Mid-America Apartment Communities 10-Q 2011
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2011
¨ 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: 1-12762
MID-AMERICA APARTMENT COMMUNITIES, INC.
(Exact name of registrant as specified in its charter)
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last report)
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 such reports), and (2) has been subject to such filing requirements for the past 90 days. þYes ¨ 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). þ Yes ¨ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
¨ Yes þ No
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date:
MID-AMERICA APARTMENT COMMUNITIES, INC.
TABLE OF CONTENTS
Condensed Consolidated Balance Sheets
March 31, 2011 (Unaudited) and December 31, 2010
(Dollars in thousands, except per share data)
See accompanying notes to consolidated financial statements.
Condensed Consolidated Statements of Operations
Three months ended March 31, 2011 and 2010
(Dollars in thousands, except per share data)
See accompanying notes to consolidated financial statements.
Condensed Consolidated Statements of Cash Flows
Three Months Ended March 31, 2011 and 2010
(Dollars in thousands)
See accompanying notes to consolidated financial statements.
Mid-America Apartment Communities, Inc.
Notes to Condensed Consolidated Financial Statements
March 31, 2011 and 2010
Consolidation and Basis of Presentation
Mid-America Apartment Communities, Inc., or we, or MAA, is a self-administered real estate investment trust, or REIT, that owns, acquires, renovates, develops and manages apartment communities in the Sunbelt region of the United States. As of March 31, 2011, we owned or owned interests in a total of 159 multifamily apartment communities comprising 46,950 apartments located in 13 states, including two communities comprising 626 apartments owned through our joint venture, Mid-America Multifamily Fund I, LLC, and five communities comprising 1,635 apartments owned through our joint venture, Mid-America Multifamily Fund II, LLC. In addition, we also had one development community and a second phase to an existing community under construction totaling 638 units as of March 31, 2011. No units for the development projects were completed as of March 31, 2011 and they are therefore not included in the totals above.
The accompanying unaudited condensed consolidated financial statements have been prepared by our management in accordance with U.S. generally accepted accounting principles, or GAAP, for interim financial information and applicable rules and regulations of the Securities and Exchange Commission, or the SEC, and our accounting policies as set forth in our December 31, 2010 annual consolidated financial statements. The accompanying unaudited condensed consolidated financial statements include the accounts of MAA and its subsidiaries, including Mid-America Apartments, L.P. In our opinion, all adjustments necessary for a fair presentation of the condensed consolidated financial statements have been included and all such adjustments were of a normal recurring nature. All significant intercompany accounts and transactions have been eliminated in consolidation. The results of operations for the three month period ended March 31, 2011 are not necessarily indicative of the results to be expected for the full year. These financial statements should be read in conjunction with our audited financial statements and notes thereto included in our Annual Report on Form 10-K filed with the SEC on February 24, 2011.
The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent liabilities at the dates of the financial statements and the amounts of revenues and expenses during the reporting periods. Actual amounts realized or paid could differ from those estimates.
Earnings per Common Share
Basic earnings per share is computed by dividing net income attributable to common stockholders by the weighted average number of shares outstanding during the period. All outstanding unvested restricted share awards contain rights to non-forfeitable dividends and participate in undistributed earnings with common shareholders and, accordingly, are considered participating securities that are included in the two class method of computing basic earnings per share. Both the unvested restricted shares and other potentially dilutive common shares, and the related impact to earnings, are considered when calculating earnings per share on a diluted basis with our diluted earnings per share being the more dilutive of the treasury stock or two class methods. Operating partnership units are included in dilutive earnings per share calculations when they are dilutive to earnings per share. For the three month periods ended March 31, 2011 and 2010, our basic earnings per share is computed using the two class method and our diluted earnings per share is computed using the treasury stock method as follows:
(1) Operating partnership units are not included in dilutive earnings per share calculations for the three months ended March 31, 2010, as they were not dilutive
As of March 31, 2011, we owned or had an ownership interest in 159 multifamily apartment communities in 13 different states from which we derived all significant sources of earnings and operating cash flows. Senior management evaluates performance and determines resource allocations by reviewing apartment communities individually and in the following reportable operating segments:
On the first day of each calendar year, we determine the composition of our same store operating segments for that year, which allows us to evaluate full period-over-period operating comparisons. We utilize net operating income, or NOI, in evaluating the performance. Total NOI represents total property revenues less total property operating expenses, excluding depreciation, for all properties held during the period regardless of their status as held for sale. We believe NOI is a helpful tool in evaluating the operating performance of our segments because it measures the core operations of property performance by excluding corporate level expenses and other items not related to property operating performance.
Revenues and NOI for each reportable segment for the three month periods ended March 31, 2011 and 2010, were as follows (dollars in thousands):
Assets for each reportable segment as of March 31, 2011 and December 31, 2010, were as follows (dollars in thousands):
Total comprehensive income, equity and their components for the three month periods ended March 31, 2011, and 2010, were as follows (dollars in thousands, except per share and per unit data):
The marked-to-market adjustment on derivative instruments is based upon the change of interest rates available for derivative instruments with similar terms and remaining maturities existing at each balance sheet date.
The following communities were purchased during the quarter ended March 31, 2011:
The acquisition of Alamo Ranch and MAA’s share of the net purchase price of Verandas at SouthWood were funded by common stock issuances through MAA’s at-the-market program.
On March 31, 2011, 36,545,130 common shares and 2,013,393 operating partnership units were outstanding, representing a total of 38,558,523 shares and units. Additionally, we had outstanding options for the purchase of 14,907 shares of common stock at March 31, 2011, of which 6,115 were anti-dilutive. At March 31, 2010, 29,684,303 common shares and 2,302,504 operating partnership units were outstanding, representing a total of 31,986,807 shares and units. Additionally, MAA had outstanding options for the purchase of 22,382 shares of common stock at March 31, 2010, of which 11,369 were anti-dilutive.
On November 3, 2006, we entered into a sales agreement with Cantor Fitzgerald & Co. to sell up to 2,000,000 shares of our common stock, from time to time in at-the-market, or ATM, offerings or negotiated transactions through a controlled equity offering program. On July 3, 2008, and November 5, 2009, we entered into second and third sales agreements with Cantor Fitzgerald & Co. with materially the same terms for an additional 1,350,000 shares and 4,000,000 shares, respectively. On August 26, 2010, we entered into sales agreements with Cantor Fitzgerald & Co., Raymond James & Associates, Inc. and Merrill Lynch, Pierce, Fenner & Smith Incorporated with materially the same terms as our previous at-the-market agreements for a combined total of 6,000,000 shares of our common stock.
During the three months ended March 31, 2011, we issued 993,799 shares of common stock through our at-the-market, or ATM, programs for net proceeds of $61.2 million. During the three months ended March 31, 2010, we issued a total of 571,000 shares of common stock through our ATM programs for net proceeds of $29.9 million.
During the three months ended March 31, 2011, we issued 495,007 shares of common stock through the optional cash purchase feature of our Dividend and Distribution Reinvestment and Share Purchase Program, or DRSPP. The issuance resulted in net proceeds of $30.0 million. No such issuances were made during the three months ended March 31, 2010.
During the three months ended March 31, 2011, 25,082 shares of MAA’s common stock were acquired from employees to satisfy tax withholding obligations that arose upon vesting of restricted stock granted pursuant to approved plans.
On March 31, 2011, we had total indebtedness of $1.5 billion, compared to $1.5 billion as of December 31, 2010. Our indebtedness as of March 31, 2011 consisted of both conventional and tax exempt debt. Borrowings were made through individual property mortgages as well as company-wide secured credit facilities.
As of March 31, 2011, approximately 83% of our outstanding debt was borrowed through secured credit facility relationships with Prudential Mortgage Capital, which are credit enhanced by the Federal National Mortgage Association, or FNMA, Financial Federal, which are credit enhanced by the Federal Home Loan Mortgage Corporation, or Freddie Mac, and a $50 million bank facility with a syndicate of banks.
We utilize interest rate swaps and interest rate caps to help manage our current and future interest rate risk and entered into 30 interest rate swaps and 21 interest rate caps as of March 31, 2011, representing notional amounts of $735 million and $271 million, respectively.
The following table summarizes our debt structure as of March 31, 2011 (dollars in thousands):
(1) Includes capped balances.
Risk Management Objective of Using Derivatives
We are exposed to certain risk arising from both our business operations and economic conditions. We principally manage our exposures to a wide variety of business and operational risks through management of our core business activities. We manage economic risks, including interest rate, liquidity and credit risk, primarily by managing the amount, sources and duration of our debt funding and the use of derivative financial instruments. Specifically, we enter into derivative financial instruments to manage exposures that arise from business activities that result in the payment of future contractual and forecasted cash amounts, principally related to our borrowings, the value of which are determined by changing interest rates.
Cash Flow Hedges of Interest Rate Risk
Our objectives in using interest rate derivatives are to add stability to interest expense and to manage our exposure to interest rate movements. To accomplish this objective, we use interest rate swaps and interest rate caps as part of our interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for us making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount. Interest rate caps designated as cash flow hedges involve the receipt of variable amounts from a counterparty if interest rates rise above the strike rate on the contract in exchange for an up front premium.
The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in accumulated other comprehensive income and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings. During the three months ended March 31, 2011 and 2010, such derivatives were used to hedge the variable cash flows associated with existing variable-rate debt. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings. During the three months ended March 31, 2011 and 2010, we recorded ineffectiveness of $5,000 (decrease to interest expense) and $105,000 (increase to interest expense), respectively, attributable to a mismatch in the underlying indices of the derivatives and the hedged interest payments made on our variable-rate debt.
During the three months ended March 31, 2011, we also had eight interest rate caps with a total a notional amount of $51.2 million, (two of these caps with a collective notional of $19.5 million matured during the first quarter of 2011), where only the changes in intrinsic value are recorded in accumulated other comprehensive income. Changes in fair value of these interest rate caps due to changes in time value (e.g. volatility, passage of time, etc.) are excluded from effectiveness testing and are recognized directly in earnings. During the three months ended March 31, 2011 and 2010, we recorded a loss of $3,000 and $31,000, respectively, due to changes in the time value of these interest rate caps.
Amounts reported in accumulated other comprehensive income related to derivatives designated in qualifying cash flow hedges will be reclassified to interest expense as interest payments are made on our variable-rate debt. During the next twelve months, we estimate that an additional $24.8 million will be reclassified to earnings as an increase to interest expense, which primarily represents the difference between our fixed interest rate swap payments and the projected variable interest rate swap payments.
As of March 31, 2011, we had the following outstanding interest rate derivatives that were designated as cash flow hedges of interest rate risk:
We do not use derivatives for trading or speculative purposes and currently do not have any derivatives that are not designated as qualifying accounting hedges under ASC 815.
Tabular Disclosure of Fair Values of Derivative Instruments on the Balance Sheet
The table below presents the fair value of our derivative financial instruments as well as their classification on the Consolidated Balance Sheet as of March 31, 2011 and December 31, 2010, respectively:
Fair Values of Derivative Instruments on the Condensed Consolidated Balance Sheet as of
March 31, 2011 and December 31, 2010 (dollars in thousands)
Tabular Disclosure of the Effect of Derivative Instruments on the Statement of Operations
The tables below present the effect of our derivative financial instruments on the Consolidated Statement of Operations for the three months ended March 31, 2011 and 2010, respectively.
Effect of Derivative Instruments on the Consolidated Statement of Operations for the
Three Months Ended March 31, 2011 and 2010 (dollars in thousands)
Credit-risk-related Contingent Features
As of March 31, 2011, derivatives that were in a net liability position and subject to credit-risk-related contingent features had a termination value of $46.1 million, which includes accrued interest but excludes any adjustment for nonperformance risk. These derivatives had a fair value, gross of asset positions, of $41.4 million at March 31, 2011.
Certain of our derivative contracts contain a provision where if we default on any of our indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender, then we could also be declared in default on our derivative obligations. As of March 31, 2011, we had not breached the provisions of these agreements. If we had breached these provisions, we could have been required to settle our obligations under the agreements at their termination value of $16.9 million.
Certain of our derivative contracts are credit enhanced by either FNMA or Freddie Mac. These derivative contracts require that our credit enhancing party maintain credit ratings above a certain level. If our credit support providers were downgraded below Baa1 by Moody’s or BBB+ by Standard & Poor’s, or S&P, we may be required to either post 100 percent collateral or settle the obligations at their termination value of $46.1 million as of March 31, 2011. Both FNMA and Freddie Mac are currently rated Aaa by Moody’s and AAA by S&P, and therefore, the provisions of this agreement have not been breached and no collateral has been posted related to these agreements as of March 31, 2011.
Although our derivative contracts are subject to master netting arrangements, which serve as credit mitigants to both us and our counterparties under certain situations, we do not net our derivative fair values or any existing rights or obligations to cash collateral on the consolidated balance sheet.
See also Note 8.
Cash and cash equivalents, restricted cash, accounts payable, accrued expenses and other liabilities and security deposits are carried at amounts that reasonably approximate their fair value due to their short term nature.
Fixed rate notes payable at March 31, 2011 and December 31, 2010, totaled $289 million and $267 million, respectively, and had estimated fair values of $256 million and $238 million (excluding prepayment penalties), respectively, based upon interest rates available for the issuance of debt with similar terms and remaining maturities as of March 31, 2011 and December 31, 2010. The carrying value of variable rate notes payable (excluding the effect of interest rate swap and cap agreements) at March 31, 2011 and December 31, 2010, totaled $1,163 million and $1,233 million, respectively, and had estimated fair values of $1,096 million and $1,151 million (excluding prepayment penalties), respectively, based upon interest rates available for the issuance of debt with similar terms and remaining maturities as of March 31, 2011 and December 31, 2010.
On January 1, 2008, we adopted FASB ASC 820 Fair Value Measurements and Disclosures, or ASC 820. ASC 820 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. ASC 820 applies to reported balances that are required or permitted to be measured at fair value under existing accounting pronouncements; accordingly, the standard does not require any new fair value measurements of reported balances.
ASC 820 emphasizes that fair value is a market-based measurement, not an entity-specific measurement. Therefore, a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering market participant assumptions in fair value measurements, ASC 820 establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy).
Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that we have the ability to access. Level 2 inputs are inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs may include quoted prices for similar assets and liabilities in active markets, as well as inputs that are observable for the asset or liability (other than quoted prices), such as interest rates, foreign exchange rates, and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability, which are typically based on an entity’s own assumptions, as there is little, if any, related market activity. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. Our 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.
Derivative financial instruments
Currently, we use interest rate swaps and interest rate caps (options) to manage our interest rate risk. 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 and implied volatilities. 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 fair values of interest rate options are determined using the market standard methodology of discounting the future expected cash receipts that would occur if variable interest rates rise above the strike rate of the caps. The variable interest rates used in the calculation of projected receipts on the cap are based on an expectation of future interest rates derived from observable market interest rate curves and volatilities.
To comply with the provisions of ASC 820, we incorporate credit valuation adjustments to appropriately reflect both our own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of our derivative contracts for the effect of nonperformance risk, we have considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts and guarantees.
Although we have determined that the majority of the inputs used to value our derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with our derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by ourself and our counterparties. In prior periods, we classified our derivative valuations within the Level 3 fair value hierarchy because those valuations contain certain Level 3 inputs (e.g. credit spreads). Commencing with the year ended December 31, 2010, we determined that the significance of the impact of the credit valuation adjustments made to our derivative contracts, which determination was based on the fair value of each individual contract, was not significant to the overall valuation. As a result, all of our derivatives held as of March 31, 2011 and December 31, 2010 were classified as Level 2 of the fair value hierarchy.
The table below presents our assets and liabilities measured at fair value on a recurring basis as of March 31, 2011 and December 31, 2010, aggregated by the level in the fair value hierarchy within which those measurements fall.
Assets and Liabilities Measured at Fair Value on a Recurring Basis at March 31, 2011
(dollars in thousands)
Assets and Liabilities Measured at Fair Value on a Recurring Basis at December 31, 2010
(dollars in thousands)
The fair value estimates presented herein are based on information available to management as of March 31, 2011 and December 31, 2010. These estimates are not necessarily indicative of the amounts we could ultimately realize. See also Note 7.
Impact of Recently Issued Accounting Standards
In June 2008, the FASB issued ASC 810-10-05, Amendments to FASB Interpretation No. 46(R), or ASC 810-10-05, which amends events that would require reconsidering whether an entity is a variable interest entity; it amends the criteria used to determine the primary beneficiary of a variable interest entity; and it expands disclosures about an enterprise’s involvement in variable interest entities. ASC 810-10-05 is effective for annual reporting periods beginning after November 15, 2009 and earlier application is prohibited. We adopted ASC 810-10-05 effective January 1, 2010. The adoption did not have a material impact on our consolidated financial condition or results of operations taken as a whole.
Real Estate Acquisitions
On April 20, 2011, we purchased The Retreat at Magnolia Parke, a 204-unit apartment community located in Gainesville, Florida.
On April 29, 2011, we purchased Atlantic Crossing, a 200-unit apartment Community located in Jacksonville, Florida.
On May 4, 2011, we purchased a 25.98-acre parcel of land in Little Rock, Arkansas and entered into an agreement with a third party to develop a 312-unit apartment community on the site.
The following discussion should be read in conjunction with the condensed consolidated financial statements and notes appearing elsewhere in this report. Historical results and trends that might appear in the condensed consolidated financial statements should not be interpreted as being indicative of future operations.
Forward Looking Statements
We consider this and other sections of this Quarterly Report on Form 10-Q to contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, with respect to our expectations for future periods. Forward looking statements do not discuss historical fact, but instead include statements related to expectations, projections, intentions or other items related to the future. Such forward-looking statements include, without limitation, statements concerning property acquisitions and dispositions, development and renovation activity as well as other capital expenditures, capital raising activities, rent growth, occupancy and rental expense growth. Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates” and variations of such words and similar expressions are intended to identify such forward-looking statements. Such statements involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements to be materially different from the results of operations or plans expressed or implied by such forward-looking statements. Such factors include, among other things, unanticipated adverse business developments affecting us, or our properties, adverse changes in the real estate markets and general and local economies and business conditions. Although we believe that the assumptions underlying the forward-looking statements contained herein are reasonable, any of the assumptions could be inaccurate, and therefore such forward-looking statements included in this report may not prove to be accurate. In light of the significant uncertainties inherent in the forward-looking statements included herein, the inclusion of such information should not be regarded as a representation by us or any other person that the results or conditions described in such statements or our objectives and plans will be achieved.
The following factors, among others, could cause our future results to differ materially from those expressed in the forward-looking statements:
Critical Accounting Policies and Estimates
The following discussion and analysis of financial condition and results of operations are based upon our condensed consolidated financial statements, and the notes thereto, which have been prepared in accordance with GAAP. The preparation of these condensed consolidated financial statements requires us to make a number of estimates and assumptions that affect the reported amounts and disclosures in the condensed consolidated financial statements. On an ongoing basis, we evaluate our estimates and assumptions based upon historical experience and various other factors and circumstances. We believe that our estimates and assumptions are reasonable under the circumstances; however, actual results may differ from these estimates and assumptions.
We believe that the estimates and assumptions listed below are most important to the portrayal of our financial condition and results of operations because they require the greatest subjective determinations and form the basis of accounting policies deemed to be most critical. These critical accounting policies include revenue recognition, capitalization of expenditures and depreciation of assets, impairment of long-lived assets, including goodwill and fair value of derivative financial instruments.
We lease multifamily residential apartments under operating leases primarily with terms of one year or less. Rental revenues are recognized using a method that represents a straight-line basis over the term of the lease and other revenues are recorded when earned.
We record all gains and losses on real estate in accordance with accounting standards governing the sale of real estate.
Capitalization of expenditures and depreciation of assets
We carry real estate assets at depreciated cost. Depreciation is computed on a straight-line basis over the estimated useful lives of the related assets, which range from 8 to 40 years for land improvements and buildings, 5 years for furniture, fixtures, and equipment, 3 to 5 years for computers and software, and 6 months for acquired leases, all of which are subjective determinations. Repairs and maintenance costs are expensed as incurred while significant improvements, renovations and replacements are capitalized. The cost to complete any deferred repairs and maintenance at properties acquired by us in order to elevate the condition of the property to our standards are capitalized as incurred.
Development costs are capitalized in accordance with accounting standards for costs and initial rental operations of real estate projects and standards for the capitalization of interest cost.
Impairment of long-lived assets, including goodwill
We account for long-lived assets in accordance with the provisions of accounting standards for the impairment or disposal on long-lived assets and evaluate our goodwill for impairment under accounting standards for goodwill and other intangible assets. We evaluate goodwill for impairment on at least an annual basis, or more frequently if a goodwill impairment indicator is identified. We periodically evaluate long-lived assets, including investments in real estate and goodwill, for indicators that would suggest that the carrying amount of the assets may not be recoverable. The judgments regarding the existence of such indicators are based on factors such as operating performance, market conditions and legal factors.
Long-lived assets, such as real estate assets, equipment and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of are separately presented on the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. The assets and liabilities of a disposed group classified as held for sale are presented separately in the appropriate asset and liability sections of the balance sheet.
Goodwill is tested annually for impairment, and is tested for impairment more frequently if events and circumstances indicate that the asset might be impaired. An impairment loss for goodwill is recognized to the extent that the carrying amount exceeds the asset’s fair value. This determination is made at the reporting unit level and consists of two steps. First, we determine the fair value of a reporting unit and compare it to its carrying amount. In the apartment industry, the primary method used for determining fair value is to divide annual operating cash flows by an appropriate capitalization rate. We determine the appropriate capitalization rate by reviewing the prevailing rates in a property’s market or submarket. Second, if the carrying amount of a reporting unit exceeds its fair value, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of that goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation in accordance accounting standards for business combinations. The residual fair value after this allocation is the implied fair value of the reporting unit goodwill.
Fair value of derivative financial instruments
We utilize certain derivative financial instruments, primarily interest rate swaps and interest rate caps, during the normal course of business to manage, or hedge, the interest rate risk associated with our variable rate debt or as hedges in anticipation of future debt transactions to manage well-defined interest rate risk associated with the transaction.
In order for a derivative contract to be designated as a hedging instrument, changes in the hedging instrument must be highly effective at offsetting changes in the hedged item. The historical correlation of the hedging instruments and the underlying hedged items are assessed before entering into the hedging relationship and on a quarterly basis thereafter, and have been found to be highly effective.
We measure ineffectiveness using the change in the variable cash flows method for interest rate swaps and the hypothetical derivative method for interest rate caps for each reporting period through the term of the hedging instruments. Any amounts determined to be ineffective are recorded in earnings. The change in fair value of the interest rate swaps and the intrinsic value or fair value of interest rate caps designated as cash flow hedges are recorded to accumulated other comprehensive income in the statement of shareholders’ equity.
The valuation of our derivative financial instruments is determined using widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of each derivative. The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash payments and the discounted expected variable cash receipts. The variable cash receipts are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. The fair values of interest rate caps are determined using the market standard methodology of discounting the future expected cash receipts that would occur if variable interest rates rise above the strike rate of the interest rate caps. The variable interest rates used in the calculation of projected receipts on the interest rate cap are based on an expectation of future interest rates derived from observable market interest rate curves and volatilities. Additionally, we incorporate credit valuation adjustments to appropriately reflect both our own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. Changes in the fair values of our derivatives are primarily the result of fluctuations in interest rates. See Notes 7 and 8 of the accompanying Condensed Consolidated Financial Statements.
Overview of the Three Months Ended March 31, 2011
We experienced an increase in income from continuing operations before non-operating items for the three months ended March 31, 2011 over the three months ended March 31, 2010 as increases in revenues outpaced increases in property operating expenses. The increases in revenues came from a 4.5% increase in our secondary market same store segment, a 3.6% increase in our large market same store segment and a 123.6% increase in our non-same store and other segment which was primarily a result of acquisitions. We acquired one property for our 100% owned portfolio and one property through Fund II during the three months ended March 31, 2011. Our same store portfolio represents those communities that have been held and have been stabilized for at least 12 months. Communities excluded from the same store portfolio would include recent acquisitions, communities being developed or in lease-up, communities undergoing extensive renovations, and communities identified as discontinued operations.
We continued to benefit from reduced interest rates during the three months ended March 31, 2011 as a reduction in average interest rates partially offset the impact from an increase in the average amount of debt outstanding for the three months ended March 31, 2011 from the three months ended March 31, 2010.
As of March 31, 2011, the total number of apartment units that MAA owned 100% was 44,689 in 152 communities, compared to 42,206 apartment units in 143 communities at March 31, 2010. For these communities, the average rent per apartment unit, excluding units in lease-up, increased to $749 at March 31, 2011 from $731 at March 31, 2010. For these same units, overall occupancy at March 31, 2011 and 2010 was 95.9% and 96.6%, respectively. Average rent per unit is equal to the average of gross rent amounts for occupied units plus prevalent market rates asked for unoccupied units, divided by the total number of units.
The following is a discussion of our consolidated financial condition and results of operations for the three months ended March 31, 2011 and 2010. This discussion should be read in conjunction with all of the consolidated financial statements included in this Periodic Report on Form 10-Q.
Results of Operations
Comparison of the Three Months Ended March 31, 2011 to the Three Months Ended March 31, 2010
Property revenues for the three months ended March 31, 2011 were approximately $107.1 million, an increase of approximately $9.8 million from the three months ended March 31, 2010 due to (i) a $1.7 million increase in property revenues from our large market same store group primarily as a result in an increase in average rent per unit, (ii) a $2.0 million increase in property revenues from our secondary market same store group primarily as a result in an increase in average rent per unit and (iii) a $6.1 million increase in property revenues from our non-same store and other group, mainly as a result of acquisitions.
Property operating expenses include costs for property personnel, property personnel bonuses, building repairs and maintenance, real estate taxes and insurance, utilities, landscaping and depreciation. Property operating expenses, excluding depreciation, for the three months ended March 31, 2011 were approximately $45.6 million, an increase of approximately $4.0 million from the three months ended March 31, 2010 due primarily to increases in property operating expenses of (i) $0.5 million from our large market same store group, (ii) $0.6 million from our secondary market same store group, and (iii) $2.9 million from our non-same store and other group, mainly as a result of acquisitions.
Depreciation expense for the three months ended March 31, 2011 was approximately $27.7 million, an increase of approximately $2.7 million from the three months ended March 31, 2010 primarily due to the increases in depreciation expense of (i) $0.1 million from our large market same store group, (ii) $0.1 million from our secondary market same store group, and (iii) $2.5 million from our non-same store and other group, mainly as a result of acquisitions. Increases of depreciation expense from our large and secondary market same store groups resulted from asset additions made during the normal course of business.
Interest expense for the three months ended March 31, 2011 was approximately $14.0 million, an increase of approximately $0.1 million from the three months ended March 31, 2010 as a decrease in our average cost of debt from 4.06% for the three months ended March 31, 2010 to 3.83% for the three months ended March 31, 2011 was more than offset by an increase in our average debt outstanding from the three months ended March 31, 2010 to the three months ended March 31, 2011 of approximately $108.5 million.
Acquisition expenses increased by approximately $0.2 for the three months ended March 31, 2011 during which we acquired two communities from the three months ended March 31, 2010. No communities were acquired during the three months ended March 31, 2010.
Property management expenses and general and administrative expenses increased for the three months ended March 31, 2011 from the three months ended March 31, 2010 by $0.9 million and $1.8 million, respectively, partially as a result of increased associate incentives as a result of improved performance.
During the three months ended March 31, 2010, we contributed a community to one of our joint ventures which resulted in a gain of approximately $0.4 million.
Primarily as a result of the foregoing, net income attributable to MAA decreased by approximately $0.6 million in the three months ended March 31, 2011 from the three months ended March 31, 2010.
On June 2, 2010, we redeemed 3,100,001 shares of the 6,200,000 shares of our 8.30% Series H Cumulative Redeemable Preferred Stock, or Series H. On August 5, 2010, we redeemed all of the remaining and outstanding shares of Series H, resulting in the decrease of preferred dividends from $3.2 million for the three months ended March 31, 2010 to $0 for the three months ended March 31, 2011.
Funds From Operations and Net Income
Funds from operations, or FFO, represents net income attributable to MAA (computed in accordance with GAAP), excluding extraordinary items, gains or losses on disposition of real estate assets, plus depreciation of real estate, and adjustments for joint ventures to reflect FFO on the same basis. This definition of FFO is in accordance with the National Association of Real Estate Investment Trust’s, or NAREIT, definition. Disposition of real estate assets includes sales of discontinued operations as well as proceeds received from insurance and other settlements from property damage.
In response to SEC’s Staff Policy Statement relating to Emerging Issues Task Force Topic D-42 concerning the calculation of earnings per share for the redemption of preferred stock, we include the amount recorded to retire preferred stock in excess of carrying values in our FFO calculation.
Our policy is to expense the cost of interior painting, vinyl flooring and blinds as incurred for stabilized properties. During the stabilization period for acquisition properties, these items are capitalized as part of the total repositioning program of newly acquired properties, and thus are not deducted in calculating FFO.
FFO should not be considered as an alternative to net income attributable to MAA or any other GAAP measurement of performance, as an indicator of operating performance, or as an alternative to cash flow from operating, investing and financing activities as a measure of liquidity. We believe that FFO is helpful to investors in understanding our operating performance in that such calculation excludes depreciation expense on real estate assets. We believe that GAAP historical cost depreciation of real estate assets is generally not correlated with changes in the value of those assets, whose value does not diminish predictably over time. Our calculation of FFO may differ from the methodology for calculating FFO utilized by other REITs and, accordingly, may not be comparable to such other REITs.
The following table is a reconciliation of FFO to net income attributable to MAA for the three month periods ended March 31, 2011, and 2010 (dollars and shares in thousands):