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EX-32.1 - EXHIBIT 32.1 - ESSEX PROPERTY TRUST INCex32_1.htm
EX-32.2 - EXHIBIT 32.2 - ESSEX PROPERTY TRUST INCex32_2.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 

FORM 10-Q

 

T QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2009

OR

£ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ________to _________

Commission file number 001-13106

ESSEX PROPERTY TRUST, INC.
(Exact name of Registrant as Specified in its Charter)

Maryland
77-0369576
(State or Other Jurisdiction of Incorporation or Organization)
(I.R.S. Employer Identification Number)

925 East Meadow Drive
Palo Alto, California    94303
(Address of Principal Executive Offices including Zip Code)

(650) 494-3700
(Registrant's Telephone Number, Including Area Code)


Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file reports), and (2) has been subject to such filing requirements for the past 90 days. YES  T NO  £

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). YES £ NO £

Indicate by check mark whether the registrant is a large accelerated filer an accelerated file, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” ”accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer  T
Accelerated filer  £
Non-accelerated filer  £
Smaller reporting company  £
   
(Do not check if a smaller
 
   
reporting company)
 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act. Yes  £ No  T

APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:  29,117,693 shares of Common Stock as of November 3, 2009.
 


 
 

 

Logo 1
 
 
ESSEX PROPERTY TRUST, INC.
FORM 10-Q
INDEX
 
 
   
Page No.
PART I. FINANCIAL INFORMATION
 
     
Item 1.
3
     
 
4
     
 
5
     
 
6
     
 
7
     
 
8
     
Item 2.
19
     
Item 3.
28
     
Item 4.
29
     
PART II. OTHER INFORMATION
 
     
Item 1.
30
     
Item 1A.
30
     
Item 6
31
     
31

2


Part I -- Financial Information

Item 1: Condensed Financial Statements (Unaudited)

"Essex" or the "Company" means Essex Property Trust, Inc., a real estate investment trust incorporated in the State of Maryland, or where the context otherwise requires, Essex Portfolio, L.P., a limited partnership (the "Operating Partnership") in which Essex Property Trust, Inc. is the sole general partner.

The information furnished in the accompanying unaudited condensed consolidated balance sheets, statements of operations, stockholders' equity, noncontrolling interest, and comprehensive income and cash flows of the Company reflects all adjustments which are, in the opinion of management, necessary for a fair presentation of the aforementioned condensed consolidated financial statements for the interim periods and are normal and recurring in nature, except as otherwise noted.

The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the notes to such unaudited condensed consolidated financial statements and Management's Discussion and Analysis of Financial Condition and Results of Operations herein.  Additionally, these unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company's annual report on Form 10-K for the year ended December 31, 2008.

3


ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(Unaudited)
(Dollars in thousands, except per share amounts)

   
September 30,
   
December 31,
 
Assets
 
2009
   
2008
 
Real estate:
           
Rental properties:
           
Land and land improvements
  $ 682,599     $ 683,876  
Buildings and improvements
    2,701,148       2,595,912  
      3,383,747       3,279,788  
Less accumulated depreciation
    (721,078 )     (640,026 )
      2,662,669       2,639,762  
Real estate under development
    222,976       272,273  
Co-investments
    70,763       76,346  
      2,956,408       2,988,381  
Cash and cash equivalents-unrestricted
    81,942       41,909  
Cash and cash equivalents-restricted
    17,128       12,810  
Marketable securities
    131,349       23,886  
Funds held by 1031 exchange facilitator
    -       21,424  
Notes and other receivables
    45,762       47,637  
Prepaid expenses and other assets
    17,555       17,430  
Deferred charges, net
    14,878       11,346  
Total assets
  $ 3,265,022     $ 3,164,823  
Liabilities and  Equity
               
Mortgage notes payable
  $ 1,608,570     $ 1,468,931  
Lines of credit
    150,000       120,000  
Exchangeable bonds
    98,220       165,457  
Accounts payable and accrued liabilities
    52,383       38,223  
Construction payable
    9,438       18,605  
Dividends payable
    33,269       32,124  
Cash flow hedge liabilities
    45,965       73,129  
Other liabilities
    16,393       16,444  
Total liabilities
    2,014,238       1,932,913  
Commitments and contingencies
               
Cumulative convertible preferred stock; $.0001 par value: 4.875% Series G - 5,980,000 issued and 238,249 and 5,980,000 outstanding
    5,813       145,912  
Stockholders' equity and noncontrolling interest:
               
Common stock, $.0001 par value, 649,702,178 shares authorized 28,344,510 and 26,395,807 shares issued and outstanding
    3       3  
Cumulative redeemable preferred stock; $.0001 par value:7.8125% Series F - 1,000,000 shares authorized, issued and outstanding, liquidation value
    25,000       25,000  
Additional paid-in capital
    1,235,989       1,043,984  
Distributions in excess of accumulated earnings
    (199,600 )     (141,336 )
Accumulated other comprehensive (loss) income
    (38,551 )     (75,424 )
Total stockholders' equity
    1,022,841       852,227  
Noncontrolling interest
    222,130       233,771  
Total stockholders' equity and noncontrolling interest
    1,244,971       1,085,998  
Total liabilities and equity
  $ 3,265,022     $ 3,164,823  

See accompanying notes to the unaudited condensed consolidated financial statements.

4


ESSEX PROPERTY TRUST, INC. AND SUBSIDIARES
Condensed Consolidated Statements of Operations
(Unaudited)
(Dollars in thousands, except per share amounts)

   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2009
   
2008
   
2009
   
2008
 
Revenues:
                       
Rental and other property
  $ 100,823     $ 101,942     $ 307,525     $ 300,014  
Management and other fees from affiliates
    1,024       1,311       3,377       3,965  
      101,847       103,253       310,902       303,979  
Expenses:
                               
Property operating, excluding real estate taxes
    26,935       25,462       75,937       73,817  
Real estate taxes
    9,231       8,546       27,294       24,654  
Depreciation and amortization
    29,895       27,712       87,867       81,852  
Interest
    21,966       21,122       63,680       63,017  
General and administrative
    6,086       6,524       18,134       19,661  
Impairment and other charges
    11,104       -       16,893       -  
      105,217       89,366       289,805       263,001  
                                 
Earnings (loss) from operations
    (3,370 )     13,887       21,097       40,978  
                                 
Interest and other income
    3,471       2,841       9,521       8,042  
Equity (loss) income in co-investments
    (32 )     335       664       7,325  
Gain on early retirement of debt
    -       -       6,124       -  
Gain on sale of real estate
    -       2,446       103       2,446  
Income before discontinued operations
    69       19,509       37,509       58,791  
Income (loss) from discontinued operations
    2,280       (243 )     5,630       (360 )
Net income
    2,349       19,266       43,139       58,431  
Net income attributable to noncontrolling interest
    (3,588 )     (5,535 )     (12,984 )     (16,555 )
Net income (loss) attributable to controlling interest
    (1,239 )     13,731       30,155       41,876  
Dividends to preferred stockholders
    (902 )     (2,310 )     (4,312 )     (6,931 )
Excess of the carrying amount of preferred stock redeemed over the cash paid to redeem preferred stock
    23,880       -       49,575       -  
Net income available to common stockholders
  $ 21,739     $ 11,421     $ 75,418     $ 34,945  
                                 
Per common share data:
                               
Basic:
                               
Income before discontinued operations available to common stockholders
  $ 0.71     $ 0.46     $ 2.61     $ 1.42  
Income (loss) from discontinued operations
    0.08       (0.01 )     0.19       (0.02 )
Net income available to common stockholders
  $ 0.79     $ 0.45     $ 2.80     $ 1.40  
Weighted average number of common shares outstanding during the period
    27,591,341       25,110,710       26,887,537       24,876,611  
                                 
Diluted:
                               
Income before discontinued operations available to common stockholders
  $ 0.66     $ 0.46     $ 2.50     $ 1.40  
Income (loss) from discontinued operations
    0.08       (0.01 )     0.19       (0.01 )
Net income available to common stockholders
  $ 0.74     $ 0.45     $ 2.69     $ 1.39  
Weighted average number of common shares outstanding during the period
    30,070,076       25,474,924       29,360,710       25,182,107  
                                 
Dividend per common share
  $ 1.03     $ 1.02     $ 3.09     $ 3.06  

See accompanying notes to the unaudited condensed consolidated financial statements.

5


ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Stockholders' Equity, Noncontrolling Interest, and
Comprehensive Income for the nine months ended September 30, 2009
(Unaudited)
(Dollars and shares in thousands)

   
Series F Preferred stock Amount
   
Common stock
   
Additional paid-in capital
   
Distributions in excess of accumulated earnings
   
Accumulated other comprehensive income (loss)
   
Noncontrolling Interest
   
Total
 
       
Shares
   
Amount
                     
Balances at December 31, 2008 (as reported)
  $ 25,000       26,396     $ 3     $ 1,026,036     $ (130,697 )   $ (75,424 )   $ -     $ 844,918  
Adoption of new accounting prouncements
    -       -       -       17,948       (10,639 )     -       233,771       241,080  
Balances at December 31, 2008 (revised)
    25,000       26,396       3       1,043,984       (141,336 )     (75,424 )     233,771       1,085,998  
Comprehensive income:
                                                               
Net income
    -       -       -       -       30,155       -       12,984       43,139  
Change in fair value of cash flow hedges and amortization of settlements of swaps
    -       -       -       -       -       24,739       2,282       27,021  
Change in fair value of marketable securities
    -       -       -       -       -       12,134       1,078       13,212  
Comprehensive income
                                                            83,372  
Issuance of common stock under:
                                                               
Stock option plans
    -       22       -       704       -       -       -       704  
Sale of common stock
    -       2,277       -       159,987       -       -       -       159,987  
Equity based compensation costs
    -       -       -       6,471       -       -       (142 )     6,329  
Retirement of Series G preferred stock
    -       -       -       49,575       -       -       -       49,575  
Retirement of common stock
    -       (350 )     -       (20,271 )     -       -       -       (20,271 )
Retirement of exchangeable bonds
    -       -       -       (4,461 )     -       -       -       (4,461 )
Distributions to noncontrolling interest
    -       -       -       -       -       -       (16,782 )     (16,782 )
Dividends declared
    -       -       -       -       (88,419 )     -       -       (88,419 )
Redemptions of noncontrolling interest
    -       -       -       -       -       -       (11,061 )     (11,061 )
Balances at September 30, 2009
  $ 25,000       28,345     $ 3     $ 1,235,989     $ (199,600 )   $ (38,551 )   $ 222,130     $ 1,244,971  

See accompanying notes to the unaudited condensed consolidated financial statements

6


ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(Dollars in thousands)

 
 
Nine Months Ended
 
 
 
September 30,
 
 
 
2009
   
2008
 
Net cash provided by operating activities
  $ 147,662     $ 143,048  
 
               
Cash flows used in investing activities:
               
Additions to real estate:
               
Acquisitions of real estate
    -       (87,533 )
Improvements to recent acquisitions
    (2,560 )     (6,373 )
Redevelopment expenditures
    (20,345 )     (28,652 )
Revenue generating capital expenditures
    (190 )     (4,781 )
Non-revenue generating capital expenditures
    (14,989 )     (18,987 )
Additions to real estate under development
    (68,763 )     (92,497 )
Dispositions of real estate
    31,998       44,980  
Changes in restricted cash and refundable deposits
    17,702       (2,791 )
Purchases of marketable securities
    (106,444 )     (62,522 )
Sales and maturities of marketable securities
    15,200       5,925  
Proceeds from tax credit investor
    3,762       -  
Advances under notes and other receivables
    (1,566 )     (1,958 )
Collections of notes and other receivables
    2,960       5,980  
Contributions to co-investments
    (270 )     (4,183 )
Distributions from co-investments
    -       9,423  
Net cash used in investing activities
    (143,505 )     (243,969 )
 
               
Cash flows from financing activities:
               
Borrowings under mortgage and other notes payable and lines of credit
    304,563       565,096  
Repayment of mortgage and other notes payable and lines of credit
    (134,943 )     (450,485 )
Additions to deferred charges
    (1,982 )     (2,105 )
Settlement of forward-starting swaps
    -       (1,840 )
Retirement of exchangeable bonds
    (66,460 )     -  
Retirement of common stock
    (20,271 )     (13,723 )
Retirement of preferred stock, Series G
    (90,614 )     -  
Net proceeds from stock options exercised
    704       4,841  
Net proceeds from issuance of common stock
    159,987       133,654  
Distributions to noncontrolling interest
    (16,782 )     (18,128 )
Redemption of noncontrolling interest
    (11,061 )     (12,304 )
Common and preferred stock dividends paid
    (87,265 )     (80,637 )
Net cash provided by financing activities
    35,876       124,369  
 
               
Net increase in cash and cash equivalents
    40,033       23,448  
Cash and cash equivalents at beginning of period
    41,909       9,956  
Cash and cash equivalents at end of period
  $ 81,942     $ 33,404  
 
               
Supplemental disclosure of cash flow information:
               
Cash paid for interest, net of $8.4 million and $5.3 million capitalized in 2009 and 2008, respectively
  $ 50,973     $ 46,929  
Supplemental disclosure of noncash investing and financing activities:
               
Mortgage note assumed by buyer in connection with sale of property
  $ -     $ 42,200  
Mortgage note issued to buyer in connection with sale of property
  $ -     $ 4,070  
Property received in satisfaction of note receivable
  $ -     $ 1,500  
Accrual of dividends
  $ 33,269     $ 32,037  
Change in value of cash flow hedge liabilities
  $ 27,164     $ 6,923  
Change in construction payable
  $ 9,167     $ 14,724  
Land contributed to consolidated joint venture
  $ -     $ 10,500  
Transfer of assets from real estate under development to rental properties
  $ 96,836     $ -  

See accompanying notes to the unaudited condensed consolidated financial statements.

7


ESSEX PROPERTY TRUST, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
September 30, 2009 and 2008
(Unaudited)

(1)  Organization and Basis of Presentation

The unaudited condensed consolidated financial statements of the Company are prepared in accordance with U.S. generally accepted accounting principles for interim financial information and in accordance with the instructions to Form 10-Q.  In the opinion of management, all adjustments necessary for a fair presentation of the financial position, results of operations and cash flows for the periods presented have been included and are normal and recurring in nature, except as otherwise noted.  These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company's annual report on Form 10-K for the year ended December 31, 2008.

All significant intercompany balances and transactions have been eliminated in the condensed consolidated financial statements.

The unaudited condensed consolidated financial statements for the three and nine months ended September 30, 2009 and 2008 include the accounts of the Company and Essex Portfolio, L.P. (the "Operating Partnership", which holds the operating assets of the Company).  See below for a description of entities consolidated by the Operating Partnership.  The Company is the sole general partner in the Operating Partnership, with a 92% general partnership interest as of September 30, 2009.  Total Operating Partnership units outstanding were 2,449,317 and 2,413,078 as of September 30, 2009 and December 31, 2008, respectively, and the redemption value of the units, based on the closing price of the Company’s common stock totaled $194.9 million and $185.2 million, as of September 30, 2009 and December 31, 2008, respectively.

As of September 30, 2009, the Company owned or had ownership interests in 133 apartment communities, (aggregating 27,221 units) (collectively, the “Communities”, and individually, a “Community”), five office and commercial buildings and three active development projects (collectively, the “Portfolio”).  The Communities are located in Southern California (Los Angeles, Orange, Riverside, Santa Barbara, San Diego, and Ventura counties), Northern California (the San Francisco Bay Area) and the Seattle metropolitan area.

Fund Activities

Essex Apartment Value Fund II, L.P. (“Fund II”) is an investment fund formed by the Company to add value through rental growth and asset appreciation, utilizing the Company’s development, redevelopment and asset management capabilities.

Fund II has eight institutional investors, and the Company, with combined partner equity contributions of $265.9 million.  The Company contributed $75.0 million to Fund II, which represents a 28.2% interest as general partner and limited partner.  Fund II utilized leverage equal to approximately 55% upon the initial acquisition of the underlying real estate.  Fund II invested in apartment communities in the Company’s targeted West Coast markets and, as of September 30, 2009, owned 14 apartment communities.  The Company records revenue for its asset management, property management, development and redevelopment services when earned, and promote income when realized if Fund II exceeds certain financial return benchmarks.

Marketable Securities

As of September 30, 2009 marketable securities consisted primarily of investment-grade unsecured bonds and investment funds that invest in U.S. treasury or agency securities.  As of September 30, 2009 the Company had classified the marketable securities as available for sale and the Company reports these securities at fair value, based on quoted market prices (Level 2 for the unsecured bonds and level 1 for the investment funds, as defined by the Financial Accounting Standards Board ("FASB") standard entitled “Fair Value Measurements and Disclosures”  as discussed later in Note 1), and any unrealized gain or loss is recorded as other comprehensive income (loss).  Realized gains and losses and interest income are included in interest and other income on the condensed consolidated statement of operations.  Amortization of unearned discounts is included in interest income.

Variable Interest Entities

The Company consolidates 19 DownREIT limited partnerships (comprising twelve communities), an office building that is subject to loans made by the Company, and 55 low income housing units since the Company is the primary beneficiary of these variable interest entities (“VIEs”).  As of December 31, 2008 the consolidated VIEs include a development joint venture, which is no longer a VIE as of September 30, 2009 as a result of the Company’s buyout of almost all of the co-investment’s interests.  Total DownREIT units outstanding were 1,137,623 and 1,148,510 as of September 30, 2009 and December 31, 2008 respectively, and the redemption value of the units, based on the closing price of the Company’s common stock totaled $90.5 million and $88.1 million, as of September 30, 2009 and December 31, 2008, respectively.  The consolidated total assets and liabilities related to these VIEs, net of intercompany eliminations, were approximately $237.0 million and $163.1 million, respectively, as of September 30, 2009 and $256.0 million and $169.1 million, respectively, as of December 31, 2008.  Interest holders in VIEs consolidated by the Company are allocated net income equal to the cash payments made to those interest holders or distributions from cash flow.  The remaining results of operations are generally allocated to the Company.  As of September 30, 2009 and December 31, 2008, the Company did not have any VIE’s of which it was not deemed to be the primary beneficiary.

8


Stock-Based Compensation

The Company accounts for share based compensation using the fair value method of accounting.  The estimated fair value of stock options granted by the Company is being amortized over the vesting period of the stock options.  The estimated grant date fair values of the long term incentive plan units (discussed in Note 13, “Stock Based Compensation Plans,” in the Company’s Form 10-K for the year ended December 31, 2008) are being amortized over the expected service periods.

Stock-based compensation expense for options and restricted stock totaled $0.2 million and $0.4 million for the three months ended September 30, 2009 and 2008, respectively, and $0.7 million and $0.9 million for the nine months ended September 30, 2009 and 2008, respectively.  The intrinsic value of the stock options exercised during the three months ended September 30, 2009 and 2008 totaled $0.1 million and $1.4 million, respectively and $0.5 million and $4.1 million for the nine months ended September 30, 2009 and 2008 respectively.  As of September 30, 2009, the intrinsic value of the stock options outstanding and fully vested totaled $3.3 million.  As of September 30, 2009, total unrecognized compensation cost related to unvested share-based compensation granted under the stock option and restricted stock plans totaled $2.9 million.  The cost is expected to be recognized over a weighted-average period of 2 to 5 years for the stock option plans and is expected to be recognized straight-line over 7 years for the restricted stock awards.

The Company has adopted an incentive program involving the issuance of Series Z and Series Z-1 Incentive Units (collectively referred to as “Z Units”) of limited partnership interest in the Operating Partnership.  Stock-based compensation expense for Z Units totaled $0.4 million for the three months ended September 30, 2009 and 2008, respectively, and $1.1 million for the nine months ended September 30, 2009 and 2008, respectively.

Stock-based compensation capitalized for stock options, restricted stock awards, and the Z Units totaled $0.1 million and $0.2 million for the three months ended September 30, 2009 and 2008, respectively, and $0.3 million and $0.6 million for the nine months ended September 30, 2009 and 2008, respectively.  As of September 30, 2009, the intrinsic value of the Z Units subject to future vesting totaled $8.7 million.  As of September 30, 2009, total unrecognized compensation cost related to Z Units subject to future vesting granted under the Z Units totaled $5.0 million.  The unamortized cost is expected to be recognized over the next 2 to 10 years subject to the achievement of the stated performance criteria.

Stock-based compensation expense for the Outperformance Plan, (the “OPP”) adopted in December 2007 totaled approximately $0.3 million for three months ended September 30, 2009 and 2008, respectively and $0.9 million for the nine months ended September 30, 2009 and 2008.  During September 2009, the Company elected to cancel the OPP for senior officers and non-employee directors and wrote-off $3.8 million in unamortized costs related to the OPP.

Fair Value of Financial Instruments

The Company adopted an accounting standard issued by the FASB entitled “Fair Value Measurements and Disclosures” as of January 1, 2008, which provides guidance on using fair value to measure assets and liabilities.  The Company values its financial instruments based on the fair value hierarchy of valuation techniques described in this standard.  Level 1 inputs are unadjusted, quoted prices in active markets for identical assets or liabilities at the measurement date.  Level 2 inputs include quoted prices for similar assets and liabilities in active markets and inputs other than quoted prices observable for the asset or liability.   Level 3 inputs are unobservable inputs for the asset or liability.

The Company uses Level 1 inputs for the fair values of its cash equivalents and its marketable securities except for unsecured bonds.  The Company uses Level 2 inputs for its investments in unsecured bonds, notes receivable, notes payable, and cash flow hedges.  These inputs include interest rates for similar financial instruments.  The Company’s valuation methodology for cash flow hedges is described in more detail in Note 8.  The Company does not use Level 3 inputs to estimate fair values of any of its financial instruments.  The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and considers factors specific to the asset or liability.

9


Management believes that the carrying amounts of its amounts outstanding under lines of credit, notes receivable and other receivables from related parties, and notes and other receivables approximate fair value as of September 30, 2009 and December 31, 2008, because interest rates, yields and other terms for these instruments are consistent with yields and other terms currently available for similar instruments.  Management has estimated that the fair value of the Company’s $1.46 billion of fixed rate debt at September 30, 2009 is approximately $1.48 billion and the fair value of the Company’s $251.6 million of variable rate debt at September 30, 2009 is $228.5 million based on the terms of existing mortgage notes payable and variable rate demand notes compared to those available in the marketplace.  Management believes that the carrying amounts of cash and cash equivalents, restricted cash, accounts payable and accrued liabilities, other liabilities and dividends payable approximate fair value as of September 30, 2009 due to the short-term maturity of these instruments.  Marketable securities and cash flow hedge liabilities are carried at fair value as of September 30, 2009, as discussed further above and in Note 8.

Accounting Estimates and Reclassifications

The preparation of condensed consolidated financial statements, in accordance with U.S. generally accepted accounting principles, requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to acquiring, developing and assessing the carrying values of its real estate properties, its investments in and advances to joint ventures and affiliates, its notes receivables and its qualification as a Real Estate Investment Trust (“REIT”). The Company bases its estimates on historical experience, current market conditions, and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may vary from those estimates and those estimates could be different under different assumptions or conditions. Reclassifications for discontinued operations and noncontrolling interest have been made to prior year statements of operations balances in order to conform to current year presentation.  Such reclassifications have no impact on reported earnings, cash flows, total assets or total liabilities.

New Accounting Pronouncements and the Resulting Revision of Previously Reported Amounts

In July 2009, the FASB established a codification as the single source of authoritative nongovernmental US GAAP (except for SEC rules and interpretive releases) which is effective for interim and annual reporting periods ending after September 15, 2009 (the "Codification").  The Codification is intended to reorganize, rather than change, existing US GAAP.  However, all existing accounting standard documents are superseded by the Codification and all accounting literature excluded from the Codification became nonauthoritative upon the effective date in September 2009.  Accordingly, all references to currently existing US GAAP have been removed and have been replaced with references to the Codification or plain English explanations of our accounting policies.  The adoption of the Codification did not have a material impact on the Company’s financial position or results of operations.

In December 2007, the FASB issued a standard entitled “Noncontrolling Interests in Consolidated Financial Statements” which establishes accounting and reporting standards that require the ownership interests in subsidiaries held by parties other than the parent be clearly identified, labeled, and presented in the consolidated balance sheet within equity, but separate from the parent’s equity; the amount of consolidated net income attributable to the parent and to the noncontrolling interest be clearly identified and presented on the face of the consolidated statement of operations; changes in a parent’s ownership interest while the parent retains its controlling financial interest in its subsidiary be accounted for consistently; when a subsidiary is deconsolidated, any retained noncontrolling equity investment in the former subsidiary be initially measured at fair value; and entities provide sufficient disclosures that clearly identify and distinguish between the interests of the parent and the interests of the noncontrolling owners.   The standard is effective for fiscal years beginning on or after December 15, 2008.  As summarized in the table below, the accompanying 2008 condensed consolidated financial statements have been revised to record the impact of the adoption of  the standard.

In May 2008, the FASB issued FASB a standard entitled “Accounting for Convertible Debt Instruments That May be Settled in Cash Upon Conversion,” which requires the issuer of certain convertible debt instruments that may be settled in cash (or other assets) upon conversion to separately account for the liability (debt) and equity (conversion option) components of the instruments in a manner that reflects the issuer’s nonconvertible debt borrowing rate.   This standard requires the initial debt proceeds from the sale of a company’s convertible debt instrument to be allocated between the liability component and the equity component.  The resulting debt discount will be amortized over the period during which the debt is expected to be outstanding (i.e., through the first optional redemption dates) as additional non-cash interest expense.  The standard is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008.  Accounting for the Company’s $225.0 million exchangeable bonds (the “Bonds”) with a coupon rate of 3.625% due November 2025, which were issued in the fourth quarter of 2005, was impacted by the standard.  During the fourth quarter of 2008, the Company repurchased $53.3 million of the Bonds, and during the first quarter of 2009 the Company repurchased an additional $71.3 million of the Bonds.

10


On January 1, 2009, the Company retrospectively adopted the standard discussed above for the Bonds.  The Company estimated that the market interest rate for the debt only portion of the Bonds as of the date of issuance was 5.75%, compared to the coupon rate of 3.625%.  The Company computed the estimated fair value of the debt portion of the Bonds as the present value of the expected cash flows discounted at 5.75%.  The difference between the fair value of the debt portion of the Bonds and the carrying value as previously reported was added to additional paid in capital as of the date of issuance.  The discount on the debt is amortized over the period from issuance to the date of the first call option by the holders of the Bonds which occurs in November 2010 resulting in non-cash interest expense in addition to the interest expense calculated based on the coupon rate.  This resulted in non-cash interest charges of $0.5 million and $1.0 million for the three months ended September 30, 2009 and 2008, respectively, and $1.6 million and $3.0 million for the nine months ended September 30, 2009 and 2008, respectively.  The standard requires that the fair value of the debt portion of any bonds that are retired early be estimated to calculate the gain on retirement.   The difference between the estimated fair value of the debt portion of the Bonds and the standard carrying value of the debt portion of the Bonds is recorded as gain on early retirement of debt and  additional paid in capital is reduced to reflect the remaining portion of the total amount paid to retire the Bonds.

The following is a summary of the impact to the December 31, 2008 consolidated balance sheet and the three and nine months ended September 30, 2008 consolidated statement of operations from amounts previously reported to amounts included in the accompanying condensed consolidated financial statements as a result of the retrospective adoption of the standards discussed above (in thousands except per share amounts):

   
As reported December 31, 2008
   
Noncontrolling Interest Retrospective Adjustments
   
Bonds Retrospective Adjustment
   
Revised December 31, 2008
 
Selected balance sheet data:
                       
Exchangeable bonds
  $ 171,716     $ -     $ (6,259 )   $ 165,457  
Minority interests
    234,821       (233,771 )     (1,050 )     -  
Additional paid-in-capital
    1,026,036       -       17,948       1,043,984  
Distributions in excess of accumulated earnings
    (130,697 )     -       (10,639 )     (141,336 )
Noncontrolling interest
    -       233,771       -       233,771  


   
Three Months Ended September 30,
 
Selected statement of operations data:
 
As reported 2008 (1)
   
Noncontrolling Interest Retrospective Adjustments
   
Bonds Retrospective Adjustment
   
Revised 2008
 
Interest expense
  $ 20,085       -       1,037     $ 21,122  
Noncontrolling interest
    5,666       -       (131 )     5,535  
Earnings per diluted share
    0.49       -       (0.04 )     0.45  


   
Nine Months Ended September 30,
 
Selected statement of operations data:
 
As reported 2008 (1)
   
Noncontrolling Interest Retrospective Adjustments
   
Bonds Retrospective Adjustment
   
Revised 2008
 
Interest expense
  $ 59,944       -       3,073     $ 63,017  
Noncontrolling interest
    16,929       -       (374 )     16,555  
Earnings per diluted share
    1.50       -       (0.11 )     1.39  

(1)
As reported balances are adjusted for discontinued operations.

In June 2009, the FASB issued a standard entitled, “Business Combinations” which establishes principles and requirements for how the acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any noncontrolling interest in the acquiree; recognizes and measures the goodwill acquired in a business combination or a gain from a bargain purchase; and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. This standard is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008.  The adoption of this standard on January 1, 2009 did not have any impact on the Company’s consolidated financial position, results of operations or cash flows as it relates only to business combinations for the Company that take place on or after January 1, 2009.

11


In June 2009, the FASB issued SFAS No. 167, "Amendments to FASB Interpretation No. 46(R)”, which amends existing standards  to replace the quantitative-based risks and rewards calculation for determining which enterprise, if any, has a controlling financial interest in a variable interest entity with an approach focused on identifying which enterprise has the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and (1) the obligation to absorb losses of the entity or (2) the right to receive benefits from the entity. An approach that is expected to be primarily qualitative will be more effective for identifying which enterprise has a controlling financial interest in a variable interest entity.  This Statement has not been incorporated into the FASB Accounting Standards Codification as of September 30, 2009.  The new standard shall be effective as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Earlier application is prohibited. Management is currently evaluating the impact this standard will have on the Company’s condensed consolidated financial statements.

In May 2009, the FASB issued a standard entitled “Subsequent Events” which defines subsequent events as events or transactions that occur after the balance sheet date but before financial statements are issued or available to be issued. Under the standard, the requirements for disclosing subsequent events remain unchanged from the previous requirements. However, the standard contains an additional requirement that companies must disclose the date through which subsequent events have been evaluated and the rationale for selecting that date.  The Company has adopted the provisions of the standard  and has evaluated subsequent events for the period ended September 30, 2009 through November 4, 2009, the date the financial statements were issued.  There were no events or transactions subsequent to September 30, 2009 that required recognition or disclosure in the financial statements.

(2)  Significant Transactions During the Third Quarter

(a)  Dispositions

During the third quarter, the Company sold Spring Lake, a 69-unit community located in Seattle, Washington for $5.7 million and recognized a gain of $2.5 million.

(b) Equity

During the third quarter, the Company issued 1,130,800 shares of common stock at an average price of $75.56 for $84.2 million, net of fees and commissions through the Company’s Controlled Equity Offering Program.

During the third quarter, the Company repurchased $81.9 million of its Series G Cumulative Convertible Preferred Stock, at a $23.9 million discount to its carrying value.

 (c) Debt and Financing Activities

The Company obtained a fixed rate mortgage loan secured by Huntington Breakers totaling $40.5 million at a fixed rate of 5.4% which matures in October 2019, during the third quarter.  Additionally, the Company paid-off a $5.6 million mortgage loan secured by Mt. Sutro at a fixed rate of 7.7%.

(d) Outperformance Plan

During the third quarter, the Company elected to cancel the Outperformance Plan (the “OPP”) for senior officers and non-employee directors and wrote-off $3.8 million in unamortized costs related to the OPP.  The costs were included in impairment and other charges in the accompanying consolidated statement of operations.

(e) Land Impairment

The Company wrote-off development costs totaling $6.7 million related to two land parcels that will no longer be developed by the Company.  The costs were included in impairment and other charges in the accompanying consolidated statement of operations.

12


(3) Co-investments

The Company has joint venture investments in co-investments, which are accounted for under the equity method.  The joint ventures own, operate and develop apartment communities.  The following table details the Company's co-investments (dollars in thousands):

   
September 30, 2009
   
December 31, 2008
 
             
Investments in joint ventures accounted for under the equity method of accounting:
           
             
Limited partnership interest of 27.2% and general partner interest of 1% in Essex Apartment Value Fund II, L.P ("Fund II")
  $ 70,263     $ 70,469  
Development joint venture
    -       5,377  
      70,263       75,846  
Investments accounted for under the cost method of accounting:
               
Series A Preferred Stock interest in Multifamily Technology Solutions, Inc
    500       500  
Total co-investments
  $ 70,763     $ 76,346  

During 2006, the Company made a contribution to a development with a joint venture partner totaling $3.4 million, and over the past three years the Company made additional contributions and capitalized costs to this joint venture totaling $2.4 million for a total investment of $5.8 million.  This joint venture was to obtain entitlements and make option payments towards the purchase of land parcels in Marina del Rey, California for a proposed development project.  During the first quarter of 2009, the Company wrote-off its investment in the joint venture development project of $5.8 million, and the write-off of these costs is included in other non-cash expenses in the accompanying consolidated condensed statements of operations. The combined summarized balance sheet and statements of operations for co-investments, which are accounted for under the equity method, are as follows (dollars in thousands).

   
September 30, 2009
   
December 31, 2008
 
Balance sheets:
 
 
   
 
 
Rental properties and real estate under development
  $ 499,152     $ 526,906  
Other assets
    36,603       40,877  
                 
Total assets
  $ 535,755     $ 567,783  
                 
Mortgage notes and construction payable
  $ 316,524     $ 308,853  
Other liabilities
    9,433       8,481  
Partners' equity
    209,798       250,449  
                 
Total liabilities and partners' equity
  $ 535,755     $ 567,783  
                 
Company's share of equity
  $ 70,263     $ 75,846  


`
 
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2009
   
2008
   
2009
   
2008
 
Statements of operations:
                       
Property revenues
  $ 11,684     $ 11,906     $ 35,395     $ 34,232  
Property operating expenses
    (4,882 )     (4,565 )     (13,878 )     (13,180 )
Net property operating income
    6,802       7,341       21,517       21,052  
Interest expense
    (2,878 )     (2,876 )     (7,723 )     (8,205 )
Depreciation and amortization
    (4,066 )     (3,308 )     (11,447 )     (9,979 )
                                 
Total net (loss) income
  $ (142 )   $ 1,157     $ 2,347     $ 2,868  
                                 
Company's share of operating net (loss) income
    (32 )     335       664       1,007  
Company's preferred interest/gain - Mt. Vista
    -       -       -       6,318  
Company's share of net (loss) income
  $ (32 )   $ 335     $ 664     $ 7,325  

13


In January 2008, the Company received $7.5 million and recognized $6.3 million of preferred interest in the joint venture which is included in equity income in co-investments from the repayment of its investment in Mountain Vista Apartments, LLC.

(4) Notes and Other Receivables

Notes receivable secured by real estate, and other receivables consist of the following as of September 30, 2009 and December 31, 2008 (dollars in thousands):

   
September 30, 2009
   
December 31, 2008
 
             
Note receivable, secured, bearing interest at LIBOR + 3.69%, due June 2010
  $ 6,761     $ 7,325  
Note receivable, secured, bearing interest at 8.0%, due November 2010
    971       965  
Note receivable, secured, bearing interest at LIBOR + 2.95%, due December 2010
    12,541       14,043  
Note receivable, secured, bearing interest at LIBOR + 4.75%, due March 2011
    7,358       7,294  
Note receivable, secured, bearing interest at 6.5%, due August 2011
    3,221       4,070  
Non-performing note receivable, secured
    13,448       13,448  
Other receivables
    3,182       1,192  
Allowance for loan losses
    (1,720 )     (700 )
    $ 45,762     $ 47,637  

In September 2007, the Company originated a loan to the owners of an apartment community under development in Vancouver, Washington, with a maturity date of February 2009.  The proceeds from the loan refinanced the property and provided funding for the completion of the 146-unit apartment community.  In July 2008, the Company ceased recording interest income and issued a notice of monetary default to the borrower, and the borrower filed for bankruptcy.  During the fourth quarter of 2008, the Company recorded a loan loss reserve in the amount of $0.7 million with an additional reserve of $0.4 million recorded during the second quarter of 2009 on this non-performing note receivable.  The Company recorded an additional $0.6 million loan loss reserve during the third quarter of 2009.  In October the property was sold through the bankruptcy trustee and the loan was repaid at no additional loss to the Company.

In the second quarter of 2009, the borrower on the loan secured by Emeryville Marketplace, a mixed use commercial property located in Emeryville, California made a principal payment of $0.5 million to pay down the loan to $6.8 million and the Company extended the maturity of the loan until June 2010.  In the first quarter of 2009, the borrower on the bridge loan secured by 301 Ocean Avenue, a 47-unit apartment community located in Santa Monica, California, made a principal payment of $1.6 million to pay down the loan to $12.5 million and the Company extended the maturity of the loan until December 2010.

(5) Related Party Transactions

Management and other fees from affiliates includes management, development and redevelopment fees from Fund II of $1.0 million and $1.3 million for the three months ended September 30, 2009 and 2008 respectively, and $3.4 million and $4.0 million for the nine months ended September 30, 2009 and 2008 respectively.  As discussed in Note 3, in January 2008, the Company received $7.5 million from an investment held in an affiliate of TMMC and recognized $6.3 million of preferred income which is included in equity (loss) income from co-investments.

14


(6) Segment Information

The Company defines its reportable operating segments as the three geographical regions in which its apartment communities are located: Southern California, Northern California and Seattle Metro.  Excluded from segment revenues are properties classified in discontinued operations, management and other fees from affiliates, and interest and other income.  Non-segment revenues and net operating income included in the following schedule also consist of revenue generated from commercial properties which are primarily office buildings.  Other non-segment assets include co-investments, real estate under development, cash and cash equivalents, marketable securities, notes receivable, other assets and deferred charges.  The revenues, net operating income, and assets for each of the reportable operating segments are summarized as follows for the three months ended September 30, 2009 and 2008 (dollars in thousands):

   
Three Months Ended September 30,
 
   
2009
   
2008
 
Revenues:
           
Southern California
  $ 51,265     $ 52,002  
Northern California
    30,145       30,516  
Seattle Metro
    17,550       18,085  
Other real estate assets
    1,863       1,339  
Total property revenues
  $ 100,823     $ 101,942  
                 
Net operating income:
               
Southern California
  $ 33,733     $ 35,191  
Northern California
    19,263       19,740  
Seattle Metro
    10,583       11,833  
Other real estate assets
    1,078       1,170  
Total net operating income
    64,657       67,934  
                 
Depreciation and amortization
    (29,895 )     (27,712 )
Interest expense
    (21,966 )     (21,122 )
General and administrative
    (6,086 )     (6,524 )
Impairment and other charges
    (11,104 )     -  
Management and other fees from affiliates
    1,024       1,311  
Gain on sale of real estate
    -       2,446  
Interest and other income
    3,471       2,841  
Equity (loss) income from co-investments
    (32 )     335  
                 
Income before discontinued operations
  $ 69     $ 19,509  

15


The revenues, net operating income, and assets for each of the reportable operating segments are summarized as follows for the nine months ended September 30, 2009 and 2008 (dollars in thousands):

   
Nine Months Ended September 30,
 
   
2009
   
2008
 
Revenues:
           
Southern California
  $ 155,716     $ 155,419  
Northern California
    91,523       88,783  
Seattle Metro
    54,774       51,822  
Other real estate assets
    5,512       3,990  
Total property revenues
  $ 307,525     $ 300,014  
                 
Net operating income:
               
Southern California
  $ 104,876     $ 106,626  
Northern California
    61,040       57,765  
Seattle Metro
    34,923       34,412  
Other real estate assets
    3,455       2,740  
Total net operating income
    204,294       201,543  
                 
Depreciation and amortization
    (87,867 )     (81,852 )
Interest expense
    (63,680 )     (63,017 )
General and administrative
    (18,134 )     (19,661 )
Impairment and other charges
    (16,893 )     -  
Management and other fees from affiliates
    3,377       3,965  
Gain on early retirement of debt
    6,124       -  
Gain on sale of real estate
    103       2,446  
Interest and other income
    9,521       8,042  
Equity income from co-investments
    664       7,325  
Income before discontinued operations
  $ 37,509     $ 58,791  


   
September 30, 2009
   
December 31, 2008
 
Assets:
           
Southern California
  $ 1,228,809     $ 1,291,850  
Northern California
    927,708       850,170  
Seattle Metro
    423,736       431,041  
Other real estate assets
    82,416       66,701  
Net reportable operating segments - real estate assets
    2,662,669       2,639,762  
Real estate under development
    222,976       272,273  
Cash and cash equivalents
    99,070       54,719  
Marketable securities
    131,349       23,886  
Funds held by 1031 exchange facilitator
    -       21,424  
Notes and other receivables
    45,762       47,637  
Other non-segment assets
    103,196       105,122  
Total assets
  $ 3,265,022     $ 3,164,823  

16


(7)  Net Income Per Common Share
(Amounts in thousands, except per share and unit data)

   
Three Months Ended
   
Three Months Ended
 
   
September 30, 2009
   
September 30, 2008
 
   
Income
   
Weighted- average Common Shares
   
Per Common Share Amount
   
Income
   
Weighted- average Common Shares
   
Per Common Share Amount
 
Basic:
                                   
Income from continuing operations available to common stockholders
  $ 19,700       27,591     $ 0.71     $ 11,625       25,111     $ 0.46  
Income (loss) from discontinued operations available to common stockholders
    2,039       27,591       0.08       (204 )     25,111       (0.01 )
      21,739             $ 0.79       11,421             $ 0.45  
                                                 
                                                 
Effect of Dilutive Securities (1)(2)
    506       2,479               -       364          
                                                 
Diluted:
                                               
Income from continuing operations available to common stockholders (1)
  $ 19,700             $       $ 11,625             $    
Add: noncontrolling interests OP unitholders
    265                       -                  
Adjusted income from continuing operations available to common stockholders (1)
    19,965       30,070       0.66       11,625       25,475       0.46  
Income (loss) from discontinued operations available to common stockholders
    2,039                       (204 )                
Add: noncontrolling interests OP unitholders
    241                       -                  
Adjusted income from discontinued operations available to common stockholders
    2,280       30,070       0.08       (204 )     25,475       (0.01 )
    $ 22,245             $ 0.74     $ 11,421             $ 0.45  


   
Nine Months Ended
   
Nine Months Ended
 
   
September 30, 2009
   
September 30, 2008
 
   
Income
   
Weighted Average Common Shares
   
Per Common Share Amount
   
Income
   
Weighted Average Common Shares
   
Per Common Share Amount
 
Basic:
                                   
Income before discontinued operations available to common stockholders
  $ 70,258       26,888     $ 2.61     $ 35,213       24,877     $ 1.42  
Income (loss) from discontinued operations available to common stockholders
    5,160       26,888       0.19       (268 )     24,877       (0.02 )
      75,418             $ 2.80       34,945             $ 1.40  
                                                 
Effect of Dilutive Securities (1)(2)
    3,638       2,473               -       305          
                                                 
Diluted:
                                               
Income from continuing operations available to common stockholders (1)
  $ 70,258             $       $ 35,213             $    
Add: noncontrolling interests OP unitholders
    3,168                       -                  
Adjusted income from continuing operations available to common stockholders (1)
    73,426       29,361       2.50     $ 35,213       25,182       1.40  
Income (loss) from discontinued operations available to common stockholders
    5,160                       (268 )                
Add: noncontrolling interests OP unitholders
    470                       -                  
Adjusted income from discontinued operations available to common stockholders
    5,630       29,361       0.19       (268 )     25,182       (0.01 )
    $ 79,056             $ 2.69     $ 34,945             $ 1.39  

17


(1)
Weighted convertible limited partnership units of 2,161,053 and 2,161,453 for the three and nine months ended September 30, 2009, respectively, and vested Series Z incentive units of 288,651 and 286,716 for the three and nine months ended September 30, 2009, respectively, were included in the determination of diluted EPS because they were dilutive.  Weighted convertible limited partnership units of 2,184,446 and 2,224,828 and vested Series Z incentive units of 250,927 and 250,514 for the three and nine months ended September 30, 2008, respectively, were excluded in the determination of diluted EPS because they were anti-dilutive.  The Company has the ability to redeem DownREIT limited partnership units for cash and does not consider them to be potentially dilutive securities.

The holders of the exchangeable notes may exchange, at the then applicable exchange rate, the notes for cash and, at the Company’s option, a portion of the notes may be exchanged for Essex common stock; the original exchange rate was $103.25 per share of Essex common stock.  During the three and nine months ended September 30, 2009 and 2008 the weighted average common stock price did not exceed the strike price (which was $101.30 as of September 30, 2009) and therefore common stock issuable upon exchange of the exchangeable notes was not included in the diluted share count as the effect was anti-dilutive.

Stock options of 243,313 and 28,250 for the three months ended September 30, 2009 and 2008, respectively, and 257,857 and 75,111 for the nine months ended September 30, 2009 and 2008, respectively, were not included in the diluted earnings per share calculation because the exercise price of the options were greater than the average market price of the common shares for the three months ended and, therefore, were anti-dilutive.  Stock options of 29,031 and 119,530 for the three months ended September 30, 2009 and 2008, respectively, and 25,003 and 132,214 were included in the determination of diluted EPS for the nine months ended September, 30, 2009 and 2008, respectively.

All shares of cumulative convertible preferred stock Series G have been excluded from diluted earnings per share for the three and nine months ended September 30, 2009 and 2008, respectively, as the effect was anti-dilutive.

(2)
For the three and nine months ended September 30, 2009, net income allocated to convertible limited partnership units and vested Series Z units aggregating $0.5 million and $3.6 million, respectively, have been added to income available to common stock holders for the calculation of net income per common share since these units are excluded in the diluted weighted average common shares for these periods.

(8)  Derivative Instruments and Hedging Activities

Currently, the Company uses interest rate swaps and interest rate cap contracts to manage certain interest rate risks. The valuation of these instruments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves. The fair values of interest rate swaps are determined using the market standard methodology 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 rates (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 of September 30, 2009 the Company had seven forward-starting interest rate swap contracts totaling a notional amount of $375.0 million with interest rates ranging from 5.1% to 5.9% and settlements dates ranging from October 2010 to October 2011.  These derivatives qualify for hedge accounting as they are expected to economically hedge the cash flows associated with future financing of debt between 2010 and 2011.  The Company had eleven interest rate cap contracts totaling a notional amount of $167.4 million that qualify for hedge accounting as they effectively limit the Company’s exposure to interest rate risk by providing a ceiling on the underlying variable interest rate for the Company’s $251.6 million of tax exempt variable rate debt.  The aggregate carrying value of the forward-starting interest rate swap contracts was a net liability of $46.3 million and the aggregate carrying value of the interest rate cap contracts was an asset of $0.3 million.  The overall fair value of the derivatives changed by $27.2 million during the nine months ended September 30, 2009 to a net liability of $46.0 million as of September 30, 2009, and the derivative liability was recorded in cash flow hedge liabilities in the Company’s condensed consolidated financial statements.  The changes in the fair values of the derivatives are reflected in other comprehensive (loss) income in the Company’s condensed consolidated financial statements.  No hedge ineffectiveness on cash flow hedges was recognized during the quarter ended September 30, 2009 and 2008.

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(9)  Discontinued Operations

In the normal course of business, the Company will receive offers for sale of its communities, either solicited or unsolicited. For those offers that are accepted, the prospective buyer will usually require a due diligence period before consummation of the transaction.  It is not unusual for matters to arise that result in the withdrawal or rejection of the offer during this process.  The Company classifies real estate as "held for sale" when all criteria under the FASB standard entitled, "Property, Plant, and Equipment" have been met.

During the third quarter of 2009, the Company sold Spring Lake, a 69-unit community located in Seattle, Washington for $5.7 million resulting in a $2.5 million gain.

During the second quarter of 2009, the Company sold Mountain View Apartments, a 106-unit community located in Camarillo, California for $14.0 million resulting in a $0.8 million gain.

In the first quarter of 2009, the Company sold Carlton Heights Villas, a 70-unit property located in Santee, California for $6.9 million resulting in a $1.6 million gain and Grand Regency, a 60-unit property in Escondido, California, for $5.0 million resulting in a $0.9 million gain.

In the fourth quarter of 2008, the Company sold Coral Gardens, a 200-unit property located in El Cajon, California for $19.8 million, and in the third quarter of 2008, the Company sold Cardiff by the Sea Apartments, located in Cardiff, California for $71.0 million and St. Cloud Apartments, located in Houston, Texas for $8.8 million.  The operations for these sold communities are included in discontinued operations for the three and nine months ended September 30, 2008.

The components of discontinued operations are outlined below and include the results of operations for the respective periods that the Company owned such assets, as described above (dollars in thousands).

   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
   
2009
   
2008
   
2009
   
2008
 
                         
Rental revenues
  $ 64     $ 2,648     $ 1,406     $ 9,419  
Property operating expenses
    (21 )     (1,523 )     (561 )     (4,592 )
Interest expense
    -       (545 )     -       (2,087 )
Depreciation and amortization
    -       (869 )     (306 )     (3,146 )
Income (loss) from real estate sold
    43       (289 )     539       (406 )
Gain on sale
    2,467       46       5,708       46  
Internal disposition costs (1)
    (230 )     -       (617 )     -  
                                 
Income (loss) from discontinued operations
  $ 2,280     $ (243 )   $ 5,630     $ (360 )

(1)  Internal disposition costs relate to a disposition incentive program established to pay incremental bonuses for the sale of certain of the Company's communities that are part of the program.

(10)  Commitments and Contingencies

The Company is subject to various lawsuits in the normal course of its business operations.  Such lawsuits could, but are not expected to have a material adverse effect on the Company’s financial condition, results of operations or cash flows.

Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with our Condensed Consolidated Financial Statements and accompanying Notes thereto included elsewhere herein and with our 2008 Annual Report on Form 10-K for the year ended December 31, 2008 and our Current Report on Form 10-Q for the quarter ended September 30, 2009.

The Company is a fully integrated Real Estate Investment Trust (“REIT”), and its property revenues are generated primarily from apartment community operations.  Our investment strategy has two components:  constant monitoring of existing markets, and evaluation of new markets to identify areas with the characteristics that underlie rental growth.  Our strong financial condition supports our investment strategy by enhancing our ability to quickly shift our acquisition, development, and disposition activities to markets that will optimize the performance of the portfolio.

As of September 30, 2009, we had ownership interests in 133 apartment communities, comprising 27,221 apartment units.  Our apartment communities are located in the following major West Coast regions:

19


Southern California (Los Angeles, Orange, Riverside, Santa Barbara, San Diego and Ventura counties)
Northern California (the San Francisco Bay Area)
Seattle Metro (Seattle metropolitan area)

As of September 30, 2009, we also had ownership interests in five office and commercial buildings (with approximately 215,840 square feet).

As of September 30, 2009, our consolidated development pipeline was comprised of three development projects, two predevelopment projects and four land parcels held for future development or sale aggregating 1,818 units, with total incurred costs of $223.0 million.  The estimated remaining project costs of active development projects were $85.0 million for total estimated active development project costs of $189.3 million.

The Company’s consolidated apartment communities are as follows:

 
 
As of September 30, 2009
   
As of September 30, 2008
 
 
 
Apartment Units
   
%
   
Apartment Units
   
%
 
Southern California
    12,264       51 %     12,225       51 %
Northern California
    6,695       28 %     6,457       27 %
Seattle Metro
    5,297       22 %     5,338       22 %
Total
    24,256       100 %     24,020       100 %

Co-investments including Fund II communities and communities included in discontinued operations are not included in the table above for both years presented above.

Comparison of the Three Months Ended September 30, 2009 to the Three Months Ended September 30, 2008

Our average financial occupancies for the Company’s stabilized apartment communities or “Quarterly Same-Property” (stabilized properties consolidated by the Company for the quarters ended September 30, 2009 and 2008) increased 70 basis points to 97.0% as of September 30, 2009 from 96.3% as of September 30, 2008.  Financial occupancy is defined as the percentage resulting from dividing actual rental revenue by total possible rental revenue. Actual rental revenue represents contractual rental revenue pursuant to leases without considering delinquency and concessions.  Total possible rental revenue represents the value of all apartment units, with occupied units valued at contractual rental rates pursuant to leases and vacant units valued at estimated market rents.  We believe that financial occupancy is a meaningful measure of occupancy because it considers the value of each vacant unit at its estimated market rate.  Financial occupancy may not completely reflect short-term trends in physical occupancy and financial occupancy rates as disclosed by other REITs may not be comparable to our calculation of financial occupancy.

The regional breakdown of the Company’s Quarterly Same-Property portfolio for financial occupancy for the quarter ended September 30, 2009 and 2008 is as follows:

   
Three months ended
 
   
September 30,
 
   
2009
   
2008
 
Southern California
    96.6 %     95.4 %
Northern California
    97.6 %     97.7 %
Seattle Metro
    97.1 %     96.6 %

20


The following table provides a breakdown of revenue amounts, including revenues attributable to the Quarterly Same-Property portfolio:

   
Number of Properties
   
Three Months Ended
   
Dollar Change
   
Percentage Change
 
       
September 30,
         
       
2009
   
2008
         
Property Revenues (dollars in thousands)
                &