ITEM 1. BUSINESS
General - -------
Gables Realty Limited Partnership (the "Operating Partnership" or "Gables") is the entity through which Gables Residential Trust (the "Company"), a real estate investment trust (a "REIT"), conducts substantially all of its business and owns (either directly or through subsidiaries) substantially all of its assets. The Operating Partnership is one of the largest owners, operators and developers of multifamily apartment communities in the Southwestern and Southeastern region of the United States (the "Sunbelt" or "Sunbelt Region"). In 1993, the Company was formed under Maryland law and the Operating Partnership was organized as a Delaware limited partnership to continue and expand the multifamily apartment community management, development, construction and acquisition operations of its privately owned predecessor organization. The Company completed its initial public offering on January 26, 1994 (the "IPO").
The Company controls the Operating Partnership through Gables GP, Inc. ("GGPI"), a wholly-owned subsidiary and the sole general partner of the Operating Partnership (this structure is commonly referred to as an umbrella partnership REIT or "UPREIT"). At December 31, 1998, the Company was an 80.3% economic owner of the common equity of the Operating Partnership. The Board of Directors of GGPI, the members of which are the same as the members of the Board of Trustees of the Company, manages the affairs of the Operating Partnership by directing the affairs of GGPI. The Company's limited partner and indirect general partner interests in the Operating Partnership entitle it to share in cash distributions from, and in the profits and losses of, the Operating Partnership in proportion to its ownership interest therein and entitle the Company to vote on all matters requiring a vote of the limited partners.
Generally, the other limited partners of the Operating Partnership are persons who contributed their direct or indirect interests in certain properties to the Operating Partnership primarily in connection with the IPO and the South Florida Acquisition. The Operating Partnership is obligated to redeem each common unit of limited partnership ("Unit") held by a person other than the Company, at the request of the holder thereof for cash equal to the fair market value of a share of the Company's common shares of beneficial interest, par value $.01 per share ("Common Shares"), at the time of such redemption, provided that the Company at its option may elect to acquire any such Unit presented for redemption for one Common Share or cash. The Company presently anticipates that it will elect to issue Common Shares to acquire Units presented for redemption, rather than paying cash. With each such redemption the Company's percentage ownership interest in the Operating Partnership will increase. In addition, whenever the Company issues Common Shares, the Company is obligated to contribute any net proceeds therefrom to the Operating Partnership and the Operating Partnership is obligated to issue an equivalent number of Units to the Company. Units issued to the Company in connection with the issuance and sale by the Company of a series of preferred shares (and the subsequent contribution to the Operating Partnership of the net proceeds therefrom) ("Preferred Shares"), will, in general, have, with respect to other Units, rights and preferences that the series of Preferred Shares have with respect to the Common Shares.
The Operating Partnership may issue additional Units to acquire land parcels for the development of apartment communities or operating apartment communities in transactions that in certain circumstances defer some or all of the sellers' tax consequences. The Operating Partnership believes that many potential sellers of multifamily residential properties have a low tax basis in their properties and would be more willing to sell the properties in transactions that defer Federal income taxes. Offering Units instead of cash for properties may provide potential sellers partial Federal income tax deferral.
GEOGRAPHIC EXPANSION AND ACQUISITION. On April 1, 1998, Gables acquired the properties and operations of Trammell Crow Residential South Florida ("TCR/SF"), which consisted of fifteen multifamily apartment communities containing a total of 4,197 apartment homes, and all of TCR/SF's residential construction and development and third party management activities in South Florida (collectively, the "South Florida Acquisition"). The communities acquired in the South Florida Acquisition are located in Palm Beach County, Broward County and Dade County and encompass the metropolitan areas of Palm Beach, Fort Lauderdale and Miami, respectively. Such locations are collectively referred to herein as "Boca Raton" or "South Florida." Gables' management believes that the South Florida Acquisition facilitated the following goals:
- - Establishing a growth platform in the South Florida markets by integrating the existing operating, acquisition, development and construction personnel of TCR/SF into Gables' existing management team.
- - Allowing Gables to enter into the South Florida markets with a critical mass of multifamily apartment communities that have internal earnings growth potential and product quality characteristics consistent with Gables' existing portfolio.
- - Providing further geographic and economic diversification of Gables' portfolio of multifamily apartment communities, thereby enhancing the stability of Gables' cash flow.
- - Generating a pipeline of acquisition and development opportunities in the South Florida markets, which are characterized by high job growth and high barriers to entry.
- - Allowing Gables to generate economies of scale by spreading its corporate overhead costs over a larger portfolio and increasing its buying power with vendors.
- - Producing immediate earnings growth and accelerating long-term earnings growth.
As of December 31, 1998, Gables owned 84 multifamily apartment communities and had an indirect 25% interest in two multifamily apartment communities (collectively, the "Current Communities") located in the following major cities in Texas, Georgia, Florida and Tennessee: Houston, Dallas, Austin, San Antonio, Atlanta, Boca Raton, Orlando, Memphis and Nashville (the "Core Markets"). The Current Communities totaled 25,288 apartment homes and included two multifamily apartment communities in the final stages of lease-up. Gables also owned five multifamily apartment communities that were under construction at December 31, 1998 that Gables expects will comprise 1,613 apartment homes upon completion (collectively, the "Development Communities" and, with the Current Communities, the "Communities"). Gables also owns sites (the "Undeveloped Sites") on which it intends to develop seventeen additional multifamily apartment communities that Gables expects will comprise an estimated 4,093 apartment homes and has rights (the "Development Rights") to acquire additional sites on which Gables believes it could develop multifamily apartment communities comprising an estimated 1,570 apartment homes. See "Recent Developments" on page 9 for certain events occurring subsequent to December 31, 1998.
Gables' executive offices are located at 2859 Paces Ferry Road, in Atlanta, Georgia 30339 and its telephone number is (770) 436-4600.
MANAGEMENT STRUCTURE. Gables has been responsible for the development or acquisition of approximately 50,000 apartment homes since 1982 and its senior management team has, on average, in excess of fifteen years experience in the multifamily industry. Gables provides a full range of integrated real estate services through a staff of approximately 1,350 employees who have experience in property operations, development, acquisition and construction. Gables maintains offices in Atlanta, Boca Raton, Houston and Dallas, each with its own fully integrated organization, including experienced in-house management, development and acquisition staffs with specific knowledge of the particular markets served. Gables believes that its competitive strength and growth potential lie in management's in-depth knowledge of the changing opportunities available in each local market and in its locally focused management structure, which enables highly experienced development and acquisition personnel to pursue new opportunities in each market and highly experienced on-site managers to make the day-to-day decisions needed to maximize the performance of existing properties. The finance, accounting and administrative functions for Gables are controlled by a central staff located in Atlanta.
COMPETITIVE ADVANTAGES. Gables believes that it has several competitive advantages. These advantages include:
- - A fully integrated organization: a fully integrated organization with a track record of approximately sixteen years in all phases of real estate property management, development, acquisition, construction, rehabilitation, financing and marketing.
- - Product focus: a portfolio concentration of Class AA/A apartment communities that are targeted toward the lifestyle renter, are located primarily in in-fill locations and master-planned communities, and include garden, townhome and higher density apartment communities.
- - Local presence in multiple markets: an established local presence in each of its markets, which Gables serves through an experienced staff with superior knowledge of local markets and a culture which provides incentives for outstanding performance at all levels.
- - Geographic diversification: an established market presence in nine major markets in the Sunbelt Region that are geographically independent, rely on diverse economic foundations, and during the past several years have shown job growth substantially above national averages.
- - Service-oriented philosophy: a service-oriented philosophy which focuses on offering extensive resident amenities and services in quality apartment homes to increase occupancy and rental rates and reduce resident turnover.
The Management Companies - ------------------------
Gables' management operations with respect to properties in which Gables does not have an interest are conducted through subsidiaries of the Operating Partnership (the "Management Companies"). The Management Companies also provide other services to third parties, including construction, brokerage and corporate rental housing. Certain of these services are, or may also be, provided by the Operating Partnership directly, to the extent consistent with the gross income requirements for REITs under the Internal Revenue Code of 1986, as amended (the "Code"). To maintain the Company's qualifications as a REIT while realizing income from its fee management and related service business, the Operating Partnership owns 100% of the nonvoting common stock (representing 98.99% of the total equity) of each Management Company and 1% of the voting common stock (representing .01% of the total equity) of each Management Company. The nonvoting common stock and voting common stock owned by the Operating Partnership together represent 99% of the equity interests in each Management Company. Executive officers of GGPI hold, in the aggregate, the remaining 1% of the equity in each Management Company, representing 99% of the voting interest therein. The voting common stock held by such executive officers is subject to a provision of the by-laws of each Management Company that is designed to ensure that the stock will be held by officers of GGPI at all times. This bylaw provision of each Management Company cannot be amended without the vote of 100% of the outstanding voting common stock of such company.
Brand Name Strategy - -------------------
Gables is continuing to pursue a long standing strategy of brand name development by linking the "Gables" name to its communities. This strategy is intended to reinforce Gables' reputation and to build recognition of its multifamily communities as a high quality, recognizable brand. Gables believes that increased consumer recognition of the "Gables" brand name in each of its markets has enhanced its ability to attract new residents, increased the markets' perception of the Communities as high quality residential developments and enhanced its relationships with local authorities.
Business Objectives and Strategy of Gables - ------------------------------------------
OVERVIEW. The Company's objective is to increase shareowner value by being a profitable owner and operator of Class AA/A multifamily apartment communities in the Sunbelt Region of the United States. To achieve its objective, Gables employs a number of business strategies. First, Gables adheres to a strategy of owning and operating Class AA/A apartment communities which should maintain high levels of occupancy and rental rates. Gables believes that such communities, when supplemented with high quality services and amenities, attract the affluent renter-by-choice, who is willing to pay a premium for conscientious service and high quality communities. Accordingly, Gables' communities possess innovative architectural designs and numerous amenities and services that Gables believes are desired by its target customers. Second, Gables seeks to grow cash flow from operating communities through innovative, proactive property management that focuses on resident satisfaction and retention, increases in property rents and occupancy levels, and the control of operating expenses through improved economies of scale. Third, Gables develops and acquires high-quality apartment communities in in-fill locations and master-planned communities near major employment centers in the Sunbelt Region with the objective of achieving critical mass in the most desirable submarkets. Finally, due to the cyclical nature of the real estate markets, Gables has adopted an investment strategy based on a strong local presence and expertise, which it believes will allow for growth through acquisitions and development (as warranted by underlying market fundamentals) and will help ensure favorable initial and long-term returns. Gables believes the successful execution of these operating and investment strategies will result in operating cash flow growth.
Gables believes that it is well positioned to continue achieving its objective because of its long-established presence as a fully integrated real estate management, development, construction and acquisition company in its markets. Gables believes that its established, local market presence creates a competitive advantage during different economic cycles in generating increased cash flow from (i) property operations and (ii) new investment opportunities that involve local market knowledge, site selection and requests for entitlements and zoning petitions. Gables' markets are geographically independent, rely on diverse economic foundations and have experienced above-average job growth.
PROPERTY OPERATIONS. The property management group operates the Communities to maximize cash flow and create long-term value. This is achieved by aggressive marketing and leasing of apartment homes, providing the best possible resident service and maintaining the Communities to the highest standards. Management believes that excellent service will distinguish Gables from its competitors and will retain current residents and attract new prospects. Gables has a service oriented philosophy which is reinforced through its "College of Career Development" named Gables University. This comprehensive training system for Gables' employees is overseen by full-time training coordinators and offers classes in a variety of different schools, such as the School of Leasing, the School of People Resources and the School of Maintenance Development. Additionally, there are "degree" programs which are completed with graduation ceremonies. Service is also reinforced with quarterly "I Made a Difference" recognition ceremonies, where personal achievement by associates is acknowledged by senior management in each of the markets where Gables operates.
Financial and marketing information is collected and distributed through on-site computer systems at all Communities and effectively summarizes operating and marketing data critical for making accurate daily decisions. The system also compiles demographic profile information on prospective and current residents, allowing Gables to effectively target its customer base.
The property management group is strategically focused on the following areas:
- - EMPLOYEES. Hiring the highest quality associates possible through extensive screening and proactive recruiting, and encouraging loyalty and reducing employee turnover by providing outstanding training, career opportunities and benefit programs. The average tenure for vice presidents and regional managers of the group is over eight years and the average tenure of property managers is over six years.
- - RESIDENTS. Providing exceptional services to Gables' relatively affluent residents, who expect a service level commensurate with the high quality product and resultant high level rents.
- - FINANCIAL PERFORMANCE. Maximizing revenues from the Communities by empowering and encouraging property managers to make decisions regarding rental rates and implementation of marketing programs to attract and retain residents; reducing property operating expenses by continuously evaluating vendors and service contracts, utilizing volume discount purchasing programs and analyzing tax and utility expenses; and monitoring overall appearance and appeal of the Communities by ensuring cleanliness, investing wisely in major capital expenses and ensuring the quality of the landscaping.
DEVELOPMENT. The development team has extensive experience in the identification of sites, land planning, product development and construction in the Sunbelt Region. In evaluating whether to develop an apartment community, the development team analyzes current demographics and economic data such as household formation rates, income levels, rental rates and occupancies. Gables relies both on internal and external market research to determine the current position of the real estate cycle.
Successful development has been instrumental to the growth of Gables and, since 1982, Gables has developed approximately 30,000 apartment homes. Gables seeks to develop properties in markets where it discerns a strong demand, which Gables anticipates will enable it to achieve its targeted initial yields. Gables expects to continue to focus on the Sunbelt Region which, as a result of job growth and household formation, has generally experienced high occupancy levels and rising rents in recent years. The typical submarket where Gables develops its communities is one where resident profiles, including relatively high income households, justify the development of Class AA/A multifamily communities offering extensive resident amenities and services. Fundamental to Gables' development is its in-house construction group, which allows Gables to act as its own general contractor, which helps control quality, scheduling and cost. In addition, Gables' development and construction expertise has enabled it to develop a variety of multifamily communities, including Class AA/A garden apartments, townhomes and higher density apartments in a variety of geographic areas.
ACQUISITION. Gables also focuses its efforts on the acquisition of existing multifamily communities which management believes are consistent with the characteristics of its existing portfolio or present opportunities for creating value, including properties requiring extensive renovations and market repositioning. Since 1982, Gables has acquired and repositioned communities comprising a total of approximately 20,000 apartment homes, of which approximately 3,000 apartment homes were value-added acquisitions which required substantial redevelopment, repositioning, and strong management skills. Gables will seek to invest in those properties that management believes are available at prices below estimated replacement cost, are located in submarkets with a relatively high income population with close proximity to major employment centers, and are capable of growth in cash flow through application of Gables' management ability and strategic capital improvements.
FEE MANAGEMENT BUSINESS AND RELATED SERVICES. As of December 31, 1998, Gables managed for third parties 53 multifamily communities comprising approximately 17,500 apartment homes. These fee management contracts are maintained with a total of approximately 27 owners. In addition to contributing modestly to earnings, engaging in fee management allows Gables to leverage its management operations costs, provides access to development and acquisition opportunities and provides Gables with additional market knowledge. In addition to its fee management business, Gables provides other services through the Management Companies, including construction and brokerage services and the provision of corporate rental housing.
Competition - ------------
All of the Communities are located in developed areas that include other apartment communities. The number of competitive multifamily communities in a particular area could have a material effect on Gables' ability to lease apartment homes at the Communities or at any newly developed or acquired community, as well as on the rents charged. Gables may be competing for development and acquisition opportunities with others that have greater resources than Gables (including other REITs). In addition, the Communities must compete for residents with new and existing homes and condominiums. The home affordability index in all of Gables' markets is above the national average. This competitive environment is partially offset by the propensity to rent for households in Gables' markets which in all cases exceeds the national average.
The fee management business is highly competitive, and Gables faces competition from a variety of local, regional and national firms. Gables competes against these firms by stressing the quality and experience of its employees, the services provided by Gables and the market presence and experience it has developed over the past fifteen years. Gables may, nevertheless, lose some of its third party management business, particularly when such properties are sold.
Environmental Matters - ---------------------
Under various Federal, state and local environmental laws, ordinances and regulations, a current or previous owner or operator of real property may be required to investigate and clean up hazardous or toxic substances or petroleum product releases at such property, and may be held liable to a governmental entity or to third parties for property damage and for investigation and clean-up costs incurred by such parties in connection with the contamination. Such laws, ordinances and regulations typically impose clean-up responsibility and liability without regard to whether the owner knew of or caused the presence of the contaminants, and the liability under such laws has been interpreted to be joint and several unless the harm is divisible and there is a reasonable basis for allocation of responsibility. The cost of investigation, remediation or removal of such substances may be substantial, and the presence of such substances, or the failure to properly remediate the contamination on such property, may adversely affect the owner's ability to sell or rent such property or to borrow using such property as collateral. Persons who arrange for the disposal or treatment of hazardous or toxic substances also may be liable for the costs of removal or remediation of such substances at the disposal or treatment facility, whether or not such facility is owned or operated by such person. In addition, some environmental laws create a lien on the contaminated site in favor of the government for damages and costs it incurs in connection with the contamination. Finally, the owner or operator of a site may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from a site. In connection with the ownership, operation, management and development of the Communities and other real properties, Gables may be potentially liable for such damages and costs.
Certain Federal, state and local laws, ordinances and regulations govern the removal, encapsulation and disturbance of asbestos-containing materials ("ACMs") when such materials are in poor condition or in the event of construction, remodeling, renovation or demolition of a building. Such laws, ordinances and regulations may impose liability for release of ACMs and may provide for third parties to seek recovery from owners or operators of real properties for personal injury associated with ACMs. In connection with its ownership, operation, management and development of the Communities and other real properties, Gables may be potentially liable for such costs.
In addition, recent studies have linked radon, a naturally-occurring substance, to increased risks of lung cancer. While there are currently no state or Federal requirements regarding the monitoring for, presence of, or exposure to, radon in indoor air, the U.S. Environmental Protection Agency ("EPA") and the Surgeon General recommend testing residences for the presence of radon in indoor air, and the EPA further recommends that concentrations of radon in indoor air be limited to less than 4 picocuries per liter of air (pCi/L) (the "Recommended Action Level"). The presence of radon in concentrations equal to or greater than the Recommended Action Level in a Community may adversely affect Gables' ability to rent apartment homes in that Community and the market value of the Community.
Finally, recently-enacted Federal legislation will eventually require owners and landlords of residential housing constructed prior to 1978 to disclose to potential tenants or purchasers of the Communities any known lead-paint hazards and will impose treble damages for failure to so notify. In addition, lead-based paint in any of the Communities may result in lead poisoning in children residing in that Community if chips or particles of such lead-based paint are ingested, and Gables may be held liable under state laws for any such injuries caused by ingestion of lead-based paint by children living at the Communities.
Gables' assessments of the Communities have not revealed any environmental liability that Gables believes would have a material adverse effect on Gables' business, assets or results of operations, nor is Gables aware of any such material environmental liability. Nevertheless, it is possible that Gables' assessments do not reveal all environmental liabilities or that there are material environmental liabilities of which Gables is unaware. Moreover, there can be no assurance that (i) future laws, ordinances or regulations will not impose any material environmental liability or (ii) the current environmental condition of the Communities will not be affected by tenants, by the condition of land or operations in the vicinity of the properties (such as the presence of underground storage tanks), or by third parties unrelated to Gables.
Gables believes that no ACMs were used in connection with the construction of the Communities or will be used in connection with future construction by the Company. Gables' environmental assessments have revealed the presence of "potentially friable" ACMs at two Current Communities and non-friable ACMs at four Current Communities. Gables has programs in place to maintain and monitor ACMs. Gables believes that the Communities are in compliance in all material respects with all Federal, state and local laws, ordinances and regulations regarding hazardous or toxic substances or petroleum products. Gables has not been notified by any governmental authority, and is not otherwise aware, of any material noncompliance, liability or claim relating to hazardous or toxic substances or petroleum products in connection with any of its present properties that would involve substantial expenditure, and Gables does not believe that compliance with applicable environmental laws or regulations will have a material adverse effect on Gables or its financial condition or results of operations.
Costs of Compliance with Americans with Disabilities Act and Similar Laws - -------------------------------------------------------------------------
Under the Americans with Disabilities Act of 1990 (the "ADA"), all places of public accommodation are required to meet certain Federal requirements related to access and use by disabled persons. These requirements became effective in 1992. Management of Gables believes that the Communities are substantially in compliance with present requirements of the ADA, as they apply to multifamily dwellings. A number of additional Federal, state and local laws exist which also may require modifications to the Communities, or regulate certain further renovations thereof, with respect to access thereto by disabled persons. For example, the Fair Housing Amendments Act of 1988 (the "FHAA") requires apartment communities first occupied after March 13, 1990 to be accessible to the handicapped. Noncompliance with the FHAA could result in the imposition of fines or an award of damages to private litigants. Gables believes that the Communities that are subject to the FHAA are in compliance with such law.
Additional legislation may impose further burdens or restrictions on owners with respect to access by disabled persons. The ultimate amount of the cost of compliance with the ADA or such legislation is not currently ascertainable, and, while such costs are not expected to have a material effect on Gables, such costs could be substantial. Limitations or restrictions on the completion of certain renovations may limit application of Gables' investment strategy in certain instances or reduce overall returns on Gables' investments.
Insurance - ---------
Gables carries comprehensive liability, fire, extended coverage and rental loss insurance with respect to all of the Current Communities, with policy specifications, insured limits and deductibles customarily carried for similar properties. Gables carries similar insurance with respect to its other properties, but with such exceptions as are appropriate given the undeveloped nature of certain of these properties. There are, however, certain types of losses (such as losses arising from acts of war) that are not generally insured because they are either uninsurable or not economically insurable. Should an uninsured loss or a loss in excess of insured limits occur, Gables could lose its capital invested in a property, as well as the anticipated future revenues from such property and would continue to be obligated on any mortgage indebtedness or other obligations related to the property. Any such loss would adversely affect Gables.
Employees - ---------
Gables provides a full range of real estate services through a staff of approximately 1,350 employees, including an experienced management team. There are no collective bargaining agreements with any of Gables' employees.
Tax Matters - -----------
The Operating Partnership is a limited partnership and as such is not subject to Federal or state income taxes. The partners of the Operating Partnership are required to include their respective share of profits and losses in their income tax returns. The Company elected to be taxed as a REIT under the Code, commencing with the taxable year ended December 31, 1994, and intends to maintain its qualification as a REIT in the future. As a qualified REIT, with limited exceptions, the Company will not be taxed under Federal and certain state income tax laws at the corporate level on its net income.
Policies with Respect to Certain Activities - -------------------------------------------
The following is a discussion of certain investment, financing and other policies of Gables. These policies have been determined by The Company's Board of Trustees and GGPI's Board of Directors (collectively, the "Board") and may be amended or revised from time to time by the Board without a vote of the Company's shareholders, except that (i) the Company cannot change its policy of holding its assets and conducting its business only through the Operating Partnership, the Management Companies and other permitted subsidiaries without the consent of the holders of Units as provided in the partnership agreement of the Operating Partnership, (ii) changes in certain policies with respect to conflicts of interest must be consistent with legal requirements, and (iii) the Company cannot take any action intended to terminate its qualification as a REIT without the approval of the holders of two-thirds of the Common Shares.
INVESTMENT POLICIES. The Company will conduct all its investment activities through the Operating Partnership and its subsidiaries. Gables' investment objectives are to provide quarterly cash distributions and achieve long-term capital appreciation through increases in the value of Gables. Gables may purchase income-producing multifamily apartments or other types of properties for long-term investment, expand and improve the communities presently owned or other properties purchased, or sell such communities or other properties, in whole or in part, when circumstances warrant. Gables may also participate with third parties in apartment community ownership, through joint ventures or other types of co-ownership. Equity investments may be subject to existing mortgage financing and other indebtedness or such financing or indebtedness as may be incurred in connection with acquiring or refinancing these investments. Debt service on such financing or indebtedness will have a priority over the Company's Common Shares and any distributions thereon.
While Gables emphasizes equity real estate investments in multifamily apartment communities, it may, in the discretion of the Board, invest in other types of equity real estate investments, mortgages (including participating or convertible mortgages) and other real estate interests. Gables currently intends to invest in apartment communities in the Sunbelt Region. However, future development or investment activities will not be limited to any geographic area or product type or to a specified percentage of Gables' assets. Gables will not have any limit on the amount or percent of its assets invested in one property. Subject to the percentage of ownership limitations and gross income and asset tests necessary for REIT qualification, Gables also may invest in securities of other REITs, other entities engaged in real estate activities or securities of other issuers, including for the purpose of exercising control over such entities, although it does not presently intend to do so and it has not done so in the past. Gables may enter into joint ventures or partnerships for the purpose of obtaining an equity interest in a particular property in accordance with Gables' investment policies. Such investments may permit Gables to own interests in larger assets without unduly restricting diversification and,
therefore, add flexibility in structuring its portfolio. Gables will not enter into a joint venture or partnership to make an investment that would not otherwise meet its investment policies. Investment in these securities is also subject to Gables' policy not to be treated as an investment company under the Investment Company Act of 1940.
FINANCING POLICIES. The debt to total market capitalization ratio of Gables (i.e., the total consolidated debt of Gables as a percentage of the December 31, 1998 market value of outstanding Common Shares of the Company and Operating Partnership Units, plus total consolidated debt and preferred shares and units at liquidation value) was approximately 47% at December 31, 1998. Excluding construction-related indebtedness, this ratio was 42% at December 31, 1998. This ratio will fluctuate with changes in the price of the Common Shares (and the issuance of additional Common Shares, or other forms of shares of beneficial interest, if any) and differs from the debt to book capitalization ratio, which is based upon book values. This percentage will increase as Gables uses financing to continue construction of the Development Communities and to acquire additional multifamily apartment communities. As the debt to book capitalization ratio may not reflect the current income potential of a company's assets and operations, Gables believes that, in most circumstances, the debt to total market capitalization ratio provides an alternative indication of leverage for a company whose assets are primarily income-producing real estate and should be evaluated along with the debt service coverage and underlying components of Gables' indebtedness.
Gables currently has a policy of incurring debt only if upon such incurrence the ratio of debt to total market capitalization would be 60% or less. The Company's Amended and Restated Declaration of Trust and Second Amended and Restated Bylaws do not, however, limit the amount or percentage of indebtedness that Gables may incur. In addition, Gables may from time to time modify its debt policy in light of current economic conditions, relative costs of debt and equity capital, market values of its Communities, general conditions in the market for debt and equity securities, fluctuations in the market price of Common Shares, growth opportunities and other factors. Accordingly, Gables may increase or decrease its debt to total market capitalization ratio beyond the limits described above. To the extent that the Board decides to obtain additional capital, Gables may raise such capital through additional equity offerings (including offerings of senior securities), debt financings or retention of Funds from Operations (subject to satisfying provisions in the Code, requiring minimum distributions of net income in order to maintain tax status as a REIT), or a combination of these methods. Gables presently anticipates that any additional borrowings would be made through the Operating Partnership, although the Company might incur indebtedness, the proceeds of which would be reloaned to the Operating Partnership. Borrowings may be unsecured or may be secured by any or all of the assets of the Company, the Operating Partnership or any existing or new property owning partnership and may have full or limited recourse to all or any portion of the assets of the Company, the Operating Partnership or any existing or new property owning partnership. Indebtedness incurred by Gables may be in the form of bank borrowings, tax-exempt bonds, purchase money obligations to sellers of apartment communities or other properties, publicly or privately placed debt instruments or financing from institutional investors or other lenders. The proceeds from any borrowings by Gables may be used for working capital, to refinance existing indebtedness and to finance acquisitions, expansions or development of new communities and other properties, and for the payment of distributions. Gables has not established any limit on the number or amount of mortgages that may be placed on any single property or on its portfolio as a whole.
Gables currently has a senior unsecured debt rating of BBB from Standard and Poor's and Baa2 from Moody's Investors Service. The Company's Series A Preferred Shares currently have a rating of BBB- from Standard and Poor's and baa3 from Moody's Investors Service. Gables intends to adhere to financing policies that will allow it to maintain these investment grade credit ratings.
CONFLICT OF INTEREST POLICIES. As part of their employment agreements, each of Messrs. Bromley, Rippel, Clark, Banks and Wheeler is bound by a non-competition covenant with the Company. These non-competition covenants provide that during the term of employment, and for a period of one year following termination of employment under certain circumstances, each individual is prohibited from, directly or indirectly, competing with the Company with respect to any multifamily apartment residential real estate property development, construction, acquisition or management activities then undertaken or being considered by the Company. These employment agreements also contain certain non-solicitation covenants, whereby each individual subject to such an agreement is prohibited, during the term of employment and for a period of one year thereafter, from, directly or indirectly (i) soliciting or inducing any present or future employee of the Company to accept employment with such individual or any person or entity associated with such individual, (ii) employing, or causing any person or entity associated with such individual to employ, any present or future employee of the Company without providing the Company with prior written notice of such proposed employment or (iii) either for himself or for any other person or entity, competing for or soliciting the third party owners with whom the Company has an existing property management agreement. The employment agreements with Mssrs. Bromley, Rippel, Clark and Banks terminate on January 1,
2000 but are automatically extended for additional one-year periods unless notice is given by the Company or the employee, three months prior to the agreement's expiration, that the agreement will not be renewed. The employment agreement with Mr. Wheeler terminates on September 30, 1999, but also provides for automatic one-year extensions subject to notice of non-renewal. See "Recent Developments" below.
The Company has adopted a policy that, without the approval of a majority of the trustees who are neither officers of the Company nor affiliated with the Company, it will not (i) acquire from or sell to any trustee, officer or employee of the Company, or any entity in which a trustee, officer or employee of the Company beneficially owns more than a 1% interest, or acquire from or sell to any affiliate of any of the foregoing, any of the assets or other property of the Company, (ii) make any loan to or borrow from any of the foregoing persons or (iii) engage in any other transaction with any of the foregoing persons.
Recent Developments - -------------------
On March 4, 1999, Gables sold an apartment community located in Atlanta comprising 213 apartment homes for $19.3 million.
On March 18, 1999, Gables announced the resignation of John Rippel as President and Chief Operating Officer effective in May, 1999. Marc Bromley, Chief Executive Officer, will oversee property operations until the position is filled.
On March 22, 1999, the Company announced a common share repurchase program pursuant to which the Company is authorized to purchase up to $50 million of its outstanding Common Shares. The Company plans to repurchase shares from time to time in open market and privately negotiated transactions, depending on market prices and other conditions using proceeds from sales of selected assets.
On March 26, 1999, Gables entered into a joint venture agreement with an affiliate of J.P. Morgan Investment, Inc. ("J.P. Morgan"). The business purpose of the venture is to develop, own and operate seven multifamily apartment communities located in four of Gables' nine markets, which are expected to comprise 2,181 apartment homes. As of December 31, 1998, Gables (i) had commenced construction of four of the communities, (ii) owned the land for the future development of two of the communities and (iii) owned the acquisition right for the land for the future development of one of the communities. The capital budget for the development of the seven communities is approximately $213 million and is anticipated to be funded with 50% debt and 50% equity. The equity component will be funded 80% by J.P. Morgan and 20% by Gables. Gables' portion of the equity will be funded through a contribution of cash and property. Gables will serve as the managing member of the venture and will have responsibility for all day-to-day operating issues. Gables will also serve as the general contractor during construction and as the property manager.
ITEM 2.
ITEM 2. PROPERTIES
As of December 31, 1998, Gables owned or had an interest in 86 Current Communities, consisting of 25,288 apartment homes, and owned five Development Communities, consisting of 1,613 apartment homes. The Communities, comprising a total of 26,901 apartment homes, are located in Texas, Georgia, Florida and Tennessee. The following table shows the locations of the Communities and the number of apartment homes in each metropolitan area:
CURRENT COMMUNITIES. Gables developed 41 Current Communities (consisting of 11,531 apartment homes), and acquired 45 Current Communities (consisting of 13,757 apartment homes). All of the Current Communities are managed and operated by the Company. The Current Communities typically are two and three story garden apartments, townhomes and higher-density apartments. As of December 31, 1998, the Current Communities had an average scheduled monthly rental rate per apartment home of approximately $863 and, with the exception of two Current Communities in the final lease-up phase, had a physical occupancy rate of 94%. The average age of the Current Communities is approximately eight years. Most of the Communities offer many attractive features designed to enhance their market appeal, such as vaulted ceilings, fireplaces, dishwashers, disposals, washer/dryer connections, ice-makers, patios and decks. Recreational facilities include swimming pools, fitness facilities, playgrounds, picnic areas and tennis and racquetball courts. In many Communities, Gables makes amenities and services available to residents, such as aerobic classes, resident social events, dry cleaning pick up and delivery, and the use of fax, computer and copy equipment. In-depth market research, including periodic focus groups with residents and feedback from on-site management personnel, is used to refine and enhance management services and community design.
DEVELOPMENT COMMUNITIES. The Development Communities have been designed to generally resemble the Current Communities developed by Gables and to offer similar amenities. The Development Communities and the recently completed Current Communities reflect Gables' continuing research of consumer preferences for upscale multifamily rental housing and incorporate and emphasize garage parking, increased privacy, high quality interiors and private telephone and television systems. Certain information regarding Gables' Development Communities at December 31, 1998 is presented below:
UNDEVELOPED SITES. As of December 31, 1998, Gables owned seventeen Undeveloped Sites and intends to develop multifamily communities at those sites in the future:
Metropolitan Estimated Number Undeveloped Sites Area of Apartment Homes - ----------------- ---------------- ------------------ Gables at Sugarloaf II Atlanta, GA 300 Gables at Sugarloaf III Atlanta, GA 300 Gables Metropolitan II Atlanta, GA 200 Gables Plaza Atlanta, GA 100 Gables Green Oaks II Dallas, TX 200 Gables State Thomas I Dallas, TX 290 (1) Gables State Thomas II Dallas, TX 123 Gables State Thomas III Dallas, TX 300 Gables State Thomas IV Dallas, TX 300 Gables at Little Lake Bryan II/III Orlando, FL 448 Gables Celebration II Orlando, FL 315 Gables Meyer Park II Houston, TX 296 Gables New Territory II Houston, TX 248 Gables White Oak Houston, TX 186 Gables Colonnade II San Antonio, TX 150 Gables Palma Vista Boca Raton, FL 189 (1) Gables Quail Ridge II Memphis, TN 148 ----- Total 4,093 =====
(1) Represents an Undeveloped Site that was contributed into the joint venture with J.P. Morgan in March, 1999. See "Recent Developments" in Item 1.
There can be no assurance of when or if the Undeveloped Sites will be developed.
DEVELOPMENT RIGHTS. As of December 31, 1998, Gables had five Development Rights which are located in three cities:
Metropolitan Estimated Number Development Right Area of Apartment Homes ------------------ --------------- -------------------- Gables at Grand Isle Boca Raton, FL 320 (1) Gables Crestwood Boca Raton, FL 290 Gables Stuart Boca Raton, FL 220 Gables at First Street Austin, TX 400 Gables at Little Lake Bryan IV Orlando, FL 340 (2) ----- Total 1,570 =====
(1) Represents a Development Right that was contributed into the joint venture with J.P. Morgan in March, 1999. See "Recent Developments" in Item 1.
(2) Gables has this land parcel under option.
There can be no assurance of when or if the Development Rights will be exercised.
The projections contained in the tables above under the captions "Development Communities," "Undeveloped Sites" and "Development Rights" are forward-looking statements. These forward-looking statements involve risks and uncertainties and actual results may differ materially from those projected in the forward-looking statements. Risks associated with Gables' development, construction and land acquisition activities, which could impact the forward-looking statements made, include: development and acquisition opportunities may be abandoned; construction costs of a community may exceed original estimates, possibly making the community uneconomical; and construction and lease-up may not be completed on schedule, resulting in increased debt service and construction costs. Development of the Undeveloped Sites and the Development Rights is subject to permits and other governmental approvals, as well as ongoing business review by Gables of the underlying real estate fundamentals and the impact on its capital structure. There can be no assurance that Gables will decide or be able to develop the Undeveloped Sites, to complete development of all or any of the communities subject to the Development Rights, or to complete the number of apartment homes shown above.
CURRENT COMMUNITY FEATURES AS OF DECEMBER 31, 1998 --------------------------------------------------
CURRENT COMMUNITY FEATURES AS OF DECEMBER 31, 1998 --------------------------------------------------
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
Neither Gables nor any of the Communities is presently subject to any material litigation or, to Gables' knowledge, is any litigation threatened against Gables or any of the Communities, other than routine actions for negligence or other claims and administrative proceedings arising in the ordinary course of business, some of which are expected to be covered by liability insurance and all of which collectively are not expected to have a material adverse effect on the business or financial condition of Gables.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS
There is no established public trading market for the Units. As of March 18, 1999, there were 90 holders of record of Units.
The following table sets forth the quarterly distributions per Unit to holders of its Units for the period indicated.
Distribution Quarter Ended Declared - ------------- ------------
March 31, 1997 $0.49 June 30, 1997 0.49 September 30, 1997 0.50 December 31, 1997 0.50 March 31, 1998 0.50 June 30, 1998 0.50 September 30, 1998 0.51 December 31, 1998 0.51 March 31, 1999 0.51
The Operating Partnership currently intends to make quarterly distributions to holders of its Units. Distributions are declared at the discretion of the Board of Directors of GGPI, the general partner of the Operating Partnership, and will depend on actual funds from operations of the Operating Partnership, its financial condition, capital requirements, the annual distribution requirements under the REIT provisions of the Code and such other factors as the board of directors may deem relevant. The Board of Directors may modify the Operating Partnership's distribution policy from time to time.
Certain of the Operating Partnership's loan agreements contain customary representations, covenants and events of default, including covenants which restrict the ability of the Operating Partnership to make distributions in excess of stated amounts. In general, during any fiscal year the Operating Partnership may only distribute up to 95% of the Operating Partnership's consolidated income available for distribution (as defined in the related agreement) exclusive of distributions of capital gains for such year. The applicable loan agreements contain exceptions to these limitations to allow the Operating Partnership to make any distributions necessary to allow the Company to maintain its status as a REIT. The Operating Partnership does not anticipate that this provision will adversely effect the ability of the Operating Partnership to make distributions, as currently anticipated.
On November 12, 1998, the Operating Partnership issued 2,000,000 of its Series B Preferred Units (the "Series B Units") to an institutional investor at a gross price of $25.00 per unit, resulting in net proceeds to the Operating Partnership of approximately $48.7 million. The Series B Units are exchangeable into the Company's 8.625% Series B Cumulative Redeemable Preferred Shares on a one-for-one basis. The exchange right is exercisable, in whole but not in part, at the option of holders of 51% of the Series B Units (i) at any time on or after November 15, 2008, (ii) at any time if full quarterly distributions shall not have been made for six quarters, whether or not consecutive, or (iii) upon the occurrence of certain specified events related to the treatment of the
Series B Units for Federal income tax purposes. The Series B Units were issued in reliance on an exemption from registration under Section 4(2) of the Securities Act, and the rules and regulations promulgated thereunder.
On December 9, 1998, the Operating Partnership issued 18,482 Units (valued at approximately $0.5 million at the time of issuance) in connection with the April, 1998 acquisition of four apartment communities comprising 913 apartment homes located in Houston. Such Units were issued in reliance on an exemption from registration under Section 4(2) of the Securities Act, and the rules and regulations promulgated thereunder.
Each time the Company issues shares of beneficial interest, it contributes the proceeds of such issuance to the Operating Partnership in return for a like number of units with rights and preferences analogous to the shares issued. During the period commencing on October 1, 1998 and ending on December 31, 1998, in connection with issuances of common shares by the Company during that time period, the Operating Partnership issued an aggregate 129,881 Units to the Company. Such Units were issued in reliance on an exemption from registration under Section 4(2) of the Securities Act and the rules and regulations promulgated thereunder.
ITEM 6.
ITEM 6. SELECTED FINANCIAL AND OPERATING INFORMATION
The following table sets forth selected financial and operating information on a historical basis for the Operating Partnership and on a combined historical and pro forma basis for the Operating Partnership's predecessors as applicable. The following information should be read in conjunction with all of the financial statements and notes thereto included elsewhere herein. The consolidated operating information of the Operating Partnership for the years ended December 31, 1998, 1997 and 1996 have been derived from the financial statements audited by Arthur Andersen LLP, independent public accountants, whose report with respect thereto is included elsewhere herein. The consolidated operating information of the Operating Partnership for the year ended December 31, 1995 and for the period from January 26, 1994 to December 31, 1994 and the combined operating information of the Operating Partnership's predecessors for the period from January 1, 1994 to January 25, 1994 has been derived from audited financial statements not included in such report.
The unaudited selected pro forma financial operating information is presented as if the IPO and the various related formation transactions occurred as of the beginning of the period presented. The pro forma financial information is not necessarily indicative of what the actual financial position and results of operations of the Operating Partnership would have been as of the date or for the period indicated, nor does it purport to represent the Operating Partnership's future financial position and results of operations.
SELECTED FINANCIAL AND OPERATING INFORMATION
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Amounts in Thousands, Except Property and Per Unit Amounts)
Overview - --------
The Operating Partnership is the entity through which the Company, a real estate investment trust (a "REIT") focused within the multifamily industry in the Sunbelt Region of the United States, conducts substantially all of its business and owns (either directly or through subsidiaries) substantially all of its assets. Gables' operating performance relies predominantly on net operating income from its apartment communities. Gables' net operating income is influenced by operating expenses and rental revenues, which are affected by the supply and demand dynamics within Gables' markets. Gables' performance is also affected by the general availability and cost of capital and by its ability to develop and to acquire additional apartment communities with returns in excess of its blended cost of equity and debt capital.
The Company's objective is to increase shareowner value by being a profitable owner and operator of Class AA/A multifamily apartment communities in the Sunbelt Region. To achieve its objective, Gables employs a number of business strategies. First, Gables adheres to a strategy of owning and operating Class AA/A apartment communities which should maintain high levels of occupancy and rental rates. Gables believes that such communities, when supplemented with high quality services and amenities, attract the affluent renter-by-choice, who is willing to pay a premium for conscientious service and high quality communities. Accordingly, Gables' communities possess innovative architectural designs and numerous amenities and services that Gables believes are desirable by its target customers. Second, Gables seeks to grow cash flow from operating communities through innovative, proactive property management that focuses on resident satisfaction and retention, increases in property rents and occupancy levels, and the control of operating expenses through improved economies of scale. Third, Gables develops and acquires high-quality apartment communities in in-fill locations and master-planned communities near major employment centers in the Sunbelt with the objective of achieving critical mass in the most desirable submarkets. Finally, due to the cyclical nature of the real estate markets, Gables has adopted an investment strategy based on strong local presence and expertise, which it believes will allow for growth through acquisition and development (as warranted by underlying market fundamentals) and will help ensure favorable initial and long-term returns. Gables believes the successful execution of these operating and investment strategies will result in operating cash flow growth.
Gables believes it is well positioned to continue achieving its objective because of its long-established presence as a fully integrated real estate management, development, construction and acquisition company in its markets. Gables believes that its established, local market presence creates a competitive advantage in generating increased cash flow from (i) property operations during different economic cycles and (ii) new investment opportunities that involve site selection, market information and requests for entitlements and zoning petitions. Gables' markets are geographically independent, rely on diverse economic foundations and have experienced above-average job growth.
Portfolio-wide occupancy levels have remained high and portfolio-wide rental rates have continued to increase during each of the last several years. Gables expects portfolio-wide rental expenses to increase at a rate slightly ahead of inflation, but less than the increase in property revenues, for the coming twelve months. In certain situations, management's evaluation of the growth prospects for a specific asset may result in a determination to dispose of the asset. In this event, management would intend to sell the asset and utilize the net proceeds from any such sale to invest in new assets which are expected to have better growth prospects, reduce indebtedness or, in certain circumstances with appropriate approval from the board of trustees, repurchase outstanding common shares. Gables maintains staffing levels sufficient to meet the existing construction, acquisition, and leasing activities. If market conditions warrant, management would anticipate adjusting staffing levels to mitigate a negative impact on results of operations.
The following discussion and analysis of the financial condition and results of operations should be read in conjunction with the accompanying consolidated financial statements and the notes thereto.
This report contains forward-looking statements. Actual results or developments could differ materially from those projected in such statements as a result of the risk factors set forth in the relevant paragraphs of "Management's Discussion and Analysis of Financial Condition and Results of Operations" and elsewhere in this report.
MANAGEMENT'S DISCUSSION AND ANALYSIS (Amounts in Thousands, Except Property and Per Unit Amounts) - -----------------------------------------------------------
Recent Portfolio Acquisitions - -----------------------------
On April 1, 1998, Gables acquired the properties and operations of Trammell Crow Residential South Florida ("TCR/SF"), which consisted of fifteen multifamily apartment communities containing a total of 4,197 apartment homes, and all of TCR/SF's residential construction and development and third party management activities in South Florida (collectively, the "South Florida Acquisition"). In consideration for such properties and operations, Gables (i) paid $155.0 million in cash, (ii) assumed approximately $135.9 million of tax-exempt debt and (iii) issued approximately 2,348 Units, valued at approximately $64.9 million. The cash portion of the purchase price was funded through borrowings under Gables' unsecured credit facilities (the "Credit Facilities"). In addition, up to $12.5 million of the purchase price was deferred by Gables until January 1, 2000, at which time Gables will issue a number of Units equal in value to such deferred amount. The acquisition increased the size of Gables' portfolio under management on April 1, 1998 from approximately 28,000 to 40,000 apartment homes.
In April, 1998, Gables acquired four multifamily apartment communities comprising a total of 913 apartment homes located in Houston, Texas (the "Greystone Acquisition"). In connection with such acquisition, Gables assumed approximately $31.0 million of indebtedness, at fair value, and issued approximately 665 Units valued at $18.0 million.
Secondary Offerings and Issuances of Operating Partnership Units - ----------------------------------------------------------------
SECONDARY COMMON SHARE OFFERINGS
Since the IPO, the Company has issued a total of 14,831 common shares in eight offerings generating $347,771 in net proceeds which were generally used (i) to reduce outstanding indebtedness under interim financing vehicles utilized to fund Gables' development and acquisition activities (the "Interim Financing Vehicles") and (ii) for general working capital purposes including funding of future development and acquisition activities.
PREFERRED SHARE OFFERINGS
On July 24, 1997, the Company issued 4,600 shares of 8.30% Series A Cumulative Redeemable Preferred Shares (liquidation preference $25.00 per share) (the "Series A Preferred Shares"). The net proceeds from this offering of approximately $111.0 million were used to reduce outstanding indebtedness under the Interim Financing Vehicles. The Series A Preferred Shares, which may be redeemed by the Company at $25.00 per share, plus accrued and unpaid dividends, on or after July 24, 2002, have no stated maturity, sinking fund or mandatory redemption and are not convertible into any other securities of the Company.
On June 18, 1998, the Company issued 180 shares of 5.0% Series Z Cumulative Redeemable Preferred Shares (liquidation preference $25.00 per share) (the "Series Z Preferred Shares") in connection with the acquisition of a parcel of land for future development. The Series Z Preferred Shares, which may be redeemed by the Company at $25.00 per share, plus accrued and unpaid dividends, at any time, are subject to mandatory redemption on June 18, 2018. The Series Z Preferred Shares are not subject to any sinking fund and are not convertible into any other securities of the Company.
ISSUANCES OF COMMON OPERATING PARTNERSHIP UNITS
Since the IPO, Gables has issued a total of 3,917 Units in connection with the South Florida Acquisition, the Greystone Acquisition and the acquisition of operating apartment communities and a parcel of land for future development.
ISSUANCE OF PREFERRED OPERATING PARTNERSHIP UNITS
On November 12, 1998, the Operating Partnership issued 2,000 of its 8.625% Series B Preferred Units (the "Series B Preferred Units") to an institutional investor. The net proceeds from this issuance of approximately $48.7 million were used to reduce outstanding indebtedness under the Interim Financing Vehicles. The Series B Preferred Units may be redeemed by the Company at its option after November 14, 2003 and are exchangeable by the holder into 8.625% Series B Cumulative Redeemable Preferred Shares of the Company on a one-for-one basis. This exchange right is generally not exercisable until after November 14, 2008. The Series B Preferred Units have no stated maturity, sinking fund, or mandatory redemption.
RESULTS OF OPERATIONS - ---------------------
COMPARISON OF OPERATING RESULTS OF GABLES FOR THE YEAR ENDED DECEMBER 31, 1998 (THE "1998 PERIOD") TO THE YEAR ENDED DECEMBER 31, 1997 (THE "1997 PERIOD").
Gables' net income is generated primarily from the operation of its apartment communities. For purposes of evaluating comparative operating performance, Gables categorizes its operating communities based on the period each community reaches stabilized occupancy. A community is considered by Gables to have achieved stabilized occupancy on the earlier to occur of (i) attainment of 93% physical occupancy or (ii) one year after completion of construction. The operating performance for all of Gables' apartment communities combined for the years ended December 31, 1998 and 1997 is summarized as follows:
MANAGEMENT'S DISCUSSION AND ANALYSIS (Amounts in Thousands, Except Property and Per Unit Amounts) - -----------------------------------------------------------
Total property revenues increased $70,587, or 50.9%, from $138,693 to $209,280 due primarily to increases in the number of apartment homes resulting from the acquisition and development of additional communities and to increases in rental rates on communities stabilized throughout both periods ("same store"). Below is additional information regarding the increases in total property revenues for three of the five community categories presented in the preceding table:
Same store communities:
Communities stabilized during the 1998 Period but not during the 1997 Period:
Increase Number of in Total Occupancy Number of Apartment Percent Property During the Market Communities Homes Of Total Revenues 1998 Period - ------ ----------- ----- -------- -------- -----------
Atlanta 4 1,246 61.2% $4,024 95.0% Memphis 2 490 24.1% 509 94.1% Dallas 1 300 14.7% 59 91.2% ----- ------ ------- ------ ------- 7 2,036 100.0% $4,592 94.2% ===== ====== ======= ====== =======
Development and lease-up communities:
Increase Number of In Total Occupancy Number of Apartment Percent Property During the Market Communities Homes Of Total Revenues 1998 Period - ------ ----------- ----- -------- -------- -----------
Austin 2 529 31.5% $3,569 76.3% Orlando 2 511 30.4% 2,521 48.7% Atlanta 1 386 22.9% 1,164 29.5% Houston 1 256 15.2% 987 34.8% ----- ------ ------- ----- ------ 6 1,682 100.0% $8,241 50.8% ===== ====== ======= ===== ======
MANAGEMENT'S DISCUSSION AND ANALYSIS (Amounts in Thousands, Except Property and Per Unit Amounts) - -----------------------------------------------------------
Other revenues increased $2,599, or 54.8%, from $4,745 to $7,344 due primarily to an increase in property management revenues of $1,501, or 49.5%, from $3,032 to $4,533 resulting from a net increase in properties managed by Gables for third parties primarily as a result of the South Florida Acquisition, in addition to an increase in income from certain ancillary services.
Property operating and maintenance expense (exclusive of depreciation and amortization) increased $22,910, or 48.1%, from $47,592 to $70,502 due to an increase in apartment homes resulting from the acquisition and development of additional communities and an increase in property operating and maintenance expense for same store communities of 2.8%. The same store increase in operating expenses represents increased payroll costs, property taxes and maintenance costs, offset in part by reduced utilities, marketing and insurance expenses.
Real estate asset depreciation and amortization expense increased $15,375, or 62.2%, from $24,712 to $40,087 due primarily to the acquisition and development of additional communities.
Property management expense for owned communities and third/related party properties on a combined basis increased $2,281, or 40.0%, from $5,696 to $7,977 due primarily to a net increase of 11,000 apartment homes managed from 27,000 in the 1997 Period to 38,000 in the 1998 Period resulting primarily from the South Florida Acquisition, in addition to inflationary increases in expenses and certain non-recurring expense savings in the 1997 Period. Gables allocates property management expenses to both owned communities and third/related party properties based on the proportionate share of total apartment homes and units managed.
General and administrative expense increased $2,994, or 92.2%, from $3,248 to $6,242 due primarily to (i) compensation and other costs for new positions associated with the South Florida Acquisition, (ii) increased compensation costs and (iii) the expensing of internal costs of identifying and acquiring operating apartment communities effective March 20, 1998 in accordance with EITF No. 97-11.
Interest expense increased $13,715, or 55.3%, from $24,804 to $38,519 due to an increase in operating debt associated with the acquisition and development of additional communities, including the debt assumed in connection with the South Florida Acquisition and the Greystone Acquisition. These increases in interest expense have been offset in part as a result of the offerings Gables has consummated between periods, the proceeds of which have been primarily used to reduce indebtedness.
Loss on treasury locks of $5,637 in the 1998 Period represents mark to market losses recorded upon the expiration of the terms of treasury lock agreements that were (i) entered into in anticipation of a projected debt offering, (ii) subsequently extended in connection with modifications in the projected timing of the debt offering and (iii) terminated due to economic conditions affecting the unsecured debt market.
MANAGEMENT'S DISCUSSION AND ANALYSIS (Amounts in Thousands, Except Property and Per Unit Amounts) - -----------------------------------------------------------
COMPARISON OF OPERATING RESULTS OF GABLES FOR THE YEAR ENDED DECEMBER 31, 1997 (THE "1997 PERIOD") TO THE YEAR ENDED DECEMBER 31, 1996 (THE "1996 PERIOD").
Gables' net income is generated primarily from the operation of its apartment communities. For purposes of evaluating comparative operating performance, Gables categorizes its operating communities based on the period in which each community reaches stabilized occupancy. A community is considered by Gables to have achieved stabilized occupancy on the earlier to occur of (i) attainment of 93% physical occupancy or (ii) one year after completion of construction. The operating performance for all of Gables' apartment communities combined for the years ended December 31, 1997 and 1996 is summarized as follows:
MANAGEMENT'S DISCUSSION AND ANALYSIS (Amounts in Thousands, Except Property and Per Unit Amounts) - -----------------------------------------------------------
Total property revenues increased $29,222, or 26.7%, from $109,471 to $138,693 due primarily to increases in the number of apartment homes resulting from the development and acquisition of additional communities and to increases in rental rates on communities stabilized throughout both periods ("same store"). Below is additional information regarding the increases in total property revenues for three of the five community categories presented in the preceding table:
Same store communities:
Communities stabilized during the 1997 Period but not during the 1996 Period:
Increase (Decrease) Number of in Total Occupancy Number of Apartment Percent Property During the Market Communities Homes of Total Revenues 1997 Period - ------ ----------- ----- -------- -------- -----------
Atlanta 2 695 32% $-45 95.0% San Antonio 2 544 25% 497 92.9% Austin 1 256 12% 327 95.6% Nashville 1 254 12% 338 96.1% Houston 1 246 11% 205 95.0% Dallas 1 188 8% 306 93.4% ------ ------- ------ ------ ------ 8 2,183 100% $1,628 94.6% ====== ======= ====== ====== ======
Development and lease-up communities:
Increase Number of in Total Occupancy Number of Apartment Percent Property During the Market Communities Homes of Total Revenues 1997 Period - ------ ---------- ----- -------- -------- -----------
Atlanta 3 862 40% $2,985 55.5% Austin 2 529 24% 1,586 42.0% Memphis 2 490 22% 3,185 84.6% Dallas 1 300 14% 1,427 87.4% ------ ----- ------ ------- ------ 8 2,181 100% $9,183 64.3% ====== ===== ====== ======= ======
MANAGEMENT'S DISCUSSION AND ANALYSIS (Amounts in Thousands, Except Property and Per Unit Amounts) - -----------------------------------------------------------
Other revenues decreased $1,965, or 29.3%, from $6,710 to $4,745 due to (i) $900 of net revenues generated in the 1996 Period from certain corporate apartment home leases entered into in connection with the 1996 Olympic games held in Atlanta, (ii) $557 of interest earned on an investment Gables made in an apartment community on October 1, 1996 via a mortgage note receivable (in January, 1997, Gables acquired the apartment community from the borrower and the mortgage note receivable was repaid in full), and (iii) a decrease in property management revenues of $839, or 21.7%, from $3,871 to $3,032 resulting from a net decrease in properties managed by Gables for third parties primarily due to the sale of such properties by the owners. Such decreases were offset in part by an increase in revenues in the 1997 Period related to the provision of certain ancillary services.
Property operating and maintenance expense (exclusive of depreciation and amortization) increased $8,899, or 23.0%, from $38,693 to $47,592 due to an increase in apartment homes resulting from the development and acquisition of additional communities and an increase in property operating and maintenance expense for same store communities of 3.1%. The same store increase in operating expenses represents inflationary increases in expenses and increased marketing and redecorating expenses in certain of Gables' markets. Such same store increases have been offset in part by certain decreases in landscape and utilities costs.
Real estate asset depreciation and amortization expense increased $6,235, or 33.7%, from $18,477 to $24,712 due primarily to the completion of newly developed communities and acquisition of other communities.
Property management expense for owned communities and third/related party properties on a combined basis increased $79, or 1.4%, from $5,617 to $5,696 due primarily to inflationary increases in expenses, offset in part by certain non-recurring expense savings in the 1997 Period. Gables allocates property management expenses to both owned communities and third/related party properties based on the proportionate share of total apartment homes and units managed.
General and administrative expense increased $203, or 6.7%, from $3,045 to $3,248 due primarily to increases in certain costs associated with increases in Gables' size and inflationary increases in expenses.
Interest expense increased $3,692, or 17.5%, from $21,112 to $24,804 due to an increase in operating debt associated with newly developed or acquired communities in addition to communities currently in the lease-up phase. These increases in interest expense have been offset in part as a result of the offerings Gables has consummated between periods, the proceeds of which have been primarily used to reduce indebtedness.
Loss on treasury locks of $1,178 in the 1997 Period represents mark to market losses recorded upon the expiration of the term of a treasury lock agreement that was (i) entered into in anticipation of a projected debt offering and (ii) subsequently extended in connection with modifications in the projected timing of the debt offering.
Gain on sale of real estate assets of $5,349 in the 1997 Period represents the gain generated in connection with (i) the January, 1997 sale of Club Candlewood, a community comprised of 486 apartment homes and (ii) the July, 1997 sale of 2 acres of Gables' 12-acre Gables Colonnade Phase II land parcel.
Extraordinary loss of $712 in the 1997 Period represents (i) the write-off of unamortized deferred financing costs and prepaid credit enhancement fees associated with the defeasance of the tax-exempt bond financing encumbering the Club Candlewood property that was sold in January, 1997 and (ii) the write-off of unamortized deferred financing costs associated with the February 28, 1997 retirement of a conventional mortgage note payable that was scheduled to mature on September 1, 1997.
MANAGEMENT'S DISCUSSION AND ANALYSIS (Amounts in Thousands, Except Property and Per Unit Amounts) - -----------------------------------------------------------
Liquidity and Capital Resources - -------------------------------
Gables' net cash provided by operating activities increased from $69,519 for the year ended December 31, 1997 to $90,147 for the year ended December 31, 1998, due to (i) an increase of $31,460 in income before certain non-cash items including depreciation, amortization, equity in income of joint ventures, gain on sale of real estate assets, long-term compensation expense, loss on treasury locks and extraordinary losses and (ii) the change in other liabilities between periods of $7,771. Such increases were offset in part by (i) the change in restricted cash between periods of $7,438 and (ii) the change in other assets between periods of $11,165.
Gables' net cash used in investing activities increased from $228,969 for the year ended December 31, 1997 to $358,855 for the year ended December 31, 1998, due primarily to increased acquisition and development activities in 1998 when compared to 1997, and the net proceeds from the sale of real estate assets in 1997. During the year ended December 31, 1998, Gables expended approximately $203.3 million related to acquisitions of operating apartment communities, including those acquired in the South Florida Acquisition; $138.1 million related to development expenditures, including related land acquisitions; approximately $8.0 million related to recurring, non-revenue enhancing, capital expenditures for operating apartment communities; and approximately $8.9 million related to non-recurring, renovation/revenue-enhancing capital expenditures.
Gables' net cash provided by financing activities increased from $158,244 for the year ended December 31, 1997 to $272,583 for the year ended December 31, 1998 due to increased acquisition and development activities. During the year ended December 31, 1998, Gables had net borrowings of $210.5 million which were used in conjunction with $136.2 million of proceeds from a common share offering and the Series B Preferred Unit offering primarily to fund Gables' acquisition and development activities discussed previously. These proceeds from financing activities were offset in part by the payment of dividends and distributions totaling approximately $72.3 million.
As of December 31, 1998, Gables had total indebtedness of $812,788, cash and cash equivalents of $7,054 and principal escrow deposits reflected in restricted cash of $2,445. Gables' indebtedness has an average of 5.9 years to maturity at December 31, 1998. Excluding monthly principal amortization payments, over the next five years Gables has the following scheduled debt maturities for indebtedness outstanding at December 31, 1998:
1999 $13,000 2000 53,583 2001 165,000 2002 83,331 2003 62,801
The debt maturities in 2001 include $110,000 of outstanding indebtedness under the $225 Million Credit Facility which has two one-year extension options. The debt maturities in 2003 include $44,930 of tax-exempt bond indebtedness credit-enhanced through a letter of credit facility which has unlimited one-year extension options. Three of the underlying bond issues mature in December, 2007 and the fourth underlying bond issue matures in August, 2024.
MANAGEMENT'S DISCUSSION AND ANALYSIS (Amounts in Thousands, Except Property and Per Unit Amounts) - -----------------------------------------------------------
A summary of Gables' portfolio indebtedness and interest rate protection agreements as of December 31, 1998 follows:
PORTFOLIO INDEBTEDNESS SUMMARY
Percentage Interest Total Years to Type of Indebtedness Balance of Total Rate(1) Rate(2) Maturity - -------------------- ---------------- --------------- --------
Fixed-rate: Secured notes ....................$125,546 15.4% 7.80% 7.80% 9.25 Unsecured notes .................. 323,442 39.8% 7.20% 7.20% 4.70 Tax-exempt ....................... 90,730 11.2% 6.02% 6.32% 8.70 -------- ------ ----- ----- ---- Total fixed-rate ............$539,718 66.4% 7.14% 7.19% 6.43 -------- ------ ----- ----- ----
Tax-exempt variable-rate .........$150,070 18.5% 3.90% 4.88% 7.39 -------- ------ ----- ----- ----
Unsecured credit facilities ......$123,000 15.1% 6.38% 6.38% 2.01 -------- ------ ----- ----- ----
Total portfolio debt (3), (4) ....$812,788 100.0% 6.43% 6.64% 5.94 ======== ====== ===== ===== ====
(1) Interest Rate represents the weighted average interest rate incurred on the indebtedness, exclusive of deferred financing cost amortization and credit enhancement fees, as applicable.
(2) Total Rate represents the Interest Rate (1) plus credit enhancement fees, as applicable.
(3) Interest associated with construction activities is capitalized as a cost of development and does not impact current earnings. The qualifying construction expenditures at December 31, 1998 for purposes of interest capitalization were $144,122.
(4) Excludes $16.4 million of tax-exempt bonds and $17.8 million of outstanding conventional indebtedness related to joint ventures in which Gables owns a 25% interest.
INTEREST RATE PROTECTION AGREEMENT SUMMARY
Notional Strike Effective Termination Description of Agreement Amount Price Date Date - ------------------------ --------- ------ --------- ------------
LIBOR, 30-day - "Rate Cap" $44,530 6.25%(5) 01/27/94 01/30/99
LIBOR, 30-day - "Rate Swap" $44,530 5.35%(5) 08/30/96 08/30/99 (6)
LIBOR, 30-day - "Rate Swap" $25,000 5.76%(5) 02/27/98 02/27/00 (7)
LIBOR, 30-day - "Rate Swap" $40,000 4.79%(5) 11/30/98 09/29/00
(5) The 30-day LIBOR rate in effect at December 31, 1998 was 5.63%.
(6) This is a knock-out swap agreement which fixes Gables' underlying 30-day LIBOR rate at 5.35%. The swap terminates upon the earlier to occur of (i) the termination date or (ii) a rate reset date on which the 30-day LIBOR rate is 6.26% or higher.
(7) This is a knock-out swap agreement which fixes Gables' underlying 30-day LIBOR rate at 5.76%. The swap terminates upon the earlier to occur of (i) the termination date or (ii) a rate reset date on which the 30-day LIBOR rate is 6.70% or higher.
MANAGEMENT'S DISCUSSION AND ANALYSIS (Amounts in Thousands, Except Property and Per Unit Amounts) - -----------------------------------------------------------
Gables' distributions through the fourth quarter of 1998 have been paid from cash provided by operating activities. Gables anticipates that distributions will continue to be paid on a quarterly basis from cash provided by operating activities.
Gables has met and expects to continue to meet its short-term liquidity requirements generally through net cash provided by operations. Gables' net cash provided by operations has been adequate and Gables believes that it will continue to be adequate to meet both operating requirements and payment of dividends in accordance with REIT requirements. The budgeted expenditures for improvements and renovations to the communities, in addition to monthly principal amortization payments, are also expected to be funded from net cash provided by operations. Gables anticipates construction and development activities and land purchases will be initially funded primarily through borrowings under its Credit Facilities described below.
Gables expects to meet certain of its long-term liquidity requirements, such as scheduled debt maturities, repayment of short-term financing of construction and development activities and possible property acquisitions, through long-term secured and unsecured borrowings, the issuance of debt securities or equity securities, private equity investments in the form of joint ventures, or through the disposition of assets which, in management's evaluation, may no longer meet Gables' investment requirements.
$225 MILLION CREDIT FACILITY
In March, 1996, Gables closed a $175 million unsecured revolving credit facility. In May, 1998, the $175 million commitment level was increased to $225 million and the maturity date was extended to May, 2001 with two one-year extension options. Gables' availability under the facility is limited to the lesser of the total $225 million commitment or the borrowing base. The borrowing base available under the facility is based on the value of Gables' unencumbered real estate assets as compared to the amount of Gables' unsecured indebtedness. As of December 31, 1998, Gables had $110.0 million in borrowings outstanding under the facility and, therefore, had $115.0 million of remaining capacity on the $225 million available commitment. Borrowings currently bear interest at LIBOR plus 0.80%. Additionally, a competitive bid option feature is in place for up to 50% of the total commitment.
$25 MILLION CREDIT FACILITY
In November, 1996, Gables closed an unsecured revolving credit facility that currently provides for up to $25 million in borrowings. This facility has an initial term of one year and has unlimited one-year extension options. Gables has exercised two of its one-year extension options resulting in a maturity date for the facility of October, 1999. Borrowings currently bear interest under this facility at LIBOR plus 0.80%. As of December 31, 1998, Gables had no borrowings outstanding under this facility.
RESTRICTIVE COVENANTS
Certain of Gables' debt agreements contain customary representations, covenants and events of default, including covenants which restrict the ability of the Operating Partnership to make distributions in excess of stated amounts, which in turn restricts the discretion of the Company to declare and pay dividends. In general, during any fiscal year the Operating Partnership may only distribute up to 95% of the Operating Partnership's consolidated income available for distribution (as defined in the related agreement) exclusive of distributions of capital gains for such year. The applicable debt agreements contain exceptions to these limitations to allow the Operating Partnership to make any distributions necessary to allow the Company to maintain its status as a REIT. Gables does not anticipate that this provision will adversely effect the ability of the Operating Partnership to make distributions or the Company to declare dividends, as currently anticipated.
SHELF REGISTRATION STATEMENT
On December 3, 1998, the Company and the Operating Partnership filed a shelf registration statement with the Securities and Exchange Commission to add an additional $500 million of equity capacity and an additional $300 million of debt capacity. Gables believes it is prudent to maintain shelf registration capacity in order to facilitate future capital raising activities.
MANAGEMENT'S DISCUSSION AND ANALYSIS (Amounts in Thousands, Except Property and Per Unit Amounts) - -----------------------------------------------------------
PROPERTY SALE
On March 4, 1999, Gables sold an apartment community located in Atlanta comprising 213 apartment homes for $19.3 million. The net proceeds were initially used to paydown outstanding borrowings under Gables' Credit Facilities.
COMMON SHARE REPURCHASE PROGRAM
On March 22, 1999, the Company announced a common share repurchase program pursuant to which the Company is authorized to purchase up to $50 million of its outstanding common shares. The Company plans to repurchase shares from time to time in open market and privately negotiated transactions, depending on market prices and other conditions, using proceeds from sales of selected assets.
JOINT VENTURE WITH J.P. MORGAN
On March 26, 1999, Gables entered into a joint venture agreement with an affiliate of J.P. Morgan Investment, Inc. ("J.P. Morgan"). The business purpose of the venture is to develop, own and operate seven multifamily apartment communities located in four of Gables' nine markets, which are expected to comprise 2,181 apartment homes. As of December 31, 1998, Gables (i) had commenced construction of four of the communities, (ii) owned the land for the future development of two of the communities and (iii) owned the acquisition right for the land for the future development of one of the communities. The capital budget for the development of the seven communities is approximately $213 million and is anticipated to be funded with 50% debt and 50% equity. The equity component will be funded 80% by J.P. Morgan and 20% by Gables. Gables' portion of the equity will be funded through a contribution of cash and property. Gables will serve as the managing member of the venture and will have responsibility for all day-to-day operating issues. Gables will also serve as the general contractor during construction and as the property manager.
Inflation - ---------
Substantially all of Gables' leases at its communities are for a term of one year or less, which may enable Gables to seek increased rents upon renewal of existing leases or commencement of new leases in times of rising prices. The short-term nature of these leases generally serves to lessen the impact of cost increases arising from inflation.
Book Value of Assets and Partners' Capital - ------------------------------------------
The application of historical cost accounting in accordance with generally accepted accounting principles ("GAAP") for Gables' UPREIT structure results in an understatement of total assets and partners' capital compared to the amounts that would be recorded via the application of purchase accounting in accordance with GAAP had Gables not been organized as an UPREIT. Management believes it is imperative to understand this difference when evaluating the book value of assets and partners' capital. The understatement of basis related to this difference in organizational structure at December 31, 1998 is $112,494, exclusive of the effect of depreciation. Accordingly, on a pro forma basis, the real estate assets before accumulated depreciation, total assets and total partners' capital (including limited and preferred partners' capital interests) as of December 31, 1998 would be $1,794,455, $1,698,811, and $831,067, respectively, if such $112,494 value were reflected.
Certain Factors Affecting Future Operating Results - --------------------------------------------------
This report contains forward-looking statements. The words "believe," "expect," "anticipate," "intend," "estimate," "assume" and other similar expressions which are predictions of or indicate future events and trends and which do not relate solely to historical matters identify forward-looking statements. Reliance should not be placed on forward-looking statements because they involve known and unknown risks, uncertainties and other factors, which are in some cases beyond the control of Gables and may cause the actual results, performance or achievements of Gables to differ materially from anticipated future results, performance or achievements expressed or implied by such forward-looking statements.
MANAGEMENT'S DISCUSSION AND ANALYSIS (Amounts in Thousands, Except Property and Per Unit Amounts) - -----------------------------------------------------------
Factors that might cause such a difference include, but are not limited to, the following: Gables may abandon or fail to secure development opportunities; construction costs of a community may exceed original estimates; construction and lease-up may not be completed on schedule, resulting in increased debt service expense and construction costs and reduced rental revenues; occupancy rates and market rents may be adversely affected by local economic and market conditions which are beyond management's control; financing may not be available, or may not be available on favorable terms; Gables' cash flow may be insufficient to meet required payments of principal and interest; and existing indebtedness may mature in an unfavorable credit environment, preventing such indebtedness from being refinanced, or, if financed, causing such refinancing to occur on terms that are not as favorable as the terms of existing indebtedness.
Recent Accounting Pronouncements - --------------------------------
See Note 4 to Consolidated Financial Statements.
Year 2000 Compliance - --------------------
The statements in the following section include "Year 2000 readiness disclosure" within the meaning of the Year 2000 Information and Readiness Disclosure Act of 1998.
The Year 2000 issue occurs when business application software or embedded microcontrollers use two digits to specify the year, rather than four. Therefore, on January 1, 2000, unless corrections are made, most computers with time-sensitive software programs will recognize the year as "00" and may assume that the year is "1900". This could result in a system failure or miscalculations which could result in disruptions of normal business operations. The Year 2000 issue can also affect embedded microcontrollers in non-computer equipment such as elevators, HVAC and security systems. Gables is in the process of assessing the impact of the Year 2000 issue on its computer systems (hardware), software and other equipment with embedded microcontrollers (non-IT). Gables' Year 2000 Project is divided into four phases, as described below:
Phase 1 - Inventory assessment: Identify all equipment that could potentially be affected by the Year 2000 issue. Equipment is divided into three categories: hardware, software and non-IT.
Phase 2 - Contact vendors and third-party service providers: Contact the vendors and third-party service providers that maintain and/or support the equipment identified in Phase I to obtain a Year 2000 compliance certification.
Phase 3 - Determine scope of non-compliance: Based on vendor response and in-house testing, assemble a list of items that will not be compliant and prioritize the items to be either replaced or retrofitted.
Phase 4 - Implementation, identification of alternative solutions and testing: Replace or retrofit items that are not Year 2000 compliant, identify and implement alternative solutions to items that cannot be replaced or retrofitted, and perform testing thereof.
Gables' progress is described by category in the following table:
Actual or Expected Category Status Phase 4 Completion Date -------- ------ ------------------------- Hardware Complete 3/31/99 Software Complete 3/31/99 Non-IT Working on Phase 3 5/31/99
Gables' costs of addressing the Year 2000 issue have not been, and are not expected to be, material and will relate primarily to costs of upgrading older equipment, in addition to personnel resource allocation. However, no estimates can be made as to the potential adverse impact resulting from the failure of third party service providers and vendors to prepare for the Year 2000 issue. Gables has included banks and utilities in its vendor survey, as their services are considered to be mission-critical to its business function. As with other vendors, Gables is attempting to attain compliance certification from these vendors to assure that there will be no business interruption to its customers on January 1, 2000. Based on vendor response and in-house testing, Gables will develop specific contingency plans, if necessary. In addition, Gables will design a general contingency plan to be implemented in the event of unanticipated equipment and systems failures. However, there can be no assurance that such plan will be adequate or that failures or delays by third parties in achieving Year 2000 compliance will not result in material business interruptions, loss of revenues or other adverse effects.
MANAGEMENT'S DISCUSSION AND ANALYSIS (Amounts in Thousands, Except Property and Per Unit Amounts) - -----------------------------------------------------------
The discussion above regarding Gables' Year 2000 Project contains forward-looking statements. Gables' assessment of the impact of the Year 2000 issue may prove to be inaccurate due to a number of factors which cannot be determined with certainty, including the receipt of inaccurate compliance certifications from third party vendors, inaccurate testing or assessments by Gables' personnel of its equipment or systems, and inaccurate projections by Gables of the cost of remediation and/or replacement of affected equipment and systems. A failure by Gables to adequately remediate or replace affected equipment or systems due to the factors cited above or for other reasons, a material increase in the actual cost of such remediation or replacement, or a failure by a third party vendor to remediate Year 2000 problems in systems that are vital to the operation of Gables' properties or financial systems, could cause a material disruption to its business and adversely affect its results of operations and financial condition.
MANAGEMENT'S DISCUSSION AND ANALYSIS (Amounts in Thousands, Except Property and Per Unit Amounts) - -----------------------------------------------------------
SUPPLEMENTAL DISCUSSION - FUNDS FROM OPERATIONS AND ADJUSTED FUNDS FROM OPERATIONS
Gables considers funds from operations ("FFO") to be a useful performance measure of the operating performance of an equity REIT because, together with net income and cash flows, FFO provides investors with an additional basis to evaluate the ability of a REIT to incur and service debt and to fund acquisitions and other capital expenditures. Gables believes that in order to facilitate a clear understanding of its operating results, FFO should be examined in conjunction with net income as presented in the financial statements and data included elsewhere in this report. Gables computes FFO in accordance with standards established by the National Association of Real Estate Investment Trusts ("NAREIT"). FFO as defined by NAREIT represents net income (loss) determined in accordance with GAAP, excluding gains or losses from sales of assets or debt restructuring, plus certain non-cash items, primarily real estate depreciation, and after adjustments for unconsolidated partnerships and joint ventures. In addition, extraordinary or unusual items, along with significant non-recurring events that materially distort the comparative measure of FFO are typically disregarded in its calculation. FFO presented herein is not necessarily comparable to FFO presented by other real estate companies due to the fact that not all real estate companies use the same definition. However, Gables' FFO is comparable to the FFO of real estate companies that use the NAREIT definition. Adjusted funds from operations ("AFFO") is defined as FFO less recurring, non-revenue enhancing, capital expenditures. FFO and AFFO should not be considered as alternatives to net income as indicators of Gables' operating performance or as alternatives to cash flows as measures of liquidity. FFO does not measure whether cash flow is sufficient to fund all of Gables' cash needs including principal amortization, capital expenditures, and distributions to unitholders. Additionally, FFO does not represent cash flows from operating, investing or financing activities as defined by GAAP. Reference is made to "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources" for a discussion of Gables' cash needs and cash flows. A reconciliation of FFO and AFFO follows:
Years ended December 31, 1998 1997 -------- -------- Net income available to common unitholders $35,182 $35,390 Extraordinary loss 0 712 Loss on treasury locks (a) 5,637 1,178 Amortization of loss on extension of used treasury locks (142) 0 Gain on sale of real estate assets 0 (5,349) Real estate asset depreciation: Wholly-owned real estate assets 40,087 24,712 Joint venture real estate assets 225 223 ------- ------- Total 40,312 24,935 ------- -------
Funds from operations - basic $80,989 $56,866 ------- ------- Amortization of discount on long-term liability (b) 576 0 ------- ------- Funds from operations - diluted $81,565 $56,866 ------- -------
Capital expenditures for operating apartment communities: Carpet $3,092 $1,860 Roofing 246 139 Exterior painting 0 283 Appliances 394 204 Other additions and improvements 4,223 2,392 ------- ------ Total $7,955 $4,878 ------- -------
Adjusted funds from operations - diluted $73,610 $51,988 ======= ======= Average Units outstanding - basic 30,212 23,441 ======= ======= Average Units outstanding - diluted 30,679 23,591 ======= =======
(a) This item is disregarded in the calculation of FFO as it represents a significant non-recurring event that materially distorts the comparative measurement of Gables' performance over time. While Gables may utilize derivative financial instruments, such as rate locks, to hedge interest rate exposure by modifying the interest rate characteristics of prospective financing transactions, it believes the events and circumstances that resulted in these losses are non-recurring in nature. (b) This obligation will be settled with Units. Such Units are excluded from basic Units outstanding, but are included in the calculation of diluted Units outstanding.
MANAGEMENT'S DISCUSSION AND ANALYSIS (Amounts in Thousands, Except Property and Per Unit Amounts) - -----------------------------------------------------------
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Gables' capital structure includes the use of variable rate and fixed rate indebtedness. As such, Gables is exposed to the impact of changes in interest rates. Gables' senior management periodically seeks input from third party consultants regarding market interest rate and credit risk in order to evaluate its interest rate exposure. In certain situations, Gables may utilize derivative financial instruments, in the form of rate caps, rate swaps or rate locks, to hedge interest rate exposure by modifying the interest rate characteristics of related balance sheet instruments and prospective financing transactions. Gables does not utilize such instruments for trading or speculative purposes.
Gables typically refinances maturing debt instruments at then-existing market interest rates and terms which may be more or less than the interest rates and terms on the maturing debt.
The following table provides information about Gables' derivative financial instruments and other financial instruments that are sensitive to changes in interest rates and should be read in conjunction with the Notes to Consolidated Financial Statements. For debt obligations, the table presents principal cash flows and related weighted-average interest rates in effect at December 31, 1998 by expected maturity dates. For interest rate swaps and the interest rate cap, the table presents the notional amounts and related weighted-average pay rates by fiscal year of maturity.
Gables estimates that the fair value of its debt approximates carrying value based upon its effective current borrowing rate for issuance of debt with similar terms and remaining maturities.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The financial statements and supplementary data are listed under Item 14(a) and filed as part of this report on the pages indicated.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
PART III
GGPI, the sole general partner of the Registrant, is a wholly-owned subsidiary of Gables Residential Trust. The members of the Board of Directors of GGPI are the same as the members of the Board of Trustees of Gables Residential Trust. The "executive officers" of GGPI are the same as the "executive officers" of Gables Residential Trust. Other than Gables Residential Trust, which beneficially owns 80.3% of the Registrant's outstanding common Units as of March 18, 1999, no person beneficially owns more than 5% of the Registrant's outstanding common Units. All applicable information required by this Part III with respect to the Registrant will be included in Gables Residential Trust's Proxy Statement to be filed in connection with its 1999 Annual Meeting of Shareholders.
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information concerning the Directors and Executive Officers of the Registrant required by Item 10 shall be included in Gables Residential Trust's Proxy Statement to be filed relating to the 1999 Annual Meeting of Shareholders and is incorporated herein by reference.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information concerning Executive Compensation required by Item 11 shall be included in Gables Residential Trust's Proxy Statement to be filed relating to the 1999 Annual Meeting of Shareholders and is incorporated herein by reference.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information concerning Security Ownership of Certain Beneficial Owners and Management required by Item 12 shall be included in Gables Residential Trust's Proxy Statement to be filed relating to the 1999 Annual Meeting of Shareholders and is incorporated herein by reference.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Not applicable.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS AND SCHEDULE AND REPORTS ON FORM 8-K
14(a)(1)and (2) Financial Statements and Schedule
The financial statements and schedule listed below are filed as part of this annual report on the pages indicated.
Report of Independent Public Accountants 40 Consolidated Balance Sheets as of December 31, 1998 and December 31, 1997 41 Consolidated Statements of Operations for the years ended December 31, 1998, 1997 and 1996 42 Consolidated Statements of Partners' Capital for the years ended December 31, 1998, 1997 and 1996 43 Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996 44 Notes to Consolidated Financial Statements 45
Schedule III - Real Estate Investments and Accumulated Depreciation as of December 31, 1998 60
14(a)(3) Exhibits - -----------------
Certain of the exhibits required by Item 601 of Regulation S-K have been filed with previous reports by the Registrant or the Company (File No. 1-12590) and are incorporated herein by reference to the filing in the corresponding numbered footnote.
Exhibit No. Description - ----------- ------------
3.1 --- Fourth Amended and Restated Agreement of Limited Partnership of the Operating Partnership (1) 3.2 --- Amended and Restated Declaration of Trust of the Company (2) 3.3 --- Articles of Amendment to the Company's Amended and Restated Declaration of Trust (3) 3.4 --- Articles Supplementary to the Company's Amended and Restated Declaration of Trust creating the 8.30% Series A Cumulative Redeemable Preferred Shares (4) 3.5 --- Articles Supplementary to the Company's Amended and Restated Declaration of Trust creating the 5.00% Series Z Cumulative Redeemable Preferred Shares (3) 3.6 --- Articles Supplementary to the Company's Amended and Restated Declaration of Trust creating the 8.625% Series B Cumulative Redeemable Preferred Shares (1) 3.7 --- Second Amended and Restated Bylaws of the Company (5) 3.8 --- Articles of Incorporation of Gables GP, Inc. (6) 3.9 --- Bylaws of Gables GP, Inc. (6) 4.1 --- Indenture, dated as of March 23, 1998, between the Operating Partnership and First Union National Bank (7) 4.2 --- Supplemental Indenture No. 1, dated March 23, 1998, between the Operating Partnership and First Union National Bank (7) 4.3 --- The Operating Partnership 6.80% Senior Note due 2005 (7) 4.4 --- Supplemental Indenture No. 2, dated September 30, 1998 between the Operating Partnership and First Union National Bank (8) 4.5 --- The Operating Partnership 6.55% Senior Note due 2000 (8) 4.6 --- Supplemental Indenture No. 3, dated October 8, 1998, between the Operating Partnership and First Union National Bank (9) 4.7 --- The Operating Partnership 6.60% Senior Note due 2001 (9) 10.1 --- Articles of Incorporation of East Apartment Management, Inc. (6) 10.2 --- Bylaws of East Apartment Management, Inc. (6) 10.3 --- Articles of Incorporation of Central Apartment Management, Inc. (6) 10.4 --- Bylaws of Central Apartment Management, Inc. (6) 10.5 --- Interest rate protection agreement (notional amount of $44,530,000) between the Operating Partnership and NationsBank of North Carolina, N.A. dated January 25,1994(10) 10.6 --- Interest rate protection agreement (notional amount of $44,530,000) between the Operating Partnership and First Union National Bank of Georgia, dated August 21, 1996 (11) 10.7 --- Interest rate protection agreement (notional amount of $25,000,000) between the Operating Partnership and First Union National Bank of Georgia, dated as of May 23, 1997 (12) 10.8 --- Forward Treasury Lock Agreement (notional amount of $75,000,000) between the Operating Partnership and J.P. Morgan Securities, Inc. dated as of September 22, 1997 (12) 10.9 --- Forward Treasury Lock Agreement (notional amount of $75,000,000) between the Operating Partnership and J.P. Morgan Securities, Inc. dated as of September 22, 1997 and amended on December 17, 1997 (13) 10.10 --- Forward Treasury Lock Agreement (notional amount of $75,000,000) between the Operating Partnership and J.P. Morgan Securities, Inc. dated as of September 22, 1997 and amended on February 11, 1998 (13) 10.11 --- Forward Treasury Lock Agreement (notional amount of $25,000,000) between the Operating Partnership and J.P. Morgan Securities, Inc. dated as of December 17, 1997 (13) 10.12 --- Forward Treasury Lock Agreement (notional amount of $25,000,000) between the Operating Partnership and J.P. Morgan Securities, Inc. dated as of December 17, 1997 and amended on February 11, 1998 (13)
Exhibit No. Description - ----------- ------------
10.13 --- Forward Treasury Lock Agreement (notional amount of $50,000,000) between Gables Realty Limited Partnership and J.P. Morgan Securities Inc., dated as of September 22, 1997 and amended on May 28, 1998 (3) 10.14 --- Forward Treasury Lock Agreement (notional amount of $50,000,000) between Gables Realty Limited Partnership and J.P. Morgan Securities Inc., dated as of September 22, 1997 and amended on July 24, 1998 (3) 10.15 --- Forward Treasury Lock Agreement (notional amount of $50,000,000) between Gables Realty Limited Partnership and J.P. Morgan Securities Inc., dated as of September 22, 1997 and amended on August 19, 1998 (14) 10.16 --- Forward Treasury Lock Agreement (notional amount of $50,000,000) between Gables Realty Limited Partnership and J.P. Morgan Securities Inc., dated as of September 22, 1997 and amended on September 30, 1998 (14) 10.17 --- Interest Rate Swap Agreement (notional amount of $40,000,000) between Gables Realty Limited Partnership and Morgan Guaranty Trust Company of New York, dated as of September 28, 1998(14) 10.18 --- Loan Agreement, Conversion and Note Agreement, Security Deed Note and Deed of Trust Notes between Teachers Insurance and Annuity Association of America ("lender") and the Operating Partnership and the Tennessee Partnership (collectively, the borrower)for a $130,689,000 loan, dated December 29, 1995(15) 10.19 --- First Amendment to Conversion and Note Agreement effective December 30, 1996 between the Operating Partnership, the Tennessee Partnership, the Company and Teachers Insurance and Annuity Association of America (12) 10.20 --- Second Amendment to Conversion and Note Agreement effective August 13, 1997 between the Operating Partnership, the Tennessee Partnership, the Company and Teachers Insurance and Annuity Association of America (12) 10.21 --- Unsecured Note No. 1 for $86,346,000 date August 13, 1997 between the Operating Partnership, the Tennessee Partnership and Teachers Insurance and Annuity Association of America(12) 10.22 --- Unsecured Note No. 2 for $29,681,000 dated August 13, 1997 between the Operating Partnership, the Tennessee Partnership and Teachers Insurance and Annuity Association of America(12) 10.23 --- $225,000,000 Amended and Restated Credit Agreement dated as of May 13, 1998 by and among Gables Realty Limited Partnership (as Borrower) and Wachovia Bank, N.A., First Union National Bank, Chase Bank of Texas, National Association, PNC Bank, National Association, Guaranty Federal Bank, F.S.B., AmSouth Bank of Alabama and Commerzbank AG, Atlanta Agency (collectively, as lenders) and Wachovia Bank, N.A. (as Agent) (3) 10.24 --- Promissory Note dated November 29, 1994 for a $53,000,000 mortgage loan from the Northwestern Mutual Life Insurance Company to the Operating Partnership (10) 10.25 --- Contribution Agreement with an effective date of March 16, 1998 between the Company, the Operating Partnership and specified representatives of Trammell Crow Residential("TCR") executed in connection with the Company's April 1, 1998 acquisition of the properties and operations of TCR-South Florida (16) 10.26 --- Amendment No. 1 to Contribution Agreement dated April 1, 1998 (17) 21.1 * --- Schedule of Subsidiaries of the Operating Partnership 23.1 * --- Consent of Arthur Andersen LLP 27.1 * --- Financial Data Schedule for the fiscal year ended December 31, 1998 ___________
* Filed herewith
(1) The Operating Partnership's Current Report on Form 8-K dated November 12, 1998. (2) The Operating Partnership's Registration Statement on Form S-11 (File No.33-70570), as amended. (3) The Operating Partnership's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998. (4) The Company's Current Report on Form 8-K dated July 24, 1997. (5) The Company's Registration Statement on Form 8-A/A-2. (6) The Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1993. (7) The Operating Partnership's Current Report on Form 8-K dated March 23, 1998.
(8) The Operating Partnership's Current Report on Form 8-K dated October 5, 1998. (9) The Operating Partnership's Current Report on Form 8-K dated October 8, 1998. (10) The Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994. (11) The Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1996. (12) The Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 1997. (13) The Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1997. (14) The Operating Partnership's Quarterly Report on Form 10-Q for the quarter ended September 30, 1998. (15) The Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995. (16) The Operating Partnership's Current Report on Form 8-K dated March 16, 1998. (17) The Operating Partnership's Current Report on Form 8-K dated April 1, 1998, as amended.
Gables Residential Trust's proxy statement is to be filed with the Securities and Exchange Commission not later than 120 days after December 31, 1998 (the end of the fiscal year covered by this Annual Report on Form 10-K).
14(b) Reports on Form 8-K - --------------------------
(i) A Form 8-K dated October 5, 1998 was filed with the Securities and Exchange Commission with the underwriting agreement, indenture and other related items executed in connection with the Operating Partnership's issuance of $50 million of 6.55% Senior Unsecured Notes due October, 2000.
(ii) A Form 8-K dated October 8, 1998 was filed with the Securities and Exchange Commission with the underwriting agreement, indenture and other related items executed in connection with the Operating Partnership's issuance of $15 million of 6.60% Senior Unsecured Notes due October, 2001.
(iii)A Form 8-K dated November 12, 1998 was filed with the Securities and Exchange Commission with the Fourth Amended and Restated Agreement of Limited Partnership of the Operating Partnership and other related items executed in connection with the Operating Partnership's issuance of $50 million of Series B Preferred Units.
14(c) Exhibits - ---------------
See Item 14(a)(3) above.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, Gables Residential Trust certifies that it has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
GABLES REALTY LIMITED PARTNERSHIP By: Gables GP, Inc. Its: General Partner
By: /s/ Marcus E. Bromley ------------------------------- Marcus E. Bromley, Chairman of the Board of Directors and Chief Executive Officer
March 29 1999
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of Gables GP, Inc., as general partner of Gables Realty Limited Partnership, and in the capacities and on the dates indicated.
Signatures Title Date - --------------- --------- ---------
/s/ Marcus E. Bromley Chairman of the Board of Directors March 29, 1999 - ------------------------ and Chief Executive Officer Marcus E. Bromley (Principal Executive Officer)
/s/ Marvin R. Banks, Jr. Chief Financial Officer (Principal March 29, 1999 - ------------------------ Financial Officer and Principal Marvin R. Banks, Jr. Accounting Officer)
/s/ John T. Rippel President, Chief Operating Officer March 29, 1999 - ------------------------ and Director John T. Rippel
/s/ David M. Holland Director March 29, 1999 - ------------------------ David M. Holland
/s/ Lauralee E. Martin Director March 29, 1999 - ------------------------ Lauralee E. Martin
/s/ John W. McIntyre Director March 29, 1999 - ------------------------ John W. McIntyre
/s/ D. Raymond Riddle Director March 29, 1999 - ------------------------ D. Raymond Riddle
/s/ Chris D. Wheeler Director March 29, 1999 - ------------------------- Chris D. Wheeler
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To Gables Realty Limited Partnership:
We have audited the accompanying consolidated balance sheets of Gables Realty Limited Partnership and subsidiaries as of December 31, 1998 and 1997 and the related consolidated statements of operations, partners' capital and cash flows for each of the three years in the period ended December 31, 1998. These financial statements and schedule are the responsibility of the management of Gables Realty Limited Partnership. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Gables Realty Limited Partnership and subsidiaries as of December 31, 1998 and 1997 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles.
Our audits were made for the purpose of forming an opinion on the basic financial statements taken as a whole. The schedule listed in the index to financial statements is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic financial statements and, in our opinion, fairly states in all material respects the financial data required to be set forth therein in relation to the basic financial statements taken as a whole.
/s/ Arthur Andersen LLP
Atlanta, Georgia March 5, 1999
GABLES REALTY LIMITED PARTNERSHIP CONSOLIDATED BALANCE SHEETS (Amounts in Thousands, Except Per Unit Amounts)
GABLES REALTY LIMITED PARTNERSHIP CONSOLIDATED STATEMENTS OF OPERATIONS (Amounts in Thousands, Except Per Unit Amounts)
GABLES REALTY LIMITED PARTNERSHIP CONSOLIDATED STATEMENTS OF PARTNERS' CAPITAL (Amounts in Thousands, Except Per Unit Amounts)
GABLES REALTY LIMITED PARTNERSHIP CONSOLIDATED STATEMENTS OF CASH FLOWS (Amounts in Thousands, Except Per Unit Amounts)
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Amounts in Thousands, Except Property and Per Unit Information - --------------------------------------------------------------
1. ORGANIZATION AND FORMATION OF THE OPERATING PARTNERSHIP
Gables Realty Limited Partnership (the "Operating Partnership" or "Gables") is the entity through which Gables Residential Trust (the "Company"), a real estate investment trust (a "REIT"), conducts substantially all of its business and owns (either directly or through subsidiaries) substantially all of its assets. In 1993, the Company was formed under Maryland law and the Operating Partnership was organized as a Delaware limited partnership to continue and expand the multifamily apartment community management, development, construction and acquisition operations of its privately owned predecessor organization. The Company completed its initial public offering on January 26, 1994 (the "IPO"). The Operating Partnership's third party management businesses are conducted through two subsidiaries, Central Apartment Management, Inc., a Texas corporation, and East Apartment Management, Inc., a Georgia corporation.
The Company was an 80.3% economic owner of the common equity of the Operating Partnership as of December 31, 1998. The Company controls the Operating Partnership through Gables GP, Inc. ("GGPI"), a wholly-owned subsidiary of the Company and the sole general partner of the Operating Partnership (this structure is commonly referred to as an umbrella partnership REIT or "UPREIT"). The board of directors of GGPI, the members of which are the same as the members of the Board of Trustees of the Company, manages the affairs of the Operating Partnership by directing the affairs of GGPI. The Company's limited partner and indirect general partner interests in the Operating Partnership entitle it to share in cash distributions from, and in the profits and losses of, the Operating Partnership in proportion to its ownership interest therein and entitle the Company to vote on all matters requiring a vote of the limited partners. Generally, the other limited partners of the Operating Partnership are persons who contributed their direct or indirect interests in certain properties to the Operating Partnership primarily in connection with the IPO, the South Florida Acquisition and the Greystone Acquisition (as defined herein). The Operating Partnership is obligated to redeem each common unit of limited partnership interest ("Unit") held by a person other than the Company, at the request of the holder thereof, for cash equal to the fair market value of a share of the Company's common shares at the time of such redemption, provided that the Company at its option may elect to acquire any such Unit presented for redemption for one common share or cash. The Company presently anticipates that it will elect to issue its common shares to acquire Units presented for redemption, rather than paying cash. Such limited partners' redemption rights are reflected in "limited partners' capital interest" in the accompanying consolidated balance sheets at the cash redemption amount at the balance sheet date. With each such redemption the Company's percentage ownership interest in the Operating Partnership will increase. In addition, whenever the Company issues common shares or preferred shares, the Company is obligated to contribute any net proceeds therefrom to the Operating Partnership and the Operating Partnership is obligated to issue an equivalent number of common or preferred units, as applicable, to the Company.
Distributions to holders of Units are made to enable distributions to be made to the Company's shareholders under its dividend policy. Federal income tax laws require the Company, as a REIT, to distribute 95% of its ordinary taxable income. The Operating Partnership makes distributions to the Company to enable it to satisfy this requirement.
As of December 31, 1998, Gables owned 84 completed multifamily apartment communities comprising 24,625 apartment homes, of which 39 were developed and 45 were acquired by Gables, and an indirect 25% general partner interest in two apartment communities developed by Gables comprising 663 apartment homes. Two of the completed communities comprising 642 apartment homes were in the lease-up stage at December 31, 1998. Gables also owned five multifamily apartment communities that were under construction at December 31, 1998 that are expected to comprise 1,613 apartment homes upon completion. As of December 31, 1998, Gables owned parcels of land for the future development of seventeen apartment communities expected to comprise an estimated 4,093 apartment homes. There can be no assurance that Gables will develop such land. Additionally, Gables has contracts or options to acquire additional parcels of land. There can be no assurance that Gables will acquire these land parcels, however it is Gables' intent to develop an apartment community on each such land parcel, if purchased. See Note 14 for certain events occurring subsequent to December 31, 1998.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Amounts in Thousands, Except Property and Per Unit Information - --------------------------------------------------------------
2. PORTFOLIO ACQUISITIONS
On April 1, 1998, Gables acquired the properties and operations of Trammell Crow Residential South Florida ("TCR/SF"), which consisted of fifteen multifamily apartment communities containing a total of 4,197 apartment homes, and all of TCR/SF's residential construction and development and third party management activities in South Florida (collectively, the "South Florida Acquisition"). In consideration for such properties and operations, Gables (i) paid $155.0 million in cash, (ii) assumed approximately $135.9 million of tax-exempt debt and (iii) issued approximately 2,348 Units valued at approximately $64.9 million. In addition, up to $12.5 million of the purchase price was deferred by Gables until January 1, 2000, at which time Gables will issue a number of Units equal in value to such deferred amount. The acquisition increased the size of Gables' portfolio under management on April 1, 1998 from approximately 28,000 to 40,000 apartment homes.
The South Florida Acquisition has been accounted for under the purchase method of accounting in accordance with Accounting Principles Board Opinion No. 16. Accordingly, assets acquired and liabilities assumed have been recorded at their estimated fair values. The accompanying consolidated statements of operations include the operating results of TCR/SF since April 1, 1998, the closing date of the South Florida Acquisition. The following unaudited pro forma information for the years ended December 31, 1998 and 1997 has been prepared assuming the South Florida Acquisition had been consummated on January 1, 1997. The unaudited pro forma information (i) includes the historical operating results of the properties and activities acquired and (ii) does not purport to be indicative of the results which actually would have been obtained had the South Florida Acquisition been consummated on January 1, 1997, or which may be attained in future periods.
Years Ended December 31, 1998 1997 -------- -------- Total revenues $226,652 $180,671 Income available to common unitholders before extraordinary loss 34,632 28,711 Net income available to common unitholders 34,632 28,165 Per Unit information: Income before extraordinary loss - basic $1.12 $1.45 Net income - basic $1.12 $1.42 Income before extraordinary loss - diluted $1.12 $1.44 Net income - diluted $1.12 $1.41
In April, 1998, Gables acquired four multifamily apartment communities comprising a total of 913 apartment homes located in Houston, Texas (the "Greystone Acquisition"). In connection with such acquisition, Gables assumed approximately $31.0 million of indebtedness, at fair value, and issued approximately 665 Units valued at approximately $18.0 million. In addition, Gables has accrued approximately $0.5 million as of December 31, 1998 for a portion of the purchase price that was deferred by Gables, the payment of which is contingent upon 1999 economic performance. Gables will issue a number of Units equal in value to the amount due once determined.
3. SECONDARY OFFERINGS AND ISSUANCES OF OPERATING PARTNERSHIP UNITS
SECONDARY COMMON SHARE OFFERINGS
Since the IPO, the Company has issued a total of 14,831 common shares in eight offerings generating $347,771 in net proceeds which were generally used (i) to reduce outstanding indebtedness under interim financing vehicles utilized to fund Gables' development and acquisition activities (the "Interim Financing Vehicles") and (ii) for general working capital purposes including funding of future development and acquisition activities.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Amounts in Thousands, Except Property and Per Unit Information - --------------------------------------------------------------
PREFERRED SHARE OFFERINGS
On July 24, 1997, the Company issued 4,600 shares of 8.30% Series A Cumulative Redeemable Preferred Shares (liquidation preference $25.00 per share) (the "Series A Preferred Shares"). The net proceeds from this offering of approximately $111.0 million were used to reduce outstanding indebtedness under the Interim Financing Vehicles. The Series A Preferred Shares, which may be redeemed by the Company at $25.00 per share, plus accrued and unpaid dividends, on or after July 24, 2002, have no stated maturity, sinking fund or mandatory redemption and are not convertible into any other securities of the Company.
On June 18, 1998, the Company issued 180 shares of 5.0% Series Z Cumulative Redeemable Preferred Shares (liquidation preference $25.00 per share) (the "Series Z Preferred Shares") in connection with the acquisition of a parcel of land for future development. The Series Z Preferred Shares, which may be redeemed by the Company at $25.00 per share, plus accrued and unpaid dividends, at any time, are subject to mandatory redemption on June 18, 2018. The Series Z Preferred Shares are not subject to any sinking fund and are not convertible into any other securities of the Company.
ISSUANCES OF COMMON OPERATING PARTNERSHIP UNITS
Since the IPO, Gables has issued a total of 3,917 Units in connection with the South Florida Acquisition, the Greystone Acquisition and the acquisition of operating apartment communities and a parcel of land for future development.
ISSUANCE OF PREFERRED OPERATING PARTNERSHIP UNITS
On November 12, 1998, the Operating Partnership issued 2,000 of its 8.625% Series B Preferred Units (the "Series B Preferred Units") to an institutional investor. The net proceeds from this issuance of approximately $48.7 million were used to reduce outstanding indebtedness under the Interim Financing Vehicles. The Series B Preferred Units may be redeemed by the Company at its option after November 14, 2003 and are exchangeable by the holder into 8.625% Series B Cumulative Redeemable Preferred Shares of the Company on a one-for-one basis. This exchange right is generally not exercisable until after November 14, 2008. The Series B Preferred Units have no stated maturity, sinking fund, or mandatory redemption.
4. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS
Gables engages in the multifamily apartment community management, development, construction, and acquisition businesses, including the provision of related brokerage and corporate rental housing services. Gables' operating performance relies predominantly on net operating income from the multifamily apartment communities it owns which are located in nine core cities in Texas, Georgia, Florida and Tennessee.
BASIS OF PRESENTATION
The accompanying consolidated financial statements of Gables Realty Limited Partnership include the consolidated accounts of Gables Realty Limited Partnership and its subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.
RECLASSIFICATIONS
Certain amounts in the 1997 and 1996 financial statements have been reclassified to conform to the 1998 presentation.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Amounts in Thousands, Except Property and Per Unit Information - --------------------------------------------------------------
USE OF ESTIMATES
The preparation of financial statements in conformity with generally accepted accounting principles ("GAAP") requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
REAL ESTATE ASSETS AND DEPRECIATION
Real estate assets are stated at the lower of depreciated cost or fair value, if deemed impaired. The cost of buildings and improvements includes interest, property taxes, insurance and allocated development overhead incurred during the construction period. Ordinary repairs and maintenance are expensed as incurred; major replacements and betterments are capitalized and depreciated over their useful lives. Depreciation is computed on a straight-line basis over the useful lives of the real estate assets (buildings and improvements 19-40 years; furniture, fixtures and equipment 5-10 years).
INVESTMENT IN JOINT VENTURES
Gables' 25% general partner interests in Arbors of Harbortown JV and Metropolitan Apartments JV are accounted for on the equity method of accounting.
REVENUE RECOGNITION
Rental: Gables leases its residential properties under operating leases with terms generally equal to one year or less. Rental income is recognized when earned which materially approximates revenue recognition on a straight-line basis.
Property management: Gables provides property management services for properties in which it does not own a controlling interest. Income is recognized when earned.
Development and construction services: Gables periodically provides development and construction services for properties in which it does not own a controlling interest. Income is recognized when earned on a percentage of completion basis.
CASH AND CASH EQUIVALENTS
For purposes of the statements of cash flows, all investments purchased with an original maturity of three months or less are considered to be cash equivalents.
RESTRICTED CASH
Restricted cash is primarily comprised of residential security deposits, tax escrow funds, repairs and maintenance reserve funds, and principal escrow bond funds.
DEFERRED FINANCING COSTS AND AMORTIZATION
Deferred financing costs include fees and costs incurred to obtain financing and are capitalized and amortized over the terms of the related notes payable and are written off upon the expiration thereof.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Amounts in Thousands, Except Property and Per Unit Information - --------------------------------------------------------------
INTEREST RATE PROTECTION AGREEMENTS
In the ordinary course of business, Gables is exposed to interest rate risks. Gables' senior management periodically seeks input from third party consultants regarding market interest rate and credit risk in order to evaluate its interest rate exposure. In certain situations, Gables may utilize derivative financial instruments, in the form of rate caps, rate swaps or rate locks, to hedge interest rate exposure by modifying the interest rate characteristics of related balance sheet instruments and prospective financing transactions. Gables does not utilize such instruments for trading or speculative purposes. Derivatives used as hedges must be effective at reducing the risk associated with the exposure being hedged, correlate in nominal amount, rate, and term with the balance sheet instrument being hedged, and must be designated as a hedge at the inception of the derivative contract.
Lump sum payments made or received at the inception or settlement of derivative instruments designated as hedges are capitalized and amortized as an adjustment to interest expense over the life of the associated balance sheet instrument. Monthly amounts paid or received under rate cap and rate swap hedge agreements are recognized as adjustments to interest expense as incurred. In the event that circumstances arise that indicate that an existing derivative instrument no longer meets the hedge criteria described above, the derivative is marked to market in the statement of operations.
In anticipation of a projected seven-year debt offering, Gables entered into two forward treasury lock agreements in late 1997. The timing and amount of the projected debt offering was modified several times as a result of unanticipated capital transactions, including the South Florida Acquisition. The treasury lock agreements were extended to align with the projected timing of the debt offering. The treasury lock agreement in place in September, 1998 was terminated due to certain economic conditions affecting the unsecured debt market. For the years ended December 31, 1998 and 1997, Gables recognized mark to market losses of $5,637 and $1,178, respectively, upon the expiration of the original and extended terms of the treasury lock agreements since the required hedge criteria no longer existed at those dates.
PROPERTY MANAGEMENT EXPENSES
Gables manages its owned properties, as well as properties owned by third and related parties for which Gables provides services for a fee. Property management expenses have been allocated between owned and third/related party properties in the accompanying statements of operations based on the proportionate number of owned and third/related party apartment homes managed by Gables during the applicable periods.
INCOME TAXES
No Federal or state income taxes are reflected in the accompanying financial statements since Gables Realty Limited Partnership is a partnership and its partners are required to include their respective share of profits and losses in their income tax returns. Additionally, certain subsidiaries of Gables, formed to provide management and other services to third and related parties, are taxed based on reportable income. The tax attributes of these entities are immaterial to the accompanying consolidated financial statements.
RECENT ACCOUNTING PRONOUNCEMENTS
Gables adopted SFAS No. 130, "Reporting Comprehensive Income," during 1998. SFAS No. 130 established standards for reporting and disclosing comprehensive income (defined as revenues, expenses, gains and losses that under GAAP are not included in net income) and its components. As of December 31, 1998, Gables had no items of other comprehensive income.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Amounts in Thousands, Except Property and Per Unit Information - --------------------------------------------------------------
In June, 1998, SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" was issued establishing accounting and reporting standards requiring that every derivative instrument (including certain derivative instruments embedded in other contracts) be recorded in the balance sheet as either an asset or liability measured at its fair value. SFAS No. 133 requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows a derivative's gains and losses to offset related results on the hedged item in the statement of operations, and requires that a company must formally document, designate, and assess the effectiveness of transactions that receive hedge accounting. SFAS No. 133 is effective for Gables beginning January 1, 2000. The impact of SFAS No. 133 on Gables' financial statements will depend on the extent, type and effectiveness of Gables' hedging activities. SFAS No. 133 could increase volatility in net income and other comprehensive income.
5. NOTES PAYABLE
Notes payable consist of the following: December 31, 1998 1997 ------ ------ Secured conventional fixed-rate $125,546 $ 96,135 Unsecured conventional fixed-rate 323,442 158,526 Tax-exempt fixed-rate 90,730 60,150 ------- ------- Total fixed-rate 539,718 314,811 Tax-exempt variable-rate 150,070 44,930 Unsecured credit facilities 123,000 75,621 ------- ------- Total notes payable $812,788 $435,362 ======= =======
SECURED CONVENTIONAL FIXED-RATE NOTES PAYABLE
At December 31, 1997, the fixed-rate notes payable were comprised of five loans collateralized by seven apartment communities included in real estate assets. At December 31, 1997, the interest rates on these notes payable ranged from 7.13% to 8.77% (weighted average of 8.14%) and the maturity dates ranged from May, 2003 to December, 2009.
In April, 1998, Gables assumed $31,029 of indebtedness, at fair value, in connection with the Greystone Acquisition.
At December 31, 1998, the fixed-rate notes payable are comprised of nine loans collateralized by eleven apartment communities included in real estate assets. At December 31, 1998, the interest rates on these notes payable ranged from 6.75% to 8.77% (weighted average of 7.80%) and the maturity dates ranged from May, 2003 to December, 2015. Principal amortization payments are required on a monthly basis for all notes payable based on amortization schedules ranging from 25 to 30 years.
UNSECURED CONVENTIONAL FIXED-RATE NOTES PAYABLE
At December 31, 1997, the unsecured, fixed-rate notes payable were comprised of four loans. At December 31, 1997, the interest rates on these notes payable ranged from 6.10% to 8.62% (weighted average of 7.78%) and the maturity dates ranged from November, 2001 to December, 2007.
In March, 1998, Gables issued $100,000 of senior unsecured notes which bear interest at 6.80%, were priced to yield 6.84% and mature in March, 2005. In October, 1998, Gables issued (i) $50,000 of senior unsecured notes which bear interest at 6.55%, were priced to yield 6.59% and mature in October, 2000 and (ii) $15,000 of senior unsecured notes which bear interest at 6.60%, were priced at par and mature in October, 2001.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Amounts in Thousands, Except Property and Per Unit Information - --------------------------------------------------------------
In November, 1998, Gables acquired a parcel of land and assumed $829 of indebtedness associated therewith. Such indebtedness bears interest at 5.25%, requires principal amortization payments over its 20 year term, and has a maturity of November, 2018.
At December 31, 1998, the unsecured fixed-rate notes payable were comprised of eight loans. At December 31, 1998, the interest rates on these notes payable ranged from 5.25% to 8.62% (weighted average of 7.20%) and the maturity dates ranged from October, 2000 to November, 2018. Principal amortization payments are required on certain of these loans based on amortization schedules ranging from 20 to 30 years.
TAX-EXEMPT FIXED-RATE NOTES PAYABLE
At December 31, 1998 and 1997, the tax-exempt, fixed-rate indebtedness was comprised of five and two loans, respectively. One such loan outstanding at December 31, 1998 and 1997 has a principal balance of $48,365, and is collateralized by three communities induced for tax-exempt financing and three additional communities. Principal amortization payments based on a 30 year amortization schedule are required on a monthly basis. These payments are retained in an escrow account and are not applied to reduce the outstanding principal balance of the loan. Principal payments through December 31, 1998 and 1997 are included in restricted cash in the accompanying balance sheets. The note payable bears interest at 6.38% and matures in August, 2004. The three underlying tax-exempt bond issues mature in August, 2024. The second loan, with an outstanding principal balance of $11,630 and $11,785 as of December 31, 1998 and 1997, respectively, represents a tax-exempt bond financing secured by one apartment community. The bond issue was credit enhanced for an annual fee of 0.60% and bears interest at a weighted average rate of 7.03% on a fixed basis for 30 years. Gables is required to make monthly escrow payments each year totaling the annual principal payment due to the bondholders in the month of January thereafter.
On April 1, 1998, Gables assumed three bond issues totaling $30,735 in connection with the South Florida Acquisition. Two of the bond issues bear interest at 4.75% and are enhanced by letters of credit provided by a letter of credit facility entered into on April 1, 1998 (the "Florida Enhancement Facility"). The fee for the letters of credit is 1.0% per annum. The Florida Enhancement Facility has an initial term of 10 years and has three five-year extension options. The third bond issue bears interest at 5.75% and is not currently enhanced by a letter of credit. Such bond issue may be refunded and upon such refunding will be enhanced by the Florida Enhancement Facility. The Florida Enhancement Facility is collateralized by (i) each apartment community induced for tax-exempt financing for which a letter of credit is issued and outstanding thereunder and (ii) two additional communities. The maturity dates of the three bond issues range from February, 2004 to April, 2009. The bonds do not require principal amortization payments.
TAX-EXEMPT VARIABLE-RATE NOTES PAYABLE TOTALING $44,930
At December 31, 1998 and 1997, the variable-rate mortgage notes payable securing tax-exempt bonds totaling $44,930 were comprised of four loans, each of which is collateralized by an apartment community included in real estate assets. These bonds bear interest at a variable rate of interest, adjusted weekly based upon a negotiated rate. The interest rate in effect at December 31, 1998 and 1997 was 4.1% and 4.2%, respectively. Tax-exempt variable rates are, and historically have been, significantly higher at year-end than during the year. The effective interest rates were 3.5%, 3.7% and 3.5% for the years ended December 31, 1998, 1997 and 1996, respectively. The bonds are currently enhanced by four letters of credit provided by a letter of credit facility entered into in October, 1997. The fee for these letters of credit was 1.5% per annum through June, 1995, 1.25% per annum through March, 1996, 1.0% through September, 1997 and is currently 0.95% per annum. The letter of credit facility has an initial term of five years and has unlimited one-year extension options. Gables has exercised the first of its one-year extension options resulting in a maturity date for the facility of October, 2003. Three of the underlying bond issues mature in December, 2007 and the fourth underlying bond issue matures in August, 2024.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Amounts in Thousands, Except Property and Per Unit Information - --------------------------------------------------------------
TAX-EXEMPT VARIABLE-RATE NOTES PAYABLE TOTALING $105,140
On April 1, 1998, Gables assumed five bond issues totaling $105,140 in connection with the South Florida Acquisition. At December 31, 1998, the interest rates on these bonds ranged from 3.45% to 4.05% (weighted average of 3.81%) and the maturity dates of the underlying bond issues ranged from August, 2006 to September, 2008. The effective interest rate for these bonds averaged 3.6% for the period from April 1, 1998 to December 31, 1998. The bonds are enhanced by letters of credit provided by the Florida Enhancement Facility described above.
$225 MILLION CREDIT FACILITY
In March, 1996, Gables closed a $175 million unsecured revolving credit facility. In May, 1998, the $175 million commitment level was increased to $225 million and the maturity date was extended to May, 2001 with two one-year extension options. Gables' availability under the facility is limited to the lesser of the total $225 million commitment or the borrowing base. The borrowing base available under the facility is based on the value of Gables' unencumbered real estate assets as compared to the amount of Gables' unsecured indebtedness.
Borrowings bore interest at LIBOR plus 1.50% (reduced from 1.65% in November, 1996) through April, 1997. In April, 1997, Gables' borrowing costs under the facility were reduced to LIBOR plus 1.10% in connection with Gables' attainment of senior unsecured debt ratings of BBB from Standard and Poor's and Baa2 from Moody's Investors Service (the "Credit Ratings"). In August, 1997, Gables' borrowing costs were renegotiated and were reduced to LIBOR plus 0.80%. Additionally, a competitive bid option was added for up to 50% of the total commitment. As of December 31, 1998, Gables had $110.0 million in borrowings outstanding under the facility and, therefore, had $115.0 million of remaining capacity on the $225.0 million available commitment.
$25 MILLION CREDIT FACILITY
In November, 1996, Gables closed an unsecured revolving credit facility that currently provides for up to $25 million in borrowings. This facility has an initial term of one year and has unlimited one-year extension options. Gables has exercised two of its one-year extension options resulting in a maturity date for the facility of October, 1999. Borrowings bore interest under this facility at LIBOR plus 1.50% through April, 1997. In April, 1997, Gables' borrowing costs were reduced to LIBOR plus 1.10% in connection with the attainment of the Credit Ratings. In August, 1997, Gables' borrowing costs were renegotiated and were reduced to LIBOR plus 0.80%. As of December 31, 1998, Gables had no borrowings outstanding under this facility.
$25 MILLION BORROWING FACILITY
At December 31, 1998, Gables had $13.0 million in borrowings outstanding under this unsecured credit facility at an interest rate of 6.0%. The facility currently matures on April 28, 1999.
RESTRICTIVE COVENANTS
Certain of Gables' debt agreements contain customary representations, covenants and events of default, including covenants which restrict the ability of the Operating Partnership to make distributions in excess of stated amounts, which in turn restricts the discretion of the Company to declare and pay dividends. In general, during any fiscal year the Operating Partnership may only distribute up to 95% of the Operating Partnership's consolidated income available for distribution (as defined in the related agreement) exclusive of distributions of capital gains for such year. The applicable debt agreements contain exceptions to these limitations to allow the Operating Partnership to make any distributions necessary to allow the Company to maintain its status as a REIT. Gables does not anticipate that this provision will adversely effect the ability of the Operating Partnership to make distributions or the Company to declare dividends, as currently anticipated.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Amounts in Thousands, Except Property and Per Unit Information - --------------------------------------------------------------
The tax-exempt bonds contain certain covenants which require a certain percentage of the apartments in such communities be rented to individuals based upon income levels specified by U.S. government programs, as defined.
MATURITIES
The aggregate maturities of notes payable at December 31, 1998 are as follows:
1999 $16,144 2000 56,912 2001 168,599 2002 86,280 2003 65,601 2004 and thereafter 419,252 -------- $812,788 ========
The debt maturities in 2001 include $110,000 of outstanding indebtedness under the $225 Million Credit Facility which has two remaining one-year extension options. The debt maturities in 2003 include $44,930 of tax-exempt bond indebtedness credit-enhanced through a letter of credit facility which has unlimited one-year extension options. Three of the underlying bond issues mature in December, 2007 and the fourth underlying bond issue matures in August, 2024.
JOINT VENTURE INDEBTEDNESS
The Arbors of Harbortown apartment community secures a $16.4 million tax-exempt bond obligation, which is recourse to Gables up to $1.0 million (this amount is fully cash-collateralized and is held by the Arbors of Harbortown JV), bears interest at a variable low-floater rate, has a maturity date of April, 2013, and is payable in monthly installments of interest only. The credit enhancement for the bond obligation expires in May, 2001. The Metropolitan Uptown apartment community secures a conventional fixed-rate loan with $17.8 million outstanding at December 31, 1998, 25% of which has been guaranteed by Gables. The loan has a maturity date of December 31, 2002 and bears interest at a rate of 7.18%.
INTEREST RATE PROTECTION AGREEMENTS
Gables has four interest rate protection agreements in place at December 31, 1998, the current terms of which are discussed below:
Notional Strike Effective Termination Description of Agreement Amount Price Date Date - ------------------------ ------ ------- ---------- ----------
LIBOR, 30-day - "Rate Cap" $44,530 6.25%(a) 01/27/94 01/30/99 LIBOR, 30-day - "Knock-out Rate Swap" 44,530 5.35%(a) 08/30/96 08/30/99(b) LIBOR, 30-day - "Knock-out Rate Swap" 25,000 5.76%(a) 02/27/98 02/27/00(c) LIBOR, 30-day - "Rate Swap" 40,000 4.79%(a) 11/30/98 09/29/00
(a) The 30-day LIBOR rate in effect at December 31, 1998 was 5.63%.
(b) This agreement fixes Gables' underlying 30-day LIBOR rate at 5.35% and terminates upon the earlier to occur of (i) the termination date or (ii) a rate reset date on which the 30-day LIBOR rate is 6.26% or higher.
(c) This agreement fixes Gables' underlying 30-day LIBOR rate at 5.76% and terminates upon the earlier to occur of (i) the termination date or (ii) a rate reset date on which the 30-day LIBOR rate is 6.70% or higher.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Amounts in Thousands, Except Property and Per Unit Information - --------------------------------------------------------------
PLEDGED ASSETS
The aggregate net book value at December 31, 1998 of real estate assets pledged as collateral for indebtedness was $473,336.
6. COMMITMENTS AND CONTINGENCIES
OFFICE LEASES
Gables is party to office operating leases with various terms. Future minimum lease payments and rent expense for such leases are not material.
CONTINGENCIES
The various entities comprising Gables are subject to various legal proceedings and claims that arise in the ordinary course of business. These matters are generally covered by insurance. While the resolution of these matters cannot be predicted with certainty, management believes that the final outcome of such matters will not have a material adverse effect on the financial position or results of operations of Gables.
7. EXTRAORDINARY LOSS
Extraordinary loss of $712 for the year ended December 31, 1997 represents (i) the write-off of unamortized deferred financing costs and prepaid credit enhancement fees associated with the defeasance of the tax-exempt bond financing encumbering the Club Candlewood property that was sold in January, 1997 and (ii) the write-off of unamortized deferred financing costs associated with the February 28, 1997 retirement of a conventional mortgage note payable that was scheduled to mature on September 1, 1997.
Extraordinary loss of $631 for the year ended December 31, 1996 represents the write-off of unamortized deferred financing costs associated with the early retirement of a credit facility that was refinanced.
8. DISCLOSURE ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS
Disclosure about the estimated fair value of financial instruments is based on pertinent information available to management as of December 31, 1998. Such amounts have not been comprehensively revalued for purposes of these financial statements since that date and current estimates of fair value may differ significantly from the amounts presented herein.
CASH EQUIVALENTS
Gables estimates that the fair value of cash equivalents approximates carrying value due to the relatively short maturity of these instruments.
NOTES PAYABLE
Gables estimates that the fair value of notes payable approximates carrying value based upon its effective current borrowing rate for issuance of debt with similar terms and remaining maturities.
INTEREST RATE PROTECTION AGREEMENTS
The estimated fair value and the net carrying value of the $44,530 interest rate cap agreement at December 31, 1998 is $0 and $11, respectively. The estimated fair value of the three interest rate swap agreements is $(161) at December 31, 1998. The estimated fair value for these agreements is based on the value of cash flows arising in the difference in the strike price per the agreements and projected LIBOR rates over the remaining term of these agreements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Amounts in Thousands, Except Property and Per Unit Information - --------------------------------------------------------------
9. EARNINGS PER UNIT
Basic earnings per Unit are computed based on net income available to common unitholders and the weighted average number of common Units outstanding. Diluted earnings per Unit reflect the assumed issuance of common Units under share option and incentive plans. The numerator and denominator used for both basic and diluted earnings per Unit computations are as follows:
Years Ended December 31, 1998 1997 1996 ------ ------ ------ BASIC AND DILUTED INCOME AVAILABLE TO COMMON UNITHOLDERS (NUMERATOR): Income before extraordinary loss $35,182 $36,102 $27,541 Extraordinary loss 0 (712) (631) Net income 35,182 35,390 26,910
COMMON UNITS (DENOMINATOR): Average Units outstanding - basic 30,212 23,441 20,194 Incremental Units from assumed conversions of: Stock options 128 150 89 ------ ------- ------ Average Units outstanding - diluted 30,340 23,591 20,283 ====== ======= ======
10. SEGMENT REPORTING
Gables adopted SFAS No. 131, "Disclosures about Segments of an Enterprise and Related Information," during 1998. SFAS No. 131 established standards for reporting financial and descriptive information about operating segments in annual financial statements. Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. Gables' chief operating decision maker is its senior management group.
Gables owns, operates and develops multifamily apartment communities in nine major markets located in Texas, Georgia, Florida and Tennessee. Such apartment communities generate rental revenue and other income through the leasing of apartment homes to a diverse base of residents. Gables evaluates the performance of each of its apartment communities on an individual basis. However, because each of the apartment communities have similar economic characteristics, residents, and products and services, the apartment communities have been aggregated into one reportable segment. This segment comprises 97% of Gables' total revenues for the year ended December 31, 1998.
The primary financial measure for Gables' reportable business segment is net operating income ("NOI"), which represents total property revenues less property operating and maintenance expenses (as reflected in the accompanying statements of operations). Accordingly, NOI excludes certain expenses included in the determination of net income. Current year NOI is compared to prior year NOI and current year budgeted NOI as a measure of financial performance. The NOI yield or return on total capitalized costs is an additional measure of financial performance. NOI from apartment communities totaled $138,778, $91,101 and $70,778 for the years ended December 31, 1998, 1997 and 1996, respectively. All other segment measurements are disclosed in Gables' consolidated financial statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Amounts in Thousands, Except Property and Per Unit Information - --------------------------------------------------------------
Gables also provides management, brokerage, corporate apartment home and development and construction services to third parties. These operations on an individual and aggregate basis do not meet the quantitative thresholds for segment reporting per SFAS No. 131.
11. PROFIT SHARING PLAN
Eligible employees of Gables may participate in a profit sharing plan pursuant to Section 401(k) of the Internal Revenue Code. Under the plan, employees may defer a portion of their salary on a pre-tax basis. Gables also has the discretion to make matching contributions, currently equal to 50% of an employee's first 4% salary deferral contribution. Expenses under this plan for the years ended December 31, 1998, 1997 and 1996 were not material.
During January, 1996, the Company added the Gables Residential Trust Stock Fund (the "Fund") as an investment option for the plan. The Fund is comprised of common shares of the Company. In connection therewith, 100 common shares were registered for issuance under the plan. The plan trustee will purchase common shares of the Company for the Fund, at the direction of the plan investment committee, either on the open market or directly from the Company.
12. DISTRIBUTIONS AND SHARE BUILDER PLAN
The Company has declared and paid distributions to common unitholders for the years ended December 31, 1998, 1997 and 1996 as follows:
Per Share Dividends ------------------- First Qtr. to Fourth Year Fourth Qtr. Qtr. ------ ----------- ------ 1998 $2.02 $0.51 (a) 1997 1.98 0.50 (a) 1996 1.94 0.49 (b)
(a) The fourth quarter distributions in 1998 and 1997 were declared and paid in December 1998 and 1997, respectively.
(b) The fourth quarter distributions for 1996 were declared in December, 1996 and were paid in January, 1997.
In 1995, the Company implemented its Share Builder Plan, a dividend reinvestment and share purchase program that provides its shareholders a method, without brokerage commissions or service charges, of investing cash dividends or optional cash payments in additional common shares. Under the plan, shareholders may elect to reinvest dividends in additional common shares at a 2% discount to the then current market price of common shares and may purchase additional common shares for cash (up to $20 per quarter) at 100% of the then current market price.
13. 1994 SHARE OPTION AND INCENTIVE PLAN
The Company adopted the 1994 Share Option and Incentive Plan (the "Plan") to provide incentives to officers, employees and non-employee trustees. The Plan provides for the grant of options to purchase a specified number of common shares ("Options") or the grant of restricted or unrestricted common shares ("Restricted Shares" or "Unrestricted Shares"). Under the Plan, as amended, the total number of shares available for grant is 9% of the total number of common shares and Units (other than common shares or Units held by the Company or its subsidiaries) outstanding at any time and the number of common shares which may be issued as Restricted Shares or Unrestricted Shares is equal to 50% of the number of shares available for issuance under the Plan at such time. The Operating Partnership will issue a Unit for each common share of the Company issued under the Plan.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Amounts in Thousands, Except Property and Per Unit Information - --------------------------------------------------------------
To date, Options have been granted in two or more series during each of 1994 through 1998 with an exercise price equal to the fair value of the Company's common shares on the dates the Options were granted. The Options granted are generally exercisable in installments over three years beginning one year after the date of grant. At December 31, 1998, 2,022 common shares are subject to outstanding Options granted to officers, employees and trustees of the Company, of which Options to purchase approximately 608 shares are currently exercisable.
The total number of common shares reserved for issuance under the Plan at December 31, 1998 is 2,948, which is equal to 9% of the total number of common shares and Units outstanding at that time.
A summary of the Options activity for the years ended December 31, 1998, 1997 and 1996 is as follows:
1998 1997 1996 ------ ------ ------ Outstanding at beginning of year 937 904 773 Granted 1,305 235 270 Forfeited (56) (55) (72) Exercised (164) (147) (67) ----- ------ ------ Outstanding at end of year 2,022 937 904 ===== ====== ======
Option prices: Granted $26.750- $27.625 $25.000- $25.500 $22.750- $23.000 Forfeited 19.500- 27.625 19.500- 25.500 19.500- 22.750 Exercised 19.125- 25.500 19.500- 22.750 19.500- 22.500 Outstanding at end of year 19.125- 27.625 19.125- 25.500 19.125- 23.000
Gables accounts for stock options issued under the Plan in accordance with APB Opinion No. 25, "Accounting for Stock Issued to Employees," under which no compensation cost has been recognized, since all options have been granted with an exercise price equal to the fair value of the Company's common shares on the date of grant. Had compensation cost for these plans been determined consistent with Statement of Financial Accounting Standards No. 123 (FAS 123) "Accounting for Stock-Based Compensation," Gables' net income and earnings per Unit would have been reduced to the following pro forma amounts:
1998 1997 1996 ------ ------ ------ Net income available to common unitholders: As Reported $35,182 $35,390 $26,910 Pro Forma 34,639 35,130 26,762
Basic earnings per Unit: As Reported 1.16 1.51 1.33 Pro Forma 1.14 1.50 1.33
Diluted earnings per Unit: As Reported 1.16 1.50 1.32 Pro Forma 1.14 1.49 1.32
Because the FAS 123 method of accounting has not been applied to options granted prior to January 1, 1995, the resulting pro forma compensation cost may not be representative of that to be expected in future years.
The weighted average fair value of options granted is $1.92, $2.14 and $1.91 for 1998, 1997 and 1996, respectively. The fair value of each option grant as of the date of grant has been estimated using the Black-Scholes option pricing models with the following weighted-average assumptions for grants in 1998, 1997 and 1996, respectively: risk free interest rates of 4.84%, 6.45% and 6.44%; expected lives of 6.39, 3.91 and 4.90; dividend yields of 7.55%, 7.99% and 8.43%, and expected volatility of 18%, 18% and 19%.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Amounts in Thousands, Except Property and Per Unit Information - --------------------------------------------------------------
The Company has made the following grants of Restricted Shares and Unrestricted Shares (the "Share Grants") under the Plan:
The value of the Unrestricted Shares granted is accrued as long-term compensation expense in the year the related service was provided. Upon issuance of the Share Grants, the value of the Units issued is recorded to partners' capital and the value of the Restricted Shares is recorded as a reduction to partners' capital as deferred compensation. Such deferred compensation is amortized ratably over the term of the vesting period. During 1998, 7 Restricted Shares were forfeited and the appropriate adjustments were made to partners' capital and compensation expense.
14. SUBSEQUENT EVENTS (Unaudited as to events occurring subsequent to March 5, 1999)
On March 4, 1999, Gables sold an apartment community located in Atlanta comprising 213 apartment homes for $19.3 million. The net proceeds were initially used to paydown outstanding borrowings under Gables' $225 Million Credit Facility.
On March 22, 1999, the Company announced a common share repurchase program pursuant to which the Company is authorized to purchase up to $50 million of its outstanding common shares. The Company plans to repurchase shares from time to time in open market and privately negotiated transactions, depending on market prices and other conditions using proceeds from sales of selected assets.
On March 26, 1999, Gables entered into a joint venture agreement with an affiliate of J.P. Morgan Investment, Inc. ("J.P. Morgan"). The business purpose of the venture is to develop, own and operate seven multifamily apartment communities located in four of Gables' nine markets, which are expected to comprise 2,181 apartment homes. As of December 31, 1998, Gables (i) had commenced construction of four of the communities, (ii) owned the land for the future development of two of the communities and (iii) owned the acquisition right for the land for the future development of one of the communities. The capital budget for the development of the seven communities is approximately $213 million and is anticipated to be funded with 50% debt and 50% equity. The equity component will be funded 80% by J.P. Morgan and 20% by Gables. Gables' portion of the equity will be funded through a contribution of cash and property. Gables will serve as the managing member of the venture and will have responsibility for all day-to-day operating issues. Gables will also serve as the general contractor during construction and as the property manager.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Amounts in Thousands, Except Property and Per Unit Information - --------------------------------------------------------------
15. QUARTERLY FINANCIAL INFORMATION (Unaudited)
Quarterly financial information for the years ended December 31, 1998 and 1997 is as follows:
Year Ended December 31, 1998 -------------------------------- First Second Third Fourth Quarter Quarter Quarter Quarter ----------------------------------------
Total revenues $41,490 $56,176 $59,214 $59,744 Gain on sale of real estate assets 0 0 0 0 Loss on treasury locks (1,811) (199) (3,627) 0 Income before extraordinary loss 9,198 11,706 10,086 14,444 Extraordinary loss 0 0 0 0 Net income 9,198 11,706 10,086 14,444 Net income available to common unitholders 6,812 9,312 7,644 11,414 Basic earnings per common unit: Income before extraordinary loss 0.26 0.32 0.23 0.35 Net income 0.26 0.32 0.23 0.35 Diluted earnings per common unit: Income before extraordinary loss 0.26 0.32 0.23 0.35 Net income 0.26 0.32 0.23 0.35
Year Ended December 31, 1997 -------------------------------- First Second Third Fourth Quarter Quarter Quarter Quarter ----------------------------------------
Total revenues $32,232 $33,741 $36,893 $40,572 Gain on sale of real estate assets 4,858 0 491 0 Loss on treasury locks 0 0 0 (1,178) Income before extraordinary loss 12,310 7,925 10,594 9,436 Extraordinary loss (712) 0 0 0 Net income 11,598 7,925 10,594 9,436 Net income available to common unitholders 11,598 7,925 8,819 7,048 Basic earnings per common unit: Income before extraordinary loss 0.54 0.34 0.38 0.28 Net income 0.51 0.34 0.38 0.28 Diluted earnings per common unit: Income before extraordinary loss 0.53 0.34 0.38 0.28 Net income 0.50 0.34 0.38 0.28
GABLES REALTY LIMITED PARTNERSHIP Schedule III
Real Estate Investments and Accumulated Depreciation as of December 31, 1998 (Dollars in Thousands)
GABLES REALTY LIMITED PARTNERSHIP Schedule III
Real Estate Investments and Accumulated Depreciation as of December 31, 1998 (Dollars in Thousands)
A summary of activity for real estate investments and accumulated depreciation is as follows: