HOME PROPERTIES INC - 10-K - Management's Discussion and Analysis of Financial Condition and Results of Operations

(Edgar Glimpses Via Acquire Media NewsEdge) Overview Management's Discussion and Analysis of Financial Condition and Results of Operations is intended to facilitate an understanding of the Company's business and results of operations. It should be read in conjunction with the Consolidated Financial Statements, the accompanying Notes to Consolidated Financial Statements and the selected financial data included in this Form 10-K. This Form 10-K, including the following discussion, contains forward-looking statements regarding future events or trends as described more fully under "Forward-Looking Statements" on page 56. Actual results could differ materially from those projected in such statements as a result of the risk factors described in Item 1A, "Risk Factors," of this Form 10-K.

The Company is engaged in the ownership, management, acquisition, rehabilitation and development of residential apartment communities primarily in selected Northeast and Mid-Atlantic markets of the United States. As of December 31, 2012, the Company owned and operated 121 apartment communities with 42,635 apartments.

Executive Summary The Company operated during 2012 in a recovering economic environment, where the Company's markets and the country as a whole experienced job growth of 1.1% and 1.4%, respectively. This is slightly more than the job growth in the Company's markets of 0.7% in 2011. An increase in job growth leads to household formations, which creates an increase in demand for rental housing. In addition, the credit crisis of the past recession has made it more difficult for apartment residents who may have considered purchasing a home to qualify for a mortgage. After years of home ownership being the number one reason our residents gave for moving out of our apartment communities, it dropped starting in 2007, such that it is the number five reason in 2012. The combination of steady job growth and reduced flexibility for residents to purchase homes has created an environment supporting higher rental income growth and occupancy rates.

The Company owned 107 communities with 36,214 apartment units throughout 2011 and 2012 where comparable operating results are available for the years presented (the "2012 Core Properties"). Physical occupancies at the 2012 Core Properties increased slightly, by 10 basis points, from 95.5% to 95.6%.

Including bad debt in the calculation to arrive at "economic occupancy", this metric increased by 30 basis points to 94.6% for 2012 from 94.3% in 2011. The level of bad debt improved to 101 basis points in 2012 compared to 117 basis points in 2011. For 2013, we are projecting bad debt to be approximately 90 basis points of rent potential.

34 -------------------------------------------------------------------------------- Table of Contents Executive Summary (continued) The Company uses a measurement referred to as Available to Rent, or "ATR". This is a leading indicator of future occupancy rates and refers to units which will be available for rent, based upon leases signed or termination notices received relating to future move in/move out dates. As of the end of the first week of February, 2013, our ATR was 6.2%, lower than the same time period a year ago when ATR was 6.7%. Average physical occupancy for the quarter ended December 31, 2012 was at a high level of occupancy at 95.5%, with a continuation of low resident turnover of 38.9%, only 50 basis points higher than 2011. For 2013, we are projecting physical occupancy to be 30 basis points higher than 2012, as a result of a slightly less aggressive approach to rent increases combined with the continuation of limited alternatives for our residents.

Total 2012 Core Properties rental revenue growth for 2012 was projected to be 4.6%, consisting of an increase of 4.7% in rental rate growth with economic occupancy to decrease 0.1%. Actual results were positive 4.2% in rental rate growth and 0.3% increase in economic occupancy, resulting in 4.6% total rental revenue growth, or equal to guidance.

The guidance for 2013 Core Properties (apartment units owned throughout 2012 and 2013, the "2013 Core Properties") total revenue growth is 4.0% at the midpoint of guidance. Rental rates are projected to increase 3.8%, including above-average rental increases at certain communities resulting from continued efforts to upgrade the properties. Economic occupancies are expected to increase 0.4% for the year, such that rental revenues are projected to increase 4.3%. Property other income is expected to decrease slightly at 0.3% year over year, decreasing the 4.3% rental revenue increase to 4.0% total revenue growth.

Expenses for 2013 Core Properties are projected to increase 3.5% at the midpoint of guidance. The Company has experienced four straight years of negative expense growth which will be very difficult to duplicate in 2013. Some of the line items where we expect above average increases include: natural gas heating costs up 4.3%; personnel costs (specifically from health care) up 4.8%; real estate taxes up 4.7%; property insurance up over 18%; and snow removal up more than double. The Company's markets experienced extreme mild winters in 2012 which are not expected to repeat in 2013. This affects heating costs, snow removal, personnel costs and insurance.

These revenue and expense projections result in 2013 Core Properties NOI growth of 4.0% at the mid-point of 2013 guidance. Markets where the Company expects NOI results above the average include: Washington 5.5%, Philadelphia 5.3% and Boston 4.5%. Markets with below average expectations include: Florida 3.5%, Baltimore 3.1%, New York City Metro area 1.4% and Chicago 0.3%. Certain historical demographic information for these markets may be found in the tables on pages 10 and 11 of this report.

Of the two items comprising NOI, revenue and operating expenses, the operating expense component is likely to be more volatile. It is difficult to predict the weather, which can have a significant effect, and there is growing concern about real estate tax rates.

The Company has anticipated acquisitions in the range of $200 million to $300 million in its budget for 2013. The Company is committed to a disciplined approach to acquisitions, and following two very successful years in acquisitions we will be prudent in underwriting. If cap rates stabilize, interest rates continue to be historically low, and NOI growth rates improve, we may take a more aggressive approach. The Company expects to dispose of between $200 million and $300 million of properties for 2013. After many years of being a net acquirer, for 2013 the Company is looking to create a better balance, with an equal range targeted of acquisitions and dispositions. Property sale proceeds add another significant source of capital, reducing reliance on debt and equity sources.

During 2013, the Company will target leverage in a range from 40% to 42% of debt-to-total market capitalization (calculated using the stock price to estimate equity value) in order to meet the goals described above. This level is the same to slightly less than at the end of 2012.

35 -------------------------------------------------------------------------------- Table of Contents Results of Operations (dollars in thousands, except unit and per unit data) Comparison of year ended December 31, 2012 to year ended December 31, 2011.

The Company owned 107 communities with 36,214 apartment units throughout 2011 and 2012 where comparable operating results are available for the years presented (the "2012 Core Properties"). For the year ended December 31, 2012, the 2012 Core Properties showed an increase in total revenues of 4.5% and a net operating income increase of 8.1% over the 2011 period. Property level operating expenses decreased 1.1%. Average physical occupancy for the 2012 Core Properties was 95.6%, up from 95.5% in 2011, with average monthly rental rates of $1,239 per apartment unit, an increase of 4.2% over the 2011 period.

A summary of the 2012 Core Properties NOI is as follows: 2012 2011 $ Variance % Variance Rent $ 509,476 $ 487,214 $ 22,262 4.6 % Utility recovery revenue 20,471 20,753 (282 ) (1.4 )% Rent including recoveries 529,947 507,967 21,980 4.3 % Other income 24,482 22,355 2,127 9.5 % Total revenue 554,429 530,322 24,107 4.5 % Operating and maintenance (202,819 ) (205,128 ) 2,309 1.1 % Net operating income $ 351,610 $ 325,194 $ 26,416 8.1 % Net operating income ("NOI") may fall within the definition of "non-GAAP financial measure" set forth in Item 10(e) of Regulation S-K and, as a result, the Company may be required to include in this report a statement disclosing the reasons why management believes that presentation of this measure provides useful information to investors. The Company believes that NOI is helpful to investors as a supplemental measure of the operating performance of a real estate company because it is a direct measure of the actual operating results of the Company's apartment communities. In addition, the apartment communities are valued and sold in the market by using a multiple of NOI. The Company also uses this measure to compare its performance to that of its peer group. For a reconciliation of NOI to income from continuing operations, please refer to Note 15 to Consolidated Financial Statements, under Part IV, Item 15 of this Form 10-K.

During 2012, the Company acquired three apartment communities with 2,018 units and placed into service another 263 units at two development communities (the "2012 Acquisition Communities"). In addition, the Company experienced full year results for the eight apartment communities with 2,817 units acquired and 472 units placed into service at two development communities during 2011 (the "2011 Acquisition Communities"). The Company has one property with 851 units undergoing significant renovations beginning in 2011 such that the operating results are not comparable to 2012 due to units being taken out of service during the redevelopment period (the "Redevelopment Property"). The inclusion of these acquired and developed communities generally accounted for the significant changes in operating results for the year ended December 31, 2012.

36 -------------------------------------------------------------------------------- Table of Contents Results of Operations (continued) A summary of the NOI from continuing operations for the Company as a whole is as follows: 2012 2011 $ Variance % Variance Rent $ 591,933 $ 515,780 $ 76,153 14.8 % Utility recovery revenue 23,983 21,865 2,118 9.7 % Rent including recoveries 615,916 537,645 78,271 14.6 % Other income 28,122 23,756 4,366 18.4 % Total revenue 644,038 561,401 82,637 14.7 % Operating and maintenance (235,040 ) (217,069 ) (17,971 ) (8.3 )% Net operating income $ 408,998 $ 344,332 $ 64,666 18.8 % During 2012, the Company disposed of six properties in six transactions with a total of 1,596 units, which had partial results for 2012 and full year results for 2011 (the "2012 Disposed Communities"). The results of these disposed properties have been reflected in discontinued operations and are not included in the tables above.

For the year ended December 31, 2012, income from continuing operations increased by $37,156 when compared to the year ended December 31, 2011. The increase was primarily attributable to the following factors: an increase in rental income of $76,153, an increase in property other income of $6,484, a decrease in interest expense of $1,809, and a decrease in other expenses of $484. These changes were partially offset by increases in operating and maintenance expense of $17,971, general and administrative expense of $5,029, and depreciation and amortization of $24,929. Each of the items are described in more detail below.

Of the $76,153 increase in rental income, $32,721 is attributable to the 2011 Acquisition Communities, $21,043 is attributable to the 2012 Acquisition Communities and $127 is attributable to the Redevelopment Property. The balance, an increase of $22,262, relates to a 4.6% increase from the 2012 Core Properties as the result of a 0.3% increase in economic occupancy from 94.3% to 94.6% and a 4.2% increase in weighted average rental rates from $1,189 to $1,239 per apartment unit.

Of the $2,118 increase in utility recovery revenue, $1,898 is attributable to the 2011 Acquisition Communities, $548 is attributable to the 2012 Acquisition Communities, partially offset by a $46 reduction for the Redevelopment Property. The balance, a decrease of $282, relates to a 1.4% decrease from the 2012 Core Properties which is due primarily to warmer than normal temperatures in 2012 compared to cooler temperatures in the spring of 2011, leading to decreased energy consumption and lower heat billed through to residents, partially offset by increases in water & sewer cost increases, also billed to residents.

The remaining property other income, which consists primarily of income from operation of laundry facilities, late charges, administrative fees, garage and carport rentals, revenue from corporate apartments, cable revenue, pet charges, and miscellaneous charges to residents, increased by $4,366. Of this increase, $1,325 is attributable to the 2011 Acquisition Communities, $927 is attributable to the 2012 Acquisition Communities and $2,127 is attributable to the 2012 Core Properties resulting primarily from an increase of $1,195 in cable revenue as a result of enhanced contracts with cable providers which offer services in addition to the basic cable offering in 2011. The remaining Core Properties increase of $932 primarily relates to a higher level of pet fee income, facility rental income, lower bad debt expense and incentive rebates. These increases were offset by a $13 reduction for the Redevelopment Property.

Of the $17,971 increase in operating and maintenance expenses, $12,905 is attributable to the 2011 Acquisition Communities, $7,499 is attributable to the 2012 Acquisition Communities, partially offset by a $124 decrease for the Redevelopment Property. The balance for the 2012 Core Properties, a $2,309 decrease in operating expenses or 1.1%, is primarily a result of decreases in electricity, natural gas heating costs, repairs & maintenance, personnel expense, snow removal and property management G&A. These decreases were partially offset by increases in water & sewer costs, property insurance and real estate taxes.

37 -------------------------------------------------------------------------------- Table of Contents Results of Operations (continued) The breakdown of operating and maintenance costs for the 2012 Core Properties by line item is listed below: 2012 2011 $ Variance % Variance Electricity $ 7,142 $ 7,720 $ 578 7.5 % Gas 13,465 15,780 2,315 14.7 % Water & sewer 17,000 16,473 (527 ) (3.2 )% Repairs & maintenance 30,450 31,009 559 1.8 % Personnel expense 46,295 47,177 882 1.9 % Advertising 4,373 4,276 (97 ) (2.3 )% Legal & professional 2,002 1,866 (136 ) (7.3 )% Office & telephone 6,042 5,720 (322 ) (5.6 )% Property insurance 6,340 5,024 (1,316 ) (26.2 )% Real estate taxes 51,377 49,677 (1,700 ) (3.4 )% Snow 378 1,537 1,159 75.4 % Trash 3,023 3,078 55 1.8 % Property management G&A 14,932 15,791 859 5.4 % Total $ 202,819 $ 205,128 $ 2,309 1.1 % Electricity costs were down $578, or 7.5%, from a year ago primarily as a result of reduced commodity rates and energy conservation efforts.

Natural gas heating costs were down $2,315, or 14.7%, from a year ago due to a combination of lower commodity rates and decreased consumption resulting from a significantly warmer spring heating season in 2012 as compared to 2011. For 2012, the Company's natural gas weighted average cost, including transportation of $3.00 per decatherm, was $8.34 per decatherm, compared to $8.90 per decatherm for the 2011 period, a 6.3% decrease.

As of the middle of January, 2013, the Company has fixed-price contracts covering 99.5% of its natural gas exposure for the balance of the 2012/2013 heating season. Risk is further diversified by staggering contract term expirations. For the balance of the 2012/2013 heating season, the Company estimates the average price per decatherm will be approximately $5.05, excluding transportation, which has historically approximated $3.00 per decatherm. For the 2013/2014 heating season, the Company has fixed-priced contracts covering approximately 99.1% of its natural gas exposure for an estimated weighted average cost for fixed and floating rate contracts of $4.68 per decatherm, excluding transportation.

Water & sewer costs were up $527, or 3.2%, from a year ago and are attributable to general rate increases being assessed by local municipalities. The water & sewer recovery program enabled the Company to recapture much of these rate increases from our residents.

Repairs & maintenance expenses were down $559, or 1.8%, primarily due to accounting for involuntary conversions related to fires and floods and the associated insurance claims at certain properties. Without the impact of these insurance recoveries, the recurring repairs & maintenance expenses decreased $8, which reflects the diligent efforts of property management to control costs through the renegotiation of service contracts permitted by the competitive economic environment, coupled with a higher level of apartment upgrades in 2012 compared to 2011, which result in lower repairs expenditures. The Company has provided guidance for 2013 which anticipates a 1.3% increase in repairs and maintenance.

Personnel expenses were down $882, or 1.9%, primarily due to $734 lower health and workers' compensation insurance costs in 2012 as compared to 2011, which reflects the ongoing efforts towards the proactive settlement of prior year claims earlier in their life cycle and the positive impacts of the Company's safety in the workplace initiatives. Without the impacts of the insurance savings, personnel costs decreased $148, or 0.3% reflecting the $559 lower incentive compensation for property management personnel, partially offset by the annual wage increase of 2.6%.

38 -------------------------------------------------------------------------------- Table of Contents Results of Operations (continued) Legal & professional expenses were up $136, or 7.3%, primarily due to legal costs incurred in connection with successful tax assessment challenges.

Office & telephone expenses were up $322, or 5.6%, primarily due to $249 non-recurring refunds of certain resident fees from prior years. Without the impact of this non-recurring expense, office & telephone expense increased $73, or 1.3%.

Property insurance costs increased by $1,316, or 26.2%, primarily due to the non-recurring impact in 2011 of $2,082 in favorable close outs of significant prior year general liability claims compared to $338 of close-outs in 2012.

Both property and general liability losses in 2012 were lower by $111, or 7.3%, and $36, or 2.0% respectively, due to continued emphasis on preventing losses at the communities through safety training programs and the Company's continued focus on settling claims earlier in their life cycle. Without the impact of the major items above, recurring property and general liability insurance costs were up $281, or 6.0%.

On October 29, 2012 Hurricane Sandy hit the Mid-Atlantic and Northeast regions of the United States, causing wide-spread flooding and wind damage. Numerous communities owned by the Company were directly affected by this storm. The most severe damage occurred at properties in New Jersey and on Long Island. Property losses, estimated to be $2,225, are covered under various property and flood insurance policies. The Company's estimated net expense included in the 2012 results, after insurance reimbursement, is less than $100.

Real estate taxes were up $1,700, or 3.4%, primarily due to tax increases being offset by $1,306 in refunds received in 2012 from successful tax assessment appeals compared to $1,678 of refunds in the 2011 period. After removing the effects of the non-recurring refunds, real estate taxes were up $1,327, or 2.6%, reflecting increased assessments and typical rate increases in our markets.

Snow removal costs were down $1,159, or 75.4%, as most of our Northeast and Mid-Atlantic properties experienced the mildest winter on record in 2012.

Property management general & administrative costs decreased $859, or 5.4%.

Despite increases in the number of apartment communities and units, the Company has been able to offset costs of growth due to its scalable operating platform, including efficiencies enabled by key application software investments.

The operating expense ratio (the ratio of operating and maintenance expense compared to rental and property other income) for the 2012 Core Properties was 36.6% and 38.7% for 2012 and 2011, respectively. The 2.1% favorable improvement in 2012 is due in part to deliberate cost savings and safety initiatives implemented at the communities, a decrease in natural gas heating costs and rental income growth. In general, the Company's operating expense ratio is higher than that experienced by apartment owners in other parts of the country due to relatively high real estate taxes and heating costs in its markets.

General and administrative expenses ("G&A") increased in 2012 by $5,029, or 17.3%, from $29,145 in 2011 to $34,174 in 2012. G&A as a percentage of total revenues (including discontinued operations) was 5.0% for 2011 as compared to 5.2% for 2012, indicating that the G&A growth is consistent with revenue growth. The 2012 costs include $1,580 in connection with the departure of an executive and represent acceleration of previously granted stock-based compensation as well as future payments for salary continuation. Stock-based compensation expenses were up $3,565, or 42.5%, in 2012, of which $2,937 is due to the new three year performance restricted stock unit grants issued in 2012.

The remaining $628 stock-based compensation increase is primarily due to the impact of executives at, or near retirement age, resulting in the current year restricted stock awards and stock option grants being expensed over a one-year shorter time period in 2012 as compared to 2011. These increases were partially offset by $116 lower 2012 spending in other general and administrative areas.

Interest expense decreased by $1,809, or 1.4%, in 2012 primarily as a result of paying off $39,000 in maturing loans on several Core Properties over the past year and the redemption of the $140,000 Senior Notes. In addition, all 2011 Acquisition Communities were acquired without secured mortgage debt and only one 2012 Acquisition Community with assumed secured mortgage debt of $7,284. These decreases were partially offset by $450,000 of unsecured term and senior notes at a lower average interest rate than the Senior Notes and maturing loans.

39 -------------------------------------------------------------------------------- Table of Contents Results of Operations (continued) Depreciation and amortization expense increased $24,929, or 17.7%, due to a full year of depreciation expense for the 2011 Acquisition Communities, incremental depreciation on the capital expenditures for additions and improvements to the Core Properties of $129,045 and $113,779 in 2012 and 2011, respectively, as well as a partial year of depreciation expense for the 2012 Acquisition Communities.

Other expenses of $2,741 in 2012 and $3,225 in 2011 are property acquisition costs from the Acquisition Communities. These costs, which are primarily transfer taxes and title fees, represent 0.92% and 0.64% of the total purchase price of the 2012 and 2011 Acquisition Communities, respectively.

Net income increased $115,958 in 2012 primarily due to a gain on disposition of property of $80,532, an increase of $37,156 due to a partial year impact of the operating results of the 2012 Acquisition Communities and the full year results of the 2011 Acquisition Communities plus improved operating results from the 2012 Core Properties. This is partially offset by $1,730 lower income from discontinued operation in 2012 compared to 2011.

Comparison of year ended December 31, 2011 to year ended December 31, 2010.

The Company owned 97 communities with 33,354 apartment units throughout 2010 and 2011 where comparable operating results are available for the years presented (the "2011 Core Properties"). For the year ended December 31, 2011, the 2011 Core Properties showed an increase in total revenues of 4.3% and a net operating income increase of 7.7% over the 2010 period. Property level operating expenses decreased 0.7%. Average physical occupancy for the 2011 Core Properties was 95.5%, up from 95.2% in 2010, with average monthly rental rates of $1,184 per apartment unit, an increase of 3.7% over the 2010 period.

A summary of the 2011 Core Properties NOI is as follows: 2011 2010 $ Variance % Variance Rent $ 446,628 $ 428,955 $ 17,673 4.1 % Utility recovery revenue 20,090 18,803 1,287 6.8 % Rent including recoveries 466,718 447,758 18,960 4.2 % Other income 20,832 19,875 957 4.8 % Total revenue 487,550 467,633 19,917 4.3 % Operating and maintenance (189,311 ) (190,610 ) 1,298 0.7 % Net operating income $ 298,239 $ 277,024 $ 21,215 7.7 % The inclusion of the 2011 Acquisition Communities generally accounted for the significant changes in operating results for the year ended December 31, 2011.

A summary of the NOI from continuing operations for the Company as a whole is as follows: 2011 2010 $ Variance % Variance Rent $ 515,780 $ 457,819 $ 57,961 12.7 % Utility recovery revenue 21,865 19,775 2,090 10.6 % Rent including recoveries 537,645 477,594 60,051 12.6 % Other income 23,756 21,089 2,667 12.6 % Total revenue 561,401 498,683 62,718 12.6 % Operating and maintenance (217,069 ) (203,421 ) (13,648 ) (6.7 )% Net operating income $ 344,332 $ 295,262 $ 49,070 16.6 % 40 -------------------------------------------------------------------------------- Table of Contents Results of Operations (continued) During 2010, the Company sold its general partnership interest in one investment where the Company was the managing general partner that had been determined to be a Variable Interest Entity ("VIE") as defined by authoritative guidance.

During 2012, the Company disposed of six properties in six transactions with a total of 1,596 units, which had full year results for 2011 and 2010 (the "2012 Disposed Communities"). The results of these disposed properties and general partnership interest have been reflected in discontinued operations and are not included in the tables above.

For the year ended December 31, 2011, income from continuing operations increased by $19,851 when compared to the year ended December 31, 2010. The increase was primarily attributable to the following factors: an increase in rental income of $57,961, and an increase in property other income of $4,757.

These changes were partially offset by increases in operating and maintenance expense of $13,648, general and administrative expense of $4,007, interest expense of $6,966, depreciation and amortization of $17,941 and other expenses of $354. Each of the items are described in more detail below.

Of the $57,961 increase in rental income, $26,311 is attributable to the 2010 Acquisition Communities, $14,871 is attributable to the 2011 Acquisition Communities, partially offset by an $894 reduction for the Redevelopment Property. The balance, an increase of $17,673, relates to a 4.1% increase from the 2011 Core Properties as the result of a 0.4% increase in economic occupancy from 93.9% to 94.3% and a 3.7% increase in weighted average rental rates from $1,141 to $1,184 per apartment unit.

Of the $2,090 increase in utility recovery revenue, $505 is attributable to the 2010 Acquisition Communities, $563 is attributable to the 2011 Acquisition Communities, partially offset by a $265 reduction for the Redevelopment Property. The balance, an increase of $1,287, relates to a 6.8% increase from the 2011 Core Properties as the result of the increase in economic occupancy and comparable increase in water and sewer expense.

The remaining property other income, which consists primarily of income from operation of laundry facilities, late charges, administrative fees, garage and carport rentals, revenue from corporate apartments, cable revenue, pet charges, and miscellaneous charges to residents, increased by $2,667. Of this increase, $1,019 is attributable to the 2010 Acquisition Communities, $663 is attributable to the 2011 Acquisition Communities and $28 for the Redevelopment Property and $957 is attributable to the 2011 Core Properties.

Of the $13,648 increase in operating and maintenance expenses, $9,543 is attributable to the 2010 Acquisition Communities, $6,052 is attributable to the 2011 Acquisition Communities, partially offset by a $649 decrease for the Redevelopment Property. The balance for the 2011 Core Properties, a $1,298 decrease in operating expenses or 0.7%, is primarily a result of decreases in electricity, natural gas heating costs, personnel expense, property insurance, snow removal and trash hauling. These decreases were partially offset by increases in water & sewer costs, repairs & maintenance, legal & professional, real estate taxes and property management G&A.

41 -------------------------------------------------------------------------------- Table of Contents Results of Operations (continued) The breakdown of operating and maintenance costs for the 2011 Core Properties by line item is listed below: 2011 2010 $ Variance % Variance Electricity $ 7,033 $ 7,222 $ 189 2.6 % Gas 15,239 15,637 398 2.5 % Water & sewer 15,560 14,522 (1,038 ) (7.1 )% Repairs & maintenance 28,778 27,176 (1,602 ) (5.9 )% Personnel expense 42,986 44,285 1,299 2.9 % Advertising 3,738 3,797 59 1.6 % Legal & professional 1,753 1,515 (238 ) (15.7 )% Office & telephone 5,242 5,364 122 2.3 % Property insurance 4,158 5,924 1,766 29.8 % Real estate taxes 45,907 45,592 (315 ) (0.7 )% Snow 1,447 2,045 598 29.2 % Trash 2,868 3,128 260 8.3 % Property management G&A 14,602 14,403 (199 ) (1.4 )% Total $ 189,311 $ 190,610 $ 1,299 0.7 % Electricity costs were down $189, or 2.6% from a year ago primarily as a result of energy conservation efforts including a compact fluorescent bulb replacement program and the installation of motion sensors and timers in common areas.

Natural gas heating costs were down $398, or 2.5% from a year ago due to a combination of lower commodity rates offset by increased consumption resulting from a colder spring heating season in 2011 as compared to 2010. For 2011, the Company's natural gas weighted average cost, including transportation of $3.00 per decatherm, was $8.91 per decatherm, compared to $9.37 per decatherm for the 2010 period, a 4.9% decrease.

Water & sewer costs were up $1,038, or 7.1%, from a year ago and are attributable to general rate increases being assessed by local municipalities.

The water & sewer recovery program enabled the Company to recapture much of these rate increases from our residents.

Repairs & maintenance expenses were up $1,602, or 5.9%, primarily due to insurance claim recoveries of $782 in 2010 compared to insurance claim expenses of $248 in 2011. Without the impacts of these insurance claim recoveries and expenses, the recurring repairs & maintenance costs increased $572, or 2.0% from a year ago. The increase reflects normal increases in supplies and contract services partially offset by the favorable impact of lower resident turnover of 38.1% in 2011 as compared to 38.7% in 2010, which resulted in less spending on apartment turnover costs.

Personnel expenses were down $1,299, or 2.9%, primarily due to a reduction in workers' compensation costs which reflects the ongoing efforts towards the proactive settlement of prior year claims earlier in their life cycle and the positive impacts of the Company's safety in the workplace initiatives.

42 -------------------------------------------------------------------------------- Table of Contents Results of Operations (continued) Advertising expenses were down $59, or 1.6%, in 2011 and is reflective of the resident marketing program which places less emphasis and spending on print media and more focus on internet-based methods and resident programs which have resulted in a 1% increase in traffic in 2011 as compared to 2010.

Legal & professional expenses were up $238, or 15.7%, primarily due to legal costs incurred in connection with successful tax assessment challenges.

Property insurance costs decreased by $1,766, or 29.8%, primarily due to positive trends in general liability claims, which are reflective of the increased emphasis on preventing losses at the communities through safety training programs and the Company's continued focus on settling claims earlier in their life cycle.

Real estate taxes were up $315, or 0.7%, primarily due to tax increases being offset by $1,678 in refunds received in 2011 from successful tax assessment appeals compared to $737 in the 2010 period. After removing the effects of the non-recurring refunds, real estate taxes were up $1,256, or 2.7%.

Snow removal costs were down $598, or 29.2%, as most of our Mid-Atlantic region properties suffered from record storms in the first quarter 2010 which were not repeated in 2011.

Trash removal costs were down $260, or 8.3%, as a result of effective rebidding with trash haulers that took effect in late 2010.

Property management general & administrative costs increased $199, or 1.4%, which reflects annual wage increases of 2.4% that were partially offset by staff reductions as a result of efficiencies enabled through key application software investments.

The operating expense ratio (the ratio of operating and maintenance expense compared to rental and property other income) for the 2011 Core Properties was 38.7% and 40.8% for 2011 and 2010, respectively. The 2.1% favorable improvement in 2011 is due in part to deliberate cost savings and safety initiatives implemented at the communities which resulted in lower insurance costs coupled with rental income growth. In general, the Company's operating expense ratio is higher than that experienced by apartment owners in other parts of the country due to relatively high real estate taxes and heating costs in its markets.

General and administrative expenses ("G&A") increased in 2011 by $4,007, or 15.9%, from $25,138 in 2010 to $29,145 in 2011. G&A as a percentage of total revenues (including discontinued operations) was 4.9% for 2010 as compared to 5.0% for 2011, indicating that the G&A growth is consistent with revenue growth. The 2011 incentive bonus is up $1,791, or 68.7%, as compared to 2010, reflecting the Company's favorable operating performance versus its peers.

Stock based compensation expenses were up $1,813 in 2011 as compared to 2010, primarily due to the impact of employees nearing retirement age vesting over one less year in 2011 as compared to 2010. These increases were partially offset by $400 savings realized in 2011 for director costs as we had four fewer directors beginning in May 2011 due to retirement.

Interest expense increased by $6,966, or 5.8%, in 2011 primarily as a result of interest expense on the new debt of several 2011 Core Properties, which were refinanced during 2010 at approximately $200,000 higher principal than the maturing loans and full year impact of 2010 Acquisition Communities which included $156,000 of assumed debt. All 2011 Acquisition Communities were acquired without secured mortgage debt. These increases were partially offset by lower interest on the unsecured line of credit due to a lower outstanding balance and a lower interest rate in 2011 compared to 2010 and an overall savings in 2011 from the redemption of the Exchangeable Senior Notes and the subsequent unsecured term loan and unsecured senior notes at a lower average interest rate.

Depreciation and amortization expense increased $17,941, or 14.6%, due to a full year of depreciation expense for the 2010 Acquisition Communities, incremental depreciation on the capital expenditures for additions and improvements to the Core Properties of $98,420 and $83,245 in 2011 and 2010, respectively, as well as a partial year of depreciation expense for the 2011 Acquisition Communities.

43 -------------------------------------------------------------------------------- Table of Contents Results of Operations (continued) Other expenses of $3,225 in 2011 and $2,871 in 2010 are property acquisition costs from the Acquisition Communities. These costs, which are primarily transfer taxes and title fees, represent 0.64% and 0.85% of the total purchase price of the 2011 and 2010 Acquisition Communities, respectively.

Included in discontinued operations for 2011 are the operating results of the 2012 Disposed Communities. Included in discontinued operations for 2010 are the operating results of the 2012 Disposed Communities and the VIE. For purposes of the discontinued operations presentation, the Company includes interest expense and losses from early extinguishment of debt associated with specific mortgage indebtedness of the properties that are sold or held for sale.

Included in the $13 loss on disposition of property reported for 2010 are residual items relating to the 2009 Disposed Communities.

Net income increased $21,346 in 2011 primarily due to a partial year impact of the operating results of 2011 Acquisition Communities and the full year results of the 2010 Acquisition Communities plus improved operating results from the 2011 Core Properties.

Liquidity and Capital Resources General The Company's principal liquidity demands are expected to be distributions to the common stockholders and holders of UPREIT Units, capital improvements and repairs and maintenance for its properties, acquisition and development of additional properties and debt repayments. The Company may also acquire equity ownership in other public or private companies that own and manage portfolios of apartment communities.

The Company intends to meet its short-term liquidity requirements through net cash flows provided by operating activities and its existing bank line of credit, described below. The Company considers its ability to generate cash to be adequate to meet all operating requirements, including availability to pay dividends to its stockholders and make distributions to its Unit holders in accordance with the provisions of the Internal Revenue Code, as amended, applicable to REITs.

To the extent that the Company does not satisfy its short-term liquidity requirements through net cash flows provided by operating activities and its existing bank line of credit, it intends to satisfy such requirements through proceeds from the sale of properties, from the issuance of unsecured senior notes and from the issuance of its common stock through its equity offering programs, described below.

In 2000, the Company obtained an investment grade rating from Fitch, Inc. The rating in effect at December 31, 2012 is a corporate credit rating of "BBB" (Triple B), which was reaffirmed on June 27, 2012.

For 2013, plans include increasing the level of the value of unencumbered properties to over 40% of the portfolio, maintaining the debt-to-total market capitalization ratio at a level equal to or slightly less than the level at December 31, 2012 and issuing shares under the current or future ATM programs.

Cash Flow Summary The Company's cash flow activities are summarized as follows (in millions): Year Ended December 31, 2012 2011 2010 Net cash provided by operating activities $ 268 $ 198 $ 160 Net cash used in investing activities (366 ) (664 ) (335 ) Net cash provided by financing activities 111 464 176 44 -------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources (continued) The Company's net cash flow from operating activities was $268 million in 2012 compared to $198 million in 2011. The $70 million increase was primarily a result of $65 million higher NOI in 2012 partially offset by $5 million higher general and administrative costs in 2012 as compared to 2011, with the increases primarily attributable to the 2012 and 2011 Acquisition Communities.

The Company's net cash flow from operating activities was $198 million in 2011 compared to $160 million in 2010. The $38 million increase was primarily a result of $49 million higher NOI in 2011 partially offset by $6 million higher interest expense and $4 million higher general and administrative costs in 2011 as compared to 2010, with the increases primarily attributable to the 2011 and 2010 Acquisition Communities.

Cash used in investing activities was $366 million during 2012 compared to $664 million in 2011. The $298 million decrease in investing between periods is primarily due to the $290 million used for acquisition of three properties in 2012 as compared to $499 million for the eight properties acquired in 2011.

Cash outflows for capital improvements were $153 million in 2012 compared to $127 million in 2011. In addition, the Company spent $12 million on redevelopment in 2012. The investments in both periods reflects management's strategy to continually reposition and perform selective rehabilitation in markets that are able to support rent increases, with the year-over-year increase reflective of the demand in the market for upgraded apartments. Cash outflows for additions to construction in progress were $62 million in 2012 as compared to $32 million in 2011. Cash outflows for the purchase of land for development was $13 million in 2011.

Cash used in investing activities was $335 million in 2010. Cash outflows for acquisitions were $186 million, capital improvements were $98 million and additions to construction in progress were $46 million in 2010.

Net cash provided by financing activities totaled $111 million for 2012, primarily as a result of net proceeds from the unsecured line of credit of $160 million, the sale of common stock under the ATM offering of $145 million, $50 million issued in unsecured notes and proceeds from stock option exercises of $17 million. Total proceeds were partially offset by payments on mortgages of $103 million and distributions paid to stockholders and UPREIT Unitholders of $159 million.

Net cash provided by financing activities totaled $464 million for 2011, primarily as a result of the $400 million issuance of unsecured notes, the sale of common stock under the public offering of $337 million and the ATM offering of $190 million and proceeds from stock option exercises of $21 million being partially offset by payments on mortgages of $163 million, distributions paid to stockholders and UPREIT Unitholders of $131 million, repurchase of senior notes of $130 million, net payments under the unsecured line of credit of $54 million and payments of $5 million for mortgage borrowing costs.

Net cash provided by financing activities totaled $176 million in 2010. Cash flows from the sale of common stock under the ATM offering of $108 million, net proceeds from mortgage financing of $172 million, proceeds from stock option exercises of $11 million and net borrowing under the unsecured line of credit of $3 million were partially offset by distributions paid to stockholders and UPREIT Unitholders of $112 million and payments of $6 million for mortgage borrowing costs.

Unsecured Line of Credit As of December 31, 2012, the Company had a $275 million unsecured line of credit agreement with M&T Bank and U.S. Bank National Association, as joint lead banks, and nine other participating commercial banks, with an initial maturity date of December 8, 2015 and a one-year extension, at the Company's option. The Company had $162.5 million outstanding under the credit facility on December 31, 2012.

The line of credit agreement provides the ability to issue up to $20 million in letters of credit. While the issuance of letters of credit does not increase the borrowings outstanding under the line of credit, it does reduce the amount available. At December 31, 2012, the Company had outstanding letters of credit of $16.4 million resulting in the amount available on the credit facility of $96.1 million. Borrowings under the line of credit bear interest at a variable rate based on LIBOR, plus a spread from 1.00% to 2.00% based on the Company's leverage ratio. As of December 31, 2012, based on the Company's leverage ratio, the LIBOR margin was 1.30%, and the one-month LIBOR was 0.25%; resulting in an effective rate of 1.55% for the Company.

45 -------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources (continued) Unsecured Term Loans On October 28, 2011, the Company entered into an unsecured term loan agreement with M&T Bank that had a total limit of $140 million. On November 1, 2011, the Company borrowed $135 million on this facility which was used to fund the repurchase of the exchangeable senior notes. The term loan was repaid on December 9, 2011 with proceeds of the $250 million term loan described below.

The loan bore interest at 2.41% (2.1% above the one-month LIBOR) and had covenants that aligned with the unsecured line of credit facility.

On December 9, 2011, the Company entered into a $250 million five-year unsecured term loan with M&T Bank as lead bank, and ten other participating lenders. The term loan generated net proceeds of $248 million, after fees and closing costs, which were used to pay off the $135 million unsecured term loan, purchase an unencumbered property and acquire land for future development. The loan bears monthly interest at a variable rate based on LIBOR, plus a spread from 1.00% to 2.00% based on the Company's leverage ratio. On July 19, 2012, the Company entered into interest rate swap agreements with major financial institutions that effectively convert the variable LIBOR portion of this loan to a fixed rate of 0.685%. As of December 31, 2012, based on the Company's leverage ratio, the spread was 1.30%, and the swapped one-month LIBOR was 0.685%; resulting in an effective rate of 1.99% for the Company, as described in Note 11 to Consolidated Financial Statements. The loan has covenants that align with the unsecured line of credit facility.

Unsecured Demand Note On June 27, 2012, the Company entered into a loan agreement with M&T Bank with a maximum principal amount of $100 million and monthly interest at a variable rate based on LIBOR, plus a spread from 1.00% to 2.00% based on the Company's leverage ratio. The Company borrowed the maximum amount of $100 million.

Proceeds from this demand note were utilized to partially fund the purchase of a 1,350 unit apartment community on June 28, 2012. During the fourth quarter, 2012, the Company repaid the $100 million note in full.

Unsecured Senior Notes On December 19, 2011, the Company issued $150 million of unsecured senior notes. The notes were offered in a private placement in two series: Series A: $90 million with a seven-year term due December 19, 2018 at a fixed interest rate of 4.46% ("Series A"); and, Series B: $60 million with a ten-year term due December 19, 2021 at a fixed interest rate of 5.00% ("Series B"). The net proceeds of $89 million and $60 million for Series A and Series B, respectively, after fees and closing costs, were used to purchase an unencumbered property and pay off a maturing mortgage note. The notes require semiannual interest payments on June 19 and December 19 of each year until maturity and are subject to various covenants and maintenance of certain financial ratios. Although the covenants of the notes do not duplicate all the covenants of the unsecured line of credit facility, any covenants applicable to both the notes and the line are identical.

On June 27, 2012, the Company issued a private placement note in the amount of $50 million with a seven-year term, a fixed rate of 4.16% and a June 27, 2019 due date. The proceeds from this note were used to partially fund the purchase of a 1,350 unit apartment community on June 28, 2012. The note requires semiannual interest payments on June 27 and December 27 of each year until maturity and is subject to various covenants and maintenance of certain financial ratios. Although the covenants of the note do not duplicate all the covenants of the unsecured line of credit facility, any covenants applicable to both the note and the line are identical.

Exchangeable Senior Notes On November 1, 2011, the Company repurchased at face value $135 million principal amount of exchangeable senior notes ("Senior Notes"), plus accrued interest of $2.8 million, that were presented by the holders for repurchase in accordance with the October 2006 Senior Notes Indenture Agreement (the "Indenture"). On December 21, 2011 the remaining outstanding balance of $5 million principal amount of the Senior Notes was repurchased by the Company, at face value plus accrued interest at the Company's option in accordance with the Indenture. There were no outstanding Senior Notes as of December 31, 2012 or 2011.

46 -------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources (continued) Indebtedness As of December 31, 2012, the weighted average interest rate on the Company's total indebtedness of $2.8 billion was 4.55% with staggered maturities averaging approximately five years. Approximately 87% of total indebtedness is at fixed rates. This limits the exposure to changes in interest rates, minimizing the effect of interest rate fluctuations on the Company's results of operations and cash flows.

Unencumbered Assets The Company increased the percentage of unencumbered assets of the total property pool from 33% at the end of 2011, to 39% as of December 31, 2012.

Higher levels of unsecured assets add borrowing flexibility because more capacity is available for unsecured debt under the terms of the Company's unsecured line of credit agreement, and/or for the issuance of additional unsecured senior notes. It also permits the Company to place secured financing on unencumbered assets if desired.

UPREIT Units The Company believes that the issuance of UPREIT Units for property acquisitions will continue to be a potential source of capital for the Company. During 2010, the Company issued $4.8 million in 98,728 UPREIT Units as consideration for one acquired property. During 2011 and 2012, there were no UPREIT Units issued for property acquisitions.

Universal Shelf Registration On March 3, 2010, the Company filed a Form S-3 universal shelf registration statement with the SEC that registers the issuance, from time to time, of common stock, preferred stock or debt securities. The Company may offer and sell securities issued pursuant to the universal shelf registration statement after a prospectus supplement, describing the type of security and amount being offered, is filed with the SEC. Sales of common stock under the Company's ATM and public equity offerings as described below were made under this registration statement. A new Form S-3 universal shelf registration statement is expected to be filed, and immediately effective, with the SEC shortly before the expiration of the current registration statement on March 2, 2013.

At-the-Market Equity Offering Programs On December 3, 2009, the Company initiated an "At-the-Market" ("ATM") equity offering program through which it was authorized to sell up to 3.7 million shares of common stock (not to exceed $150 million of gross proceeds), from time to time in ATM offerings or negotiated transactions. From December 2009 through completion of the offering in May 2010, the Company issued 3.2 million shares of common stock at an average price per share of $47.19, for aggregate gross proceeds of $150 million and aggregate net proceeds of $147 million after deducting commissions and other transaction costs of approximately $3 million.

On September 17, 2010, the Company initiated its second ATM equity offering program through which it was authorized to sell up to 3.6 million shares of common stock from time to time in ATM offerings or negotiated transactions.

There were no shares issued from this program during 2010. During 2011 through completion of the offering in May 2012, the Company issued 3.6 million shares of common stock at an average price per share of $60.71, for aggregate gross proceeds of $219 million and aggregate net proceeds of $214 million after deducting commissions and other transaction costs of approximately $5 million.

On May 14, 2012, the Company filed a prospectus supplement with respect to another ATM equity offering program, with similar terms and conditions as the September 2010 program, through which it is authorized to sell up to 4.4 million shares of common stock, from time to time in ATM offerings or negotiated transactions. As of December 31, 2012, the Company issued 1,970,824 shares of common stock at an average price per share of $62.64, for aggregate gross proceeds of $123 million and aggregate net proceeds of $121 million after deducting commissions and other transaction costs of approximately $2 million.

Approximately 2.4 million shares remain available under this program as of December 31, 2012.

47 -------------------------------------------------------------------------------- Table of Contents Liquidity and Capital Resources (continued) At-the-Market Equity Offering Programs (continued) The Company used the net proceeds from the ATM offerings primarily for general corporate purposes including acquisitions, development and redevelopment of apartment communities.

Public Equity Offering On September 20, 2011, the Company publicly offered 6 million shares of its common stock at a price of $58.50 per share, for net proceeds of approximately $337 million after underwriting discounts, commissions and offering expenses.

All of the 6 million shares offered were purchased and subsequently delivered on September 23, 2011. The Company used the net proceeds from the offering primarily for acquisitions, development and redevelopment of apartment communities.

Dividend Reinvestment and Direct Stock Purchase Plan ("DRIP") The Company's DRIP provides the stockholders of the Company an opportunity to automatically invest their cash dividends in additional shares of common stock.

In addition, eligible participants may make monthly payments or other voluntary cash investments in shares of common stock. The maximum monthly investment permitted without prior Company approval is currently $10,000. The Company can meet share demand under the DRIP through stock repurchases by the transfer agent in the open market on the Company's behalf or new stock issuances. Management monitors the relationship between the Company's stock price and its estimated net asset value ("NAV"). During times when the difference between these two values is small, resulting in little dilution of NAV by common stock issuances, the Company can choose to issue new shares. At times when the gap between NAV and stock price is greater, the Company has the flexibility to satisfy the demand for DRIP shares with stock repurchased by the transfer agent in the open market. In addition, the Company can issue waivers to DRIP participants to provide for investments in excess of the $10,000 maximum monthly investment. No such waivers were granted during 2011 or 2012.

Stock Repurchase Program In 1997, the Board approved a stock repurchase program under which the Company may repurchase shares of its common stock or UPREIT Units ("Company Program").

The shares and units may be repurchased through open market or privately negotiated transactions at the discretion of Company management. The Board's action did not establish a target stock price or a specific timetable for repurchase. There were no repurchases under the Company Program during 2012 and 2011. The remaining authorization level as of December 31, 2012 is 2.3 million shares. The Company will continue to monitor stock prices relative to the NAV to determine the current best use of capital among our major uses of capital: stock buybacks, debt paydown to increase the unencumbered pool, acquisitions, rehabilitation and/or redevelopment of owned properties and development of new properties.

48 -------------------------------------------------------------------------------- Table of Contents Critical Accounting Policies The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions in certain circumstances that affect amounts reported in the accompanying consolidated financial statements and related notes. In preparing these financial statements, management has utilized information available including industry practice and its own past history in forming its estimates and judgments of certain amounts included in the financial statements, giving due consideration to materiality. It is possible that the ultimate outcome as anticipated by management in formulating its estimates inherent in these financial statements may not materialize. Application of the accounting policies involves the exercise of judgment and use of assumptions as to future uncertainties and, as a result, actual results could differ from these estimates. In addition, other companies may utilize different estimates which may impact comparability of the Company's financial position and results of operations to those of companies in similar businesses.

The Company's significant accounting policies are described in Notes 2 and 3 to Consolidated Financial Statements. These policies were followed in preparing the Consolidated Financial Statements for the year ended December 31, 2012 and are consistent with the year ended December 31, 2011.

The Company has identified the following 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.

Acquisition of Investments in Real Estate The Company accounts for its acquisitions of investments in real estate in accordance with the authoritative guidance for the initial measurement, which requires the assets and liabilities acquired to be recognized using fair value.

Typical assets and liabilities acquired include land, building, and personal property and identified intangible assets and liabilities, consisting of the value of above-market and below-market leases, value of in-place leases and value of resident relationships, based in each case on their fair values. In making estimates of fair value for purposes of the initial accounting of the purchased real estate, the Company utilizes a number of sources, including 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 fair value of the tangible and intangible assets acquired.

Cost Capitalization The Company capitalizes the payroll and associated costs of employees directly responsible for the supervision and construction of major capital and rehabilitation projects. These costs are reflected on the balance sheet as an increase to depreciable property.

For development properties, the Company uses its professional judgment in determining whether such costs meet the criteria for capitalization or must be expensed as incurred. Costs directly related to the development of properties are capitalized. The Company capitalizes interest, real estate taxes and insurance; and payroll and associated costs for those individuals directly responsible for and who spend all their time on development activities.

Determination of when a development project commences and capitalization begins, and when a development project is substantially complete and capitalization must end involves a degree of judgment. We begin the capitalization of costs during the pre-construction period which we define as activities that are necessary to the development of the property. We consider a development property as substantially complete after major construction has ended and the property is available for occupancy. For properties that are built in phases, we end capitalization on the portion of a property that is considered substantially complete, and we capitalize only those costs associated with the portion under construction. These costs are reflected on the balance sheet as construction in progress.

49 -------------------------------------------------------------------------------- Table of Contents Critical Accounting Policies (continued) Depreciation of Investments in Real Estate The Company depreciates the building component of its investment in real estate over a 40-year estimated useful life, building improvements over a 3-year to 20-year estimated useful life and the furniture, fixtures and equipment over a 5-year to 10-year estimated useful life, all of which are judgmental determinations. These assessments have a direct impact on the Company's net income.

Impairment of Long-Lived Assets Management reviews its long-lived assets used in operations for impairment when, in accordance with the authoritative guidance for the accounting for the impairment or disposal of long-lived assets, there is an event or change in circumstances that indicates an impairment in value. 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 could cause the Company to conclude that impairment indicators exist and an impairment charge is warranted.

Fair Value of Financial Instruments Not Carried at Fair Value For purposes of disclosure, the Company calculates the fair value of its mortgage notes payable, unsecured term loan, unsecured senior notes and unsecured line of credit facility using a discounted future cash flow technique that incorporates observable market-based inputs, including a market interest yield curve with adjustments for duration, loan to value, and risk profile. As the valuation of financial instruments requires the Company to make estimates and judgments in the calculation of the fair value of these instruments, the actual fair value of these financial instruments for disclosure purposes may differ materially if these estimates do not prove to be accurate.

Fair Value of Financial Instruments Carried at Fair Value The fair value of interest rate swaps are determined using the market standard of netting the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts). The variable cash payments (or receipts) are based on an expectation of future interest rate forward curves derived from observable market interest rate curves. The Company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty's nonperformance risk in the fair value measurements. As the valuation of financial instruments requires the Company to make estimates and judgments in the calculation of the fair value of these instruments, the actual fair value of the interest rate swaps may differ materially if these estimates do not prove to be accurate.

Derivative Instruments and Hedging Activities Derivative instruments and hedging activities require the Company to make judgments on the nature of its derivatives and their effectiveness as hedges.

These judgments determine if the changes in fair value of the derivative instruments are reported as a component of net income or as comprehensive income and equity. While the Company believes its judgments are reasonable, a change in a derivative's effectiveness as a hedge could materially affect expenses, net income and equity.

Recent Accounting Pronouncements There were no new accounting pronouncements issued or effective during the fiscal year which have had or are expected to have a material impact on the Consolidated Financial Statements. See Note 3 to the Consolidated Financial Statements for further detail on applicable accounting pronouncements that were adopted in 2012 or will be effective for 2013.

50 -------------------------------------------------------------------------------- Table of Contents Derivative Instruments and Hedging Activities The Company follows authoritative guidance for disclosure requirements for derivatives and hedging activities with the intent to provide users of financial statements with an enhanced understanding of: (a) how and why an entity uses derivative instruments, (b) how the entity accounts for derivative instruments and related hedged items, and (c) how derivative instruments and related hedged items affect an entity's financial position, financial performance, and cash flows. Further, qualitative disclosures are required that explain the Company's objectives and strategies for using derivatives, as well as quantitative disclosures about the fair value of and gains and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative instruments.

The Company records all derivatives on the balance sheet at fair value. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative, whether the Company has elected to designate a derivative in a hedging relationship and apply hedge accounting and whether the hedging relationship has satisfied the criteria necessary to apply hedge accounting.

Derivatives designated and qualifying as a hedge of the exposure to changes in the fair value of an asset, liability, or firm commitment attributable to a particular risk, such as interest rate risk, are considered fair value hedges.

Derivatives designated and qualifying as a hedge of the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges. Hedge accounting generally provides for the matching of the timing of gain or loss recognition on the hedging instrument with the recognition of the changes in the fair value of the hedged asset or liability that are attributable to the hedged risk in a fair value hedge or the earnings effect of the hedged forecasted transactions in a cash flow hedge. The Company may enter into derivative contracts that are intended to economically hedge certain of its risks, even though hedge accounting does not apply or the Company elects not to apply hedge accounting.

Contractual Obligations and Other Commitments The primary obligations of the Company relate to its borrowings under the unsecured line of credit, unsecured notes and mortgage notes. The Company's line of credit matures in December 2015 (not including a one-year extension, at the option of the Company), and had $162.5 million in loans and letters of credit totaling $16.4 million, outstanding at December 31, 2012. The $450 million in unsecured notes have maturities ranging from four to nine years. The $2.2 billion in mortgage notes have varying maturities ranging from two months to eighteen years. The principal and interest payments on the borrowings for the years subsequent to December 31, 2012, are set forth in the table below.

51 -------------------------------------------------------------------------------- Table of Contents Contractual Obligations and Other Commitments (continued) The Company leases its corporate office space from a former affiliate and the office space for its regional offices from non-affiliated third parties. The rent for the corporate office space is a gross rent that includes real estate taxes and common area maintenance. The regional office leases are net leases which require an annual base rent plus a pro-rata portion of real estate taxes.

These leases are set forth in the table below as "Operating leases." Purchase obligations represent those costs that the Company is contractually obligated to pay in the future. The significant components of this caption are costs for capital improvements at the Company's properties, as well as costs for normal operating and maintenance expenses at the site level that are tied to contracts such as utilities, landscaping and grounds maintenance and advertising. The purchase obligations include amounts tied to contracts, some of which expire in 2013. It is the Company's intention to renew these normal operating contracts, however, there has been no attempt to estimate the length or future costs of these contracts.

Tabular Disclosure of Contractual Obligations: Payments Due by Period (in thousands) Contractual Obligations (1) Total 2013 2014 2015 2016 2017 Thereafter Mortgage notes, principal (2) $ 2,165,027 $ 224,607 $ 106,377 $ 276,400 $ 345,791 $ 276,684 $ 935,168 Mortgage notes, interest (3) 492,045 103,870 93,613 85,507 63,690 53,878 91,487 Unsecured notes, principal (2) 450,000 - - - 250,000 - 200,000 Unsecured notes, interest (3) (5) 84,141 14,125 14,125 14,125 13,795 9,094 18,877 Line of credit, principal (2) (4) 162,500 - - 162,500 - - - Line of credit, interest (3) 7,398 2,519 2,519 2,360 - - - Operating leases 7,459 1,860 1,840 1,844 1,621 294 - Purchase obligations 4,778 4,574 105 66 33 - - Total $ 3,373,348 $ 351,555 $ 218,579 $ 542,802 $ 674,930 $ 339,950 $ 1,245,532 -------------------------------------------------------------------------------- (1) The contractual obligations and other commitments in the table are set forth as required by Item 303(a)(5) of Regulation S-K promulgated by the SEC in January of 2003 and are not prepared in accordance with generally-accepted accounting principles.

(2) Amounts include principal payments only. The Company will pay interest on outstanding indebtedness based on the rates and terms summarized in Note 6, 7 and 9 to Consolidated Financial Statements.

(3) Amounts include interest expected to be incurred on the Company's secured and unsecured debt based on obligations outstanding at December 31, 2012. For floating rate debt, the current rate in effect for the most recent payment through December 31, 2012 is assumed to be in effect through the respective maturity date of each instrument.

(4) The payment in 2015 reflects the line of credit agreement as described in Note 9 to Consolidated Financial Statements, and does not include the one-year extension at the Company's option.

(5) For $250,000 unsecured notes subject to interest rate swaps, the swapped rates are assumed as more fully described in Note 11 to Consolidated Financial Statements.

The Company has a secondary guarantee through 2015 on certain low income housing tax credits to limited partners in a partnership in which it previously was a general partner totaling approximately $3 million. With respect to the guarantee of the low income housing tax credits, the new unrelated general partner assumed operating deficit guarantee and primary tax credit guarantee positions, as more fully described in Note 17 to Consolidated Financial Statements. The Company believes the property's operations conform to the applicable requirements and does not anticipate any payment on the guarantee; therefore, the secondary guarantee is excluded from the table above.

52 -------------------------------------------------------------------------------- Table of Contents Off-Balance Sheet Arrangements As of December 31, 2012, the Company did not have any off-balance sheet transactions, arrangements, or obligations, including contingent obligations, other than those disclosed under contractual obligations.

Contingencies The Company is not a party to any legal proceedings which are expected to have a material adverse effect on the Company's liquidity, financial position or results of operations. The Company is subject to a variety of legal actions for personal injury or property damage arising in the ordinary course of its business, most of which are covered by liability and property insurance.

Various claims of employment and resident discrimination are also periodically brought, most of which also are covered by insurance. While the resolution of these matters cannot be predicted with certainty, management believes that the final outcome of such legal proceedings and claims will not have a material adverse effect on the Company's liquidity, financial position or results of operations.

Environmental Issues Phase I environmental site assessments have been completed on substantially all of the Properties. As of December 31, 2012, there were no recorded amounts resulting from environmental liabilities as there were no known obligations with respect thereto. Furthermore, no condition is known to exist that would give rise to a material liability for site restoration or other costs that may be incurred with respect to the sale or disposal of a property.

Capital Improvements (dollars in thousands, except unit and per unit data) Effective January 1, 2012, the Company updated its estimate of the amount of recurring, non-revenue enhancing capital expenditures incurred on an annual basis for a standard garden style apartment. The Company now estimates that the amount of these capital expenditures is $848 per apartment unit compared to $800 per apartment unit in the prior year. This new amount better reflects current actual costs since the last update.

The Company's policy is to capitalize costs related to the construction, development, rehabilitation and improvement of properties. Capital improvements are costs that increase the value and extend the useful life of an asset.

Ordinary repair and maintenance costs that do not extend the useful life of the asset are expensed as incurred. Costs incurred on a lease turnover due to normal wear and tear by the resident are expensed on the turn. Recurring capital improvements typically include appliances, carpeting and flooring, HVAC equipment, kitchen and bath cabinets, new roofs, site improvements and various exterior building improvements. Non-recurring, revenue generating capital improvements include community centers, new windows, and kitchen and bath apartment upgrades. Revenue generating capital improvements are expected to directly result in rental earnings or expense savings. The Company capitalizes interest and certain internal personnel costs related to the communities under rehabilitation and construction.

53 -------------------------------------------------------------------------------- Table of Contents Capital Improvements (continued) The table below is a list of the items that management considers recurring, non-revenue enhancing capital and maintenance expenditures for a standard garden style apartment. Included are the per unit replacement cost and the useful life that management estimates the Company incurs on an annual basis.

Maintenance Capitalized Expense Total Capitalized Expenditure Cost per Cost per Cost per Useful Per Unit Unit Unit Category Unit Life(1) Per Year(2) Per Year(3) Per Year Appliances $ 1,624 9 $ 180 $ 13 $ 193 Blinds, shades 135 3 45 5 50 Carpets, cleaning 760 4 190 142 332 Computers, equipment, misc.(4) 120 6 20 2 22 Contract repairs - - - 250 250 Exterior painting (5) 84 3 28 - 28 Flooring 250 9 28 24 52 Furnace, air (HVAC) 854 24 36 24 60 Hot water heater 293 7 42 - 42 Interior painting - - - 178 178 Kitchen, bath cabinets upgrade 1,200 15 80 - 80 Landscaping site - - - 120 120 New roof 880 24 37 - 37 Parking lot site 750 15 50 - 50 Pool, exercise facility 147 15 10 38 48 Windows major 1,663 20 83 - 83 Miscellaneous (6) 326 17 19 - 19 Total $ 9,086 $ 848 $ 796 $ 1,644 -------------------------------------------------------------------------------- (1) Estimated weighted average actual physical useful life of the expenditure capitalized.

(2) This amount is not necessarily incurred each and every year. Some years will be higher, or lower depending on the timing of certain longer life expenditures.

(3) These expenses are included in the Operating and Maintenance line item of the Consolidated Statement of Operations. Maintenance labor costs are not included in the $796 per unit estimate. All personnel costs for site supervision, leasing agents, and maintenance staff are combined and disclosed in the Company's Core Properties expense detail schedule.

(4) Includes computers, office equipment, furniture, and maintenance vehicles.

(5) The level of exterior painting may be lower than other similar titled presentations as the Company's portfolio has a significant amount of brick exteriors. In addition, the other exposed surfaces are most often covered in aluminum or vinyl.

(6) Includes items such as balconies, siding, and concrete sidewalks.

54 -------------------------------------------------------------------------------- Table of Contents Capital Improvements (continued) The breakdown of costs above reflects the Company's unique strategies to improve every property every year regardless of age, and to purchase older properties and rehabilitate and reposition them to enhance internal rates of return. These strategies result in higher costs of capital expenditures and maintenance costs which permit the Company to realize higher revenue growth, higher net operating income growth and a higher rate of property appreciation.

The Company estimates that approximately $848 and $800 per unit was spent on recurring capital expenditures in 2012 and 2011, respectively. The table below summarizes the breakdown of capital improvements by major categories between recurring and non-recurring, revenue generating capital improvements as follows: For the year ended December 31, 2012 2011 Recurring (a) Non-recurring (a) Total Capital (a) Total Capital (a) Cap Ex Per Unit Cap Ex Per Unit Improvements Per Unit Improvements Per Unit New buildings $ - $ - $ 1,352 $ 34 $ 1,352 $ 34 $ 986 $ 27 Major bldg improvements 5,221 130 22,085 550 27,306 680 15,814 427 Roof replacements 1,486 37 2,739 68 4,225 105 3,678 99 Site improvements 2,410 60 15,860 395 18,270 455 15,600 422 Apartment upgrades 5,020 125 49,209 1,225 54,229 1,350 44,148 1,193 Appliances 7,229 180 726 18 7,955 198 6,770 183 Carpeting, flooring 8,755 218 6,494 162 15,249 380 12,896 349 HVAC, mechanicals 3,132 78 11,766 293 14,898 371 13,743 371 Miscellaneous 803 20 3,841 96 4,644 116 3,717 100 Totals $ 34,056 $ 848 $ 114,072 $ 2,841 $ 148,128 $ 3,689 $ 117,352 $ 3,171 -------------------------------------------------------------------------------- (a) Calculated using the weighted average number of units owned, including 36,214 core units, 2011 acquisition units of 2,817, and 2012 acquisition units of 1,129 for 2012; and 36,214 core units and 2011 acquisition units of 784 for 2011.

The schedule below summarizes the breakdown of total capital improvements between core and non-core: For the year ended December 31, 2012 2011 Recurring (b) Non-recurring (b) Total Capital (b) Total Capital (b) Cap Ex Per Unit Cap Ex PerUnit Improvements Per Unit Improvements Per Unit Core Communities $ 30,710 $ 848 $ 98,335 $ 2,715 $ 129,045 $ 3,563 $ 113,779 $ 3,142 2012 Acquisition Communities 957 848 3,482 3,084 4,439 3,932 - - 2011 Acquisition Communities 2,389 848 12,255 4,350 14,644 5,198 3,573 4,557 Subtotal 34,056 848 114,072 2,841 148,128 3,689 117,352 3,171 2012 Disposed Communities 1,125 848 717 540 1,842 1,388 3,611 2,263 Corporate office (1) - - - - 2,803 - 2,245 - Totals $ 35,181 $ 848 $ 114,789 $ 2,767 $ 152,773 $ 3,615 $ 123,208 $ 3,134 -------------------------------------------------------------------------------- (1) No distinction is made between recurring and non-recurring expenditures for corporate office. Corporate office expenditures include principally computer hardware, software, office furniture, fixtures and leasehold improvements. Corporate office expenditures are excluded from per unit figures.

(b) Calculated using the weighted average number of units owned, including 36,214 core units, 2011 acquisition units of 2,817, 2012 acquisition units of 1,129, and 2012 disposed units of 1,327 for 2012; and 36,214 core units, 2011 acquisition units of 784, and 2012 disposed units of 1,596 for 2011.

55 -------------------------------------------------------------------------------- Table of Contents Inflation Substantially all of the leases at the communities are for a term of one year or less, which enables the Company to seek increased rents upon renewal of existing leases or commencement of new leases. These short-term leases minimize the potential adverse effect of inflation on rental income, although residents may leave without penalty at the end of their lease terms and may do so if rents are increased significantly.

Forward-Looking Statements This Form 10-K contains "forward-looking statements" within the meaning of Section 27A of the Securities Exchange Act of 1933 and Section 21E of the Securities Exchange Act of 1934, both as amended. Some examples of forward-looking statements include statements related to acquisitions (including any related pro forma financial information), future capital expenditures, potential development and redevelopment opportunities, projected costs and rental rates for development and redevelopment projects, financing sources and availability, and the effects of environmental and other regulations. Although management believes that the expectations reflected in those forward-looking statements are based upon reasonable assumptions, it can give no assurance that expectations will be achieved. Factors that may cause actual results to differ include general economic and local real estate conditions, the weather and other conditions that might affect operating expenses, the timely completion of repositioning activities and development within anticipated budgets, the actual pace of future development, acquisitions and sales, and continued access to capital to fund growth. For this purpose, any statements contained in this Form 10-K that are not statements of historical fact should be considered to be forward-looking statements. Some of the words used to identify forward-looking statements include "believes", "anticipates", "plans", "expects", "seeks", "estimates", "intends", and any other similar expressions. Readers should exercise caution in interpreting and relying on forward-looking statements since they involve known and unknown risks, uncertainties and other factors which are, in some cases, beyond the Company's control and could materially affect the Company's actual results, performance or achievements.

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