Item 1. BUSINESS
References in the Annual Report on Form 10-K to “BRE,” “we” or “us” refer to BRE Properties, Inc., a Maryland corporation.
Corporate Profile
We are a self-administered equity real estate investment trust, or REIT, focused on the development, acquisition and management of multifamily apartment communities in eight targeted metropolitan markets of the Western United States. At December 31, 2003, our multifamily portfolio had real estate assets with a net book value of approximately $2.2 billion, which included: 80 wholly or majority owned completed multifamily communities, aggregating 22,981 units in California, Arizona, Washington, Utah and Colorado; two multifamily communities owned through joint venture agreements, comprised of 488 apartment units; and seven apartment communities in various stages of construction and development totaling 1,388 units. We have been a publicly traded company since our founding in 1970 and have paid 133 consecutive quarterly dividends to our shareholders since inception.
Our principal operating objective is to maximize the economic returns of our apartment communities so as to provide our shareholders with the greatest possible total return and value. To achieve this objective, we pursue the following primary strategies and goals:
•
Seek to maintain balance sheet strength and financial flexibility to provide continued access to attractively priced capital for intelligent growth opportunities;
•
Accelerate growth from the operation of existing assets by achieving and maintaining high occupancy levels, dynamic pricing, and operating margin expansion through operating efficiencies and cost controls;
•
Deploy new and recycled capital to supply constrained markets of the West through a selective development, acquisition and disposition program that is supported by a research-driven investment model; and
•
Create a valuable customer experience that focuses on services that generate increased profitability from resident retention and referrals.
We believe we can best achieve our objectives by developing, acquiring and internally managing high-quality apartment communities in high-demand, supply constrained locations near the business, transportation, employment and recreation centers essential to customers who value the convenience, service and flexibility of rental living. Recognizing that customers have many housing choices, we focus on developing and acquiring apartment homes with customer-defined amenities and providing professional management services, delivered by well-trained associates. We have concentrated our investment and business focus in the Western United States because of certain characteristics of these markets, including the propensity to rent and a housing supply that currently cannot keep pace with population and employment growth. From time to time, we dispose of assets that do not meet our long-term investment criteria, recycling the capital derived from property sales into apartment communities in supply constrained locations that offer higher return opportunities.
Events During 2003
On April 4, 2003 we amended and restated our revolving unsecured credit facility through April 2006, maintaining an interest rate of LIBOR plus 0.70%, plus a fee of 0.20% payable on the unused portion of the credit facility. The average borrowing rate for 2003 was 2.7%. We elected to reduce the borrowing capacity from $450,000,000 to $350,000,000 on the unsecured credit facility.
On May 2, 2003, we established a $100,000,000 Fannie Mae secured credit facility. The secured credit facility matures in 2008 and is secured by five multifamily communities. Borrowings under the facility bear interest at variable rates with maturities from one to nine months, plus a facility fee of up to 0.65%. The average borrowing rate for 2003 was 2.1%, including the facility fee. Drawings on the lines of credit are available to fund our investment activities and for general corporate purposes.
On September 16, 2003, we sold 3,000,000 shares of our common stock. Proceeds to BRE, net of underwriting discounts and commissions, equaled $32.651 per share, which represented a 3.4% discount from the New York Stock Exchange closing price of $33.80 per share on September 16, 2003. The shares were re-offered to the public through the underwriter at a price of $33.10 per share. Subsequent to the end of the third quarter 2003, the underwriter exercised its over-allotment option to purchase an additional 450,000 shares. Net proceeds from the offering-after all discounts, commissions and issuance costs-totaled approximately $112,300,000.
During 2003, we acquired three properties totaling 1,038 units for approximately $116,000,000. The properties include: Corona Pointe, acquired September 15, 2003, with 714 units located in Riverside, California; Enclave at Town Square, acquired October 31, 2003, with 124 units located in Chino Hills, California; and Canyon Creek, acquired December 18, 2003, with 200 units located in Northridge, California.
During 2003, we also completed the development and lease-up of two communities: Pinnacle Denver Technological Center, with a total of 420 units located in the Denver suburb of Greenwood Village, Colorado; and Pinnacle at Talega I, with 252 units located in San Clemente, California. Both communities went through the lease-up phase during 2003 and were stabilized as of December 31, 2003. Both communities are directly owned by us.
During 2003, we sold three communities totaling 1,100 units: Berkshire Court, with 266 units, located in the Portland Oregon metro area; Brookdale Glenn, with 354 units, also located in Portland, Oregon; and Newport Landing, with 480 units, located in the Phoenix suburb of Glendale, Arizona. The sale of the two Portland area assets completed our exit from that market. The three communities were sold for an aggregate gross sales price of approximately $72,600,000, resulting in a net gain on sale of approximately $23,147,000.
During the third quarter of 2003, we settled a lawsuit that was filed by an unrelated third party in 2002 regarding the Pinnacle at MacArthur Place joint venture agreement. Under the terms of the settlement, we paid the third party $6,500,000 and retained full ownership of the asset. Also during third quarter 2003, we reached a settlement agreement regarding a class action lawsuit that was brought against us with respect to application fees charged residents from August 1998 to August 2003. Under terms of the settlement, we agreed to establish a $200,000 fund to reimburse the subject applicants up to $5.00 per applicant, and to pay certain related administration charges and legal expenses. Both settlement amounts, including all related legal and administrative costs, aggregate $7,305,000 and are reported as other expenses on the consolidated income statement.
In November of 2003, we announced a one-year executive succession plan, culminating with the retirement of Frank C. McDowell, BRE’s President and Chief Executive Officer, from the role of Chief Executive Officer at the end of 2004. On January 1, 2004, McDowell assumed the role of Vice Chairman and CEO, and Constance B. Moore became BRE’s President and Chief Operating Officer. Moore will be named President and CEO on January 1, 2005.
During the fourth quarter of 2003, we issued a notice of redemption to all holders of record of our outstanding 8.50% Series A Cumulative Redeemable Preferred Stock, at a redemption price of $25.17118 per share. The redemption price is equal to the original issuance price of $25.00 per share, plus accrued and unpaid dividends to the redemption date. The redemption date was January 29, 2004. From the redemption date forward, dividends on the 2,150,000 shares of Series A Cumulative Redeemable Preferred Stock, all of which were called for redemption, no longer accrue, and holders of any 8.50% Series A Cumulative Redeemable Preferred Stock not tendered for redemption have no rights other than the rights to receive the $25.17118 total redemption price.
Events During 2002
On March 12, 2002, we issued $150,000,000 of five-year senior unsecured notes in an underwritten public offering at a 5.95% coupon. On August 20, 2002, we issued $150,000,000 of seven-year senior unsecured notes in an underwritten public offering at a 5.75% coupon. Net proceeds from the sales of the notes totaled approximately $297,407,000, after deducting the underwriting discounts and commissions and our offering expenses, and were used to repay a portion of the borrowings under our existing unsecured credit facility.
On June 20, 2002, we closed the underwritten public offering of three million shares of 8.08% Series B Cumulative Redeemable Preferred Stock at $25 per share. The Series B Preferred Stock will be redeemable at $25 per share on or after June 20, 2007. The preferred shares trade on the NYSE under the symbol BRE_prb. Net proceeds from the offering totaled $72,291,000, after deducting the underwriting discounts and commissions and our offering expenses, and were used to invest in additional multifamily communities and, pending such use, to repay temporary borrowings under our existing unsecured credit facility.
During 2002, we consolidated five joint venture investments, transferring the assets from equity interests in real estate joint ventures to direct investments in real estate. With respect to two of the joint ventures, the consolidation reflected our acquisition of our joint venture partner’s ownership interest in the properties. These properties are: Pinnacle at Blue Ravine, a 260-unit apartment community located in Folsom, California; and Pinnacle Sonata, a 268-unit community located in Bothell, Washington. The acquisition price for our partner’s ownership interests was $56,520,000.
With respect to two of the joint ventures, the consolidation reflected the termination of the joint venture arrangements prior to funding. These properties are: Pinnacle Stonecreek, a 226-unit community located in Phoenix, Arizona; and Pinnacle at the Creek, a 216-unit community located in the Denver suburb of Aurora, Colorado. The effect of the consolidation was an increase to direct investments in real estate of $48,515,000, a reduction of equity interests in and advances to real estate joint ventures of $26,297,000 and an assumption of secured indebtedness totaling $22,218,000. After consolidating these assets we paid down $6,722,000 of the related secured indebtedness.
With respect to the remaining joint venture property: Pinnacle at MacArthur Place, a 253-unit community located in the South Coast Metro Area of Orange County, California, the consolidation resulted from a dispute between us and our joint venture partner that prevented the closing and funding of the joint venture. As noted above, we settled the litigation in 2003. The effect of the consolidation was an increase to direct investments in real estate of $64,227,000, a reduction of equity interests in and advances to real estate joint ventures of $24,227,000 and an assumption of secured indebtedness totaling $40,000,000.
During 2002, we acquired an additional four properties totaling 848 units for approximately $100,000,000. The properties include: Bernardo Crest, with 216 units located in San Diego, California; Mission Trails, with 208 units also located in San Diego; Boulder Creek, with 264 units in Riverside, California; and Emerald Pointe Apartments, with 160 units located in Diamond Bar, California.
During 2002, we also completed the construction of Pinnacle at Otay Ranch I and II, with a total of 364 units located in the San Diego suburb of Chula Vista, California; and Pinnacle at Lake Washington, with 180 units located in the Seattle suburb of Renton, Washington. Both communities are directly owned by us.
During 2002, we sold three communities totaling 663 units: The Arbors at Warner Center, with 250 units, located in the Los Angeles metro area of Woodland Hills, California; Pinnacle Lakeside, with 253 units, located in Salt Lake City, Utah; and Carriage House, with 160 units, located in the Portland, Oregon metro area. The communities were sold for an aggregate sales price of approximately $58,300,000, resulting in a net gain on sale of $10,067,000. In connection with these transactions, we repaid approximately $13,216,000 in related secured mortgage debt.
Events During 2001
In the first quarter of 2001, we issued $250,000,000 of 10-year senior unsecured notes at a 7.45% coupon. Net proceeds from the sale of the notes totaled approximately $246,586,000, after deducting the underwriting discounts and commissions and our offering expenses, and were primarily used to repay a portion of the borrowings under our existing unsecured credit facility.
During 2001, we completed the development and lease-up of one property with 248 units located in Bellevue, Washington. We also purchased Pinnacle Belltown, located in downtown Seattle, and Pinnacle at Laguna Niguel, located in Laguna Niguel, California, for a combined total of 597 units.
During 2001, we sold three Tucson communities with 621 units for an aggregate sales price of $19,000,000, pursuant to an agreement with G&I III Residential One, LLC, an affiliate of DRA Advisors, Inc. The Tucson sale completed a $280,000,000 portfolio sale of apartment communities we initiated in the third quarter of 2000 that was governed under a single master agreement. To facilitate the portfolio sale, we invested a total of approximately $13,674,000 of aggregate net proceeds in a joint venture controlled by an affiliate of the buyer, in which BRE has a 15% interest. The buyer’s affiliate, DRA Growth and Income Fund III, LLC, has an 85% interest. Our remaining investment is included in other assets.
Competition
All of our communities are located in developed areas that include other multifamily communities. There are numerous other multifamily properties and real estate companies within these areas that compete with us for residents and development and acquisition opportunities. Such competition could have a material effect on our ability to lease apartment homes at our communities or at any newly developed or acquired communities and on the rents charged. We may be competing with others that have greater resources than us. In addition, other forms of residential properties, including single-family housing, provide housing alternatives to potential residents of upscale apartment communities.
Structure, Tax Status and Investment Policy
We believe we are organized and operate so as to qualify as a real estate investment trust, or REIT, under Sections 856-860 of the Internal Revenue Code of 1986, as amended. If we qualify as a REIT, we generally will not be subject to Federal income tax to the extent we distribute 100% of our taxable income to our shareholders. REITs are subject to a number of complex organizational and operational requirements. If we fail to qualify as a REIT, our taxable income may be subject to income tax at regular corporate rates. See “Risk Factors-Tax Risks.”
Our long-range investment policy emphasizes the development, construction and acquisition of multifamily communities located in the Western United States. As circumstances warrant, certain properties may be sold and the proceeds reinvested into multifamily communities which our management believes better align with our growth objectives. Among other items, this policy is intended to enable our management to monitor developments in local real estate markets and to take an active role in managing our properties and improving their performance. The policy is subject to ongoing review by the Board of Directors and may be modified in the future to take into account changes in business or economic conditions, as circumstances warrant.
Employees
As of December 31, 2003, we had 728 employees. None of our employees are covered by collective bargaining agreements.
Company Website
To view our current and periodic reports free of charge, please go to our website at www.breproperties.com. We make these postings as soon as reasonably practicable after our filings with the SEC. Our website contains copies of our Corporate Governance Guidelines and the charters of each of our Audit and Compensation, Nominating and Governance Committees. Our website will also contain our Code of Business Conduct and Ethics, expected to be adopted and disclosed in February 2004. This information is also available in print to any shareholder who requests it by contacting us at BRE Properties, Inc., 44 Montgomery St., 36th Floor, San Francisco, California, 94104, attention: Investor Relations.
Investment Portfolio
See Part I, Item 2
Item 2. PROPERTIES
General
In addition to the information in this Item 2, certain information regarding our property portfolio is contained in Schedule III (financial statement schedule) under Part IV, Item 15(d).
Multifamily Property Data
Our multifamily properties represent 100% of our real estate portfolio and 99% of our total revenue.
No single multifamily property accounted for more than 10% of revenues in any of the five years ended December 31, 2003.
The following table discloses certain operating data about our multifamily units:
This table summarizes data about our operating multifamily properties:
(1)
Portfolio occupancy is calculated by dividing the total occupied units by the total units in the portfolio at the end of the year. Apartment units are generally leased to residents for rental terms not exceeding one year.
(2)
Represents the aggregate net operating income (NOI) from properties in each market divided by the total net operating income of multifamily properties for the year ended December 31, 2003, and includes the results of properties acquired and developed during 2003 from the date of acquisition and completion. Excludes NOI from properties sold during 2003. Accordingly, these results do not reflect a full year of operations for properties acquired or completed in 2003.
(3)
Represents average physical occupancy for all stabilized properties for the twelve months ended December 31, 2003. The total is a weighted average by units for all communities shown.
(4)
Represents average prevailing market rent per unit for the twelve months ended December 31, 2003. The total is a weighted average by units for all communities shown.
The following table summarizes our “same-store” operating results. “Same-store” properties are defined as completed and stabilized properties owned by us for at least two years.
Our business focus is the ownership and operation of multifamily communities; we evaluate performance and allocate resources primarily based on the net operating income (“NOI”) of an individual multifamily community. We define NOI as the excess of all revenue generated by the community (primarily rental revenue) less direct operating expenses (primarily, but not limited to, payroll, property taxes, insurance and maintenance expense). Accordingly, NOI excludes depreciation, capitalized expenditures and interest expense. NOI, including NOI from discontinued operations, totaled approximately $194,000,000, $199,000,000 and $193,000,000 for the years ended December 31, 2003, 2002, and 2001, respectively.
A reconciliation of net income available to common shareholders to NOI for the three years ended December 31, 2003 is as follows:
Properties Completed during 2003
In March of 2003, we completed the construction of Pinnacle Denver Technological Center, with a total of 420 units located in the Denver suburb of Greenwood Village, Colorado. In June of 2003, we completed Pinnacle at Talega I, with 252 units located in San Clemente, California.
Development Properties
The following table provides data on our seven multifamily properties that are currently under various stages of development and construction. Completion of the development properties is subject to a number of risks and uncertainties, including construction delays and cost overruns. We cannot assure that these properties will be completed, or that they will be completed by the estimated dates, or for the estimated amounts, or will contain the number of proposed units shown in the table below.
(1)
“Completion” is defined as our estimate of when an entire project will have a final certificate of occupancy issued and be ready for occupancy. Completion dates have been updated to reflect our current estimates of receipt of final certificates of occupancy, which are dependent on several factors, including construction delays and the inability to obtain necessary public approvals.
(2)
Reflects all recorded costs incurred as of December 31, 2003, recorded on our consolidated balance sheet as “direct investments in real estate-construction in progress.”
(3)
Land under development represents projects in various stages of pre-development, development, and initial construction, for which construction or supply contracts have not yet been finalized. As these contracts are finalized, projects are transferred to construction in progress on our consolidated balance sheet.
Insurance, Property Taxes and Income Tax Basis
We carry comprehensive liability, fire, pollution, extended coverage and rental loss insurance on our properties with certain policy specifications, limits and deductibles. In addition, at December 31, 2003, we carried flood and earthquake coverage with an annual aggregate limit of $100,000,000 (after policy deductibles ranging from 2%-5% of damages). Management believes the properties are adequately covered by such insurance.
Property taxes on portfolio properties are assessed on asset values based on the valuation method and tax rate used by the respective jurisdictions. The gross carrying value of our direct investments in operating rental properties was $2,281,048,000 as of December 31, 2003. On the same date our assets had an underlying gross federal income tax basis of approximately $2,049,048,000, reflecting, among other factors, the carryover of basis on tax-deferred exchanges.
Headquarters
We lease our corporate headquarters at 44 Montgomery Street, 36th Floor, San Francisco, California, 94104-4809, from OTR, an Ohio general partnership. The lease covers 15,170 rentable square feet at annual per square foot rents, which began at $37.00 in 1998, and rise to $44.00 in the eighth year of the lease. The lease term ends on January 31, 2006. We also maintain regional offices in: Irvine, California; Phoenix, Arizona; and Denver, Colorado.
Item 3.
Item 3. LEGAL PROCEEDINGS
BRE is defending various claims and legal actions that arise in its normal course of business. While it is not feasible to predict or determine the ultimate outcome of these matters, in the opinion of management, none of these actions will have a material adverse effect on us.
Item 4.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
PART II
Item 5.
Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock is traded on the New York Stock Exchange under the symbol “BRE”. As of February 10, 2004, there were approximately 4,900 recordholders of BRE’s common stock and the last reported sales price on the NYSE was $33.97. The number of holders does not include shares held of record by a broker or clearing agency, but does include each such broker or clearing agency as one recordholder. As of February 10, 2004, there were approximately 28,500 beneficial holders of BRE’s common stock.
This table shows the high and low sales prices of our common stock reported on the NYSE Composite Tape and the dividends we paid for each common share:
Since 1970, when BRE was founded, we have made regular and uninterrupted quarterly distributions to shareholders. The payment of distributions by BRE is at the discretion of the Board of Directors and depends on numerous factors, including our cash flow, financial condition and capital requirements, REIT provisions of the Internal Revenue Code and other factors.
During the three months ended December 31, 2003, an aggregate 173,726 limited partnership units in BRE Property Investors LLC were exchanged for shares of BRE common stock. For the year ended December 31, 2003, an aggregate 233,083 limited partnership units in BRE Property Investors LLC were exchanged for shares of BRE common stock. The exchange of limited partnership units for shares of our common stock was exempt from the registration requirements of the Securities Act pursuant to Section 4(2) of the Securities Act and Rule 506 of Regulation D.
Item 6.
Item 6. SELECTED FINANCIAL DATA
The selected financial data below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and notes. The results are affected by numerous acquisitions and dispositions as discussed in “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” Therefore, the consolidated financial statements and notes thereto included elsewhere in this report are not directly comparable to prior years.
(1)
Excludes revenues from discontinued operations totaling $1,984; $15,427; $15,762; $14,862 and $14,039 in 2003, 2002, 2001, 2000 and 1999, respectively.
(2)
We consider Funds from Operations to be an appropriate supplemental measure of the performance of an equity REIT because it is predicated on cash flow analyses that facilitate an understanding of the operating performances of our properties without giving effect to non-cash items such as depreciation. Additionally, we analyze the relationship between dividend payments and FFO to measure our ability to pay dividends to our shareholders. FFO is defined by the National Association of Real Estate Investment Trusts as net income or loss (computed in accordance with accounting principles generally accepted in the United States) excluding gains or losses from debt restructuring and sales of property, plus depreciation and amortization of real estate assets. FFO does not represent cash generated from operating activities in accordance with accounting principles generally accepted in the United States, and therefore should not be considered a substitute for net income as a measure of results of operations or for cash flow from operations as a measure of liquidity. The application and calculation of FFO by other REITs may vary materially from our calculations, and therefore our FFO and the FFO of other REITs may not be directly comparable. On October 27, 1999, NAREIT revised its definition for periods after January 1, 2000. Consequently, FFO calculations for periods ending subsequent to January 1, 2000 may not be comparable to calculations for periods ended prior to that date. Expenses related to VelocityHSI were added back to operating results to determine FFO from real estate in prior years. The effect of including losses from this investment in FFO would be to decrease FFO by $7,163 and $8,765 for the years ended December 31, 2001 and 2000, respectively. There was no impact from VelocityHSI in 2003, 2002 or 1999.
(3)
Represents legal settlement charges related to the settlement of two lawsuits during the third quarter of 2003.
Item 7.
Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Executive Summary
We are a self-administered equity real estate investment trust or “REIT” focused on the development, acquisition and management of multifamily apartment communities in eight metropolitan markets of the Western United States. At December 31, 2003, our portfolio had real estate assets with a net book value of approximately $2.2 billion that included 80 wholly or majority owned completed apartment communities, aggregating 22,981 units; two multifamily communities owned in joint ventures, comprised of 488 apartment units; and seven apartment communities in various stages of construction and development, totaling 1,388 units.
Our 2003, 2002 and 2001 operating results reflect deteriorating national and regional economic conditions and the corresponding impact on our market level rents and occupancy. Operating metrics toward the end of 2000, including market rents, occupancy and turnover, reflected national and regional economic cycles at peak levels, just prior to entering a recessionary phase. Recessionary pressures and weakening employment conditions that accelerated during 2001 continued throughout 2002 and 2003, resulting in depressed market rents, flat average occupancy levels and higher than normal resident turnover levels.
Economic conditions and continued job losses had the greatest impact in our San Francisco Bay Area market. During 2003, market level rents in our San Francisco Bay Area communities continued to decline from 2000 peak levels. Market rent in our Bay Area portfolio peaked in the third quarter of 2000 at approximately $2,000 per unit and has declined sequentially each of the past three years, averaging $1,795, $1,523 and $1,371 per unit in 2001, 2002, and 2003, respectively. Management does not expect a recovery in this region until there is job recovery. Market declines in the Bay Area and other regions have been partially offset by sustained growth in our Southern California markets, which comprised 41% of our real estate net operating income in 2003. Market rents in Southern California have increased 11% over the past three years and occupancy and turnover have remained stable. Management has focused its efforts on growth in the Southern California markets due to these market dynamics, and continues to closely monitor and act upon the key operating metrics-market rent, occupancy, and turnover-in each of our markets. We earn revenue and generate cash primarily by collecting monthly rent from our apartment residents.
Our 80 wholly or majority owned apartment communities can be categorized as follows to better understand our overall results:
•
18,656 units in 64 communities were completed and stabilized for all of 2003 and 2002 (“same-store” communities);
•
1,886 units in seven communities were acquired in 2003 or 2002 and as a result did not have comparable year-over-year operating results;
•
1,216 units in four development communities were completed and stabilized during 2003 and 2002 and as a result did not have comparable year-over-year operating results; and
•
1,223 units in five acquired or developed communities were previously subject to joint venture agreements but were consolidated in 2002, and as a result did not have comparable year-over-year operating results.
In addition to year-over-year economic operating performance, our results of operations for the three years ended December 31, 2003 were affected by income derived from acquisitions and completions of apartment communities, and the volume and timing associated with acquisition and disposition activities. We have engaged in disposition activities in an effort to reposition our portfolio through the sale of apartment communities located in non-core markets. Properties disposed of in the first six months of 2003 and in 2002 contributed net operating income that was $8,200,000 greater in 2002 than in 2003. Acquisition activities effectively increased 2003 net operating income by $4,200,000 as compared with 2002.
RESULTS OF OPERATIONS
Comparison of the Years ended December 31, 2003, 2002 and 2001
Revenues
Total revenues were $275,143,000 in 2003, $262,780,000 in 2002, and $247,914,000 in 2001, excluding revenues from discontinued operations. The increase in revenues in 2003 was primarily derived from properties acquired, developed, and consolidated during the past two years. These increases were partially offset by a 4% reduction in revenues from “same-store” communities in 2003 as compared to 2002, and a $2,003,000 reduction in partnership and other income. The increase in revenues in 2002 was derived from properties acquired, developed, and consolidated during 2002 and 2001. These increases were partially offset by a 3% reduction in revenues from “same-store” communities in 2002 as compared to 2001 and a $3,416,000 reduction in partnership and other income. A summary of revenues for the years ended December 31, 2003, 2002 and 2001 follows:
Rental and Ancillary Income
As described above, the increase in rental and ancillary revenues relates to acquired and developed communities. The following table summarizes our multifamily property acquisitions, development properties completed, and dispositions for the years ended December 31, 2003, 2002 and 2001 (dollar amounts are gross acquisition costs in the case of acquisitions, total delivered cost in the case of completed development communities and gross sales prices in the case of property dispositions):
Increased revenues from non “same-store” communities were offset by negative “same-store” operating results. On a “same-store” basis, rental and ancillary revenues decreased $8,793,000, or 4%, primarily due to average market rent per unit decreasing approximately 4%. On a “same-store” basis in 2002, rental revenues decreased $6,219,000 or 3%, as market rent per unit decreased approximately 5%. Occupancy for each of the three years ended December 31, 2003 follows:
Portfolio occupancy is calculated by dividing the total occupied units by the total units in stabilized communities in the portfolio.
Partnership and other income
Partnership and other income totaled $2,344,000, $4,347,000 and $7,763,000 for the years ended December 31, 2003, 2002 and 2001, respectively. The decrease in 2003 from 2002 is driven by the consolidation of five communities during 2002. The decrease in 2002 from 2001 primarily relates to the absence of development fee income in 2002 due to the stage of completion of our joint venture pipeline in 2002. The 2001 total includes development fees of $2,105,000. Additionally, partnership income in 2002 was lower than the 2001 amount due to the 2002 consolidations.
Expenses
Real estate expenses
A summary of real estate expenses follows:
Real estate expenses for multifamily rental properties (which include repairs and maintenance, utilities, on-site staff payroll, property taxes, insurance, advertising and other direct operating expenses) increased $9,709,000 or 13% for the year ended December 31, 2003, as compared to the prior year. The three communities acquired and two communities developed in 2003, combined with 2002 acquisition and development communities operating for a full year, drive the year-over-year increase. Additionally, “same-store” expenses increased by $1,439,000, or 2% in 2003, primarily driven by an increase in payroll expense offset by a reduction of utility expenses. The overall level of “same-store” expense increase was consistent with historical levels. In 2002, real estate expenses increased by $8,061,000 or 12% because of the 11 communities acquired or developed in 2002, combined with 2001 acquisition and development communities operating for a full year.
Provision for depreciation
The provision for depreciation increased by $8,450,000 (19%) for the year ended December 31, 2003 compared to 2002, and increased by $7,037,000 (19%) for the year ended December 31, 2002 compared to 2001. The increases in 2003 and 2002 resulted from higher depreciable bases on new property acquisitions and development properties completed.
Interest expense
During the past three years, our interest expense has increased due to higher average fixed rate debt balances to support our acquisition and development activities and a reduced level of capitalized interest. Interest expense for the years ended December 31, 2003, 2002 and 2001 follows:
Year-end debt balances at December 31, 2003, 2002 and 2001 follow:
Interest expense increased $3,511,000 to $59,617,000 in 2003 over 2002, primarily due to lower levels of capitalized interest than in 2002. Capitalized interest decreased during both 2003 and 2002 due to the delivery and completion of certain properties in construction, and reduced interest rates. Additionally, we raised $300,000,000 in senior unsecured notes during 2002 to fix interest rates on a significant portion of our debt during the low interest rate environment. This has the short-term effect of increasing our interest expense, as we paid down balances on our variable rate line of credit with the proceeds of the notes. Overall, interest expense increased by $8,584,000 to $56,106,000 in 2002 due to the shift from floating to fixed rate debt, higher average debt balances to fund construction and property acquisitions in 2002, and a lower level of capitalized interest, offset by a reduction in variable interest rates and our hedging activities over the course of 2002.
General and administrative expenses
General and administrative expenses for the three years ended December 31, 2003 were as follows:
In 2003, we began expensing the cost associated with stock options in accordance with FAS 123. Stock option expense totaled $454,000 in 2003. General and administrative expenses for the two years ended December 31, 2002 do not include any expense associated with stock options. The 2002 amount includes a $540,000 expense related to the retirement of one of our executive officers. The stock option expense and increased professional fees account for the increase in overall general and administrative expenses as compared with 2002 levels excluding the retirement charge.
Office rent totaling $1,283,000, $1,213,000 and $1,246,000 for the years ended December 31, 2003, 2002 and 2001 respectively, is included in general and administrative expense.
Losses from Internet business
Losses from Internet business total $7,163,000, for the year ended December 31, 2001, and represent the net losses of VelocityHSI, Inc., our former non-real estate investment which was spun off by BRE on August 15, 2000, including a $2,400,000 provision for potential future losses taken in 2001. Subsequent to the spin-off, our investment in VelocityHSI was recorded under the equity method of accounting. We were required to record 100% of VelocityHSI’s losses to the extent of our investment, including advances, until it secured an independent source of financing or our investment and advances were reduced to zero. During the second quarter of 2001, we reduced our investment, including advances to VelocityHSI, to zero and provided for a reserve for our potential liabilities related to VelocityHSI. VelocityHSI filed for bankruptcy protection during the third quarter of 2001. There were no expenses incurred related to VelocityHSI in 2003 or 2002.
Net gain (loss) on sales of investments and rental properties
During 2002, we sold our minority partnership interest in a commercial property for a net gain on sale of approximately $7,200,000. We also sold our investment in shares of common stock of Corrigo, Inc., a non-affiliated technology company, for a loss of $800,000. In addition, we sold excess land at a loss of approximately $1,500,000. These three transactions completed the disposition of our non-multifamily investments and resulted in a net gain of $4,862,000.
During 2001, we sold three Tucson, Arizona communities with 621 units for an aggregate sales price of approximately $19,000,000, pursuant to an agreement with G&I III Residential One, LLC, an affiliate of DRA Advisors, Inc. The sale completed a $280,000,000 portfolio sale of 22 apartment communities (4,909 units) initiated by us in the third quarter of 2000 that was governed under a single master agreement. To facilitate the sale, we retained a 15% equity interest in a joint venture with DRA Growth and Income Fund III, LLC. In addition, we sold our minority interest in a non-multifamily asset for $1,115,000. The transactions resulted in an aggregate net loss of $327,000 in 2001.
Other expenses
Other expenses in 2003 represent legal settlement charges that are outside our normal course of business. During the third quarter of 2003, we executed a settlement agreement in connection with litigation with an unrelated third party regarding the Pinnacle at MacArthur Place joint venture agreement. Under the terms of the settlement agreement, we paid the third party $6,500,000 and retained full ownership of the asset. Pinnacle at MacArthur Place is a recently developed and stabilized, 253-unit community in Santa Ana, California. Also during the third quarter of 2003, we reached a settlement agreement regarding a class action lawsuit brought against us with respect to application fees charged to residents from August 1998 to August 2003. Under the terms of the settlement, we agreed to establish a $200,000 fund to reimburse prior applicants up to $5.00 per applicant, and to pay certain related administration charges and legal expenses. The combined settlement amounts, legal fees and related expenses aggregate $7,305,000, and are reported as other expenses on our consolidated income statement.
Minority interests in income
Minority interests in income relate to the earnings attributable to the minority members of our consolidated subsidiaries and were $3,195,000 for the year ended December 31, 2003, down from $3,682,000 and $4,068,000 for the years ended December 31, 2002 and 2001, respectively. Minority interests and consequently, minority interests in income declined each year as operating company unit holders of BRE Property Investors LLC exchanged their units for shares of BRE common stock. Conversions of operating company units to common shares totaled 233,083, 433,112 and 648,449 for the years ended December 31, 2003, 2002 and 2001, respectively.
Discontinued operations
In October 2001, the Financial Accounting Standards Board, or FASB, issued Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” or SFAS No. 144, which became effective on January 1, 2002. For properties accounted for under SFAS No. 144, the results of operations for properties sold during the period or designated as held for sale at the end of the period are required to be classified as discontinued operations. The property-specific components of net earnings that are classified as discontinued operations include all property-related revenues and operating expenses, depreciation expense recognized prior to the classification as held for sale, and property-specific interest expense to the extent there is secured debt on the property. In addition, the net gain or loss on the eventual disposal of properties held for sale is reported as discontinued operations.
During 2003, we sold three operating communities with a total of 1,100 units. The communities were sold for an aggregate sales price of approximately $72,600,000, resulting in a net gain on sale of approximately $23,100,000. During 2002, we sold three operating communities with a total of 663 units. The communities were sold for an aggregate sales price of approximately $58,300,000, resulting in a net gain on sale of approximately $10,100,000. The net gain on sale and the combined results of operations for these three communities for each year presented are included in discontinued operations on the consolidated statements of income. These amounts totaled $24,083,000, $15,562,000, and $6,163,000 for the years 2003, 2002 and 2001, respectively.
Dividends attributable to preferred stock
Dividends attributable to preferred stock represent the dividends on our 8.50% Series A and 8.08% Series B Cumulative Redeemable Preferred Stock. Dividend payments totaled $10,629,000, $7,765,000 and $4,569,000 for the years 2003, 2002 and 2001, respectively. The Series B Preferred Stock offering closed on June 20, 2002.
In connection with the issuance of the Series A Cumulative Redeemable Preferred Stock in January 1999, we incurred approximately $2,166,000 in issuance costs and recorded such costs as a reduction of shareholders’ equity. Due to the redemption of these shares, we recognized a redemption charge of $2,166,000 during 2003, which is treated as a preferred stock dividend on the consolidated statements of income.
Net income available to common shareholders
As a result of the various factors mentioned above, net income available to common shareholders for the year ended December 31, 2003 was $70,333,000, or $1.48 per diluted share, as compared with $88,044,000, or $1.91 per diluted share for the year ended December 31, 2002 and $78,808,000, or $1.69 per diluted share for the year ended December 31, 2001.
Liquidity and Capital Resources
Depending upon the availability and cost of external capital, we anticipate making additional investments in multifamily apartment communities. These investments are expected to be funded through a variety of sources. These sources may include internally generated cash, temporary borrowings under our revolving unsecured line of credit, proceeds from asset sales, public and private offerings of debt and equity securities, and in some cases the assumption of secured borrowings. To the extent that these additional investments are initially financed with temporary borrowings under our revolving unsecured line of credit, we anticipate that permanent financing will be provided through a combination of public and private offerings of debt and equity securities, proceeds from asset sales, and secured debt. We believe our liquidity and various sources of available capital are sufficient to fund operations, meet debt service and dividend requirements, and finance future investments.
During the second half of 2003, we sold 3,450,000 shares of our common stock. Net proceeds to BRE were $32.651 per share, which represented a 3.4% discount from the New York Stock Exchange closing price of $33.80 per share on September 16, 2003. The shares were re-offered to the public through the underwriter at a price of $33.10 per share. Net proceeds from the offering-after all discounts, commissions and anticipated issuance costs-totaled approximately $112,300,000. Proceeds from the offering were used for general corporate purposes, including the repayment of debt, redemption of equity securities, and funding for development activities and financing for acquisitions.
We amended and restated our revolving unsecured credit facility on April 4, 2003, extending the maturity date from December 2003 to April 2006, with an option to extend the term one year beyond the maturity date. We elected to reduce the borrowing capacity from $450,000,000 to $350,000,000. The interest rate on the line of credit was maintained at LIBOR plus 0.70%, plus a fee of 0.20% payable on the unused portion of the credit facility. Our pricing spread above LIBOR is dependent upon our credit ratings and can range from 0.50% to 1.45%. Our average cost on the unsecured line of credit for the twelve months ended December 31, 2003 was 2.73%.
Borrowings under our revolving unsecured line of credit totaled $196,000,000 at December 31, 2003, compared to $181,000,000 at December 31, 2002. Drawings on the revolving unsecured line of credit are available to fund our investment activities and general corporate purposes. We typically reduce our outstanding balance on the revolving unsecured line of credit with available cash balances.
During the second quarter of 2003, we also established a secured $100,000,000 Fannie Mae credit facility maturing in 2008. Borrowings under our secured line of credit totaled $100,000,000 at December 31, 2003. The credit facility is secured by five multifamily communities, which are held by a bankruptcy-remote special purpose consolidated subsidiary of BRE. Borrowings under the facility bear interest at variable rates with maturities from one to nine months, plus a facility fee of up to 0.65%. Our average borrowing cost for the secured line, including interest, margin and fees, was 2.07% during 2003. We also have the option to convert variable-rate borrowings to fixed-rate borrowings. Subject to the terms of the facility, we have the option to increase its size to $250,000,000. Drawings on the secured line of credit are available to fund our investment activities and for general corporate purposes.
We had a total of $763,000,000 in unsecured senior notes (excluding a basis adjustment of $915,000 from hedging activities) at December 31, 2003, consisting of the following:
In addition, at December 31, 2003, we had mortgage indebtedness totaling $131,069,000 (excluding a basis adjustment of $1,345,000 from hedging activities) at an average interest rate of 5.97%, and remaining terms of from less than one to seven years.
As of December 31, 2003, we had total outstanding debt balances of $1,192,329,000 and total outstanding shareholders’ equity and minority interests of $999,403,000, representing a debt to total book capitalization ratio of approximately 54%.
Our indebtedness contains financial covenants as to minimum net worth, interest coverage ratios, maximum secured debt and total debt to capital, among others. We were in compliance with all such financial covenants throughout the year ended December 31, 2003.
We anticipate that we will continue to require outside sources of financing to meet our long-term liquidity needs beyond 2003, including scheduled debt repayments, construction funding and property acquisitions. At December 31, 2003, we had an estimated cost of $45,500,000 to complete existing construction in progress, with funding estimated from 2004 through 2005.
Scheduled contractual obligations required for the next five years and thereafter are as follows:
We manage joint venture investments that are recorded under the equity method of accounting with total assets of $42,294,000 as of December 31, 2003. These joint ventures carry debt totaling $19,189,000, none of which is guaranteed by us at December 31, 2003.
We have an effective shelf registration statement on file with the Securities and Exchange Commission under which we may issue up to $700,000,000 of securities including debt, common stock and preferred stock. Our recent common stock offering totaling $114,200,000, our $300,000,000 aggregate principal amount of note issuances in 2002, and our $75,000,000 preferred stock offering in 2002 reduced the amount available for future issuances under this registration statement to $210,800,000. Depending upon market conditions, we may issue additional securities under existing or future shelf registration statements. Proceeds from these issuances may be used to fund additional investments in multifamily communities, and for permanent financing of investments initially funded through temporary borrowings under our revolving lines of credit. In addition, proceeds may be used for other general corporate purposes, including development activities, capital expenditures, redemption of equity securities, increasing our working capital and to repay indebtedness. Pending the application of the net proceeds, we may invest the proceeds in investment-grade, interest-bearing securities or temporarily reduce borrowings under our revolving unsecured line of credit. In 2001, we commenced a medium-term note program for the possible issuance, from time to time, of up to $300,000,000 of medium term notes as part of our shelf registration, subject to the amount remaining available under our shelf registration statement. To date, no such notes have been issued under the program.
During 2001, our Board of Directors authorized the purchase of our common stock in an amount up to $60,000,000. The timing of repurchase activity is dependent upon the market price of our shares, and other market conditions and factors. During the first quarter of 2003, we repurchased approximately $724,000 of common stock, representing 25,500 shares at an average purchase price of $28.39 per share. No shares have been repurchased subsequent to March 31, 2003. As of December 31, 2003, we had cumulatively repurchased a total of approximately $51,100,000 of common stock, representing 1,785,600 shares at an average purchase price of $28.64 per share.
We continue to consider other sources of possible funding, including further joint ventures and additional secured construction debt. We own unencumbered real estate assets that could be sold, contributed to joint ventures or used as collateral for financing purposes (subject to certain lender restrictions) and have encumbered assets with significant equity that could be further encumbered should other sources of capital not be available.
During the fourth quarter of 2003, we issued a notice of redemption to all holders of record of our outstanding 8.50% Series A Cumulative Redeemable Preferred Stock, at a redemption price of $25.17118 per share. The redemption price is equal to the original issuance price of $25.00 per share, plus accrued and unpaid dividends to the redemption date. The redemption date was January 29, 2004. From the redemption date forward, dividends on the 2,150,000 shares of Series A Cumulative Redeemable Preferred Stock, all of which were called for redemption, no longer accrue, and holders of any 8.50% Series A Cumulative Redeemable Preferred Stock not tendered for redemption have no rights other than the rights to receive the $25.17118 total redemption price.
Critical Accounting Policies
We define critical accounting policies as those that require management’s most difficult, subjective or complex judgments. A summary of our critical accounting policies follows. Additional discussion of accounting policies that we consider significant, including further discussion of the critical accounting policies described below, can be found in the notes to our consolidated financial statements.
Investments in Rental Properties
Rental properties are recorded at cost, less accumulated depreciation, less an adjustment, if any, for impairment. A land value is assigned based on the purchase price if land is acquired separately, or based on
market research if acquired in a merger or in an operating community acquisition. We have a development group which manages the design, development and construction of our apartment communities. Projects under development are carried at cost, including direct and indirect costs incurred to ready the assets for their intended use and which are specifically identifiable, including capitalized interest and property taxes until units are placed in service. Direct investment development projects are considered placed in service as certificates of occupancy are issued and the units become ready for occupancy. Depreciation begins as units are placed in service. Land acquired for development is capitalized and reported as “Land under development” until the development plan for the land is formalized. Once the development plan is determined and construction contracts are signed, the costs are transferred to the balance sheet line item “Construction in progress.” Costs of replacements, such as appliances, carpets and drapes, are expensed. Improvements and betterments that increase the value of the property or extend its useful life are capitalized.
Depreciation is computed on a straight-line basis over the estimated useful lives of the assets, which range from 35 to 45 years for buildings and three to ten years for other property. The determination as to whether expenditures should be capitalized or expensed, and the period over which depreciation is recognized, requires management’s judgment.
In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” our investments in real estate are periodically evaluated for indicators of impairment. The evaluation of impairment and the determination of values are based on several factors, and future events could occur which would cause management to conclude that indicators of impairment exist and a reduction in carrying value to estimated fair value is warranted.
In the normal course of business, we will receive offers for sale of our properties, either solicited or unsolicited. For those offers that are accepted, the prospective buyer will usually require a due diligence period before consummation of the transaction. It is not unusual for matters to arise that result in the withdrawal or rejection of the offer during this process. We classify real estate as “held for sale” when all criteria under SFAS No. 144 have been met.
SFAS No. 144 also requires that the assets and liabilities and the results of operations of any communities that have been sold, or otherwise qualify as held for sale, be presented as discontinued operations in our consolidated financial statements in all periods presented. The community specific real estate classified as held for sale is stated at the lower of its carrying amount or estimated fair value less disposal costs. Depreciation is not recorded on assets classified as held for sale.
Derivatives and Hedging Activities
We use derivative financial instruments in the normal course of business with the objective of lowering our overall borrowing costs. As of December 31, 2003, we had five-interest rate swap agreements with a notional value aggregating approximately $65,000,000, which are used to attain a floating rate of interest on a portion of our fixed rate debt, maturing in 2004 and 2005. These derivatives qualify for hedge accounting as discussed in Note 9 to our December 31, 2003 consolidated financial statements. A third party values the instruments. The values of these derivatives will change over time as cash receipts and payments are made and as market conditions change.
Stock-Based Compensation
Effective January 1, 2003, we adopted the fair value recognition provisions of Statement of Accounting Standard (SFAS) No. 123, “Accounting for Stock-Based Compensation” (SFAS 123), as amended by SFAS 148, “Accounting for Stock Based Compensation-Transition and Disclosure” (SFAS 148). We have adopted the prospective method as provided for in SFAS 148, under which the provisions of SFAS 123 will be applied prospectively to all awards granted, modified or settled after January 1, 2003. Prior to 2003, we accounted for stock-based compensation under the recognition and measurement provisions of APB Opinion No. 25,
“Accounting for Stock Issued to Employees,” and related Interpretations, which resulted in no expense recognition. Under SFAS 123, we include in general and administrative expense a charge based on the implied value of options vesting in the current period. The change in accounting method did not have a material impact on our consolidated financial statements. The options are valued using the Black-Scholes option-pricing model.
Consolidation
In January 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities,” an interpretation of ARB No. 51, as amended by FASB Staff Position No. 46-6 in October 2003 (“FIN 46”). Under FIN 46, a variable interest entity (“VIE”) is created when (i) the equity investment at risk in the entity is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties, or (ii) the entity’s equity holders as a group either: (a) lack direct or indirect ability to make decisions about the entity, (b) are not obligated to absorb expected losses of the entity if they occur, or (c) do not have the right to receive expected residual returns of the entity if they occur. If an entity is deemed to be a VIE pursuant to FIN 46, the enterprise that is deemed to absorb a majority of the expected losses, receive a majority of the entity’s expected residual returns, or both, is considered the primary beneficiary and must consolidate the VIE. Expected losses and residual returns for VIEs are calculated based on the probability of estimated future cash flows as defined in FIN 46. FIN 46 is effective immediately for arrangements entered into after January 31, 2003, and will be applied as of March 31, 2004, to all arrangements entered into before February 1, 2003.
Under FIN 46, a non-refundable deposit paid to an entity is deemed to be a variable interest that will absorb some or all of the entity’s expected losses if they occur. Therefore, whenever we enter into a land option or purchase contract with an entity and make a non-refundable deposit, a VIE may have been created. We evaluate our land option and purchase contract investments to determine if a VIE has been created under the definition of FIN 46. When a VIE is deemed to exist, the identification of the primary beneficiary is determined through allocation of the VIE’s estimated expected losses and residual returns to the related variable interest holders. Any VIEs created after January 31, 2003 for which we are deemed the primary beneficiary are consolidated from the date of investment. VIEs created prior to February 1, 2003 will be evaluated for consolidation for the quarter ended March 31, 2004.
We consolidate entities not deemed as VIEs which we have the ability to control. Our consolidated financial statements include the accounts of the Company, the Operating Company and other controlled subsidiaries. All significant intercompany balances and transactions are eliminated in consolidation.
Impact of Inflation
Approximately 99% of our total revenues for 2003 were derived from apartment properties. Due to the short-term nature of most apartment unit leases (typically one year or less), we may seek to adjust rents to mitigate the impact of inflation upon renewal of existing leases or commencement of new leases, although we cannot assure that we will be able to adjust rents in response to inflation. In addition, market rates may also fluctuate due to short-term leases and other permitted and non-permitted lease terminations.
Dividends Paid to Common and Preferred Shareholders and Distributions to Minority Members
A cash dividend has been paid to common shareholders each quarter since our inception in 1970. Cash dividends per common share were $1.95 in 2003, $1.95 in 2002 and $1.86 in 2001. Total cash dividends paid to common shareholders for the three years ended December 31, 2003, 2002 and 2001 were $91,994,000, $89,614,000, and $86,289,000, respectively. In 2003, 2002 and 2001, respectively, $10,629,000, $7,765,000 and $4,569,000 in dividends were paid to preferred shareholders.
Distributions to minority members were $3,206,000 in 2003, $3,784,000 in 2002, and $4,167,000 in 2001.
Item 7A.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risks relating to our operations result primarily from changes in short-term LIBOR interest rates. We do not have any direct foreign exchange or other significant market risk.
Our exposure to market risk for changes in interest rates relates primarily to our lines of credit. We primarily enter into fixed and variable rate debt obligations to support general corporate purposes, including acquisitions and development, capital expenditures and working capital needs. We continuously evaluate our level of variable rate debt with respect to total debt and other factors, including our assessment of the current and future economic environment. We utilize five interest rate swap agreements to attain a floating rate of interest on a portion of our fixed rate debt. The objective of the agreements is to lower our overall borrowing costs. The swaps hedge the fair market value of a portion of our debt. We do not use derivatives for trading or speculative purposes. The hedges are perfectly effective and, therefore, changes in the derivative fair value and the change in fair value of the hedged items during the hedging period exactly offset with no valuation impact on our current earnings. The notional amount of the interest rate swaps and their termination dates, shown in the table below, match the principal amounts and maturities of the hedged fixed rate debt balances. As a result of the interest rate swaps, the effective interest rate for the twelve months ended December 31, 2003 on the aggregate hedged debt was reduced from a weighted average stated rate of 7.45% to 4.19%. The fair value of the interest rate swaps was approximately $2,260,000 at December 31, 2003.
Table of Interest Rate Swaps:
The fair values of our financial instruments (including such items in the financial statement captions as cash, other assets, accounts payable and accrued expenses, and lines of credit) approximate their carrying or contract values based on their nature, terms and interest rates that approximate current market rates. The fair value of mortgage loans payable and unsecured senior notes is estimated using discounted cash flow analyses with an interest rate similar to that of current market borrowing arrangements. The estimated fair value of our mortgage loans and unsecured senior notes is approximately $941,191,000 at December 31, 2003, as compared with a carrying value of $896,329,000 at that date.
We had $386,560,000 and $338,467,000 in variable rate debt outstanding at December 31, 2003 and 2002, respectively. A hypothetical 10% adverse change in interest rates would have had an annualized unfavorable impact of approximately $1,100,000 and $1,200,000 on our earnings and cash flows based on these period-end debt levels and our average variable interest rates for the twelve months ended December 31, 2003 and 2002, respectively. We cannot predict the effect of adverse changes in interest rates on our variable rate debt and, therefore, our exposure to market risk, nor can we assure that fixed rate, long-term debt will be available to us at advantageous pricing. Consequently, future results may differ materially from the estimated adverse changes discussed above.
Item 8.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
See Part IV, Item 15. Our Consolidated Financial Statements and Schedules are incorporated herein by reference.
Item 9.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
Item 9A.
Item 9A. DISCLOSURE CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Our Chief Executive Officer and Chief Financial Officer have concluded that there are reasonable assurances that our controls and procedures will achieve the desired control objectives. Also, we have investments in certain unconsolidated entities. As we do not control these entities, our disclosure controls with respect to such entities are necessarily substantially more limited than those we maintain with respect to our consolidated subsidiaries.
As of December 31. 2003, the end of the fiscal year covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on the foregoing, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective.
There have been no significant changes in our internal controls over financial reporting during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal controls over financial reporting.
PART III
Item 10.
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
(a) Executive Officers. See “Executive Officers of the Registrant” in Part I of this report.
(b) Directors. The information required by this Item is incorporated herein by reference to our Proxy Statement relating to our 2004 Annual Meeting of Shareholders, under the headings “Election of Directors” and “Section 16(a) Beneficial Ownership Reporting Compliance,” to be filed with the Securities and Exchange Commission within 120 days of December 31, 2003. A summary of the directors and their principal business for the last five years follows:
Item 11.
Item 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated herein by reference from our Proxy Statement, relating to our 2004 Annual Meeting of Shareholders, under the headings “Executive Compensation and Other Information” and “Election of Directors-Board and Committee Meetings; Compensation of Directors,” to be filed with the Securities and Exchange Commission within 120 days of December 31, 2003.
Item 12.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL HOLDERS AND MANAGEMENT
The information required by this Item is incorporated herein by reference from our Proxy Statement, relating to our 2004 Annual Meeting of Shareholders, under the heading “Security Ownership of Certain Beneficial Owners and Management” to be filed with the Securities and Exchange Commission within 120 days of December 31, 2003.
Item 13.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is incorporated herein by reference from our Proxy Statement, relating to our 2004 Annual Meeting of Shareholders, under the headings “Certain Relationships and Related Transactions”, to be filed with the Securities and Exchange Commission within 120 days of December 31, 2003.
Item 14.
Item 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this Item is incorporated by reference from our Proxy Statement, relating to our 2004 Annual Meeting of Shareholders, under the heading “Report of the Audit Committee,” to be filed with the Securities and Exchange Commission within 120 days of December 31, 2003.
PART IV
Item 15.
Item 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) Financial Statements
1.
Financial Statements:
Report of Independent Auditors
Consolidated Balance Sheets at December 31, 2003 and 2002
Consolidated Statements of Income for the years ended December 31, 2003, 2002 and 2001
Consolidated Statements of Cash Flows for the years ended December 31, 2003, 2002 and 2001
Consolidated Statements of Shareholders’ Equity for the years ended December 31, 2003, 2002 and 2001
Notes to Consolidated Financial Statements
2.
Financial Statement Schedule:
Schedule III-Real Estate and Accumulated Depreciation
All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and, therefore, have been omitted.
3.
See Index to Exhibits immediately following the Consolidated Financial Statements. Each of the exhibits listed is incorporated herein by reference.
(b) Reports on Form 8-K:
On October 15, 2003, we filed a Current Report on Form 8-K to furnish, pursuant to Item 12 of Form 8-K, our earnings press release for the quarter and nine months ended September 30, 2003.
On October 16, 2003, we filed a Current Report on Form 8-K to disclose, pursuant to Item 5 of Form 8-K, our results of operations for the quarter and nine months ended September 30, 2003.
On November 20, 2003, we filed a Current Report on Form 8-K to disclose, pursuant to Item 5 of Form 8-K, the approval of our regular common and preferred stock dividends for the quarter ended December 31, 2003.
On November 24, 2003, we filed a Current Report on Form 8-K to disclose, pursuant to Item 5 of Form 8-K, that the registrant’s board of directors had implemented a phased, one-year executive succession plan, culminating in the retirement of Frank C. McDowell.
On December 2, 2003, we filed a Current Report on Form 8-K to disclose, pursuant to Item 5 of Form 8-K, the redemption of our outstanding 8.50% Series A Cumulative Redeemable Preferred Stock.
On December 3, 2003, we filed a Current Report on Form 8-K to furnish, pursuant to Item 9 of Form 8-K, a copy of a slide show presentation given at the Wachovia Securities 7th Annual Real Estate Securities Conference.
(c) Exhibits
See Index to Exhibits.
(d) Financial Statement Schedules
See Index to Financial Statements and Financial Statement Schedule.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities and Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:
REPORT OF INDEPENDENT AUDITORS
To the Shareholders and Directors of
BRE Properties, Inc.
We have audited the accompanying consolidated balance sheets of BRE Properties, Inc. and subsidiaries (the Company) as of December 31, 2003 and 2002, and the related consolidated statements of income, cash flows and shareholders’ equity for each of the three years in the period ended December 31, 2003. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and the related schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and the related schedule based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States. 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 consolidated financial position of BRE Properties, Inc. and subsidiaries at December 31, 2003 and 2002, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
San Francisco, California
January 19, 2004, except for Note 18 as to
which the date is January 29, 2004
BRE PROPERTIES, INC.
CONSOLIDATED BALANCE SHEETS
(Dollar amounts in thousands, except per share data)
See Accompanying Notes to Consolidated Financial Statements
BRE PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF INCOME
(Amounts in thousands, except per share data)
See Accompanying Notes to Consolidated Financial Statements
BRE PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
See Accompanying Notes to Consolidated Financial Statements
BRE PROPERTIES, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY
(Dollar amounts in thousands, except share and per share data)
See Accompanying Notes to Consolidated Financial Statements
BRE PROPERTIES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Company
BRE Properties, Inc., a Maryland corporation (“BRE” or the “Company”), was formed in 1970. BRE is a self-administered real estate investment trust focused on the development, acquisition and management of multifamily apartment communities in the Western United States. At December 31, 2003, BRE’s portfolio, owned directly or through wholly or majority owned subsidiaries, consisted of 80 multifamily communities (aggregating 22,981 units), classified as direct investments in real estate-investments in rental properties on the accompanying consolidated balance sheets. Of these properties, 51 were located in California, 13 in Washington, seven in Arizona, five in Colorado and four in Utah. In addition, at December 31, 2003, there were seven properties under various stages of construction and development aggregating an estimated 1,388 units, including four directly owned properties with 744 units classified as direct investments in real estate-construction in progress and three land parcels estimated to have 644 units which are classified as land under development. BRE also holds a 35% interest and is the managing member of two real estate joint ventures that own two multifamily properties with a total of 488 units, and a 15% joint venture interest in a multifamily portfolio totaling 3,815 units managed by a third party at December 31, 2003.
The Operating Company
In November 1997, BRE acquired 16 completed properties and eight development properties from certain entities of Trammell Crow Residential-West (the “Transaction”) pursuant to a definitive agreement (the “Contribution Agreement”). BRE paid a total of approximately $160,000,000 in cash and issued $100,000,000 in common stock based on a stock price of $26.93 per share, as provided for in the Contribution Agreement. In addition, certain entities received Operating Company Units (“OC Units”) valued at $76,000,000 in BRE Property Investors LLC (the “Operating Company”), a Delaware limited liability company and a majority owned subsidiary of BRE. The Operating Company assumed approximately $120,000,000 in debt in connection with this purchase. BRE is the sole managing member and majority owner of the Operating Company at December 31, 2003. Substantially all of the properties acquired in the Transaction are held through the Operating Company, which was formed by BRE for the purpose of acquiring the properties in the Transaction.
The OC Units held by non-managing members are included in minority interests in the Company’s consolidated financial statements. Starting in November 1999, non-managing members of the Operating Company can exchange their units for common stock of BRE on a 1:1 basis or, at the option of the Company, cash in an amount equal to the market value of such common stock at the time of the exchange. As of December 31, 2003, 2,201,152 OC Units have been exchanged for common stock. The non-managing members are entitled to priority distributions regardless of the cash flows of the Operating Company. The Operating Company is also required to maintain certain financial ratios to protect the non-managing members’ distributions. Further, the Company has certain restrictions from selling assets of the Operating Company in a taxable sale for a period ranging from eight to ten years from the date of the Transaction. The Operating Company has also guaranteed the repayment of the Company’s $350,000,000 unsecured line of credit.
2. Summary of Significant Accounting Policies
Consolidation
In January 2003, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. 46, “Consolidation of Variable Interest Entities,” an interpretation of ARB No. 51, as amended by FASB Staff Position No. 46-6 in October 2003 (“FIN 46”). Under FIN 46, a variable interest entity (“VIE”) is created when (i) the equity investment at risk in the entity is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties, or (ii) the entity’s equity holders as a group either:
(a) lack direct or indirect ability to make decisions about the entity, (b) are not obligated to absorb expected losses of the entity if they occur, or (c) do not have the right to receive expected residual returns of the entity if they occur. If an entity is deemed to be a VIE pursuant to FIN 46, the enterprise that is deemed to absorb a majority of the expected losses, receive a majority of the entity’s expected residual returns, or both, is considered the primary beneficiary and must consolidate the VIE. Expected losses and residual returns for VIEs are calculated based on the probability of estimated future cash flows as defined in FIN 46. FIN 46 is effective immediately for arrangements entered into after January 31, 2003, and will be applied as of March 31, 2004, to all arrangements entered into before February 1, 2003.
At December 31, 2003, BRE has made cash deposits for seven land purchase option agreements totaling approximately $1,207,000, which are included in Other Assets on our consolidated balance sheet. Our option deposits generally represent our maximum exposure to loss if we elect not to purchase the optioned property. The initial adoption of FIN 46 for arrangements entered into after January 31, 2003, did not have a material impact on BRE’s 2003 financial position or results of operations. BRE is still evaluating the impact of FIN 46 for all arrangements entered into prior to February 1, 2003. However, BRE does not anticipate that the impact of these arrangements will have a material effect on BRE’s financial position or results of operations.
BRE consolidates entities not deemed as VIEs that it has the ability to control. The accompanying consolidated financial statements include the accounts of the Company, the Operating Company and other subsidiaries controlled either through ownership or by contract. At December 31, 2003, BRE owned 91% of the Operating Company. All significant intercompany balances and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of consolidated financial statements, in accordance with accounting principles generally accepted in the United States of America, requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to acquiring, developing and assessing the carrying values of its real estate properties, its investments in and advances to joint ventures and affiliates, and its qualification as a REIT. The Company bases its estimates on historical experience, current market conditions, and various other assumptions that are believed to be reasonable under the circumstances. Actual results may vary from those estimates and those estimates could vary under different assumptions or conditions.
Investments in Rental Properties
Rental properties are recorded at cost, less accumulated depreciation, less an adjustment, if any, for impairment. A land value is assigned based on the purchase price if land is acquired separately, or based on market research if acquired in a merger or in an operating community acquisition. BRE has a development group which manages the design development and construction of its apartment communities. Projects under development are carried at cost, including direct and indirect costs incurred to ready the assets for their intended use and which are specifically indentifiable, including capitalized interest and property taxes until units are placed in service. Direct investment development projects are considered placed in service as certificates of occupancy are issued and the units become ready for occupancy. Depreciation begins as units are placed in service. Land acquired for development is capitalized and reported as “Land under development” until the development plan for the land is formalized. Once the development plan is determined and construction contracts are signed, the costs are transferred to the balance sheet line item “Construction in progress.” Costs of replacements, such as appliances, carpets and drapes, are expensed. Improvements and betterments that increase the value of the property or extend its useful life are capitalized.
Depreciation is computed on a straight-line basis over the estimated useful lives of the assets, which range from 35 to 45 years for buildings and three to ten years for other property.
The Company periodically evaluates its long-lived assets, including its investments in rental properties, for impairment indicators. The judgments regarding the existence of impairment indicators are based on factors such as operational performance, market conditions, the expected holding period of each asset and legal and environmental concerns. Future events could occur which would cause the Company to conclude that impairment indicators exist and an impairment loss is warranted. There were no assets for which an adjustment for impairment in value was made in 2003, 2002 or 2001.
In the normal course of business, BRE will receive offers for sale of its properties, either solicited or unsolicited. For those offers that are accepted, the prospective buyer will usually require a due diligence period before consummation of the transaction. It is not unusual for matters to arise that result in the withdrawal or rejection of the offer during this process. The Company classifies real estate as “held for sale” when all of the following criteria have been met: management has committed to a plan to sell the asset, the asset is available for immediate sale in its present condition, an active program to locate a buyer has been initiated, the sale of the asset is probable within one year, the asset is being actively marketed for sale at a price that is reasonable in relation to its current fair value, and actions required to complete the plan indicate that it is unlikely that significant changes to the plan will be made or that the plan will be withdrawn.
The Company adopted Statement of Financial Accounting Standards (SFAS) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” in 2002. SFAS No. 144 requires that the assets and liabilities and the results of operations of any communities that have been sold, or otherwise qualify as “held for sale,” be presented as discontinued operations in all periods presented. The community specific components of net income that are presented as discontinued operations include operating results, depreciation and interest expense to the extent there is a secured loan on the property. In addition, the net gain or loss on the eventual disposal of communities held for sale will be presented as income from discontinued operations when recognized. Real estate assets held for sale are measured at the lower of the carrying amount or the fair value less the cost to sell. Subsequent to classification of a community as held for sale, no further depreciation is recorded on the assets.
Sales are generally recorded after title has been transferred to the buyer and after appropriate payments have been received and other criteria met.
Equity Interests in Real Estate Joint Ventures
The Company’s investments in non-controlled real estate joint ventures are recorded under the equity method of accounting on the accompanying consolidated financial statements. Investments in real estate joint ventures that are managed or developed by the Company are included in equity interests in and advances to real estate joint ventures. BRE has received certain fees for the development and construction of the real estate property held by these joint ventures and has recognized other income using the percent of completion method to the extent of the third-party interest. Investments in real estate joint ventures managed by third parties are included in other assets because such investments do not represent a core activity within BRE’s overall real estate investment strategy.
Rental Revenue
Rental income is recorded when due from residents and is recognized monthly as it is earned, which is not materially different than on a straight-line basis as lease terms are generally for periods of one year or less. There were no contingent rental payments or percentage rents in the three years ended December 31, 2003.
Cash
The Company maintains its cash at financial institutions. The combined account balances at one or more institutions periodically exceed the Federal Depository Insurance Corporation (“FDIC”) insurance coverage, and, as a result, there is a concentration of credit risk related to amounts on deposit in excess of FDIC insurance coverage. The Company believes that the risk is not significant, as the Company places its cash deposits and temporary cash investments with financial institutions believed by management to be creditworthy and of high quality.
Deferred Costs
Included in other assets are costs incurred in obtaining debt financing that are deferred and amortized over the terms of the respective debt agreements as interest expense. Related amortization expense is included in interest expense in the accompanying consolidated statements of income. Net deferred financing costs included in other assets in the accompanying consolidated balance sheets are $13,650,000 and $12,917,000 as of December 31, 2003 and 2002, respectively. Amortization of deferred costs is included in interest expense and totaled $3,874,000 and $3,036,000 for the years ended December 31, 2003 and 2002, respectively.
Income Taxes
BRE has elected to be taxed as a Real Estate Investment Trust (“REIT”) under the Internal Revenue Code of 1986, as amended (“the Code”). As a result, BRE will not be subject to federal taxation at the corporate level to the extent it distributes, annually, at least 100% of its REIT taxable income, as defined by the Code, to its shareholders and satisfies certain other requirements. In addition, the states in which BRE owns and operates real estate properties have provisions equivalent to the federal REIT provisions. Accordingly, no provision has been made for federal or state income taxes in the accompanying consolidated financial statements.
Fair Value of Financial Instruments
The fair values of BRE’s financial instruments (including such items in the consolidated financial statement captions as cash, other assets, and lines of credit) approximate their carrying or contract values based on their nature, terms and interest rates that approximate current market rates. The fair value of mortgage loans payable and unsecured senior notes is estimated using discounted cash flow analyses with an interest rate similar to that of current market borrowing arrangements. The fair value of the Company’s mortgage loans payable and unsecured senior notes was approximately $941,191,000 and $1,022,800,000 at December 31, 2003 and 2002, respectively.
Derivative instruments and hedging activities
BRE has five-interest rate swap contracts that attain a floating rate of interest on a portion of its fixed rate debt. BRE designated these derivative instruments to be utilized as fair value hedges in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended. Under SFAS 133, the resulting assets or liabilities attributed to derivative instruments are carried on BRE’s consolidated financial statements at their estimated fair values. The hedges are perfectly effective and, therefore, changes in the derivative fair value and the change in fair value of the hedged items during the hedging period exactly offset with no valuation impact on BRE’s current earnings.
Stock-based compensation
Effective January 1, 2003, BRE adopted the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” (SFAS 123), as amended by SFAS No. 148, “Accounting for Stock Based Compensation-Transition and Disclosure” (SFAS 148). Under the fair value method compensation cost is measured at the grant date based on the value of the award and is recognized over the service period, which is usually the vesting period. BRE has adopted the prospective method as provided for in SFAS 148, under which the provisions of SFAS 123 will be applied prospectively to all awards granted, modified or settled after January 1, 2003. Therefore, the cost related to stock-based compensation included in the determination of consolidated net income for the year ended December 31, 2003 is less than that which would have been recognized if the fair value method had been applied to all awards in prior years. Prior to 2003, BRE accounted for stock-based compensation under the recognition and measurement provisions of Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations. Awards under BRE’s option plans vest over periods ranging from one to five years.
The following table illustrates the pro forma effect on consolidated net income and earnings per share of all outstanding awards in each period.
The fair value for these options was estimated as of the date of grant using a Black-Scholes option pricing model, with the following weighted average assumptions for the years ended December 31, 2003, 2002, and 2001:
The effect of pro forma application of SFAS 123 is not necessarily representative of the effect on consolidated net income for future periods.
The Black-Scholes option-pricing model was developed for use in estimating the fair market value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. Because the above stock option plans have characteristics significantly different from those of traded options, and because, in management’s opinion, changes in the subjective input assumptions can materially affect the fair value estimate, the existing models do not necessarily provide a reliable single measure of the fair value of the above stock option plans.
Reclassifications
Certain reclassifications have been made to the prior years’ consolidated financial statements to conform to the presentation of the current year’s consolidated financial statements.
Reportable Segments
SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” requires certain descriptive information to be provided about an enterprise’s reportable segments. BRE has determined that it has only one operating and reportable segment, multifamily communities, which comprised 98% of BRE’s consolidated assets at December 31, 2003 and 2002 and approximately 99% of its total consolidated revenues for the three years ended December 31, 2003.
Concentration Risk
All multifamily communities owned by the Company are located in the Western United States, in three general markets that it defines as California, Pacific Northwest, and Mountain/Desert States. All revenues are from external customers and there are no revenues from transactions with other segments. There are no residents that contributed 10% or more of BRE’s total revenues in the years ended December 31, 2003, 2002 or 2001.
Recently Issued Accounting Pronouncements
In May 2003, the FASB issued Statement of Financial Accounting Standard No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (SFAS 150). SFAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. The requirements of SFAS 150 apply to the classification and measurement of freestanding financial instruments, including those that comprise more than one option or forward contract. It requires that certain financial instruments, such as mandatorily redeemable shares, put options, forward purchase contracts, and obligations that can be settled with shares, be classified as liabilities, where in some cases these have previously been classified as equity or between the liabilities and equity section of the consolidated balance sheet. SFAS 150 was effective immediately for financial instruments entered into or modified after May 31, 2003, and otherwise was effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of SFAS 150 did not have an impact on BRE’s 2003 consolidated financial statements.
3. Real Estate Portfolio
The components of direct investments in real estate-investments in rental properties follow:
A roll-forward of direct investments in real estate-construction in progress follows:
BRE’s carrying value of its assets exceeded the tax basis by approximately $232,000,000 (unaudited) at December 31, 2003.
4. Equity Interests in and Advances to Real Estate Joint Ventures
As of December 31, 2003, BRE had two joint venture arrangements in which its capital interest is 35%; these joint ventures are managed by the Company (the “joint ventures”). Such arrangements are accounted for
using the equity method. Each of the joint ventures contains a single multifamily community that was developed by BRE and completed in 2001. BRE’s investment in the joint ventures totals $10,391,000 and $10,761,000 as of December 31, 2003 and 2002, respectively and is shown as “Equity interests in and advances to real estate joint ventures-investments in rental properties” on BRE’s consolidated balance sheets. The communities had a total cost of approximately $43,472,000. The joint ventures carry secured, non-recourse loans totaling $19,189,000, that mature in 2011 and have interest rates of 7.25% and 8.0%. BRE has not guaranteed repayment of the joint venture debt. BRE and third-party members have funded the equity. For these joint ventures, BRE’s recognition of development and construction fees and responsibility to fund costs incurred above an agreed upon level during the construction period resulted in a disproportionate capital account balance between BRE and the third-party member compared to each member’s percent interest. This amount differs from the amount of the underlying equity in the net assets of the applicable joint ventures and is being depreciated over 40 years.
In addition to the joint ventures discussed above, the Company also has an investment in a real estate joint venture managed by a third-party (non-managed joint venture). During 2000 and 2001, BRE sold a total of 22 communities in Tucson, Albuquerque, Las Vegas, and Phoenix. The Company contributed a portion of the proceeds to a joint venture related to the buyer for a 15% equity interest in order to facilitate the sale of 85% of these assets. The Company’s investment in the non-managed joint venture consists of a 15% equity interest in a portfolio of multifamily properties managed by a third-party (G&I III Residential Portfolio, LLC). The Company’s investment approximates $10,783,000 and $11,858,000 at December 31, 2003 and 2002, respectively, and is included in “Other assets” as this investment does not represent a core activity within BRE’s overall real estate investment strategy. As of December 31, 2003, the joint venture that owns this portfolio had total assets of approximately $239,000,000, liabilities of approximately $165,000,000 and equity of approximately $74,000,000 (unaudited). The joint venture has a total of 16 apartment communities totaling 3,815 units as of December 31, 2003.
The Company’s share of income from equity investments in joint ventures totaled $882,000, $3,392,000 and $3,894,000 for the years ended December 31, 2003, 2002 and 2001, respectively.
5. Other Assets
The components of other assets follow:
6. Mortgage Loans Payable and Secured Line of Credit
The following data pertain to BRE’s secured debt at December 31, 2003 and 2002:
Future scheduled principal payments are included in Note 7.
BRE has entered into three fixed to floating interest rate swap agreements on secured debt with a notional amount totaling $32,010,000 and $32,941,000 at December 31, 2003 and 2002, respectively. The difference between the carrying values of $33,355,000 and $34,871,000 at December 31, 2003 and 2002, respectively, and the notional amounts are due to basis adjustments from hedging activities of $1,345,000 in 2003 and $1,930,000 in 2002, respectively. The related debt matures in 2005.
During the second quarter of 2003, BRE established a $100,000,000 Fannie Mae credit facility maturing in 2008. Borrowings under the secured line of credit totaled $100,000,000 at December 31, 2003. Five multifamily communities secure the credit facility. The borrowing cost, including interest, margin and fees, is currently 2.1%. Subject to the terms of the facility, the Company has the option to convert variable-rate borrowings to fixed-rate borrowings and to increase the facility size to $250,000,000.
7. Unsecured Senior Notes and Unsecured Line of Credit
The following table pertains to BRE’s unsecured senior notes and unsecured line of credit at December 31, 2003 and 2002:
As of December 31, 2003, BRE had an unsecured line of credit expiring in April 2006, for up to $350,000,000. Borrowings totaled $196,000,000 and $181,000,000 at December 31, 2003 and 2002, respectively. The interest rate on the line of credit is currently based on LIBOR plus 70 basis points, plus a fee of 0.20%
payable on the unused portion. The average interest rate was approximately 2.7% and 3.2% for the years ended December 31, 2003 and 2002, respectively. Under the unsecured line of credit, BRE has capacity for up to $35,000,000 in letters of credit. As of December 31, 2003, BRE has unused letter of credit capacity totaling approximately $22,500,000. BRE enters into letters of credit for various general corporate purposes.
BRE has entered into two fixed to floating interest rate swap agreements on unsecured debt with a notional amount totaling $33,000,000 at December 31, 2003 and 2002, respectively. The difference between the carrying amount of this debt was $33,915,000 and $34,570,000 at December 31, 2003 and 2002, respectively, and the notional amounts are due to basis adjustments from hedging activities totaling $915,000 in 2003 and $1,570,000 in 2002, respectively. The related debt matures in 2004 as to $15,000,000 and in 2005 as to $18,000,000.
The unsecured line of credit and unsecured senior note agreements contain various covenants that include, among other factors, tangible net worth and requirements to maintain certain financial ratios. BRE was in compliance with all such financial covenants throughout the years ended December 31, 2003 and 2002.
Scheduled principal payments required on the lines of credit, unsecured senior notes payable and mortgage loans payable for the next five years and thereafter are as follows.
The 2006 amount includes the $196,000,000 balance at December 31, 2003 on the unsecured line of credit. The 2008 amount includes the $100,000,000 balance at December 31, 2003 on the secured line of credit. Interest expense, excluding interest from discontinued operations, on mortgage loans, lines of credit and unsecured senior notes, including amortization of related issuance costs, aggregated $68,734,000, $68,121,000 and $61,024,000 for the years ended December 31, 2003, 2002 and 2001, respectively. Capitalized interest was $9,117,000, $12,015,000 and $13,502,000 for the years ended December 31, 2003, 2002 and 2001, respectively. Excluding capitalized interest, cash paid for interest totaled $59,856,000, $51,526,000 and $41,096,000 in 2003, 2002, and 2001, respectively.
8. Accounts Payable and Accrued Expenses
The components of accounts payable and accrued expenses follow:
9. Derivative Instruments and Hedging Activities
The Company enters into interest rate swaps with the objective of lowering its overall borrowing costs. The notional amount of the interest rate swaps utilized in the fair value hedges is approximately $65,000,000, with maturity dates ranging from 2004 to 2005. The principal amount of debt being hedged equals the notional amounts of the interest rate swaps. The fair value hedges convert debt with a weighted average fixed rate of 7.45% to a floating rate equal to LIBOR plus an average spread of 3.0%, which resulted in an effective rate of 4.2% for the year ended December 31, 2003. The fair value of the interest rate swaps at December 31, 2003 and 2002 was $2,260,000 and $3,500,000, respectively, and is recorded in other assets on the consolidated balance sheets. At December 31, 2003, offsetting amounts of $1,345,000 and $915,000 have been recorded as an increase to mortgage loans payable and unsecured senior notes, respectively. At December 31, 2002, offsetting amounts of $1,930,000 and $1,570,000 have been recorded as an increase to mortgage loans payable and unsecured senior notes, respectively. To determine the fair values of derivatives, BRE uses market valuations provided by third parties.
10. Discontinued Operations
The results of operations for properties sold during the period or designated as held for sale at the end of the period are required to be classified as discontinued operations. The property-specific components of net earnings that are classified as discontinued operations include operating results, depreciation expense and interest expense as well as the net gain or loss on the disposal. At December 31, 2003, BRE had no operating apartment communities classified as held for sale.
During the first six months of 2003, BRE sold three operating communities with 1,100 units for gross proceeds of approximately $72,600,000, resulting in a gain on sale of approximately $23,100,000. During the fourth quarter of 2002, BRE sold three operating communities with a total of 663 units for an aggregate sales price of approximately $58,300,000, resulting in a net gain on sale of $10,100,000. The following is a breakdown of the results of operations and net gain on the sales of these properties that are included in discontinued operations:
11. Spin-off and Distribution of VelocityHSI, Inc.
In August 2000, BRE completed the spin-off of VelocityHSI, Inc. (“VelocityHSI”). VelocityHSI was incorporated as a wholly owned subsidiary in April 2000 and was previously a segment within BRE. VelocityHSI provided high-speed Internet access to the multifamily apartment industry. On August 15, 2000, BRE distributed shares representing approximately 87%, or $8,892,000 of BRE’s $10,200,000 investment in VelocityHSI on that date, to BRE shareholders and retained the balance. Each BRE shareholder of record as of August 7, 2000 received one share of VelocityHSI for every five common shares of BRE owned.
Subsequent to the spin-off, BRE’s ownership in VelocityHSI was reduced to approximately 9.9% and was recorded under the equity method of accounting due to BRE representation on the VelocityHSI board. BRE recorded 100% of VelocityHSI’s losses, which were applied against the Company’s investment in and
receivables from VelocityHSI, until its investment in and receivable from VelocityHSI were reduced to zero. During the quarter ended September 30, 2001, VelocityHSI filed for bankruptcy protection and the value of its shares was reduced to zero. BRE reduced the funds available to VelocityHSI for general corporate purposes by $2,400,000, to reserve against potential BRE liabilities related to VelocityHSI. BRE provided for the $2,400,000 allowance as part of its $7,163,000 charge during 2001. There was no income statement impact from VelocityHSI in 2003 or 2002.
12. Stock Option Plans
Employee Plans
The 1992 Stock Option Plan and the 1999 BRE Stock Incentive Plan, as amended (the “Plans”) provide for the issuance of incentive stock options, non-qualified stock options, share appreciation rights, restricted shares and other grants. The maximum number of shares that may be issued under the Plans is 5,850,000. The option price may not be less than the fair market value of a share on the date that the option is granted and the options generally vest over three to five years. Shareholders adopted the 1999 BRE Stock Incentive Plan in 1999. The 1999 BRE Stock Incentive Plan allows for grants of up to 3,500,000 shares. During 2002 and 2001, certain key employees were allowed to exercise options with a reload provision and 409,216 and 247,852 reload grants were made, respectively, in those years. The reload program was suspended in 2003. Changes in options outstanding during the years ended December 31, 2003, 2002 and 2001 were as follows:
At December 31, 2003, the exercise price of shares under option ranged from $22.40 to $33.80, with a weighted average exercise price of $28.97. The exercise price of all options granted in the years ended December 31, 2003, 2002 and 2001 was equal to the market price on the date of grant. Expiration dates range from 2004 through 2013; the weighted average remaining contractual life of these options is seven years. Stock options were exercised during 2003 on options originally granted with exercise prices from $17.44 to $30.60. At December 31, 2003, there were 59,298 restricted shares outstanding under the Plans. There were 49,939, 1,700 and 0 restricted shares granted in 2003, 2002 and 2001, respectively.
Non-Employee Director Stock Option and Restricted Stock Plan
The Second Amended and Restated Non-Employee Director Stock Option and Restricted Stock Plan, approved by shareholders in May of 2003, provides for: (1) annual grants of restricted stock with a market price-based value of $35,000 per year per non-employee director; (2) annual option or share appreciation right grants with an aggregate Black-Scholes-based value of $35,000 per year per non-employee director; (3) discretionary annual grants for service as Chairman of the Board or Lead Director of restricted stock and options or share appreciation rights with an aggregate value of up to $35,000 per year; and (4) annual grants for service as a
Board committee chairman of restricted stock and options and/or share appreciation rights with an aggregate Black-Scholes value of $7,000 per year per committee chairman. In May of 2003, the Board of Directors suspended use of a reload provision that granted an additional 377,915 and 280,444 options in 2002 and 2001, respectively. The maximum number of shares that may be issued under this plan is 2,300,000. As with the Plans,
the option price may not be less than the fair market value of a share on the date the option is granted. Changes in options outstanding for the years ended December 31, 2003, 2002 and 2001 were as follows:
At December 31, 2003, the exercise prices of shares under option ranged between $15.14 and $34.24, with expiration dates from 2004 to 2013. The exercise price of all options granted in the years ended December 31, 1997 through 2003 was equal to the market price on the date of grant. The options vest ratably over one year. The weighted average remaining contractual life of these options is six years. At December 31, 2003, there were 9,329 restricted shares outstanding under the Plan, all of which were granted in 2003.
Direct Stock Purchase and Dividend Reinvestment Plan
In 1996, the Company instituted a direct stock purchase and dividend reinvestment plan (the “DRIP”) in which shareholders may purchase either newly issued or previously issued shares. The total amount of shares authorized under the DRIP is 1,500,000; from inception through December 31, 2003, 122,001 new shares have been issued.
13. Earnings per Share
The following table sets forth the computation of basic and diluted earnings per share with respect to income from continuing operations:
Under FASB Statement No. 128, “Earnings per Share,” the effect of anti-dilutive operating company units has been excluded from the diluted earnings per share calculation.
14. Retirement Plan
BRE has a defined contribution retirement plan covering all employees with more than six months of continuous full-time employment. In addition to employee elective deferrals, in 2003, 2002 and 2001, BRE contributed up to 3% of the employee’s compensation up to $6,000, $6,000 and $5,100 per employee in 2003, 2002 and 2001, respectively. The aggregate amounts contributed and recognized as expense by BRE were $335,000, $341,000 and $323,000 for the years ended December 31, 2003, 2002 and 2001, respectively.
15. Related Party Transactions
Certain executives of BRE have purchased stock, the consideration for which was interest-bearing recourse loans. The loans given prior to 2000 may be forgiven in whole or in part upon the achievement of certain performance goals for BRE related to growth in assets, funds from operations and stock price. A portion of the loans expected to be forgiven are expensed currently as compensation expense. At December 31, 2003, the carrying amount of the loans was $2,836,000. The amounts of such loans expected to be forgiven and treated as compensation expense were $244,500, $215,000 and $300,000 for the years ended December 31, 2003, 2002 and 2001, respectively. Loans issued from 2000 through July 2002, at which time the loan program was suspended, no longer have forgiveness provisions.
BRE had notes receivable from third party minority interest members of limited liability company subsidiaries of the company totaling $7,640,000 and $7,676,000 at December 31, 2003 and 2002, respectively. The amounts are recorded in other assets on the consolidated balance sheets. Interest income from the notes totaled $346,000 and $232,000 for the years ended December 31, 2003 and 2002, respectively.
16. Litigation
As of December 31, 2003, there were no pending legal proceedings to which the Company is a party or of which any of its properties is the subject, the adverse determination of which the Company anticipates would have a material adverse effect upon its consolidated financial condition and results of operations.
On June 29, 2000, BRE entered into an Agreement for Formation of Limited Liability Company and Contribution of Project with an unrelated third party. The agreement contemplated that upon the completion of Pinnacle at MacArthur Place and satisfaction of other conditions, BRE would contribute the project to a joint venture in which BRE and a third party would be members. The closing deadline under the agreement was April 1, 2002. However, due to disagreements between BRE and the third party regarding their respective rights and obligations under the agreement, the closing did not occur.
On April 1, 2002, the third party brought litigation against BRE in the United States District Court for the Central District of California, Santa Ana Division. The lawsuit sought specific performance of the agreement or, in the alternative, damages. BRE filed a counterclaim for a declaration that it was not, in fact, obligated to enter into the transaction under the terms demanded by the third party. During the third quarter of 2003, BRE and the third party reached a settlement agreement. Under the terms of the settlement, BRE paid the third party $6,500,000 and retained ownership of the asset.
Also during third quarter 2003, BRE reached a settlement agreement regarding a class action lawsuit that was brought against BRE with respect to application fees charged residents from August 1998 to August 2003. Under terms of the settlement, BRE agreed to establish a $200,000 fund to reimburse prior applicants up to $5.00 per applicant, and to pay certain related administration charges and legal expenses.
The combined settlement amounts, legal fees and related expense for both suits aggregate $7,305,000 and are reported as other expenses on the consolidated income statement.
17. Supplemental Financial Data (Unaudited)
Quarterly financial information follows:
*
Revenue totals do not include revenues from discontinued operations.
For the years ended December 31, 2003, 2002 and 2001, the federal income tax components of the Company’s dividends on the common and preferred stock were as follows (unaudited).
18. Subsequent Event
On January 29, 2004, BRE redeemed its outstanding 8.50% Series A Cumulative Redeemable Preferred Stock, at a redemption price of $25.17118 per share. The redemption price is equal to the original issuance price of $25.00 per share, plus accrued and unpaid dividends to the redemption date. From the redemption date forward, dividends on the 2,150,000 shares of Series A Cumulative Redeemable Preferred Stock, all of which were called for redemption, no longer accrue, and holders of any Series A Cumulative Redeemable Preferred Stock not tendered for redemption have no rights other than the rights to receive the $25.17118 total redemption price.
In July 2003, the Securities and Exchange Commission Observer clarified that for the purposes of applying FASB-EITF Topic D-42, “The Effect on the Calculation of Earnings per Share for the Redemption or Induced Conversion of Preferred Stock,” (EITF D-42), when calculating the excess of the (1) fair value of consideration transferred to holders of the preferred stock, over the (2) carrying amount of the preferred stock in the registrant’s balance sheet, the carrying amount of the preferred stock should be reduced by the issuance costs. In connection with the issuance of the Series A Cumulative Redeemable Preferred Stock in January 1999, BRE incurred approximately $2,166,000 in issuance costs and recorded such costs as a reduction of shareholders’ equity. BRE issued the notice of redemption of the Series A Cumulative Redeemable Preferred Stock on December 2, 2003 and, in compliance with EITF D-42, recognized a redemption charge of $2,166,000 during 2003.
BRE PROPERTIES, INC.
SCHEDULE III-REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2003
(Dollar amounts in thousands)
BRE PROPERTIES, INC.
SCHEDULE III-REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2003
(Dollar amounts in thousands)
BRE PROPERTIES, INC.
SCHEDULE III-REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2003
(Dollar amounts in thousands)
BRE PROPERTIES, INC.
SCHEDULE III-REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2003
(Dollar amounts in thousands)
*
Property held by a consolidated subsidiary of the Company
**
Properties secure the Company’s secured line of credit.
BRE PROPERTIES, INC.
SCHEDULE III-REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2003
(Amounts in thousands)
The activity in investments in rental properties and related depreciation for the three-year period ended December 31, 2003 is as follows:
Investments in rental properties:
Accumulated Depreciation:
INDEX TO EXHIBITS