of items that by their nature are not comparable from period to period and tend to obscure the Company’s actual operating results. FFO, FFO available to Common Shares and Units / Units, Normalized FFO and Normalized FFO available to Common Shares and Units / Units do not represent net income, net income available to Common Shares / Units or net cash flows from operating activities in accordance with GAAP. Therefore, FFO, FFO available to Common Shares and Units / Units, Normalized FFO and Normalized FFO available to Common Shares and Units / Units should not be exclusively considered as alternatives to net income, net income available to Common Shares / Units or net cash flows from operating activities as determined by GAAP or as a measure of liquidity. The Company’s calculation of FFO, FFO available to Common Shares and Units / Units, Normalized FFO and Normalized FFO available to

	Common Shares and Units / Units may differ from other real estate companies due to, among other items, variations in cost capitalization policies for capital expenditures and, accordingly, may not be comparable to such other real estate companies.

(4)

FFO available to Common Shares and Units / Units and Normalized FFO available to Common Shares and Units / Units are calculated on a basis consistent with net income available to Common Shares / Units and reflects adjustments to net income for preferred distributions and premiums on redemption of preferred shares/preference units in accordance with GAAP. The equity positions of various individuals and entities that contributed their properties to the Operating Partnership in exchange for OP Units are collectively referred to as the “Noncontrolling Interests – Operating Partnership”. Subject to certain restrictions, the Noncontrolling Interests – Operating Partnership may exchange their OP Units for Common Shares on a one-for-one basis.