Item 1. Business
The Company
AIMCO Properties, L.P., a Delaware limited partnership, or the Partnership, and together with its consolidated subsidiaries and other controlled entities, the Company, was formed on May 16, 1994 to engage in the acquisition, ownership, management and redevelopment of apartment properties. Our securities include Partnership Common Units, or common OP Units, Partnership Preferred Units, or preferred OP Units, and High Performance Partnership Units, or High Performance Units, which are collectively referred to as “OP Units.” Apartment Investment and Management Company, or Aimco, is the owner of our general partner, AIMCO-GP, Inc., or the General Partner, and special limited partner, AIMCO-LP, Inc., or the Special Limited Partner. The General Partner and Special Limited Partner hold common OP Units and are the primary holders of outstanding preferred OP Units. “Limited Partners” refers to individuals or entities that are our limited partners, other than Aimco, the General Partner or the Special Limited Partner, and own common OP Units or preferred OP Units. Generally, after holding the common OP Units for one year, the Limited Partners have the right to redeem their common OP Units for cash, subject to our prior right to acquire some or all of the common OP Units tendered for redemption in exchange for shares of Aimco Class A Common Stock. Common OP Units redeemed for Aimco Class A Common Stock are generally on a one-for-one basis (subject to antidilution adjustments). Preferred OP Units and High Performance Units may or may not be redeemable based on their respective terms, as provided for in the Third Amended and Restated Agreement of Limited Partnership of AIMCO Properties, L.P. as amended, or the Partnership Agreement.
We, through our operating divisions and subsidiaries, hold substantially all of Aimco’s assets and manage the daily operations of Aimco’s business and assets. Aimco is required to contribute all proceeds from offerings of its securities to us. In addition, substantially all of Aimco’s assets must be owned through the Partnership; therefore, Aimco is generally required to contribute all assets acquired to us. In exchange for the contribution of offering proceeds or assets, Aimco receives additional interests in us with similar terms (e.g., if Aimco contributes proceeds of a preferred stock offering, Aimco (through the General Partner and Special Limited Partner) receives preferred OP Units with terms substantially similar to the preferred securities issued by Aimco).
Aimco frequently consummates transactions for our benefit. For legal, tax or other business reasons, Aimco may hold title or ownership of certain assets until they can be transferred to us. However, we have a controlling financial interest in substantially all of Aimco’s assets in the process of transfer to us.
As of December 31, 2005, we owned or managed a real estate portfolio of 1,370 apartment properties containing 240,484 apartment units located in 47 states, the District of Columbia and Puerto Rico. Our portfolio includes garden style, mid-rise and high-rise properties.
We own an equity interest in, and consolidate the majority of, the properties in our owned real estate portfolio. These properties represent the consolidated real estate holdings in our financial statements, which we refer to as consolidated properties. In addition, we have an equity interest in, but do not consolidate for financial statement purposes, certain properties that are accounted for under the equity method. These properties represent our investment in unconsolidated real estate partnerships in our financial statements, which we refer to as unconsolidated properties. Additionally, we manage (both property and asset) but do not own an equity interest in other properties, although in certain cases we may indirectly own generally less than one percent of the operations of such properties through a partnership syndication or other fund. Our equity holdings and managed properties are as follows as of December 31, 2005:
At December 31, 2005, we had outstanding 103,692,378 common OP Units, 45,037,094 preferred OP Units and 2,379,084 High Performance Units (includes only those units that have met the required measurement benchmarks and are dilutive - see Note 12 to the consolidated financial statements in Item 8).
Since Aimco’s initial public offering in July 1994, we have completed numerous transactions, expanding our portfolio of owned or managed properties from 132 properties with 29,343 apartment units to 1,370 properties with 240,484 apartment units as of December 31, 2005. These transactions have included purchases of properties and interests in entities that own or manage properties, as well as corporate mergers.
Except as the context otherwise requires, “we,” “our,” “us” and the “Company” refer to the Partnership, and the Partnership’s consolidated entities, collectively. Except as the context otherwise requires, “Aimco” refers to Aimco and Aimco’s consolidated entities, collectively. As used herein, and except where the context otherwise requires, “partnership” refers to a limited partnership or a limited liability company and “partner” refers to a limited partner in a limited partnership or a member in a limited liability company.
Available Information
We do not maintain a website. However, Aimco does, and it makes all of its filings with the Securities and Exchange Commission available free of charge as soon as reasonably practicable through its website at www.aimco.com. The information contained on Aimco’s website is not incorporated into this Annual Report. We will furnish copies of the Partnership’s filings free of charge upon written request to Aimco’s corporate secretary.
Financial Information About Industry Segments
We operate in two reportable segments: real estate (owning and operating apartments) and investment management business (providing property management and other services relating to the apartment business to third parties and affiliates). For further information on these segments, see Note 17 of the consolidated financial statements in Item 8, and Management’s Discussion and Analysis in Item 7.
Business Overview
Our principal objective is to increase long-term OP unitholder value, which we believe results from increasing asset values, increasing operating cash flows and long-term, predictable Funds From Operations, or FFO (as defined by the National Association of Real Estate Investment Trusts), per common OP Unit, less capital spending for replacements. For a description of the meaning of FFO and its use and limitations as an operating measure, see the discussion titled “Funds From Operations” in Item 7.
We strive to meet our objectives by focusing on property operations, generation of fees, portfolio management, reinvestment in properties, increasing land values through entitlements, managing our cost of capital by using
leverage that is largely long-term, non-recourse and property specific, and managing our general and administrative costs through increasing productivity.
Property Operations
We divide property operations into two business components: conventional and affordable. Our conventional operations, which are market-rate apartments with rents paid by the resident, include 526 properties with 151,613 units and also include our university communities portfolio (15 properties with 4,443 units). Aimco Capital conducts our affordable operations of 357 properties with 42,204 units, which typically are apartments with rents frequently subsidized or paid by a government agency.
Our property operations are characterized by diversification of product, location and price point. We operate a broad range of property types, from suburban garden-style to urban high-rise properties in 47 states, the District of Columbia and Puerto Rico at a broad range of average monthly rental rates, with most between $500 and $1,100 per month, and reaching as high as $6,400 per month at some of our premier properties. This geographic diversification insulates us, to some degree, from inevitable downturns in any one market.
Conventional
Our conventional operations at the beginning of 2006 were organized into four divisions, each of which is supervised by a Division Vice President, or DVP, and were further sub-divided into 17 regional operating centers, or ROCs. As changes in our portfolio occur, we reevaluate this structure. A Regional Vice President, or RVP, supervises each ROC. The ROCs are generally smaller business units with specialized operational, financial and human resource leadership. We seek to improve the operating results from our property operations by, among other methods, combining centralized financial control and uniform operating procedures with localized property management decision-making and market knowledge. To manage our nationwide portfolio more efficiently and to increase the benefits from our local management expertise, we have given direct responsibility for operations to the RVP with oversight from extensive regular reviews with senior management. To enable the RVPs to focus on sales and service, as well as improve financial control and budgeting, we have dedicated a regional financial officer to support each RVP. In addition, our construction services group handles all work on site beyond routine maintenance, thus reducing the need for RVPs to spend time on oversight of construction projects. We continue to improve our corporate-level oversight of conventional property operations by developing better systems, standardizing business goals, operational measurements and internal reporting, and enhancing financial controls over field operations. Our objectives are to focus on the areas discussed below:
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Customer Service. Our operating culture is to be focused on our customers. Our goal is to provide our residents with consistent service in clean, safe and attractive communities. We evaluate our performance through a customer satisfaction tracking system. In addition, we emphasize the quality of our on-site employees through recruiting, training and retention programs, which we believe contributes to improved customer service and leads to increased occupancy rates and enhanced performance.
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Resident Selection and Retention. In apartment properties, neighbors are a part of the product, together with the location of the property and the physical quality of the apartment units. Part of our conventional operations strategy is to focus on resident acquisition and retention - attracting and retaining credit-worthy residents who are good neighbors. We have structured goals and coaching for all of our sales personnel, a tracking system for inquiries and a standardized renewal communication program. We have standardized residential financial stability requirements and have policies and monitoring practices to maintain our resident quality. We believe that the costs exceed the benefits when higher occupancy results from lowering of financial stability standards.
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Revenue Increases. We increase rents where feasible and seek to improve occupancy rates. We are also focused on the automation of on-site operations, as we believe that timely and accurate collection of property performance and resident profile data will enable us to maximize revenue through better property management and leasing decisions. We have standardized policies for new and renewal pricing with timely data and analyses by floor-plan, thereby enabling us to maximize our ability to modify pricing, even in challenging sub-markets.
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Controlling Expenses. Cost controls are accomplished by local focus at the ROC level and by taking advantage of economies of scale at the corporate level. As a result of the size of our portfolio and our regional concentrations of properties, we have the ability to spread over a large property base fixed costs for
general and administrative expenditures and certain operating functions, such as purchasing, insurance and information technology. We are expanding our local vendor consolidation program and implementing an electronic procurement system to provide better ongoing control over purchasing decisions and to take advantage of volume discounts. Additionally, we intend to focus on energy management and centralized media programs to control expenses.
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Ancillary Services. We believe that our ownership and management of properties provide us with unique access to a customer base that allows us to provide additional services and thereby increase occupancy and rents, while also generating incremental revenue. We currently provide cable television, telephone services, appliance rental, and carport, garage and storage space rental at certain properties.
Aimco Capital
We are among the largest owners and operators of affordable properties in the United States. Aimco Capital was organized to focus on our affordable housing properties, the operations of which are most often subsidized or financed by the United States Department of Housing and Urban Development, or HUD, state housing agencies or tax credit financing, and is led by a management team dedicated to this sector. Aimco Capital operates our affordable properties through three ROCs. Affordable properties tend to have stable rents and occupancy due to government subsidies and thus are much less affected by market circumstances.
Aimco Capital also generates activity fees from transactions related to affordable holdings (including tax credit redevelopments, syndications, dispositions and refinancings), and asset management income from the financial management of our owned and operated affordable portfolio as well as two other large portfolios for which we provide asset management services only. We believe that Aimco Capital is well positioned as it has the national structure, knowledge and pipeline to grow as a more autonomous operation with dedicated capital.
Portfolio Management
Conventional
We view our conventional property portfolio in terms of “core” and “non-core” properties. Core properties are those properties that are located in markets where population and employment growth are expected to exceed national trends and where we believe there is potential for long-term growth at higher rates of return. During 2005, we made a decision to concentrate our core portfolio in markets located predominantly in coastal states as well as the Rocky Mountain region and Chicago. This reduced the number of markets in which we intend to remain from 38 to 27. We plan to exit certain Texas and Midwest markets where the average four-year growth rate is projected below average of the remainder of the core portfolio. At December 31, 2005, we had 272 conventional core properties, which generally we intend to hold and improve over the long-term. Within our core portfolio, the largest single market (Washington, D.C.) contributed approximately 10%, and the five largest markets (Washington, D.C., greater Los Angeles, New England, Philadelphia and Miami-Fort Lauderdale) together contributed approximately 38%, to income before depreciation and interest expense, or net operating income. At December 31, 2005, we had 254 conventional non-core properties, which we generally intend to hold for investment for the intermediate term. Non-core properties are those properties located within the 32 markets we intend to exit or in less favored locations within the 27 markets that comprise our core portfolio. We exited nine markets in 2005. During 2006, we expect to exit an additional five markets and over the next several years we expect to exit the remaining markets in which we hold our non-core properties.
Portfolio management includes expanding our core portfolio through acquisitions of properties located in markets where our core portfolio is concentrated. We specifically seek investments in a variety of asset qualities and types at a purchase price below replacement cost. Currently, we acquire properties and property interests primarily in three ways:
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the direct acquisition of a property or portfolio of properties;
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acquisition of a portfolio of properties through a purchase from, or a merger or business combination with, an entity that owns or controls the property or portfolio being acquired; and
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the purchase from third parties, subject to our fiduciary duties, of additional interests in partnerships where we own a general partnership interest.
In 2005, we completed direct acquisitions of six conventional core properties, containing approximately 1,006 residential units and six retail spaces for an aggregate purchase price of approximately $284 million (including transaction costs) and acquired additional interests in 84 partnerships for approximately $56 million (including transaction costs). These properties were located in New York City, New Jersey and Los Angeles.
Portfolio management also includes dispositions of properties located within markets we intend to exit, properties in less favored locations within the 27 markets that comprise our core portfolio or properties that do not meet our long-term investment criteria. Additionally, from time to time, we may dispose of certain core properties that are consistent with our long-term investment strategy but offer attractive returns, such as in sales to buyers who intend to convert the properties to condominiums. The sales of core and non-core properties partially fund our acquisitions and capital improvements on our existing properties. In 2005, we sold 71 non-core properties generating net cash proceeds to us, after repayment of existing debt, payment of transaction costs and distributions to limited partners, of $262 million.
Aimco Capital
The portfolio management strategy for Aimco Capital is similar to that of our Conventional portfolio. Aimco Capital seeks to dispose of properties that are inconsistent with our long-term investment strategy and Aimco Capital’s operations. During 2005, we sold 47 non-core properties from within the Aimco Capital portfolio, generating net cash proceeds to us, after repayment of existing debt, payment of transaction costs and distributions to limited partners, of $70 million. At December 31, 2005 within the Aimco Capital portfolio, we had 357 properties, a majority of which are non-core properties that we generally intend to hold for investment for the intermediate term. During 2006, we intend to sell approximately the same number of Aimco Capital properties as we sold in 2005.
Entitlements
We have the opportunity to improve land values by seeking new entitlements for many properties. Entitlements provide us the opportunity to enhance the value of our existing portfolio by obtaining local governmental approvals to increase density and add dwelling or residential units to a site. Also, we seek to add incremental value through redevelopment of existing units and excess land sales. We currently have 50 entitlement projects underway or under review. These properties are typically well located and in many cases were built 30 or more years ago. During 2005, we received final approval on the conceptual site plan for Springhill Lake in Greenbelt, Maryland, which includes doubling the density of the property from 2,899 units to 5,800 units.
Reinvestment in Properties
We believe that the physical condition and amenities of our apartment properties are important factors in our ability to maintain and increase rental rates. In 2005, we spent $89.7 million, or $597 per owned apartment unit, for Capital Replacements, which represent the share of expenditures that are deemed to replace the consumed portion of acquired capital assets. Additionally, we spent $112.0 million for Capital Improvements, which are non-redevelopment capital expenditures that are made to enhance the value, profitability or useful life of an asset from its original purchase condition.
In addition to maintenance and improvements of our properties, we focus on the redevelopment of certain properties each year. We believe redevelopment of certain properties in superior locations provides advantages over ground-up development, enabling us to generate rents comparable to new properties with relatively lower financial risk, in less time and with reduced delays associated with governmental permits and authorizations. We undertake two types of redevelopment projects: major projects, where a substantial number or all available units are vacated for significant renovations to the property; and moderate projects, where there is significant renovation, such as exteriors, common areas or unit improvements, typically done upon lease expirations without the need to vacate units on any wholesale or substantial basis. We have a specialized Redevelopment and Construction Services Group, which includes engineers, architects and construction managers, to oversee these projects. As of December 31, 2005, we had 59 projects at various stages of redevelopment. Of the 59 projects, 37 are conventional properties (two major projects and 35 moderate projects) and 22 are affordable properties. During 2005, redevelopment expenditures totaled $203.5 million, of which our share totaled $140.3 million, and we completed our two major projects as well as interior upgrades or new construction on 2,188 conventional units, of which 1,687 were leased at year-end for increased rental rates. Total redevelopment expenditures for our 35 active conventional moderate projects will be approximately $228.9 million, of which approximately $108.4 million remains to be spent. Total redevelopment expenditures for our 22 affordable redevelopments will be approximately $142.0 million, of which approximately $52.5 million remains to be spent, most of which will be funded by third-party tax credit equity and
tax-exempt debt. In 2006, we plan to invest between $150 and $200 million in conventional redevelopment projects that will impact approximately 70 properties with nearly 30,000 units. Additionally, in 2006 redevelopment expenditures on affordable properties will be approximately $80 million, predominantly funded by third-party tax credit equity, impacting 20 to 25 properties with more than 3,000 units.
Cost of Capital
We are focused on minimizing our cost of capital. We have a deliberate policy of using non-recourse property debt. The lower risk inherent in non-recourse property debt permits us to operate with higher debt leverage and a lower weighted average cost of capital. During 2005, we closed loans totaling $971.5 million at an average interest rate of 5.06%, which included the refinancing of loans totaling $415.2 million with prior interest rates averaging 7.33%. In 2006, we intend to further reduce our cost of capital through the redemption of $286.8 million of preferred securities at a weighted average cost of 9.76%.
Productivity
Over the past several years, we have had growth in our general and administrative spending as a result of the building of our infrastructure in certain areas in which we had needs, including, operational systems, information technology and other automation, human resources, and expanded accounting, legal, and financial planning and analysis functions. We are focused on containing this spending going forward through enhanced productivity, process improvements and staff reductions.
Competition
In attracting and retaining residents to occupy our properties we compete with numerous other housing alternatives. Our properties compete directly with other rental apartments, as well as with condominiums and single-family homes that are available for rent or purchase in the markets in which our properties are located. Principal factors of competition include rent or price charged, attractiveness of the location and property and quality and breadth of services. The number of competitive properties in a particular area has a material effect on our ability to lease apartment units at our properties and on the rents we charge. Additionally, we compete with other real estate investors, including other apartment REITs, pension and investment funds, partnerships and investment companies in acquiring, redeveloping and managing apartment properties. This competition affects our ability to acquire properties we want to add to our portfolio and the price that we pay in such acquisitions.
Taxation
We are treated as a “pass-through” entity for Federal income tax purposes and are not subject to Federal income taxation. Each of our partners, however, is subject to tax on his allocable share of partnership tax items, including partnership income, gains, losses, deductions and credits, or Partnership Tax Items, for each taxable year during which he is a partner, regardless of whether he receives any actual distributions of cash or other property from us during the taxable year. Generally, the characterization of any particular Partnership Tax Item is determined by us, rather than at the partner level, and the amount of a partner’s allocable share of such item is governed by the terms of the Partnership Agreement. The General Partner is our “tax matters partner” for Federal income tax purposes. The tax matters partner is authorized, but not required, to take certain actions on behalf of us with respect to tax matters.
Taxation of Aimco
Aimco has elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended, which we refer to as the Code, commencing with its taxable year ended December 31, 1994, and intends to continue to operate in such a manner. Aimco’s current and continuing qualification as a REIT depends on its ability to meet the various requirements imposed by the Code, which are related to organizational structure, distribution levels, diversity of stock ownership and certain restrictions with regard to owned assets and categories of income. If Aimco qualifies for taxation as a REIT, it will generally not be subject to United States Federal corporate income tax on its net income that is currently distributed to stockholders. This treatment substantially eliminates the “double taxation” (at the corporate and stockholder levels) that generally results from investment in a corporation.
Even if Aimco qualifies as a REIT, it may be subject to United States Federal income and excise taxes in various situations, such as on its undistributed income. Aimco also will be required to pay a 100% tax on any net income on non-arm’s length transactions between it and a TRS (described below) and on any net income from sales of property that was property held for sale to customers in the ordinary course. Aimco and its stockholders may be subject to state or local taxation in various state or local jurisdictions, including those in which it or they transact business or
reside. Any taxes imposed on Aimco would reduce our operating cash flow. The state and local tax treatment that Aimco and its stockholders receive may not conform to the United States Federal income tax treatment.
Certain of Aimco’s operations (property management, asset management, risk, etc.) are conducted through taxable REIT subsidiaries, each of which we refer to as a TRS. A TRS is a C-corporation that has not elected REIT status and as such is subject to United States Federal corporate income tax. Aimco uses the TRS format to facilitate its ability to offer certain services and activities to its residents, which services and activities are not generally considered as qualifying REIT activities.
Regulation
General
Apartment properties are subject to various laws, ordinances and regulations, including regulations relating to recreational facilities such as swimming pools, activity centers and other common areas. Changes in laws increasing the potential liability for environmental conditions existing on properties or increasing the restrictions on discharges or other conditions, as well as changes in laws affecting development, construction and safety requirements, may result in significant unanticipated expenditures, which would adversely affect our net income and cash flows from operating activities. In addition, future enactment of rent control or rent stabilization laws or other laws regulating multifamily housing may reduce rental revenue or increase operating costs in particular markets.
Environmental
Various Federal, state and local laws subject property owners or operators to liability for management, and the costs of removal or remediation, of certain hazardous substances present on a property. Such laws often impose liability without regard to whether the owner or operator knew of, or was responsible for, the release or presence of the hazardous substances. The presence of, or the failure to manage or remedy properly, hazardous substances may adversely affect occupancy at affected apartment communities and the ability to sell or finance affected properties. In addition to the costs associated with investigation and remediation actions brought by government agencies, and potential fines or penalties imposed by such agencies in connection therewith, the presence of hazardous substances on a property could result in claims by private plaintiffs for personal injury, disease, disability or other infirmities. Various laws also impose liability for the cost of removal, remediation or disposal of hazardous substances through a licensed disposal or treatment facility. Anyone who arranges for the disposal or treatment of hazardous substances is potentially liable under such laws. These laws often impose liability whether or not the person arranging for the disposal ever owned or operated the disposal facility. In connection with the ownership, operation and management of properties, we could potentially be liable for environmental liabilities or costs associated with our properties or properties we acquire or manage in the future.
We have been named as a defendant in lawsuits that have alleged personal injury and property damage as a result of the presence of mold. In addition, we are aware of lawsuits against owners and managers of multifamily properties asserting claims of personal injury and property damage caused by the presence of mold, some of which have resulted in substantial monetary judgments or settlements. We have only limited insurance coverage for property damage loss claims arising from the presence of mold and for personal injury claims related to mold exposure. We have implemented policies, procedures, third-party audits and training, and include a detailed moisture intrusion and mold assessment during acquisition due diligence. We believe these measures will prevent or eliminate mold exposure from our properties and will minimize the effects that mold may have on our residents. To date, we have not incurred any material costs or liabilities relating to claims of mold exposure or to abate mold conditions. Because the law regarding mold is unsettled and subject to change we can make no assurance that liabilities resulting from the presence of or exposure to mold will not have a material adverse effect on our consolidated financial condition or results of operations.
Insurance
Our primary lines of insurance coverage are property, general liability, and workers’ compensation. We believe that our insurance coverages adequately insure our properties against the risk of loss attributable to fire, earthquake, hurricane, tornado, flood and other perils and adequately insure us against other risks. Our coverage includes deductibles, retentions and limits that are customary in the industry. We have established loss prevention, loss mitigation, claim handling, litigation management and loss reserving procedures to manage our exposure.
Employees
We currently have approximately 6,400 employees, of which approximately 5,200 are at the property level, performing various on-site functions, with the balance managing corporate and regional operations, including investment and debt transactions, legal, financial reporting, accounting, information systems, human resources and other support functions. Unions represent approximately 200 of our employees. We have never experienced a work stoppage and believe we maintain satisfactory relations with our employees.
Item 1A.
Item 1A. Risk Factors
The risk factors noted in this section and other factors noted throughout this Annual Report, describe certain risks and uncertainties that could cause our actual results to differ materially from those contained in any forward-looking statement.
Failure to generate sufficient net operating income may limit our ability to pay distributions.
Our ability to make payments to our investors depends on our ability to generate net operating income in excess of required debt payments and capital expenditure requirements. Net operating income may be adversely affected by events or conditions beyond our control, including:
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the general economic climate;
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competition from other apartment communities and other housing options;
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local conditions, such as loss of jobs or an increase in the supply of apartments, that might adversely affect apartment occupancy or rental rates;
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changes in governmental regulations and the related cost of compliance;
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increases in operating costs (including real estate taxes) due to inflation and other factors, which may not be offset by increased rents;
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changes in tax laws and housing laws, including the enactment of rent control laws or other laws regulating multifamily housing;
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changes in interest rates and the availability of financing; and
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the relative illiquidity of real estate investments.
If we are not able successfully to acquire, operate, redevelop and expand properties, our results of operations will be adversely affected.
The selective acquisition, redevelopment and expansion of properties are components of our strategy. However, we may not be able to complete transactions successfully in the future. Although we seek to acquire, operate, redevelop and expand properties only when such activities increase our net income on a per unit basis, such transactions may fail to perform in accordance with our expectations. When we redevelop or expand properties, we are subject to the risks that:
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costs may exceed original estimates;
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occupancy and rental rates at the property may be below our projections;
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financing may not be available on favorable terms or at all;
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redevelopment and leasing of the properties may not be completed on schedule; and
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we may experience difficulty or delays in obtaining necessary zoning, land-use, building, occupancy and other governmental permits and authorizations.
Our existing and future debt financing could render us unable to operate, result in foreclosure on our properties or prevent us from making distributions on our equity.
Our strategy is generally to incur debt to increase the return on our equity while maintaining acceptable interest coverage ratios. For the year ended December 31, 2005, we had a ratio of free cash flow (net operating income less spending for capital replacements) to combined interest expense and preferred OP Unit distributions of 1.4:1. Our organizational documents do not limit the amount of debt that we may incur, and we have significant amounts of debt outstanding. Payments of principal and interest may leave us with insufficient cash resources to operate our properties or pay distributions required to be paid in order to maintain Aimco’s qualification as a REIT. We are also subject to the risk that our cash flow from operations will be insufficient to make required payments of principal and interest, and the risk that existing indebtedness may not be refinanced or that the terms of any refinancing will not be as favorable as the terms of existing indebtedness. If we fail to make required payments of principal and interest on secured debt, our lenders could foreclose on the properties securing such debt, which would result in loss of income and asset value to us. As of December 31, 2005, substantially all of the properties that we owned or controlled were encumbered by debt.
Increases in interest rates would increase our interest expense.
As of December 31, 2005, we had approximately $2,010.5 million of variable-rate indebtedness outstanding. Of the total debt subject to variable interest rates, floating rate tax-exempt bond financing was $726.1 million. Floating rate tax-exempt bond financing is benchmarked against the BMA Index, which since 1981 has averaged 68.0% of 30-day LIBOR. If this relationship continues, an increase in the 30-day LIBOR, of 1% (0.68% in tax-exempt interest rates) would result in our income before minority interests and cash flows being reduced by $17.8 million on an annual basis. This would be offset by variable rate interest income earned on certain assets, including cash and cash equivalents and notes receivable, as well as interest that is capitalized on a portion of this variable rate debt incurred in connection with our redevelopment activities. Considering these offsets, the same increase in the 30-day LIBOR would result in our income before minority interests being reduced by $8.9 million on an annual basis.
Covenant restrictions may limit our ability to make payments to our investors.
Some of our debt and other securities contain covenants that restrict our ability to make distributions or other payments to our investors unless certain financial tests or other criteria are satisfied. Our credit facility provides, among other things, that we may make distributions to our investors during any four consecutive fiscal quarters in an aggregate amount that does not exceed the greater of 95% of our Funds From Operations for such period or such amount as may be necessary to maintain Aimco’s REIT status. Our outstanding classes of preferred OP Units prohibit the payment of distributions on our common OP Units if we fail to pay the distributions to which the holders of the preferred OP Units are entitled.
We depend on distributions and other payments from our subsidiaries that they may be prohibited from making to us.
We depend on distributions and other payments from our subsidiaries in order to satisfy our financial obligations and make payments to our investors. The ability of our subsidiaries to make such distributions and other payments depends on their earnings and may be subject to statutory or contractual limitations. As an equity investor in our subsidiaries, our right to receive assets upon their liquidation or reorganization will be effectively subordinated to the claims of their creditors. To the extent that we are recognized as a creditor of such subsidiaries, our claims may still be subordinate to any security interest in or other lien on their assets and to any of their debt or other obligations that are senior to our claims.
We may be subject to litigation associated with partnership acquisitions that could increase our expenses and prevent completion of beneficial transactions.
We have engaged in, and intend to continue to engage in, the selective acquisition of interests in partnerships that own apartment properties. In some cases, we have acquired the general partner of a partnership and then made an offer to acquire the limited partners’ interests in the partnership. In these transactions, we may be subject to litigation based on claims that we, as the general partner, have breached our fiduciary duty to our limited partners or that the transaction violates the relevant partnership agreement or state law. Although we intend to comply with our fiduciary obligations and the relevant partnership agreements, we may incur additional costs in connection with the defense or settlement of this type of litigation. In some cases, this type of litigation may adversely affect our desire
to proceed with, or our ability to complete, a particular transaction. Any litigation of this type could also have a material adverse effect on our financial condition or results of operations.
The marketplace for insurance coverage is uncertain and in some cases insurance is becoming more expensive and more difficult to obtain.
The insurance market is characterized by volatility with respect to premiums, deductibles and coverage. Although we make use of many alternative methods of risk financing that enable us to insulate ourselves to some degree from variations in coverage and cost, sustained deterioration in insurance marketplace conditions may have a negative effect on our operating results.
The FBI has issued alerts regarding potential terrorist threats involving apartment buildings.
From time to time, the Federal Bureau of Investigation, or FBI, and the United States Department of Homeland Security issue alerts regarding potential terrorist threats involving apartment buildings. Threats of future terrorist attacks, such as those announced by the FBI and the Department of Homeland Security, could have a negative effect on rent and occupancy levels at our properties. The effect that future terrorist activities or threats of such activities could have on our business is uncertain and unpredictable. If we incur a loss at a property as a result of an act of terrorism, we could lose all or a portion of the capital we have invested in the property, as well as the future revenue from the property.
We depend on our senior management.
Our success depends upon the retention of our senior management, including Terry Considine, Aimco’s chief executive officer and president. There are no assurances that we would be able to find qualified replacements for the individuals who make up our senior management if their services were no longer available. The loss of services of one or more members of our senior management team could have a material adverse effect on our business, financial condition and results of operations. We do not currently maintain key-man life insurance for any of our employees. The loss of any member of senior management could adversely affect our ability to pursue effectively our business strategy.
Affordable housing regulations may limit the opportunities at some of our properties, reducing our revenue and, in some cases, causing us to sell properties that we might otherwise continue to own.
We own an equity interest in certain affordable properties and manage for third parties and affiliates other properties that benefit from governmental programs intended to provide housing to people with low or moderate incomes. These programs, which are usually administered by HUD or state housing finance agencies, typically provide mortgage insurance, favorable financing terms or rental assistance payments to the property owners. As a condition of the receipt of assistance under these programs, the properties must comply with various requirements, which typically limit rents to pre-approved amounts. If permitted rents on a property are insufficient to cover costs, a sale of the property may become necessary, which could result in a loss of management fee revenue. We usually need to obtain the approval of HUD in order to manage, or acquire a significant interest in, a HUD-assisted property. We may not always receive such approval.
Laws benefiting disabled persons may result in our incurrence of unanticipated expenses.
Under the Americans with Disabilities Act of 1990, or ADA, all places intended to be used by the public are required to meet certain Federal requirements related to access and use by disabled persons. Likewise, the Fair Housing Amendments Act of 1988, or FHAA, requires apartment properties first occupied after March 13, 1990 to be accessible to the handicapped. These and other Federal, state and local laws may require modifications to our properties, or restrict renovations of the properties. Noncompliance with these laws could result in the imposition of fines or an award of damages to private litigants and also could result in an order to correct any non-complying feature, which could result in substantial capital expenditures. Although we believe that our properties are substantially in compliance with present requirements, we may incur unanticipated expenses to comply with the ADA and the FHAA.
As a REIT, Aimco is subject to substantial risks related to its compliance with the tax laws.
Aimco may fail to qualify as a REIT. Aimco believes that it operates in a manner that enables it to meet the requirements for qualification as a REIT for Federal income tax purposes; however, future economic, market, legal, tax or other considerations may cause it to fail to qualify as a REIT, or its board of directors may determine to
revoke its REIT status. If Aimco fails to qualify, or revokes its status, as a REIT, Aimco will not be allowed a deduction for dividends paid to its stockholders in computing its taxable income, and Aimco will be subject to Federal income tax at regular corporate rates. This would substantially reduce the funds available for payment to Aimco’s investors. In addition, Aimco’s failure to qualify as a REIT would trigger the following consequences:
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Aimco would be obligated to repurchase certain classes of its preferred stock; and
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we would be in default under our primary credit facilities and certain other loan agreements.
REIT distribution requirements limit Aimco’s available cash. As a REIT, Aimco is subject to annual distribution requirements. As Aimco’s operating partnership, we pay distributions intended to enable Aimco to satisfy these distribution requirements. This limits the amount of cash we have available for other business purposes, including amounts to fund growth.
Limits on ownership of Aimco’s shares in Aimco’s charter may result in the loss of economic and voting rights by purchasers that violate those limits.
Aimco’s charter limits ownership of its common stock by any single stockholder (applying certain “beneficial ownership” rules under Federal securities laws) to 8.7% of the outstanding shares, or 15% in the case of certain pension trusts, registered investment companies and Mr. Considine. The charter also limits ownership of Aimco’s common stock and preferred stock by any single stockholder to 8.7% of the value of the outstanding common stock and preferred stock, or 15% in the case of certain pension trusts, registered investment companies and Mr. Considine. The charter also prohibits anyone from buying shares if the purchase would result in Aimco losing its REIT status. This could happen if a transaction results in fewer than 100 persons owning all of Aimco’s shares. If anyone acquires shares in excess of the ownership limit or in violation of the ownership requirements of the Code for REITs:
•
the transfer will be considered null and void;
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Aimco will not reflect the transaction on its books;
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Aimco may institute legal action to enjoin the transaction;
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Aimco may demand repayment of any dividends received by the affected person on those shares;
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Aimco may redeem the shares;
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the affected person will not have any voting rights for those shares; and
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the shares (and all voting and dividend rights of the shares) will be held in trust for the benefit of one or more charitable organizations designated by us.
Aimco may purchase the shares held in trust at a price equal to the lesser of the price paid by the transferee of the shares or the then current market price. If the trust transfers any of the shares, the affected person will receive the lesser of the price paid for the shares or the then current market price. An individual who acquires shares that violate the above rules bears the risk that the individual:
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may lose control over the power to dispose of such shares;
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may not recognize profit from the sale of such shares if the market price of the shares increases;
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may be required to recognize a loss from the sale of such shares if the market price decreases; and
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may be required to repay to Aimco any dividends received from Aimco as a result of his or her ownership of the shares.
Aimco’s charter and Maryland law may limit the ability of a third party to acquire control of Aimco.
Ownership Limit. The 8.7% ownership limit discussed above may have the effect of precluding acquisition of control of Aimco by a third party without the consent of Aimco’s board of directors.
Preferred Stock. Aimco’s charter authorizes its board of directors to issue up to 510,587,500 shares of capital stock. As of December 31, 2005, 426,157,976 shares were classified as Aimco Class A Common Stock, of which 95,732,200 were outstanding, and 84,429,524 shares were classified as preferred stock, of which 38,324,762 were outstanding. Under Aimco’s charter, its board of directors has the authority to classify and reclassify any of Aimco’s unissued shares of capital stock into shares of preferred stock with such preferences, rights, powers and restrictions as Aimco’s board of directors may determine. The authorization and issuance of preferred stock could have the effect of delaying or preventing someone from taking control of Aimco, even if a change in control were in stockholders’ best interests.
Maryland Business Statutes. As a Maryland corporation, Aimco is subject to various Maryland laws that may have the effect of discouraging offers to acquire Aimco and of increasing the difficulty of consummating any such offers, even if an acquisition would be in the best interests of Aimco stockholders or the Limited Partners. The Maryland General Corporation Law restricts mergers and other business combination transactions between Aimco and any person who acquires beneficial ownership of shares of Aimco’s stock representing 10% or more of the voting power without Aimco’s board of directors’ prior approval. Any such business combination transaction could not be completed until five years after the person acquired such voting power, and generally only with the approval of stockholders representing 80% of all votes entitled to be cast and 66-2/3% of the votes entitled to be cast, excluding the interested stockholder, or upon payment of a fair price. Maryland law also provides generally that a person who acquires shares of Aimco stock that represent 10% or more of the voting power in electing directors will have no voting rights unless approved by a vote of two-thirds of the shares eligible to vote, excluding the control shares. Maryland law provides, among other things, that the board of directors has broad discretion in adopting stockholders’ rights plans and has the sole power to fix the record date, time and place for special meetings of the stockholders. In addition, Maryland law provides that corporations that:
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have at least three directors who are not employees of the entity or related to an acquiring person; and
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are subject to the reporting requirements of the Securities Exchange Act of 1934,
may elect in their charter or bylaws or by resolution of the board of directors to be subject to all or part of a special subtitle that provides that:
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the corporation will have a staggered board of directors;
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any director may be removed only for cause and by the vote of two-thirds of the votes entitled to be cast in the election of directors generally, even if a lesser proportion is provided in the charter or bylaws;
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the number of directors may only be set by the board of directors, even if the procedure is contrary to the charter or bylaws;
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vacancies may only be filled by the remaining directors, even if the procedure is contrary to the charter or bylaws; and
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the secretary of the corporation may call a special meeting of stockholders at the request of stockholders only on the written request of the stockholders entitled to cast at least a majority of all the votes entitled to be cast at the meeting, even if the procedure is contrary to the charter or bylaws.
To date, Aimco has not made any of the elections described above.
ITEM 1.B. Unresolved Staff Comments
None.
Item 2.
Item 2. Properties
Our properties are located in 47 states, the District of Columbia and Puerto Rico. As of December 31, 2005, our conventional properties are operated through 17 regional operating centers and a university communities group. Affordable property operations are managed through Aimco Capital and are operated through three regional operating centers. The following table sets forth information on all of our property operations as of December 31, 2005 and 2004:
(1)
As our portfolio changes due to property acquisitions and dispositions, we are continually evaluating the organization of our regional operating centers, or ROCs. During 2005, the Orlando/Tampa ROC was separated into two ROCs, Tidewater was added and the Michigan and Columbia ROCs were combined into other ROCs. Subsequent to December 31, 2005, we combined the Austin and Dallas ROCs and added a ROC in New York. Additionally, the properties within University Communities have been moved into various ROCs depending on the location of the property.
At December 31, 2005, we owned an equity interest in and consolidated 619 properties containing 158,548 apartment units, which we refer to as “consolidated.” These consolidated properties contain, on average, 256 apartment units, with the largest property containing 2,899 apartment units. These properties offer residents a range of amenities, including swimming pools, clubhouses, spas, fitness centers, tennis courts and saunas. Many of the
apartment units offer features such as vaulted ceilings, fireplaces, washer and dryer hook-ups, cable television, balconies and patios. Additional information on our consolidated properties is contained in “Schedule III, Real Estate and Accumulated Depreciation” in this Annual Report. At December 31, 2005, we held an equity interest in and did not consolidate 264 properties containing 35,269 apartment units, which we refer to as “unconsolidated.” In addition, we provided property management services for third parties owning 52 properties containing 5,246 apartment units, and asset management services for third parties owning 435 properties containing 41,421 apartment units, although in certain cases we may indirectly own generally less than one percent of the operations of such properties through a partnership syndication or other fund.
Substantially all of our consolidated properties are encumbered by mortgage indebtedness. At December 31, 2005, our consolidated properties were encumbered by aggregate mortgage indebtedness totaling $5,667.2 million (not including $33.7 million of mortgage indebtedness included within liabilities related to assets held for sale), having an aggregate weighted average interest rate of 5.99%. Such mortgage indebtedness was secured by 596 properties with a combined net book value of $8,673.7 million. Included in the 596 properties, we had a total of 50 mortgage loans, with an aggregate principal balance outstanding of $795.5 million, that were each secured by property and cross-collateralized with certain (but not all) other mortgage loans within this group of 50 mortgage loans. See Note 6 of the consolidated financial statements in Item 8 for additional information about our indebtedness.
Item 3.
Item 3. Legal Proceedings
See the information under the caption “Legal Matters” in Note 9 of the consolidated financial statements in Item 8 for information regarding legal proceedings, which information is incorporated by reference in this Item 3.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
None.
PART II
Item 5.
Item 5. Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
There is no public market for the OP Units, and we do not intend to list the OP Units on any securities exchange. In addition, the Partnership Agreement restricts the transferability of OP Units. The following table sets forth the cash distributions declared per common OP Unit in each quarterly period during the two years ended December 31, 2005 and 2004:
On February 28, 2006, there were 104,495,031 common OP Units outstanding, held by 2,795 unitholders of record.
During 2005, we completed tender offers for limited partnership interests resulting in the issuance of approximately 3,000 common OP Units. Each of these transactions was exempt from registration under the Securities Act of 1933, as amended, pursuant to Section 4(2) thereof.
During the year ended December 31, 2005, we issued to Aimco 3,416,478 Class Thirteen Partnership Preferred Units in connection with the acquisition of real estate. Each of these transactions was also exempt from registration under the Securities Act of 1933, as amended, pursuant to Section 4(2) thereof of Regulation D thereunder.
Our Partnership Agreement generally provides that after holding the common OP Units for one year, our Limited Partners have the right to redeem their common OP Units for cash, subject to our prior right to cause Aimco to acquire some or all of the common OP Units tendered for redemption in exchange for shares of Aimco Class A Common Stock. Common OP Units redeemed for Aimco Class A Common Stock are generally on a one-for-one basis (subject to antidilution adjustments). The following table summarizes repurchases of our equity securities for cash for the year ended December 31, 2005. In addition, during the year ended December 31, 2005, Aimco purchased approximately 425,000 common OP Units in exchange for approximately 425,000 shares of Aimco Class A Common Stock.
(1)
The terms of our Partnership Agreement do not provide for a maximum number of units that may be repurchased, and other than the express terms of our Partnership Agreement, we have no publicly announced plans or programs of repurchase.
Distribution Payments. Our Credit Agreement includes customary covenants, including a restriction on distributions and other restricted payments, but permits distributions during any four consecutive fiscal quarters in an aggregate amount of up to 95% of Funds From Operations for such period or such amount as may be necessary for Aimco to maintain its REIT status.
Item 6.
Item 6. Selected Financial Data
The following selected financial data is based on our audited historical financial statements. This information should be read in conjunction with such financial statements, including the notes thereto, and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included herein or in previous filings with the Securities and Exchange Commission.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Executive Overview
We are a self-administered and self-managed real estate investment trust, or REIT, engaged in the ownership, acquisition, management and redevelopment of apartment properties. Our property operations are characterized by diversification of product, location and price point. As of December 31, 2005, we owned or managed 1,370 apartment properties containing 240,484 units located in 47 states, the District of Columbia and Puerto Rico. Our primary sources of income and cash are rents associated with apartment leases.
The key financial indicators that we use in managing our business and in evaluating our financial condition and operating performance are: Funds From Operations, or FFO; FFO less spending for Capital Replacements, or AFFO; same store property operating results; net operating income; net operating income less spending for Capital Replacements, or Free Cash Flow; financial coverage ratios; and leverage as shown on our balance sheet. These terms are defined and described in the sections captioned “Funds From Operations” and “Capital Expenditures” below. The key macro-economic factors and non-financial indicators that affect our financial condition and operating performance are: rates of job growth; single-family and multifamily housing starts; and interest rates.
Because our operating results depend primarily on income from our properties, the supply and demand for apartments influences our operating results. Additionally, the level of expenses required to operate and maintain our properties, the pace and price at which we redevelop, acquire and dispose of our apartment properties, and the volume and timing of fee transactions affect our operating results. Our cost of capital is affected by the conditions in the capital and credit markets and the terms that we negotiate for our equity and debt financings.
Our focus in 2005 has been to increase revenue and implement cost management and productivity initiatives, which includes centralizing purchasing, restructuring business processes, using technology to increase efficiency and implementing structured monthly reporting to identify issues and improve effectiveness of spending. We believe that our efforts are having their intended effect, are resulting in a positive trend in certain operating results and are the foundation for improved long-term operating results. These initiatives and others have also resulted in improved asset quality, and we will continue to seek opportunities to reinvest in our properties through capital expenditures and to manage our portfolio through property sales and acquisitions.
For 2006, our focus will include the following: continue to improve operations so that customer satisfaction and occupancy increase to bring improved profitability; upgrade the quality of our portfolio through portfolio management and redevelopment; increase efficiency through improved business processes and automation; improve balance sheet flexibility; minimize our cost of capital in the face of rising interest rates; and monetize a portion of the value inherent in our properties with increased entitlements.
The following discussion and analysis of the results of our operations and financial condition should be read in conjunction with the financial statements.
Results of Operations
Overview
2005 compared to 2004
We reported net income of $80.7 million and net loss attributable to common unitholders of $18.2 million for the year ended December 31, 2005, compared to net income of $293.1 million and net income attributable to common unitholders of $196.2 million for the year ended December 31, 2004, decreases of $212.4 million and $214.4 million, respectively. These decreases were principally due to the following items, all of which are discussed in further detail within this section:
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a decrease in income from discontinued operations, primarily related to lower net gains on dispositions of real estate;
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a decrease in net gain on disposition of real estate related to unconsolidated entities and other, primarily related to a 2004 gain on sale of land;
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an increase in depreciation and amortization expense;
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an increase in interest expense; and
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an increase in general and administrative expenses.
These decreases were partially offset by an increase in net operating income associated with property operations, which included increases related to acquisition, newly consolidated and same store properties.
2004 compared to 2003
We reported net income of $293.1 million and net income attributable to common unitholders of $196.2 million for the year ended December 31, 2004, compared to net income of $177.9 million and net income attributable to common unitholders of $74.2 million for the year ended December 31, 2003, increases of $115.2 million and $122.0 million, respectively. These increases were principally due to the following items, all of which are discussed in further detail within this section:
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an increase in net gain on disposition of real estate (including the gain recognized in discontinued operations and the gain related to unconsolidated entities and other); and
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an increase in activity fees and asset management revenues.
These increases were partially offset by:
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an overall decline in net operating income, which included a decline in same store net operating results, partially offset by increases related to acquisition and newly consolidated properties;
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an increase in general and administrative expenses;
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an increase in interest expense; and
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an increase in depreciation and amortization expense.
The following paragraphs discuss these and other items affecting the results of our operations in more detail.
Rental Property Operations
Our operating income is primarily generated from the operations of our consolidated properties. The principal components within our total consolidated property operations are: consolidated same store properties, which consist of all conventional properties that were owned (and not classified as held for sale) and managed by us, stabilized and consolidated for all comparable periods presented; and other consolidated entities, which primarily include acquisition, newly consolidated, affordable and redevelopment properties.
The following table summarizes the overall performance of our consolidated properties for the years ended December 31, 2005, 2004 and 2003 (in thousands):
For the year ended December 31, 2005 compared to the year ended December 31, 2004, net operating income for our consolidated property operations increased by $77.8 million, or 11.5%. This increase was principally due to a $39.3 million increase in consolidated same store net operating income (see further discussion of same store results under the heading “Conventional Same Store Property Operating Results”); a $21.3 million increase related to operations of acquisition properties, which were principally comprised of Palazzo East at Park La Brea and five other properties purchased in 2005 and The Palazzo at Park La Brea and 10 other properties purchased in 2004; an $18.0 million increase related to operations of newly consolidated properties, which are properties that had been previously unconsolidated and accounted for by the equity method (21 properties first consolidated in 2005 and 42 properties first consolidated in 2004, which includes 24 properties that were consolidated due to the adoption of FASB Interpretation No. 46, Consolidation of Variable Interest Entities, or FIN 46,); a $3.9 million increase related to operations of our affordable properties; and a $2.7 million increase related to the completion of certain redevelopment properties. These increases were offset by $6.4 million of increased property management expenses and $3.3 million of higher net casualty losses in 2005 as compared to 2004, primarily relating to greater hurricane and tropical storm damage that occurred in 2005.
For the year ended December 31, 2004, compared to the year ended December 31, 2003, net operating income for our consolidated property operations decreased by $19.9 million, or 2.9%. This decrease was principally due to a $40.3 million decrease in consolidated same store net operating income (see further discussion of same store results under the heading “Conventional Same Store Property Operating Results”). Additionally, there was a $6.6 million decrease related to net casualty losses and other costs primarily resulting from hurricanes and tropical storms in the third quarter of 2004, which damaged over 100 of our properties and $4.0 million in higher property management expenses. These decreases were offset by an $18.2 million increase related to operations of newly consolidated properties, which are properties that had been previously unconsolidated and accounted for by the equity method (42 properties first consolidated in 2004 and 12 properties that were first consolidated after the first quarter of 2003) and a $16.0 million increase related to operations of acquisition properties, which were principally comprised of The Palazzo at Park La Brea and 10 other properties purchased in 2004, and three properties purchased in 2003.
Conventional Same Store Property Operating Results
Same store operating results is a key indicator we use to assess the performance of our property operations and to understand the period over period operations of a consistent portfolio of properties. We define “same store” properties as conventional properties (i) that we manage, (ii) in which our ownership interest exceeds 10%, (iii) the operations of which have been stabilized for all periods presented and (iv) that have not been classified as held for sale. To ensure comparability, the information for all periods shown is based on our ownership in the most current period presented in each table. The following tables summarize the conventional rental property operations on a “same store” basis (which is not in accordance with generally accepted accounting principles, or GAAP) and reconcile them to consolidated rental property operations (which is in accordance with GAAP) described in the above comparative discussions (dollars in thousands):
(1)
Includes: (i) minority partners’ share of consolidated, less our share of unconsolidated, property revenues and property operating expenses (at 2005 ownership); (ii) property revenues and property operating expenses related to consolidated properties other than same store properties (e.g., affordable, acquisition and redevelopment properties); and (iii) eliminations and other adjustments and reclassifications made in accordance with GAAP.
For the year ended December 31, 2005, compared to the year ended December 31, 2004, our share of same store net operating income increased $32.8 million, or 6.3%. Revenues increased $57.7 million, or 6.1%, primarily due to higher occupancy (up 2.9%), higher average rent (up $16 per unit) and lower bad debt. Expenses increased by $24.9 million, or 6.0%, primarily due to: an increase of $9.1 million in compensation expense related to increased staffing levels to support our initiatives to improve customer service; a $7.2 million increase in utilities due primarily to higher natural gas rates; a $5.5 million increase in real estate taxes; and $2.4 million of increases primarily related to turnover expenses associated with our efforts to increase occupancy.
(1)
Includes: (i) minority partners’ share of consolidated, less our share of unconsolidated, property revenues and property operating expenses (at 2004 ownership); (ii) property revenues and property operating expenses related to consolidated properties other than same store properties (e.g., affordable, acquisition and redevelopment properties); and (iii) eliminations and other adjustments and reclassifications made in accordance with GAAP.
For the year ended December 31, 2004, compared to the year ended December 31, 2003, our share of same store net operating income decreased $30.4 million, or 5.1%. Revenues decreased $6.2 million, or 0.6%, primarily due to lower occupancy (down 1.6%), offset by higher utility reimbursements from residents and lower bad debt expense. Expenses increased by $24.1 million, or 5.8%, primarily due to: an increase of $20.0 million in compensation and benefit expense related to a new employee health plan, merit increases and increased staffing levels; an increase of $4.3 million in utilities due to the increase in the cost of natural gas; and an increase of $3.9 million in marketing and administrative expenses associated with our efforts to increase occupancy. These increases were partially offset by a decrease in property taxes related to successful appeals and changes in estimates related to assessments.
Property Management
We earn income from property management primarily from certain unconsolidated real estate partnerships for which we are the general partner. The income is primarily in the form of fees generated through property management and other associated activities. Reported revenue from property management decreases as we consolidate real estate partnerships because it is eliminated in consolidation. We expect this trend to continue as we increase our ownership in more of these partnerships or otherwise determine that consolidation is required by GAAP. Additionally, our revenue decreases as properties within our unconsolidated real estate partnerships are sold. Offsetting the revenue earned in property management are the direct expenses associated with property management.
The following table summarizes the overall performance of our property management business for the years ended December 31, 2005, 2004 and 2003 (in thousands):
For the year ended December 31, 2005, compared to the year ended December 31, 2004, net operating income from property management decreased by $5.4 million, or 24.0%. For the year ended December 31, 2004, compared to the year ended December 31, 2003, net operating income from property management decreased by $6.9 million, or 23.3%. In both periods the decreases were principally due to an increase in the number of consolidated real estate partnerships (resulting from increased ownership and GAAP consolidation requirements), which required elimination of fee income and associated property-operating expense related to such partnerships and the sales of properties within our unconsolidated partnerships (35 properties in 2005, 53 properties in 2004 and 37 properties in 2003) that had previously generated property management revenues.
Activity Fees and Asset Management
Activity fees are generated from transactional activity including tax credit syndications and redevelopments, dispositions, and refinancings. These transactions occur on varying timetables, thus the income varies from period to period. The majority of these fees are earned in connection with transactions related to affordable properties within the Aimco Capital portfolio. We have a large number of affiliated real estate partnerships for which we have identified a pipeline of transactional opportunities. As a result, we view activity fees as a predictable part of our core business strategy. Asset management revenue is from the financial management of partnerships, rather than management of day-to-day property operations. Asset management revenue includes deferred asset management fees that are recognized once a transaction or improvement in operations has occurred thereby generating available cash. Activity and asset management expenses are the direct expenses associated with transactional activities and asset management.
The following table summarizes the operating results of our transactional and asset management activities for the years ended December 31, 2005, 2004 and 2003 (in thousands):
Included in the activity fees and asset management revenues, primarily from affiliates for the years ended December 31, 2005, 2004 and 2003, were $33.3 million, $30.3 million and $18.9 million, respectively, of fees related to affordable properties within the Aimco Capital portfolio.
For the year ended December 31, 2005, compared to the year ended December 31, 2004, net operating income from activity fees and asset management increased $3.7 million, or 16.3%. This overall increase was principally a result of increased activity fees related to syndication and developer activities of $6.0 million and $3.7 million, respectively, as well as a $1.2 million decrease in expenses associated with these activities. Additionally, we received $3.1 million in promote distributions from an unconsolidated partnership, as a result of us, as general partner, achieving financial returns to the limited partners in excess of established targets. These increases were offset by a $5.2 million decrease in asset management fees and decreases of $3.3 million and $1.9 million in activity fees related to disposition and refinancing activities, respectively.
For the year ended December 31, 2004, compared to the year ended December 31, 2003, net operating income from activity fees and asset management increased by $11.2 million, or 94.4%. This overall increase was principally a result of increased activity fees related to disposition, refinancing and developer activities of $7.3 million, $2.3 million and $3.0 million, respectively, due to a greater number of transactions in 2004 than in 2003. Additionally, there was an increase of $2.9 million related to the recognition of deferred asset management fees resulting from closed transactions and improved operations. These increases were offset by a $2.1 million decrease in syndication fees and $3.4 million in higher expenses associated with these activities.
Depreciation and Amortization
For the year ended December 31, 2005, compared to the year ended December 31, 2004, depreciation and amortization increased $71.5 million, or 21.0%. This increase was principally due to: $34.6 million of additional depreciation on certain real estate assets where the depreciation was adjusted prospectively (see Impairment of Long-Lived Assets in Note 2 of the consolidated financial statements in Item 8); $13.8 million and $8.3 million of
additional depreciation related to newly consolidated and acquisition properties, respectively; and $11.0 million from the completion of certain redevelopment properties. Additionally, $4.3 million of the increase was due to a change in estimated useful lives that apply to capitalized payroll and certain indirect costs (see Capital Expenditures and Related Depreciation in Note 2 of the consolidated financial statements in Item 8).
For the year ended December 31, 2004, compared to the year ended December 31, 2003, depreciation and amortization increased $32.5 million, or 10.5%. This increase was principally due to $8.5 million and $7.2 million of additional depreciation related to the newly consolidated and acquisition properties, respectively, as well as $9.9 million from the completion of certain redevelopment properties. Additionally, $5.9 million of the increase resulted from additional depreciation on certain real estate assets where the depreciation was adjusted prospectively (see Impairment of Long-Lived Assets in Note 2 of the consolidated financial statements in Item 8).
General and Administrative Expenses
For the year ended December 31, 2005, compared to the year ended December 31, 2004, general and administrative expenses increased $15.4 million, or 19.9%. This increase was principally due to $14.1 million in higher compensation related to increased staffing levels, increased health care costs, and transition costs associated with the chief financial and chief accounting officer positions. Additionally, at the end of 2005 there was $0.6 million in severance costs related to the restructuring of regional operating centers as a result of property dispositions.
For the year ended December 31, 2004, compared to the year ended December 31, 2003, general and administrative expenses increased $29.1 million, or 60.3%. This increase was principally due to: $15.5 million in higher compensation related to increased staffing levels, merit increases and variable compensation; $7.7 million related to increased health insurance costs and the effect of a favorable change in 2003 related to our accrual for insurance claims incurred but not reported (IBNR); $3.2 million in increased amortization of restricted stock and stock option compensation; and $3.1 million in legal costs and compliance costs primarily related to the internal control reporting requirements of Section 404 of the Sarbanes-Oxley Act of 2002.
Other Expenses (Income), Net
Other expenses (income), net includes income tax provision/benefit, franchise taxes, risk management activities related to our unconsolidated partnerships and partnership expenses.
For the year ended December 31, 2005 compared to the year ended December 31, 2004, other expenses (income), net changed $8.2 million from expense of $1.9 million in 2004 to income of $6.3 million in 2005. This change was principally due to an $11.4 million higher income tax benefit recognized in 2005 as compared to 2004, reflecting increased losses of our taxable REIT subsidiaries (see further discussion in Note 10 of the consolidated financial statements in Item 8). In the year ended December 31, 2005, there was a tax benefit of $18.6 million recorded, as compared to $7.2 million in the year ended December 31, 2004. Additionally, we had higher income associated with our risk management activities, primarily due to better workers compensation claim experience as a result of more focused loss prevention measures. These increases in other income were partially offset by $3.8 million of higher partnership expenses primarily related to increases in professional fees.
For the year ended December 31, 2004, compared to the year ended December 31, 2003, other expenses (income), net changed $8.9 million from income of $7.0 million in 2003 to expense of $1.9 million in 2004. This change was principally due to a $10.8 million lower income tax benefit recognized in 2004 as compared to 2003, due primarily to an $8.0 million benefit related to the reversal of a deferred income tax asset valuation allowance in 2003 (see further discussion in Note 10 of the consolidated financial statements in Item 8). In the year ended December 31, 2004, there was a tax benefit of $7.2 million recorded, as compared to $18.0 million in the year ended December 31, 2003.
Interest Income
Interest income consists primarily of interest and accretion on general partner notes receivable from our unconsolidated real estate partnerships. Transactions that result in accretion occur on varying timetables and thus the income generated may vary from period to period.
For the year ended December 31, 2005, as compared to the year ended December 31, 2004, interest income increased $2.7 million, or 8.1%. This increase was principally a result of $4.2 million of higher interest on money market and interest-bearing accounts due to increased interest rates and higher cash balances and $3.5 million in interest earned on notes due from Aimco primarily related to the $85.4 million note issued in connection with the
acquisition of Palazzo East at Park La Brea in January 2005. These increases were partially offset by lower accretion income.
For the year ended December 31, 2004, as compared to the year ended December 31, 2003, interest income increased $7.2 million, or 27.5%. This increase was principally a result of $5.0 million in higher interest due from general partner notes receivable, and $3.0 million in higher accretion income.
Interest Expense
For the year ended December 31, 2005, compared to the year ended December 31, 2004, interest expense, which includes the amortization of deferred financing costs, increased $25.8 million, or 7.5%. This increase was principally due to: $16.0 million and $5.0 million resulting from interest on the additional debt related to acquisition and newly consolidated properties, respectively; $17.7 million due to increased borrowings and increased interest rates on corporate and variable rate property debt and other items. These increases were partially offset by: $4.8 million in lower amortization of loan costs, primarily due to corporate debt restructuring in 2004; $8.5 million in higher capitalized interest due to increased redevelopment activity; and a $2.1 million decrease related to the redemption of mandatorily redeemable preferred securities in 2004 and early 2005.
For the year ended December 31, 2004, compared to the year ended December 31, 2003, interest expense increased $24.8 million, or 7.8%. This increase was principally due to: $9.9 million resulting from interest on the additional debt related to the newly consolidated properties; $9.6 million resulting from interest on the additional debt related to acquisition properties; and a $4.7 million decrease in capitalized interest due to redevelopment properties being placed in service. Additionally, an $8.8 million increase related to the credit facility and term loan (of which $1.8 million was associated with the write-off of deferred loan costs related to the November 2004 modification of the credit facility and term loan and $0.8 million related to the payoff of the indebtedness incurred to complete the acquisition of Casden Properties, Inc) due to higher average principal balances along with a higher weighted average interest rate. The November 2004 modification reduced the spread over LIBOR by an average of 1.25%, which has favorably impacted interest expense related to our revolving credit facility and $300 million term loan. These increases were partially offset by lower weighted average effective interest rates on mortgage debt due to refinancings that occurred in 2003 and 2004.
Deficit Distributions to Minority Partners
When real estate partnerships consolidated in our financial statements make cash distributions to partners in excess of the carrying amount of the minority interest, we record a charge equal to the amount of such distribution, even though there is no economic effect or cost.
For the year ended December 31, 2005, as compared to the year ended December 31, 2004, deficit distributions to minority partners decreased $5.9 million, or 33.1%. For the year ended December 31, 2004, as compared to the year ended December 31, 2003, deficit distributions to minority partners decreased $2.4 million, or 11.6%. The decrease in both periods was due to reduced levels of distributions being made by the consolidated real estate partnerships as a result of lower refinancing activity and decreased operating results, as well as our increased ownership of such partnerships.
Gain on Dispositions of Real Estate Related to Unconsolidated Entities and Other
Gain on dispositions of real estate related to unconsolidated entities and other includes our share of gain related to dispositions of real estate within our unconsolidated real estate partnerships, gain on dispositions of land and other non-depreciable assets and costs related to asset disposal activities.
For the year ended December 31, 2005, as compared to the year ended December 31, 2004, gain on dispositions of real estate related to unconsolidated entities and other decreased $52.8 million. For the year ended December 31, 2004, as compared to the year ended December 31, 2003, gain on dispositions of real estate related to unconsolidated entities and other increased $66.1 million. The change in both periods was principally due to a $34.6 million gain on the sale of a parcel of land located in Florida and a $17.4 million gain from the sale of one of our unconsolidated core properties, both of which occurred in 2004.
Changes in the level of gains recognized from period to period reflect the changing level of our disposition activity from period to period. Additionally, gains on properties sold are determined on an individual property basis or in the aggregate for a group of properties that are sold in a single transaction, and are not comparable period to period.
Minority Interest in Consolidated Real Estate Partnerships
Minority interest in consolidated real estate partnerships reflects minority partners’ share of operating results of consolidated real estate partnerships. This includes the minority partners’ share of property management fees, interest on notes and other amounts eliminated in consolidation that we charge to such partnerships. For the years ended December 31, 2005, 2004 and 2003, such minority interests had a favorable effect on our consolidated operating results.
For the year ended December 31, 2005, as compared to the year ended December 31, 2004, the benefit from minority interest in consolidated real estate partnerships decreased $10.3 million. For the year ended December 31, 2004, as compared to the year ended December 31, 2003, the benefit from minority interest in consolidated real estate partnerships increased $16.7 million. The change in both periods was driven by property operating results. During 2005 as compared to 2004 our property operating results improved, thereby reducing the benefit from minority interest. When comparing 2004 to 2003 our property operating results declined, thereby increasing the benefit from minority interest.
Income from Discontinued Operations, Net
For properties accounted for as held for sale, the results of operations for properties sold during the period or designated as held for sale at the end of the period are generally required to be classified as discontinued operations for all periods presented (see Note 2 of the consolidated financial statements in Item 8 for further policy information). 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, property-specific interest expense to the extent there is secured debt on the property and the associated minority interest. In addition, any impairment losses on assets held for sale, and the net gain on the eventual disposal of properties held for sale are reported as discontinued operations.
For the years ended December 31, 2005, 2004, and 2003, income from discontinued operations, net totaled $110.0 million, $239.0 million and $110.4 million, respectively, which includes a loss from operations of $2.0 million in 2005 and income from operations of $9.2 million and $21.4 million in 2004 and 2003, respectively. In 2005, the income from operations included the operating results of 91 properties and one partnership that were sold or classified as held for sale during 2005. In 2004 and 2003, the income from operations included the operating results of 145 properties and one partnership and 217 properties and one partnership, respectively, that were sold or classified as held for sale in 2003, 2004 and 2005. Due to varying number of properties and the timing of sales, the income from operations is not comparable year to year.
During 2005, we sold 83 properties and one partnership, resulting in a net gain on sale of approximately $100.9 million (which is net of $4.5 million of related income taxes). Additionally, we recognized $3.8 million in impairment losses on assets sold or held for sale in 2005 and $14.9 million of net recoveries of deficit distributions to minority partners. During 2004, we sold 54 properties, resulting in a net gain on sale of approximately $233.4 million (which is net of $16.0 million of related income taxes). Additionally, we recognized $7.3 million in impairment losses on assets sold or held for sale in 2004 and $3.7 million of net recoveries of deficit distributions to minority partners. During 2003, we sold 72 properties, resulting in a net gain on sale of approximately $89.7 million (which is net of $12.1 million of related taxes). Additionally, we recognized $9.0 million in impairment losses on assets sold or held for sale in 2003 and $8.3 million of net recoveries of deficit distributions to minority partners.
Changes in the level of gains recognized from period to period reflect the changing level of our disposition activity from period to period. Additionally, gains on properties sold are determined on an individual property basis or in the aggregate for a group of properties that are sold in a single transaction, and are not comparable period to period. See Note 14 of the consolidated financial statements in Item 8 for more details on discontinued operations.
Cumulative Effect of Change in Accounting Principle
On March 31, 2004, we recorded a $4.0 million cumulative effect of change in accounting principle related to the adoption of FIN 46. This charge is attributable to our recognition of cumulative losses allocable to minority interest that would otherwise have resulted in minority interest deficits. See Note 2 of the consolidated financial statements in Item 8 for further information.
Critical Accounting Policies and Estimates
We prepare our consolidated financial statements in accordance with GAAP, which requires us to make estimates and assumptions. We believe that the following critical accounting policies involve our more significant judgments and estimates used in the preparation of our consolidated financial statements.
Impairment of Long-Lived Assets
Real estate and other long-lived assets to be held and used are stated at cost, less accumulated depreciation and amortization, unless the carrying amount of the asset is not recoverable. If events or circumstances indicate that the carrying amount of a property may not be recoverable, we make an assessment of its recoverability by comparing the carrying amount to our estimate of the undiscounted future cash flows, excluding interest charges, of the property. If the carrying amount exceeds the aggregate undiscounted future cash flows, we recognize an impairment loss to the extent the carrying amount exceeds the estimated fair value of the property.
Real estate investments are subject to varying degrees of risk. Several factors may adversely affect the economic performance and value of our real estate investments. These factors include:
•
the general economic climate;
•
competition from other apartment communities and other housing options;
•
local conditions, such as loss of jobs or an increase in the supply of apartments, that might adversely affect apartment occupancy or rental rates;
•
changes in governmental regulations and the related cost of compliance;
•
increases in operating costs (including real estate taxes) due to inflation and other factors, which may not be offset by increased rents;
•
changes in tax laws and housing laws, including the enactment of rent control laws or other laws regulating multifamily housing;
•
changes in market capitalization rates; and
•
the relative illiquidity of such investments.
Any adverse changes in these and other factors could cause an impairment in our long-lived assets, including real estate and investments in unconsolidated real estate partnerships. Based on periodic tests of recoverability of long-lived assets, for the year ended December 31, 2005, we recorded impairment losses of $3.4 million related to properties to be held and used. For the years ended December 31, 2004 and 2003, we determined that the carrying amount for our properties to be held and used was recoverable and, therefore, we did not record any impairment losses related to such properties.
Notes Receivable and Interest Income Recognition
Notes receivable from unconsolidated real estate partnerships consist primarily of notes receivable from partnerships in which we are the general partner. The ultimate repayment of these notes is subject to a number of variables, including the performance and value of the underlying real estate property and the claims of unaffiliated mortgage lenders. Our notes receivable include loans extended by us that we carry at the face amount plus accrued interest, which we refer to as “par value notes,” and loans extended by predecessors whose positions we generally acquired at a discount, which we refer to as “discounted notes.”
We record interest income on par value notes as earned in accordance with the terms of the related loan agreements. We discontinue the accrual of interest on such notes when the notes are impaired, as discussed below, or when there is otherwise significant uncertainty as to the collection of interest. We record income on such nonaccrual loans using the cost recovery method, under which we apply cash receipts first to the recorded amount of the loan; thereafter, any additional receipts are recognized as income.
We recognize interest income on discounted notes receivable based upon whether the amount and timing of collections are both probable and reasonably estimable. We consider collections to be probable and reasonably estimable when the borrower has entered into certain closed or pending transactions (which include real estate sales, refinancings, foreclosures and rights offerings) that provide a reliable source of repayment. In such instances, we recognize accretion income, on a prospective basis using the effective interest method over the estimated remaining term of the loans, equal to the difference between the carrying amount of the discounted notes and the estimated collectible value. We record income on all other discounted notes using the cost recovery method. For the year
ended December 31, 2005, if we had not been able to complete certain transactions, our accretion income would have been lower by $2.5 million. Accretion income recognized in any given period is based on our ability to complete transactions to monetize the notes receivable and the difference between the carrying value and the estimated collectible value of the notes; therefore, accretion income varies on a period by period basis and could be lower or higher than in prior periods.
Allowance for Losses on Notes Receivable
We assess the collectibility of notes receivable on a periodic basis, which assessment consists primarily of an evaluation of cash flow projections of the borrower to determine whether estimated cash flows are sufficient to repay principal and interest in accordance with the contractual terms of the note. We recognize impairments on notes receivable when it is probable that principal and interest will not be received in accordance with the contractual terms of the loan. The amount of the impairment to be recognized generally is based on the fair value of the partnership’s real estate that represents the primary source of loan repayment. In certain instances where other sources of cash flow are available to repay the loan, the impairment is measured by discounting the estimated cash flows at the loan’s original effective interest rate.
During the years ended December 31, 2005 and 2004, we recorded $1.4 million and $1.8 million in net recovery of impairment losses on notes receivable. During the year ended December 31, 2003, we identified and recorded $2.2 million in net impairment losses on notes receivable. We will continue to evaluate the collectibility of these notes, and we will adjust related allowances in the future due to changes in market conditions and other factors.
Capitalized Costs
We capitalize costs, including certain indirect costs, incurred in connection with our capital expenditure activities, including redevelopment and construction projects, other tangible property improvements, and replacements of existing property components. Included in these capitalized costs are payroll costs associated with time spent by site employees in connection with the planning, execution and control of all capital expenditure activities at the property level. We characterize as “indirect costs” an allocation of certain department costs, including payroll, at the regional operating center and corporate levels that clearly relate to capital expenditure activities. We capitalize interest, property taxes and insurance during periods in which redevelopment and construction projects are in progress. Costs incurred in connection with capital expenditure activities are capitalized where the costs of the improvements or replacements exceed $250. We charge to expense as incurred costs that do not relate to capital expenditure activities, including ordinary repairs, maintenance, resident turnover costs and general and administrative expenses. See Note 2 - Capital Expenditures and Related Depreciation of the consolidated financial statements in Item 8 for further policy information.
For the years ended December 31, 2005, 2004 and 2003, for continuing and discontinued operations, we capitalized $18.1 million, $9.5 million and $14.5 million of interest costs, respectively, and $53.3 million, $46.7 million and $45.4 million of site payroll and indirect costs, respectively.
Funds From Operations
Funds From Operations, or FFO, is a non-GAAP financial measure that we believe, when considered with the financial statements determined in accordance with GAAP, is helpful to investors in understanding our performance because it captures features particular to real estate performance by recognizing that real estate generally appreciates over time or maintains residual value to a much greater extent than do other depreciable assets such as machinery, computers or other personal property. The Board of Governors of the National Association of Real Estate Investment Trusts, or NAREIT, defines FFO as net income (loss), computed in accordance with GAAP, excluding gains from sales of depreciable property, plus depreciation and amortization, and after adjustments for unconsolidated partnerships and joint ventures. Adjustments for unconsolidated partnerships and joint ventures are calculated to reflect FFO on the same basis. We compute FFO for all periods presented in accordance with the guidance set forth by NAREIT’s April 1, 2002 White Paper, which we refer to as the White Paper. We calculate FFO (diluted) by subtracting redemption related preferred OP Unit issuance costs and distributions on preferred OP Units and adding back distributions on dilutive preferred securities and interest expense on dilutive mandatorily redeemable convertible preferred securities. FFO should not be considered an alternative to net income or net cash flows from operating activities, as determined in accordance with GAAP, as an indication of our performance or as a measure of liquidity. FFO is not necessarily indicative of cash available to fund future cash needs. In addition, although FFO is a measure used for comparability in assessing the performance of real estate investment trusts, there can be no assurance that our basis for computing FFO is comparable with that of other real estate investment trusts.
For the years ended December 31, 2005, 2004 and 2003, our FFO is calculated as follows (in thousands):
Notes:
(1)
Represents the numerator for earnings per common unit, calculated in accordance with GAAP.
(2)
Includes amortization of management contracts where we are the general partner. Such management contracts were established in certain instances where we acquired a general partner interest in either a consolidated or an unconsolidated partnership. Because the recoverability of these management contracts depends primarily on the operations of the real estate owned by the limited partnerships, we believe it is consistent with the White Paper to add
back such amortization, as the White Paper directs the add-back of amortization of assets uniquely significant to the real estate industry.
(3)
“Minority partners’ interest,” means minority interest in our consolidated real estate partnerships.
(4)
In accordance with GAAP, deficit distributions to minority partners are charges recognized in our income statement when cash is distributed to a non-controlling partner in a consolidated real estate partnership in excess of the positive balance in such partner’s capital account, which is classified as minority interest on our balance sheet. We record these charges for GAAP purposes even though there is no economic effect or cost. Deficit distributions to minority partners occur when the fair value of the underlying real estate exceeds its depreciated net book value because the underlying real estate has appreciated or maintained its value. As a result, the recognition of expense for deficit distributions to minority partners represents, in substance, either (a) our recognition of depreciation previously allocated to the non-controlling partner or (b) a payment related to the non-controlling partner’s share of real estate appreciation. Based on White Paper guidance that requires real estate depreciation and gains to be excluded from FFO, we add back deficit distributions and subtract related recoveries in our reconciliation of net income to FFO.
(5)
Represents the denominator for earnings per common unit - diluted, calculated in accordance with GAAP, plus additional common unit equivalents that are dilutive for FFO.
Liquidity and Capital Resources
Liquidity is the ability to meet present and future financial obligations either through the sale or maturity of existing assets or by the acquisition of additional funds through working capital management. Both the coordination of asset and liability maturities and effective working capital management are important to the maintenance of liquidity. Our primary source of liquidity is cash flow from our operations. Additional sources are proceeds from property sales and proceeds from refinancings of existing mortgage loans and borrowings under new mortgage loans.
Our principal uses for liquidity include normal operating activities, payments of principal and interest on outstanding debt, capital expenditures, distributions paid to unitholders and distributions paid to partners, and acquisitions of, and investments in, properties. We use our cash provided by operating activities to meet short-term liquidity needs. In the event that the cash provided by operating activities is not sufficient to cover our short-term liquidity demands, we have additional means, such as short-term borrowing availability and proceeds from property sales and refinancings, to help us meet our short-term liquidity demands. We use our revolving credit facility for general corporate purposes and to fund investments on an interim basis. We expect to meet our long-term liquidity requirements, such as debt maturities and property acquisitions, through long-term borrowings, both secured and unsecured, the issuance of debt or equity securities (including OP Units), the sale of properties and cash generated from operations.
At December 31, 2005, we had $161.7 million in cash and cash equivalents, an increase of $56.4 million from December 31, 2004, which cash is principally from sales and refinancing transactions that has yet to be distributed or applied to the outstanding balance of the revolving credit facility (see Note 8 to the consolidated financial statements in Item 8). At December 31, 2005, we had $284.8 million of restricted cash, primarily consisting of reserves and escrows held by lenders for bond sinking funds, capital expenditures, property taxes and insurance. In addition, cash, cash equivalents and restricted cash are held by partnerships that are not presented on a consolidated basis. The following discussion relates to changes in cash due to operating, investing and financing activities, which are presented in our Consolidated Statements of Cash Flows in Item 8.
Operating Activities
For the year ended December 31, 2005, our net cash provided by operating activities of $359.3 million was primarily from operating income from our consolidated properties, which is affected primarily by rental rates, occupancy levels and operating expenses related to our portfolio of properties. Cash provided by operating activities decreased $6.2 million compared with the year ended December 31, 2004, driven by changes in operating assets and liabilities. The changes in operating assets and liabilities were primarily due to cash used to reduce current liabilities related to interest and real estate tax accruals, offset by decreases in accounts receivable related to improved collections, and decreases in prepaid expense and restricted cash balances.
Investing Activities
For the year ended December 31, 2005, our net cash provided by investing activities of $36.4 million primarily resulted from proceeds received from sales of properties, partially offset by investments in our existing real estate assets through capital spending as well as the acquisition of Palazzo East at Park La Brea and five other properties (see Note 3 to the consolidated financial statements in Item 8 for further information on acquisitions).
Although we hold all of our properties for investment, we sell properties when they do not meet our investment criteria or are located in areas that we believe do not justify our continued investment when compared to alternative uses for our capital. During the year ended December 31, 2005, we sold 83 consolidated properties and 35 unconsolidated properties. These properties were sold for an aggregate sales price of $960.0 million, of which $764.0 million related to the consolidated properties. The sale of the consolidated properties generated proceeds totaling $718.4 million, after the payment of transaction costs. Our share of the total net proceeds from the sale of the 118 properties, after repayment of existing debt, payment of transaction costs and distributions to limited partners, was $331.8 million, of which $36.4 million related to the unconsolidated properties and was included in our distributions received from investments in unconsolidated real estate partnerships. Sales proceeds were used to repay a portion of our outstanding short-term indebtedness and for other corporate purposes.
We are currently marketing for sale certain properties that are inconsistent with our long-term investment strategy. Additionally, from time to time, we may market certain properties that are consistent with our long-term investment strategy but offer attractive returns, such as sales to buyers who intend to convert the properties to condominiums. Gross sales proceeds from 2006 dispositions are expected to be $750 million to $950 million, and we plan to use our share of the net proceeds from such dispositions to reduce debt, fund capital expenditures on existing assets, fund property and partnership acquisitions, redeem preferred securities and for other operating needs and corporate purposes.
Capital Expenditures
We classify all capital spending as Capital Replacements (which we refer to as CR), Capital Improvements (which we refer to as CI), casualties or redevelopment. Non-redevelopment and non-casualty capitalizable expenditures are apportioned between CR and CI based on the useful life of the capital item under consideration and the period we have owned the property (i.e., the portion that was consumed during our ownership of the item represents CR; the portion of the item that was consumed prior to our ownership represents CI).
For the year ended December 31, 2005, we spent a total of $89.7 million on CR. These are expenditures that represent the share of expenditures that are deemed to replace the consumed portion of acquired capital assets. For the year ended December 31, 2005, we spent a total of $112.0 million, $23.9 million and $140.3 million, respectively, on CI, casualties and redevelopment. CI expenditures represent all non-redevelopment and non-casualty capital expenditures that are made to enhance the value, profitability or useful life of an asset from its original purchase condition. Casualty expenditures represent capitalized costs incurred in connection with casualty losses and are associated with the restoration of the asset. A portion of the restoration costs may be reimbursed by insurance carriers subject to deductibles associated with each loss. Redevelopment expenditures represent expenditures that substantially upgrade the property.
The table below details our share of actual spending, on both consolidated and unconsolidated real estate partnerships, for CR, CI, casualties and redevelopment for the year ended December 31, 2005 on a per unit and total dollar basis (based on approximately 150,200 ownership equivalent units (excluding non-managed units) weighted for the portion of the period that we owned the property), and reconciles it to our Consolidated Statement of Cash Flows for the same period (in thousands, except per unit amounts).
Included in the above spending for CI, casualties and redevelopment, was approximately $33.2 million of our share of capitalized site payroll and indirect costs related to these activities for the year ended December 31, 2005.
We funded all of the above capital expenditures with cash provided by operating activities, working capital, property sales and borrowings under the revolving credit facility.
Financing Activities
For the year ended December 31, 2005, net cash used in financing activities of $339.3 million primarily related to payments on our secured notes payable, payment of our distributions, and redemptions of the Class D Partnership Preferred Units and Trust Based Convertible Preferred Securities, which we refer to as TOPRS, partially offset by proceeds from borrowings.
Mortgage Debt
At December 31, 2005 and 2004, we had $5.7 billion in consolidated mortgage debt outstanding, which included $33.7 million and $419.8 million, respectively, of mortgage debt classified within liabilities related to assets held for sale. During the year ended December 31, 2005, we refinanced or closed mortgage loans on 68 consolidated properties generating $591.1 million of proceeds from borrowings with a weighted average interest rate of 5.02%. Our share of the net proceeds after repayment of existing debt, payment of transaction costs and distributions to limited partners, was $254.1 million. In addition, we closed mortgage loans on 15 unconsolidated properties, with a weighted average interest rate of 4.95%. Our share of the net proceeds from these 15 mortgage loans totaled $26.4 million. We used our total net proceeds from all loans closed of $280.5 million for corporate purposes. We intend to continue to refinance mortgage debt to generate proceeds in amounts exceeding our scheduled amortizations and maturities.
During the year ended December 31, 2005, we closed five mortgage loans totaling $130.3 million, with an initial weighted average interest rate of 3.27%, to finance our consolidated acquisitions.
Revolving Credit Facility and Term Loans
We have an Amended and Restated Senior Secured Credit Agreement with a syndicate of financial institutions, which we refer to as the Credit Agreement. On June 16, 2005, we amended our Credit Agreement, to provide for $100.0 million in additional term loan borrowings. The additional term loan matures on November 2, 2009 and bears interest at a rate of either LIBOR plus 1.75% or a base rate (determined by reference to the federal funds rate or Bank of America’s prime rate) plus 0.25%. The proceeds from the additional term loan were used to repay outstanding revolving loans.
The aggregate amount of commitments and loans under the Credit Agreement is $850.0 million, comprised of $450.0 million of revolving loan commitments and $400.0 million in term loans. The term loans mature on November 2, 2009 and the revolving loans mature on November 2, 2007. At December 31, 2005, the term loans had an outstanding principal balance of $400.0 million and a weighted average interest rate of 6.18% (based on LIBOR plus 2.00% for the original $300.0 million and LIBOR plus 1.75% for the additional $100.0 million). At December 31, 2005, the revolving loans had an outstanding principal balance of $217.0 million and a weighted average interest rate of 6.26% (based on various weighted average LIBOR and base rate borrowings outstanding with various maturities). The amount available under the revolving credit facility at December 31, 2005 was $208.3 million (after giving effect to $24.7 million outstanding for undrawn letters of credit issued under the revolving credit facility). The proceeds of revolving loans are generally permitted to be used to fund working capital and for other corporate purposes. For more information, see Note 8 of the consolidated financial statements in Item 8.
Partners’ Capital Transactions
During the year ended December 31, 2005, Aimco redeemed all outstanding shares of Class D Cumulative Preferred Stock for $31.3 million. Concurrently, we redeemed for cash all outstanding Class D Partnership Preferred Units.
As of December 31, 2005, under the shelf registration statement, which was declared effective in April 2004, we had approximately $500 million of debt securities available and Aimco had approximately $877 million of debt and equity securities available. From time to time Aimco may issue preferred securities in both public offerings and private placements to generate proceeds to be used to redeem higher cost preferred securities, to finance acquisitions of real estate interests and for other corporate purposes.
Aimco’s board of directors has, from time to time authorized Aimco to repurchase shares of Aimco Class A Common Stock and preferred stock. In April 2005, Aimco’s board of directors replaced the existing authorization with a new authorization to repurchase up to a total of eight million shares of Aimco Class A Common Stock. These repurchases may be made from time to time in the open market or in privately negotiated transactions, subject to applicable law. In the event of any repurchase of a number of shares of Class A Common Stock by Aimco, we would repurchase an equal number of common OP Units owned by Aimco.
Contractual Obligations
This table summarizes information contained elsewhere in this Annual Report regarding payments due under contractual obligations and commitments as of December 31, 2005 (amounts in thousands):
(1)
The development fee payments above were established in connection with the acquisition of Casden Properties, Inc and our commitment as it relates to the Casden Development Company, LLC. We agreed to pay $2.5 million per quarter for five years (up to an aggregate amount of $50.0 million) to Casden Development Company, LLC as a retainer on account for redevelopment services on our assets.
In addition, we may enter into commitments to purchase goods and services in connection with the operations of our properties. Those commitments generally have terms of one year or less and reflect expenditure levels comparable to our historical expenditures.
Future Capital Needs
In addition to the items set forth in “Contractual Obligations” above, we expect to fund any future acquisitions, additional redevelopment projects and capital improvements principally with proceeds from property sales (including tax-free exchange proceeds), short-term borrowings, debt and equity financings and operating cash flows.
In 2006, we plan to invest between $150 and $200 million in conventional redevelopment projects that will impact approximately 70 properties with nearly 30,000 units. Additionally, in 2006 redevelopment expenditures on affordable properties will be approximately $80 million, predominantly funded by third-party tax credit equity, impacting 20 to 25 properties with more than 3,000 units.
Off-Balance Sheet Arrangements
We own general and limited partner interests in unconsolidated real estate partnerships, in which our total ownership interests range typically from less than 1% up to 50%. However, based on the provisions of the relevant partnership agreements, we are not deemed to have control of these partnerships sufficient to require or permit consolidation for accounting purposes (see Note 2 of the consolidated financial statements in Item 8). There are no lines of credit, side agreements, or any other derivative financial instruments related to or between our unconsolidated real estate partnerships and us and no material exposure to financial guarantees. Accordingly, our maximum risk of loss related to these unconsolidated real estate partnerships is limited to the aggregate carrying amount of our investment in the unconsolidated real estate partnerships and any outstanding notes receivable as reported in our consolidated financial statements. See Note 4 of the consolidated financial statements in Item 8 for additional information on our unconsolidated real estate partnerships.
ITEM 7A.
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk
Our primary market risk exposure relates to changes in interest rates. We are not subject to any foreign currency exchange rate risk or commodity price risk, or any other material market rate or price risks. We use predominantly long-term, fixed-rate non-recourse mortgage debt in order to avoid the refunding and repricing risks of short-term borrowings. We use short-term debt financing and working capital primarily to fund short-term uses and acquisitions and generally expect to refinance such borrowings with cash from operating activities, property sales proceeds, long-term debt or equity financings.
We had $2,010.6 million of floating rate debt outstanding at December 31, 2005 including debt classified within liabilities related to assets held for sale. Of the total floating rate debt, the major components were floating rate tax-exempt bond financing ($726.1 million), floating rate secured notes ($667.5 million), revolving loans ($217.0 million), and term loans ($400.0 million). Historically, changes in tax-exempt interest rates have been at a ratio of less than 1:1 with changes in taxable interest rates. Floating rate tax-exempt bond financing is benchmarked against the BMA Index, which since 1981 has averaged 68.0% of 30-day LIBOR. If this relationship continues, an increase in the 30-day LIBOR, of 1% (0.68% in tax-exempt interest rates) would result in our income before minority interests and cash flows being reduced by $17.8 million on an annual basis. This would be offset by variable rate interest income earned on certain assets, including cash and cash equivalents and notes receivable, as well as interest that is capitalized on a portion of this variable rate debt incurred in connection with our redevelopment activities. Considering these offsets, the same increase in the 30-day LIBOR would result in our income before minority interests being reduced by $8.9 million on an annual basis. Comparatively, if the 30-day LIBOR had increased by 1% in 2004, our income before minority interests would have been reduced by $6.0 million on an annual basis. The potential reduction of income before minority interest was greater in 2005 as compared to 2004 primarily due to higher floating rate balances resulting from additional borrowings, primarily related to the additional $100 million term loan, revolving loans and secured notes.
We believe that the fair value of our floating rate secured tax-exempt bond debt and floating rate secured long-term debt as of December 31, 2005 approximate their carrying values. The fair value for our fixed-rate debt agreements was estimated based on the market rate for debt with the same or similar terms. The combined carrying amount of our fixed-rate secured tax-exempt bonds and fixed-rate secured notes payable at December 31, 2005 was $4.3 billion compared to the estimated fair value of $4.4 billion (see Note 2 to the consolidated financial statements in Item 8). If market rates for our fixed-rate debt were higher by 1%, the estimated fair value of our fixed-rate debt would have decreased from $4.4 billion to $4.1 billion. If market rates for our fixed-rate debt were lower by 1%, the estimated fair value of our fixed-rate debt would have increased from $4.4 billion to $4.8 billion.
Item 8.
Item 8. Financial Statements and Supplementary Data
The independent registered public accounting firm’s report, consolidated financial statements and schedule listed in the accompanying index are filed as part of this report and incorporated herein by this reference. See “Index to Financial Statements” on page of this Annual Report.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
None.
Item 9A.
Item 9A. Controls and Procedures
Disclosure Controls and Procedures
The Partnership’s management, with the participation of the chief executive officer and chief financial officer of the General Partner, who are the equivalent of the Partnership’s chief executive officer and chief financial officer, respectively, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on such evaluation, the chief executive officer and chief financial officer of the General Partner, have concluded that, as of the end of such period, our disclosure controls and procedures are adequate.
Management’s Report on Internal Control Over Financial Reporting
Management of the Partnership is responsible for establishing and maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act as a process designed by, or under the supervision of, the General Partner’s principal executive and principal financial officers, or persons performing similar functions, and effected by the General Partner’s board of directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles and includes those policies and procedures that:
•
pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of the Partnership;
•
provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the Partnership; and
•
provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Partnership’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Projections of any evaluation of effectiveness to future periods are subject to the risks that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of the Partnership’s internal control over financial reporting as of December 31, 2005. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework.
Based on the assessment, management concluded that, as of December 31, 2005, the Partnership’s internal control over financial reporting is effective.
The Partnership’s independent registered public accounting firm has issued an audit report on our assessment of the Partnership’s internal control over financial reporting.
Changes in Internal Control over Financial Reporting
There have been no significant changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f)) under the Exchange Act) during fourth quarter 2005 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Report of Independent Registered Public Accounting Firm
The Partners of AIMCO Properties, L.P.
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that AIMCO Properties, L.P. (the “Partnership”) maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). The Partnership’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Partnership’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that AIMCO Properties, L.P. maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, AIMCO Properties, L.P. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of AIMCO Properties, L.P. as of December 31, 2005 and 2004, and the related consolidated statements of income, partners’ capital, and cash flows for each of the three years in the period ended December 31, 2005, and our report dated March 6, 2006 expressed an unqualified opinion thereon.
/s/ Ernst & Young LLP
Denver, Colorado
March 6, 2006
Item 9B.
Item 9B. Other Information
None.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
All of the executive officers of our General Partner also serve as executive officers of Aimco. Accordingly, the information below reflects the directors of our General Partner and the executive officers of both our General Partner and Aimco. The officers of Aimco and the General Partner are elected annually by their respective Board of Directors.
The following is a biographical summary for the past five years or more of the current directors and executive officers of the Company.
Terry Considine. Mr. Considine has been Chairman of the Board and Chief Executive Officer since July 1994. Mr. Considine also serves as Chairman and Chief Executive Officer of American Land Lease, Inc., another publicly held real estate investment trust. Mr. Considine devotes substantially all of his time to his responsibilities at Aimco.
Jeffrey W. Adler. Mr. Adler was appointed Executive Vice President - Conventional Property Operations in February 2004. Previously he served as Senior Vice President of Risk Management of Aimco from January 2002 until November 2002, when he added the responsibility of Senior Vice President, Marketing. Prior to joining Aimco, from 2000 to 2002, Mr. Adler was Vice President, Property/Casualty for Channelpoint, a software company.
Harry G. Alcock. Mr. Alcock was appointed Executive Vice President and Chief Investment Officer in October 1999. Mr. Alcock has had responsibility for acquisition and financing activities of the Company since July 1994, serving as a Vice President from July 1996 to October 1997 and as a Senior Vice President from October 1997 to October 1999.
Timothy J. Beaudin. Mr. Beaudin was appointed Executive Vice President and Chief Development Officer in October 2005. Prior to joining Aimco and beginning in 1995, Mr. Beaudin was with Catellus Development Corporation, a San Francisco, California-based real estate investment trust. During his last five years at Catellus, Mr. Beaudin served as served as executive vice president, with management responsibility for development, construction and asset management.
Miles Cortez. Mr. Cortez was appointed Executive Vice President, General Counsel and Secretary in August 2001. Prior to joining the Company, Mr. Cortez was the senior partner of Cortez Macaulay Bernhardt & Schuetze LLC, a Denver law firm, from December 1997 through September 2001. He served
as president of the Colorado Bar Association from 1996 to 1997 and the Denver Bar Association from 1982 to 1983.
Randall J. Fein. Mr. Fein was appointed Executive Vice President in October 2003. He supports the conventional operations group with respect to Aimco’s student housing related portfolio, including its joint venture activities. From 1989 through 2003, Mr. Fein served as general partner of Income Apartment Investors L.P., and Texas First Properties L.P., which operated student and non-student housing.
Patti K. Fielding. Ms. Fielding was appointed Executive Vice President - Securities and Debt in February 2003 and Treasurer in January 2005. She is responsible for debt financing and the treasury department. From January 2000 to February 2003, Ms. Fielding served as Senior Vice President - Securities and Debt. Ms. Fielding joined the Company as a Vice President in February 1997.
Lance J. Graber. Mr. Graber has been Executive Vice President since October 1999 and focuses on transactions related to Aimco Capital’s portfolio of affordable properties in the eastern portion of the country. Prior to joining the Company, Mr. Graber was a Director at Credit Suisse First Boston from 1994 to May 1999.
Thomas M. Herzog. Mr. Herzog was appointed Executive Vice President in July 2005 and Chief Financial Officer in November 2005. In January 2004 Mr. Herzog joined Aimco as Senior Vice President and Chief Accounting. Prior to joining Aimco, Mr. Herzog was at GE Real Estate, serving as Chief Accounting Officer & Global Controller from April 2002 to January 2004 and as Chief Technical Advisor from March 2000 to April 2002. Prior to joining GE Real Estate, Mr. Herzog was at Deloitte & Touche LLP from 1990 until 2000.
Paul J. McAuliffe. Mr. McAuliffe has been Executive Vice President since February 1999 and was appointed Chief Financial Officer in October 1999. Mr. McAuliffe stepped down as Chief Financial Officer in November 2005 and is currently serving in a senior advisory role supporting the Company in various capital markets activities. From May 1996 until he joined Aimco, Mr. McAuliffe was Senior Managing Director of Secured Capital Corp.
James G. Purvis. Mr. Purvis was appointed Executive Vice President - Human Resources in February 2003. Prior to joining Aimco, from October 2000 to February 2003, Mr. Purvis served as the Vice President of Human Resources at SomaLogic, Inc. a privately held biotechnology company in Boulder, Colorado. From July 1997 to October 2000, Mr. Purvis was the principal consultant for O(3)C Global Organization Solutions, a global human resources strategy and technology consulting company based in Colorado and London.
David Robertson. Mr. Robertson has been Executive Vice President since February 2002 and President and Chief Executive Officer of Aimco Capital since October 2002. Prior to joining the Company, from 1991 to 1996, Mr. Robertson was a member of the investment-banking group at Smith Barney. Since February 1996, Mr. Robertson has been Chairman of Robeks Corporation, a privately held chain of specialty food stores.
Robert Y. Walker, IV. Mr. Walker was appointed Senior Vice President in August 2005 and became the Chief Accounting Officer in November 2005. From June 2002 until he joined Aimco, Mr. Walker served as senior vice president and chief financial officer at Miller Global Properties, LLC, a Denver-based private equity, real estate fund manager. From May 1997 to June 2002, Mr. Walker was employed by GE Capital Real Estate, serving as global controller from May 2000 to June 2002.
Section 16(a) Beneficial Ownership Reporting Compliance. Section 16(a) of the Securities Exchange Act of 1934, as amended, requires the General Partner’s executive officers and directors, and persons who own more than ten percent of a registered class of OP Units, to file reports (Forms 3, 4 and 5) of unit ownership and changes in ownership with the Securities and Exchange Commission (“SEC”). Executive officers, directors and beneficial owners of more than ten percent of the OP Units are required by SEC regulations to furnish Aimco with copies of all such forms that they file.
Based solely on our review of the copies of Forms 3, 4 and 5 and the amendments thereto received by us for the year ended December 31, 2005, or written representations from certain reporting persons that no Forms 5 were required to be filed by those persons, we believe that during the period ended December 31, 2005, all filing requirements were complied with by the General Partner’s executive officers and directors and beneficial owners of more than ten percent of the OP Units.
Audit Committee. The board of directors of the General Partner does not have a separate audit committee because the audit committee of Aimco’s board of directors makes determinations concerning the engagement of the independent registered public accounting firm for Aimco and its subsidiaries, including the Partnership. In addition, the Aimco audit committee reviews with the independent registered public accounting firm the plans and results of the audit engagement, reviews the independence of the independent registered public accounting firm, considers the range of audit and non-audit fees and reviews the adequacy of internal control over financial reporting. The Aimco audit committee currently consists of James N. Bailey, Richard S. Ellwood, J. Landis Martin, Thomas L. Rhodes and Michael A. Stein. Aimco’s board of directors has determined that Michael A. Stein is an “audit committee financial expert.” Aimco’s board of directors has also determined that each member of the audit committee is independent, as that term is defined by Section 303.01 of the listing standards of the New York Stock Exchange relating to audit committees.
Code of Ethics
Effective November 6, 2003, Aimco’s board of directors adopted a code of ethics entitled “Code of Business Conduct and Ethics” that applies to the Partnership, the General Partner, the members of the General Partner’s board, all of the General Partner’s executive officers and all of Aimco’s (or its subsidiaries’) employees, including the equivalent of our principal executive officer, principal financial officer and principal accounting officer. The Code of Business Conduct and Ethics is posted on Aimco’s website (www.aimco.com). If, in the future, we or Aimco amends, modifies or waives a provision in the Code of Business Conduct and Ethics, rather than filing a Current Report on Form 8-K, we intend to satisfy any applicable disclosure requirement under Item 5.05 of Form 8-K by posting such information on Aimco’s website (www.aimco.com), as necessary.
Item 11.
Item 11. Executive Compensation
SUMMARY COMPENSATION TABLE
The following table sets forth the compensation earned with respect to each of the last three fiscal years, ending on December 31, 2005, 2004 and 2003, respectively, by the directors of the General Partner and the Chief Executive Officer and each of the four most highly compensated executive officers, or the Named Executive Officers, of the General Partner and Aimco. All references to stock and stock-based compensation are to shares of stock of Aimco. Information regarding stock options and other stock based compensation payable by Aimco has been included for informational purposes since we will issue to Aimco additional OP Units upon exercise of such stock options and the contribution to us of the net proceeds therefrom.
(1)
For Aimco, bonus compensation may be paid in the form of cash, restricted stock or stock options. The restricted stock grants and option grants shown in the table above under the heading “Long-Term Compensation” typically reflect bonus compensation. Amounts are determined as described below and the restricted stock grants and option grants vest on the schedules described below.
With respect to fiscal year 2005, stock options and restricted stock were granted on February 13, 2006. Except as indicated below, stock options and restricted stock granted on February 13, 2006 vest 20% on each anniversary of the grant date, beginning with the first anniversary, subject to accelerated vesting if Aimco meets a specified calendar year Funds From Operations target. For the February 13, 2006 restricted stock awards, for the purpose of calculating the number of shares of restricted stock to be granted, the dollars allocated to restricted stock were divided by $42.54, which was the average of the high and low trading prices of Aimco’s Class A Common Stock on the ten trading days preceding the grant date. For the purpose of calculating the number of shares subject to the February 13, 2006 stock options granted, the dollars allocated to stock options were divided by $5.23, which was the Black-Scholes valuation. The stock options have an exercise price per share of $42.98, which is equal to the grant date fair market value of the
OPTION/SAR GRANTS IN LAST FISCAL YEAR
Information on options to purchase shares of Aimco Class A Common Stock granted in fiscal year 2005 to the Named Executive Officers is set forth in the following table.
(1)
Under the terms of the Apartment Investment and Management Company 1997 Stock Award and Incentive Plan (the “1997 Stock Plan”), the plan administrator retains discretion, subject to certain restrictions, to modify the terms of outstanding options. The exercise price of options issued under the 1997 Stock Plan generally equals the fair market value of a share of Aimco Class A Common Stock on the date of grant.
(2)
For options for 300,000 shares granted to Mr. Considine, the vesting schedule is 20% on each anniversary of the grant date of February 16, 2005.
(3)
The estimated present value at grant date of option grants in fiscal year 2005 has been calculated using a value of $3.57 per option, which value was derived using the Black-Scholes option pricing model based on the following assumptions: exercise price per share of $38.05; an expected life of the option of five years; a fixed dividend yield of 6.31% over the life of the option; a risk free rate of 4.10%; and historical volatility of 19.0% for Aimco’s Class A Common Stock over five years. For accounting purposes, the compensation cost related to these options is based on the number of options multiplied by the $3.57 per option Black-Scholes valuation, and such compensation cost generally will be recognized over the vesting period. The ultimate value of these options depends on the actual performance of Aimco’s Class A Common Stock during the applicable period and upon when options are exercised. No gain to the optionee is possible without an increase in the share price, which would benefit all stockholders as well.
(4)
Does not reflect two option grants made to Mr. Considine on February 13, 2006. The first option grant is Mr. Considine’s bonus compensation for 2005 and is for 478,011 shares at an exercise price per share of $42.98, which represents the fair market value of Aimco’s Class A Common Stock on the grant date. This option grant vests 20% on each anniversary of the grant date. As of the grant date, the estimated present value of this award was $2.5 million based on a value of $5.23 per option, which value was derived using the Black-Scholes option pricing model based on the following assumptions: exercise price per share of $42.98; an expected life of the option of 6.5 years; a fixed dividend yield of 5.58% over the life of the option; a risk free rate of 4.58%; and historical volatility of 20.15% for Aimco’s Class A Common Stock over 6.5 years. Mr. Considine also received an option grant for 115,385 shares as his base compensation for 2006. This option grant vests on the first anniversary of the grant date and shall be forfeited in its entirety and shall not
be exercisable unless the Company achieves adjusted funds from operations of at least $2.40 per share for 2006. As of the grant date, the estimated present value of this award was $600,000 based on a value of $5.20 per option, which value was derived using the Black-Scholes option pricing model based on the following assumptions: exercise price per share of $42.98; an expected life of the option of 5.5 years; a fixed dividend yield of 5.58% over the life of the option; a risk free rate of 4.59%; and historical volatility of 20.29% for Aimco’s Class A Common Stock over 5.5 years. For accounting purposes, the compensation cost related to these options is based on the number of options multiplied by the per option Black-Scholes valuation, and such compensation cost generally will be recognized over the vesting period. The ultimate value of these options depends on the actual performance of Aimco’s Class A Common Stock during the applicable period and upon when options are exercised. No gain to the optionee is possible without an increase in the share price, which would benefit all stockholders as well.
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION/SAR VALUES
Information on Aimco’s option exercises during 2005 by the Named Executive Officers, and the value of unexercised Aimco options held by Named Executive Officers at December 31, 2005 is set forth in the following table.
EMPLOYMENT ARRANGEMENTS
Mr. Considine receives annual cash compensation pursuant to an employment contract with the Company. The initial two-year term of this contract expired in July 1996 but the contract is automatically renewed for successive one-year terms unless Mr. Considine is terminated by the Company. The base salary payable under the employment contract is subject to annual review and adjustment by the Compensation and Human Resources Committee of Aimco’s board of directors. For 2005, Mr. Considine received $500,000 in base salary. For 2006, Mr. Considine will receive his base salary in the form of stock options instead of cash. Mr. Considine is also eligible for a bonus set by the Compensation and Human Resources Committee of Aimco’s board of directors.
This employment contract provides that upon a change in control of Aimco or a termination of employment under certain circumstances, Mr. Considine will be entitled to a payment equal to three times the average annual salary for the previous three years. The contract provides that during the term of the contract and for one year thereafter in no event will Mr. Considine engage in the acquisition, development, operation or management of other multifamily rental apartment properties outside of the Company. In addition, the contract provides that the Mr. Considine will not engage in any active or passive investment in property relating to multifamily rental apartment properties, with the exception of the ownership of up to 1% of the securities of any publicly-traded company involved in those activities.
The form of restricted stock agreement used for restricted stock awards, including those outstanding grants to Messrs. Considine, Robertson, McAuliffe, Alcock and Graber, includes a provision for accelerated vesting upon a change in control.
Effective in January 2002, Aimco entered into certain non-competition and non-solicitation agreements with a number of employees, including Messrs. Considine, Robertson, McAuliffe, Alcock and Graber. Pursuant to the agreements, in consideration for payment of certain bonus and restricted stock, each of these executives agreed that during the term of his employment with Aimco and for a period of two (2) years following the termination of his employment, except in circumstances where there was a change in control of Aimco, he could not (i) be employed by a competitor of Aimco named on a schedule to the agreement, (ii) solicit other employees to leave the Aimco’s employ or (iii) solicit customers of Aimco to terminate their relationship with Aimco. The agreements further required that the executives protect Aimco’s trade secrets and confidential information.
The agreements provide that in order to enforce the above-noted non-competition condition following the executive’s termination of employment by Aimco without cause, each of Messrs. Considine, Robertson, McAuliffe, Alcock and Graber will receive, for a period not to exceed the earlier of twenty-four (24) months following such termination or the date of acceptance of employment with a non-competitor, (i) severance pay in an amount, if any, to be determined by Aimco in its sole discretion and (ii) a monthly payment equal to two-thirds (2/3) of such executive’s monthly base salary at the time of termination.
For purposes of these agreements, “cause” is defined to mean, among other things, the executive’s (i) breach of the agreement, (ii) failure to perform required employment services, (iii) misappropriation of Company funds or property, (iv) indictment, conviction, plea of guilty or plea of no contest to a crime involving fraud or moral turpitude, or (v) negligence, fraud, breach of fiduciary duty, misconduct or violation of law.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
The following table sets forth certain information available to the Company, as of March 3, 2006, with respect to OP Units of the Company beneficially owned by (i) each director and nominee, the chief executive officer of the General Partner and the Named Executive Officers of the General Partner who were serving as of March 3, 2006, and (ii) all directors and executive officers as a group. The table also sets forth certain information available to the Company, as of March 3, 2006, with respect to OP Units held by each person known to the Company to be the beneficial owner of more than 5% of such OP Units. This table does not reflect options that are not exercisable within 60 days. Unless otherwise indicated, each person has sole voting and investment power with respect to the securities beneficially owned by that person. The business address of each of the following directors and executive officers is 4582 South Ulster Street Parkway, Suite 1100, Denver, Colorado 80237, unless otherwise specified.
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
There are no compensation plans under which equity securities of the Partnership are authorized for issuance. Information on equity compensation plans as of the end of the 2005 fiscal year under which equity securities of Aimco are authorized for issuance is set forth in the following table.
Item 13.
Item 13. Certain Relationships and Related Transactions
From time to time, the Partnership has entered into various transactions with certain of its executive officers and directors. The Partnership attempts to price such transactions based on fair market value, and believes that the transactions are on terms that are as favorable to the Partnership as could be achieved with unrelated third parties.
High Performance Units
In 2005, the we sold to a limited liability company owned by members of senior management and other employees of the Company’s subsidiaries (approximately 89% by a Considine family partnership and approximately 11% by other employees, including Messrs. Alcock and Robertson) an aggregate of 5,000 Class VIII Units for approximately $780,000. The sale was approved by Aimco’s stockholders at the 2005 Annual Stockholders’ Meeting. Based on the total return of Aimco’s Class A Common Stock during 2005, compared to the peer index, and a minimum 11% return, the Class VIII Units were valued at $0 for the period of January 1, 2005 through December 31, 2005, however, the full measurement period ends on December 31, 2007.
Based on the total return of Aimco’s Class A Common Stock during 2003, 2004 and 2005, compared to the peer index, and a 36.8% minimum return, the Class VI Units were valued at $0 as of January 1, 2006 and the allocable investment made by the investors of $985,000 was lost. Based on the total return of Aimco’s Class A Common Stock during 2004 and 2005, compared to the peer index, and a minimum 23.2% return, the Class VII Units were valued at $0 for the period of January 1, 2004 through December 31, 2005, however, the full measurement period ends on December 31, 2006. We are currently proposing, if approved by Aimco’s stockholders at its 2006 Annual Stockholders’ Meeting, to issue up to 5,000 Class IX Units to a limited liability company that we expect will be owned by members of senior management (including up to 90% by a Considine family partnership) and other employees of the Company’s subsidiaries. The aggregate purchase price for the Class IX Units is $865,000.
Stock Purchase Loans
From time to time, prior to the effectiveness of the Sarbanes-Oxley Act of 2002 in July 2002, Aimco made loans to its executive officers to finance their purchase of shares of Aimco Class A Common Stock from Aimco. In order to comply with the Sarbanes-Oxley Act of 2002, Aimco no longer provides loans to executive officers and will not make any material modification to any existing loans to executive officers. The following table sets forth certain information with respect to stock purchase loans to executive officers. For those officers who have no such loans, no information is shown.
Relocation Arrangements
In connection with the relocation arrangement entered into with Mr. Robertson in March 2004, during 2005 the Company reimbursed Mr. Robertson approximately $165,000 for capital gain taxes incurred by Mr. Robertson and his wife as a result of the sale of their California residence.
Property and Investment Analysis Arrangement
In connection with the analysis and review of certain potential property investments, Aimco entered into a contract with ACP Advisors LLC. During 2005, Aimco paid ACP Advisors LLC fees in an aggregate amount of $222,515 plus reimbursement of direct expenses. Roger Cortez and Miles Cortez III are the sole members of ACP Advisors. Roger Cortez is the brother and Miles Cortez III is the son of Mr. Cortez, Aimco’s Executive Vice President, General Counsel and Secretary. Mr. Cortez does not have an interest in ACP Advisors LLC.
Item 14.
Item 14. Principal Accountant Fees and Services
The aggregate fees billed for services rendered by Ernst & Young LLP during the years ended December 31, 2005 and 2004 were approximately $10.48 and $10.51 million, respectively, and are described below.
Audit Fees
Fees for audit services totaled approximately $6.97 million in 2005 and approximately $7.44 million in 2004. These amounts include fees associated with the annual audit of the financial statements of Aimco, its internal control over financial reporting (which includes procedures related to the implementation of the internal control provisions set forth in Section 404 of the Sarbanes-Oxley Act of 2002), and the financial statements of certain of its consolidated subsidiaries and unconsolidated investees. Fees for audit services also include fees for the reviews of Aimco’s Quarterly Reports on Form 10-Q, registration statements filed with the Securities and Exchange Commission (“SEC”), other SEC filings, equity or debt offerings, comfort letters and consents.
Audit-Related Fees
Fees for audit-related services totaled approximately $0.84 million in 2005 and approximately $1.32 million in 2004. Audit-related services principally include various audit and attest work not required by statute or regulation, benefit plan audits, due diligence in connection with acquisitions, and accounting consultations.
Tax Fees
Fees billed for tax services, including tax compliance services for approximately 410 subsidiaries or affiliates of the Company, tax advice and tax planning totaled approximately $2.68 million in 2005 and approximately $1.72 million in 2004. The difference between the two amounts is substantially due to the timing of services rendered and related billing.
All Other Fees
Fees for all other services not included above totaled zero in 2005 and approximately $0.02 million in 2004, principally consisting of real estate advisory services. There were no fees billed or incurred in 2005 or 2004 related to financial information systems design and implementation.
Included in the fees above are audit and tax compliance fees of $6.6 million and $5.7 million for 2005 and 2004, respectively, for services provided to consolidated and unconsolidated partnerships for which an Aimco subsidiary is the general partner. Audit services were provided to approximately 290 such partnerships and tax compliance services were provided to approximately 410 such partnerships during 2005.
Audit Committee of Aimco’s Board of Directors Pre-Approval Policies
In 2003, the audit committee of Aimco’s board of directors adopted the Audit and Non-Audit Services Pre-Approval Policy (the “Pre-approval Policy”), which the audit committee of Aimco’s board of directors reviewed and again approved, with minor modifications, in October 2005. The Pre-approval Policy describes the Audit, Audit-related, Tax and Other Permitted services that have the general pre-approval of the audit committee of Aimco’s board of directors, typically subject to a dollar limit of $25,000. The term of any general pre-approval is generally twelve (12) months from the date of pre-approval, unless the audit committee of Aimco’s board of directors considers a different period and states otherwise. At least annually, the audit committee of Aimco’s board of directors will review and pre-approve the services that may be provided by the independent registered public accounting firm without obtaining specific pre-approval from the audit committee of Aimco’s board of directors. In accordance with this review, the audit committee may
add to or subtract from the list of general pre-approved services or modify the permissible dollar limit associated with pre-approvals. As set forth in the Pre-approval Policy, unless a type of service has received general pre-approval and is anticipated to be within the dollar limit associated with the general pre-approval, it will require specific pre-approval by the audit committee of Aimco’s board of directors if it is to be provided by the independent registered public accounting firm. For both types of pre-approval, the audit committee of Aimco’s board of directors will consider whether such services are consistent with the rules on independent registered public accounting firm independence. The audit committee of Aimco’s board of directors will also consider whether the independent registered public accounting firm is best positioned to provide the most effective and efficient service, for reasons such as its familiarity with Aimco’s business, people, culture, accounting systems, risk profile and other factors, and whether the service might enhance Aimco’s ability to manage or control risk or improve audit quality. All such factors will be considered as a whole, and no one factor will necessarily be determinative. All of the services described above were approved pursuant to the annual engagement letter or in accordance with the Pre-approval Policy; none were approved pursuant to Rule 2-01(c)(7)(i)(C) of SEC Regulation S-X.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules
(a)(1)
The financial statements listed in the Index to Financial Statements on Page of this report are filed as part of this report and incorporated herein by reference.
(a)(2)
The financial statement schedule listed in the Index to Financial Statements on Page of this report is filed as part of this report and incorporated herein by reference.
(a)(3)
The Exhibit Index is incorporated herein by reference.
INDEX TO EXHIBITS (1) (2)
(1)
Schedule and supplemental materials to the exhibits have been omitted but will be provided to the Securities and Exchange Commission upon request.
(2)
The file reference number for all exhibits is 000-24497, and all such exhibits remain available pursuant to the Records Control Schedule of the Securities and Exchange Commission.
*
Management contract or compensatory plan or arrangement
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, on the 8th day of March 2006.
Pursuant to the requirements of the Securities 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.
Signature
Title
Date
/s/ TERRY CONSIDINE
Terry Considine
Chairman of the Board, Chief Executive Officer and President of the registrant’s general partner
March 8, 2006
/s/ THOMAS M. HERZOG
Thomas M. Herzog
Executive Vice President and Chief Financial Officer of the registrant’s general partner
March 8, 2006
/s/ ROBERT Y. WALKER, IV
Robert Y. Walker, IV
Senior Vice President and Chief Accounting Officer of the registrant’s general partner
March 8, 2006
AIMCO PROPERTIES, L.P
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Partners
AIMCO Properties, L.P.
We have audited the accompanying consolidated balance sheets of AIMCO Properties, L.P. as of December 31, 2005 and 2004, and the related consolidated statements of income, partners’ capital and cash flows for each of the three years in the period ended December 31, 2005. Our audits also included the financial statement schedule listed in the accompanying Index to Financial Statements. These financial statements and schedule are the responsibility of the Partnership’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (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 AIMCO Properties, L.P. at December 31, 2005 and 2004, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2005, in conformity with United States generally accepted accounting principles. 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.
As discussed in Note 2 to the consolidated financial statements, in 2004 the Partnership adopted the provisions of Financial Accounting Standards Board Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of AIMCO Properties, L.P.’s internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 6, 2006 expressed an unqualified opinion thereon.
/s/ ERNST & YOUNG LLP
Denver, Colorado
March 6, 2006
AIMCO PROPERTIES, L.P
CONSOLIDATED BALANCE SHEETS
As of December 31, 2005 and 2004
(In thousands, except share data)
See notes to consolidated financial statements.
AIMCO PROPERTIES, L.P
CONSOLIDATED STATEMENTS OF INCOME
For the Years Ended December 31, 2005, 2004 and 2003
(In thousands, except per unit data)
See notes to consolidated financial statements.
AIMCO PROPERTIES, L.P
CONSOLIDATED STATEMENTS OF PARTNERS’ CAPITAL
For the Years Ended December 31, 2005, 2004 and 2003 (In thousands)
See notes to consolidated financial statements.
AIMCO PROPERTIES, L.P
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2005, 2004 and 2003
(In thousands)
See notes to consolidated financial statements.
AIMCO PROPERTIES, L.P
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31, 2005, 2004 and 2003
(In thousands)
See notes to consolidated financial statements.
AIMCO PROPERTIES, L.P
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2005
NOTE 1 - Organization
AIMCO Properties, L.P., a Delaware limited partnership, or the Partnership, and together with its consolidated subsidiaries and other controlled entities, the Company, was formed on May 16, 1994 to conduct the business of acquiring, redeveloping, leasing, and managing multifamily apartment properties. Our securities include Partnership Common Units, or common OP Units, Partnership Preferred Units, or preferred OP Units, and High Performance Partnership Units, or High Performance Units, which are collectively referred to as “OP Units.” Apartment Investment and Management Company, or Aimco, is the owner of our general partner, AIMCO-GP, Inc., or the General Partner, and special limited partner, AIMCO-LP, Inc., or the Special Limited Partner. The General Partner and Special Limited Partner hold common OP Units and are the primary holders of outstanding preferred OP Units. “Limited Partners” refers to individuals or entities that are our limited partners, other than Aimco, the General Partner or the Special Limited Partner, and own common OP Units or preferred OP Units. Generally, after holding the common OP Units for one year, the Limited Partners have the right to redeem their common OP Units for cash, subject to our prior right to acquire some or all of the common OP Units tendered for redemption in exchange for shares of Aimco Class A Common Stock. Common OP Units redeemed for Aimco Class A Common Stock are generally on a one-for-one basis (subject to antidilution adjustments). Preferred OP Units and High Performance Units may or may not be redeemable based on their respective terms, as provided for in the Third Amended and Restated Agreement of Limited Partnership of AIMCO Properties, L.P. as amended, or the Partnership Agreement.
We, through our operating divisions and subsidiaries, hold substantially all of Aimco’s assets and manage the daily operations of Aimco’s business and assets. Aimco is required to contribute all proceeds from offerings of its securities to us. In addition, substantially all of Aimco’s assets must be owned through the Partnership; therefore, Aimco is generally required to contribute all assets acquired to us. In exchange for the contribution of offering proceeds or assets, Aimco receives additional interests in us with similar terms (e.g., if Aimco contributes proceeds of a preferred stock offering, Aimco (through the General Partner and Special Limited Partner) receives preferred OP Units with terms substantially similar to the preferred securities issued by Aimco).
Aimco frequently consummates transactions for our benefit. For legal, tax or other business reasons, Aimco may hold title or ownership of certain assets until they can be transferred to us. However, we have a controlling financial interest in substantially all of Aimco’s assets in the process of transfer to us. Except as the context otherwise requires, “we,” “our,” “us” and the “Company” refer to the Partnership, and the Partnership’s consolidated entities, collectively. Except as the context otherwise requires, “Aimco” refers to Aimco and Aimco’s consolidated entities, collectively.
As of December 31, 2005, we:
At December 31, 2005, we had outstanding 103,692,378 common OP Units, 45,037,094 preferred OP Units and 2,379,084 High Performance Units (includes only those units that have met the required measurement benchmarks and are dilutive - see Note 12).
NOTE 2 - Basis of Presentation and Summary of Significant Accounting Policies
Principles of Consolidation
The accompanying consolidated financial statements include the accounts of the Partnership and its consolidated entities. Pursuant to a Management and Contribution Agreement between the Partnership and Aimco, we have acquired, in exchange for interests in the Partnership, the economic benefits of subsidiaries of Aimco in which we do not have an interest, and Aimco has granted us a right of first refusal to acquire such subsidiaries’ assets for no additional consideration. Pursuant to the agreement, Aimco has also granted us certain rights with respect to assets of such subsidiaries. As used herein, and except where the context otherwise requires, “partnership” refers to a limited partnership or a limited liability company and “partner” refers to a limited partner in a limited partnership or a member in a limited liability company. Interests held in consolidated real estate partnerships by limited partners other than us are reflected as minority interest in consolidated real estate partnerships. All significant intercompany balances and transactions have been eliminated in consolidation. The assets of consolidated real estate partnerships owned or controlled by Aimco or us generally are not available to pay creditors of Aimco or the Partnership.
FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities, or FIN 46, addresses the consolidation by business enterprises of variable interest entities. As a result of the adoption of FIN 46, as of March 31, 2004, we consolidate all variable interest entities for which we are the primary beneficiary. Generally, a variable interest entity, or VIE, is an entity with one or more of the following characteristics: (a) the total equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support; (b) as a group the holders of the equity investment at risk lack (i) the ability to make decisions about an entity’s activities through voting or similar rights, (ii) the obligation to absorb the expected losses of the entity, or (iii) the right to receive the expected residual returns of the entity; or (c) the equity investors have voting rights that are not proportional to their economic interests and substantially all of the entity’s activities either involve, or are conducted on behalf of, an investor that has disproportionately few voting rights. FIN 46 requires a VIE to be consolidated in the financial statements of the entity that is determined to be the primary beneficiary of the VIE. The primary beneficiary generally is the entity that will receive a majority of the VIE’s expected losses, receive a majority of the VIE’s expected residual returns, or both.
Upon adoption of FIN 46, we determined that we were the primary beneficiary of 27 previously unconsolidated and five previously consolidated VIEs. These VIEs consisted of partnerships that are engaged, directly or indirectly, in the ownership and management of 29 apartment properties with 3,478 units. The initial consolidation of the previously unconsolidated entities as of March 31, 2004 resulted in an increase in our consolidated total assets (primarily real estate), liabilities (primarily indebtedness) and minority interest of approximately $113.5 million, $90.6 million and $26.8 million, respectively. We recorded a charge of approximately $4.0 million for the cumulative effect on retained earnings resulting from the adoption of FIN 46. This charge is attributable to our recognition of cumulative losses allocable to minority interests that would otherwise have resulted in minority interest deficits.
As of December 31, 2005, we were the primary beneficiary of, and therefore consolidated, 46 VIEs, which owned 40 apartment properties with 5,816 units. Real estate with a carrying value of $378.2 million collateralized the debt of those VIEs. The creditors of the consolidated VIEs do not have recourse to our general credit. As of December 31, 2005, we also held variable interests in 107 VIEs for which we were not the primary beneficiary. Those 107 VIEs consist primarily of partnerships, in which we acquired an interest prior to the adoption of FIN 46, that are engaged, directly or indirectly, in the ownership and management of 112 apartment properties with 10,812 units. We are involved with those VIEs as a non-controlling equity holder, lender, management agent, or through other contractual relationships. Our maximum exposure to loss as a result of our involvement with unconsolidated VIEs is limited to our recorded investments in and receivables from those VIEs totaling $30.8 million at December 31, 2005. We may be subject to additional losses to the extent of any financial support that we voluntarily provide in the future.
Generally, we consolidate real estate partnerships and other entities that are not VIEs when we own, directly or indirectly, a majority voting interest in the entity. In June 2005, the Financial Accounting Standards Board, or FASB, ratified Emerging Issues Task Force Issue 04-5, Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights, or EITF 04-5. EITF 04-5 provides an accounting model to be used by a general partner, or group of general partners, to determine whether the general partner(s) controls a limited partnership or similar entity in light of certain rights held by the limited partners and provides additional guidance on what constitutes substantive kick-out rights and substantive participating
rights. EITF 04-5 was effective after June 29, 2005 for general partners of (a) all newly formed limited partnerships and (b) existing limited partnerships for which the partnership agreements have been modified. We consolidated four limited partnerships in the fourth quarter of 2005 based on EITF 04-5 requirements. The consolidation of these partnerships had an immaterial effect on our consolidated financial statements. As discussed in Note 19, we are required to apply EITF 04-5 to all existing limited partnerships and similar entities where we are the general partner as of January 1, 2006.
Acquisition of Real Estate Assets and Related Depreciation and Amortization
We capitalize the purchase price and incremental direct costs associated with the acquisition of properties as the cost of the assets acquired. In accordance with Statement of Financial Accounting Standards No. 141, Business Combinations, or SFAS 141, we allocate the cost of acquired properties to land, building, furniture, fixtures and equipment and intangibles, such as the value of above and below market leases, and origination costs associated with the in-place leases. In order to allocate purchase price on these various components we perform the following procedures for properties we acquire:
1.
Determine the “as-if vacant” fair value of the physical property acquired (this value assumes the property goes “dark”);
2.
Allocate the “as-if vacant” fair value among land, building, improvements (based on real estate valuation techniques), and furniture, fixtures and equipment; and
3.
Compute the difference between the purchase price of the property and the “as-if vacant” fair value and allocate such difference to leases in-place (based on the nature of our business, customer relationship value is assumed to be zero), which will represent the total intangible assets. The fair value of the leases in-place are comprised of:
a.
The value of the above and/or below market leases in-place. Above-market and below-market in-place lease values are computed based on the difference between (i) the contractual amounts to be paid pursuant to the in-place leases and (ii) management’s estimate of fair market lease rates for the corresponding in-place leases, measured over the period, including estimated lease renewals for below-market leases, that the leases are expected to remain in effect.
b.
Avoided leasing commissions and other costs that were incurred to execute leases.
c.
The value associated with lost rents during the absorption period (estimates of lost rental revenue during the expected lease-up periods based on current market demand).
The values of the above and below market leases are amortized over the remaining terms of the associated lease, including estimated lease renewals for below-market leases, to rental income. For the values associated with avoided leasing commissions and other costs that were incurred to execute leases and the value associated with lost rents during the absorption period, amortization expense is recorded over the expected terms of the associated leases. If a resident vacates the unit prior to the contractual termination of the lease and no rental payments are being made on the lease, any unamortized balance of the related intangible will be written off.
Depreciation for all tangible real estate assets is calculated using the straight-line method over their estimated useful lives. Acquired buildings and improvements are depreciated over a composite life of 14 to 52 years, based on the age, condition and other physical characteristics of the property. As discussed under Impairment of Long Lived Assets below, we may adjust depreciation of properties that are expected to be disposed of prior to the end of their useful lives. Furniture, fixtures and equipment associated with acquired properties are depreciated over five years.
Capital Expenditures and Related Depreciation
We capitalize costs, including certain indirect costs, incurred in connection with our capital expenditure activities, including redevelopment and construction projects, other tangible property improvements, and replacements of existing property components. Included in these capitalized costs are payroll costs associated with time spent by site employees in connection with the planning, execution and control of all capital expenditure activities at the property level. We characterize as “indirect costs” an allocation of certain department costs, including payroll, at the regional operating center and corporate levels that clearly relate to capital expenditure activities. We capitalize interest, property taxes and
insurance during periods in which redevelopment and construction projects are in progress. Costs incurred in connection with capital expenditure activities are capitalized where the costs of the improvements or replacements exceed $250. We charge to expense as incurred costs that do not relate to capital expenditure activities, including ordinary repairs, maintenance, resident turnover costs and general and administrative expenses.
We depreciate capitalized costs using the straight-line method over the estimated useful life of the related component or improvement, which is five, 15 or 30 years. Prior to July 1, 2005, we recorded capitalized site payroll costs and most capitalized indirect costs separately from other costs of the related capital projects. We depreciated capitalized site payroll costs over five years and capitalized indirect costs associated with capital replacement and improvement projects over five or 15 years. Capitalized indirect costs associated with redevelopment projects, together with other costs of the redevelopment projects, were depreciated over the estimated useful lives of those projects, predominantly 30 years.
Effective July 1, 2005, we refined the estimated useful lives for the capitalized site payroll and indirect costs that were recorded separately from other costs of the related capital projects. All capitalized site payroll and indirect costs incurred after June 30, 2005 are allocated proportionately, based on direct costs, among capital projects and depreciated over the estimated useful lives of such projects. This change in estimate is also being applied prospectively to the June 30, 2005 carrying amounts, net of accumulated depreciation, of previously incurred site payroll and indirect costs. Those amounts, based on the periods the costs were incurred, were allocated among capital projects that were completed in the corresponding periods in proportion to the original direct costs of such projects and are being depreciated over the remaining useful lives of the projects. We anticipate that these refinements will result in generally higher depreciation expense in foreseeable future accounting periods. For the year ended December 31, 2005, these changes in estimated useful lives resulted in decreased net income of approximately $5.1 million, and resulted in a decrease in basic and diluted earnings per share of $0.05.
Certain homogeneous items that are purchased in bulk on a recurring basis, such as carpeting and appliances, are depreciated using group methods that reflect the average estimated useful life of the items in each group. Except in the case of property casualties, where the net book value of lost property is written off in the determination of casualty gains or losses, we generally do not recognize any loss in connection with the replacement of an existing property component because normal replacements are considered in determining the estimated useful lives used in connection with our composite and group depreciation methods.
For the years ended December 31, 2005, 2004 and 2003, for continuing and discontinued operations, we capitalized $18.1 million, $9.5 million and $14.5 million of interest costs, respectively, and $53.3 million, $46.7 million and $45.4 million of site payroll and indirect costs, respectively.
Asset Retirement Obligations
In March 2005, the FASB issued FASB Interpretation No. 47, Accounting for Conditional Asset Retirement Obligations, or FIN 47. FIN 47 clarifies the accounting for legal obligations to perform asset retirement activity in which the timing and/or method of settlement are conditional on future events. FIN 47 requires the fair value of such conditional asset retirement obligations to be recorded as incurred, if the fair value of the liability can be reasonably estimated. We have determined that FIN 47 applies to certain obligations that we have based on laws that require property owners to remove or remediate hazardous substances in certain circumstances. We adopted the provisions of FIN 47 as of December 31, 2005 and determined that asset retirement obligations that are required to be recognized under FIN 47 are immaterial to our financial condition and results of operations. See Note 9 for further discussion of asset retirement obligations.
Impairment of Long-Lived Assets
We apply the provisions of Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets, or SFAS 144, to determine whether our real estate and other long-lived assets are impaired. Such assets to be held and used are stated at cost, less accumulated depreciation and amortization, unless the carrying amount of the asset is not recoverable. If events or circumstances indicate that the carrying amount of a property may not be recoverable, we make an assessment of its recoverability by comparing the carrying amount to our estimate of the undiscounted future cash flows, excluding interest charges, of the property. If the carrying amount exceeds the aggregate undiscounted future cash flows, we recognize an impairment loss to the extent the carrying amount exceeds the estimated fair value of the property. Based on periodic tests of recoverability of long-lived assets,
for the year ended December 31, 2005, we recorded impairment losses of $3.4 million related to properties to be held and used. For the years ended December 31, 2004 and 2003, we determined that the carrying amounts of our properties to be held and used were recoverable and, therefore, we did not record any impairment losses related to such properties.
Our tests of recoverability address real estate assets that do not currently meet all conditions to be classified as held for sale, but are expected to be disposed of prior to the end of their estimated useful lives. If an impairment loss is not required to be recorded in accordance with SFAS 144, the recognition of depreciation is adjusted prospectively, as necessary, to reduce the carrying value of the real estate to its estimated disposition value over the remaining period that the real estate is expected to be held and used. These depreciation adjustments decreased net income by $35.6 million and $7.1 million, and resulted in a decrease in basic and diluted earnings per share of $0.34 and $0.07, for the years ended December 31, 2005 and 2004, respectively.
Cash Equivalents
We consider highly liquid investments with an original maturity of three months or less to be cash equivalents.
Restricted Cash
Restricted cash includes capital replacement reserves, tax-free exchange funds, completion repair reserves, bond sinking fund amounts and tax and insurance escrow accounts held by lenders.
Accounts Receivable and Allowance for Doubtful Accounts
Accounts receivable are generally comprised of amounts receivable from residents, amounts receivable from non-affiliated real estate partnerships for which we provide property management and other services and other miscellaneous receivables from non-affiliated entities. We evaluate collectibility of accounts receivable from residents and establish an allowance, after the application of security deposits and other anticipated recoveries, for accounts greater than 30 days past due for current residents and all receivables due from former residents. Accounts receivable from residents are stated net of allowances for doubtful accounts of approximately $2.3 million and $2.4 million as of December 31, 2005 and 2004, respectively.
We evaluate collectibility of accounts receivable from non-affiliated entities and establish an allowance for amounts that are considered to be uncollectible. Accounts receivable relating to non-affiliated entities are stated net of allowances for doubtful accounts of approximately $4.2 million and $4.5 million as of December 31, 2005 and 2004, respectively.
Accounts Receivable and Allowance for Doubtful Accounts from Affiliates
Accounts receivable from affiliates are generally comprised of receivables related to property management and other services provided to unconsolidated real estate partnerships in which we have an ownership interest. We evaluate collectibility of accounts receivable balances from affiliates on a periodic basis, and establish an allowance for the amounts deemed to be uncollectible. Accounts receivable from affiliates are stated net of allowances for doubtful accounts of approximately $4.7 million and $4.4 million as of December 31, 2005 and 2004, respectively.
Deferred Costs
We defer lender fees and other direct costs incurred in obtaining financing and amortize the cost over the terms of the related loan agreements. Amortization of these costs is included in interest expense. We defer leasing commissions and other direct costs incurred in connection with successful leasing efforts and amortize the costs over the terms of the related leases. Amortization of these costs is included in property operating expenses.
Advertising Costs
We generally expense all advertising costs as incurred to property operating expense. For the years ended December 31, 2005, 2004 and 2003, for both continuing and discontinued operations, total advertising expense was $36.1 million, $33.1 million and $28.7 million, respectively.
Notes Receivable from Unconsolidated Real Estate Partnerships and Related Interest Income and Provision for Losses
Notes receivable from unconsolidated real estate partnerships consist primarily of notes receivable from partnerships in which we are the general partner. The ultimate repayment of these notes is subject to a number of variables, including the performance and value of the underlying real estate property and the claims of unaffiliated mortgage lenders. Our notes receivable include loans extended by us that we carry at the face amount plus accrued interest, which we refer to as “par value notes,” and loans extended by predecessors whose positions we generally acquired at a discount, which we refer to as “discounted notes.”
We record interest income on par value notes as earned in accordance with the terms of the related loan agreements. We discontinue the accrual of interest on such notes when the notes are impaired, as discussed below, or when there is otherwise significant uncertainty as to the collection of interest. We record income on such nonaccrual loans using the cost recovery method, under which we apply cash receipts first to the recorded amount of the loan; thereafter, any additional receipts are recognized as income.
We recognize interest income on discounted notes receivable based upon whether the amount and timing of collections are both probable and reasonably estimable. We consider collections to be probable and reasonably estimable when the borrower has entered into certain closed or pending transactions (which include real estate sales, refinancings, foreclosures and rights offerings) that provide a reliable source of repayment. In such instances, we recognize accretion income, on a prospective basis using the effective interest method over the estimated remaining term of the loans, equal to the difference between the carrying amount of the discounted notes and the estimated collectible value. We record income on all other discounted notes using the cost recovery method.
We assess the collectibility of notes receivable on a periodic basis, which assessment consists primarily of an evaluation of cash flow projections of the borrower to determine whether estimated cash flows are sufficient to repay principal and interest in accordance with the contractual terms of the note. We recognize impairments on notes receivable when it is probable that principal and interest will not be received in accordance with the contractual terms of the loan. The amount of the impairment to be recognized generally is based on the fair value of the partnership’s real estate that represents the primary source of loan repayment. In certain instances where other sources of cash flow are available to repay the loan, the impairment is measured by discounting the estimated cash flows at the loan’s original effective interest rate.
Investments in Unconsolidated Real Estate Partnerships
We own general and limited partner interests in real estate partnerships that own apartment properties. We generally account for investments in real estate partnerships that we do not consolidate under the equity method. Under the equity method, our share of the earnings or losses of the entity for the periods being presented is included in equity in earnings (losses) from unconsolidated real estate partnerships, except for our share of impairments and property disposition gains related to such entities, which we report separately in the consolidated statements of income. Certain investments in real estate partnerships that were acquired in business combinations were determined to have insignificant value at the acquisition date and are accounted for under the cost method. Any distributions received from such partnerships are recognized as income when received.
Intangible Assets
At December 31, 2005 and 2004, other assets included goodwill of $81.9 million and $88.1 million, respectively, associated with our real estate segment. We account for goodwill and other intangible assets in accordance with the requirements of Statement of Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets, or SFAS 142. SFAS 142 does not permit amortization of goodwill and other intangible assets with indefinite lives, but requires an annual impairment test of such assets. The impairment test compares the fair value of reporting units with their carrying amounts, including goodwill. Based on the application of the goodwill impairment test set forth in SFAS 142, we determined that our goodwill was not impaired in 2005, 2004 or 2003. As discussed in Note 10, we reduced goodwill by $6.2 million in 2005 in connection with the recognition of deferred income tax assets that were acquired in connection with business combinations in prior years.
Other assets also includes intangible assets for purchased management contracts with finite lives that we amortize on a straight-line basis over terms ranging from five to twenty years and intangible assets for in-place leases as discussed under Acquisition of Real Estate Assets and Related Depreciation and Amortization.
Capitalized Software Costs
Purchased software and other costs related to software developed for internal use are capitalized during the application development stage and are amortized using the straight-line method over the estimated useful life of the software, generally five years. We write off the costs of software development projects when it is no longer probable that the software will be completed and placed in service. For the years ended December 31, 2005, 2004 and 2003, we capitalized software development costs totaling $9.9 million, $18.1 million and $18.9 million, respectively. During 2005 and 2004, we wrote off $0.5 million and $1.1 million of software development costs. At December 31, 2005 and 2004, other assets included $40.2 million and $43.4 million of net capitalized software, respectively.
Minority Interest in Consolidated Real Estate Partnerships
We report unaffiliated partners’ interests in consolidated real estate partnerships as minority interest in consolidated real estate partnerships. Minority interest in consolidated real estate partnerships represents the minority partners’ share of the underlying net assets of our consolidated real estate partnerships. When these consolidated real estate partnerships make cash distributions to partners in excess of the carrying amount of the minority interest, we generally record a charge equal to the amount of such excess distribution, even though there is no economic effect or cost. We report this charge in the consolidated statements of income as deficit distributions to minority partners. We allocate the minority partners’ share of partnership losses to minority partners to the extent of the carrying amount of the minority interest. We generally record a charge when the minority partners’ share of partnership losses exceed the carrying amount of the minority interest, even though there is no economic effect or cost. We report this charge in the consolidated statements of income within minority interest in consolidated real estate partnerships. We do not record charges for distributions or losses in certain limited instances where the minority partner has a legal obligation and financial capacity to contribute additional capital to the partnership. For the years ended December 31, 2005, 2004, and 2003, we recorded charges for partnership losses resulting from depreciation of approximately $9.5 million, $5.2 million, and $1.5 million, respectively, that were not allocated to minority partners because the losses exceeded the carrying amount of the minority interest.
Minority interest in consolidated real estate partnerships consists primarily of equity interests held by limited partners in consolidated real estate partnerships that have finite lives. The terms of the related partnership agreements generally require the partnership to be liquidated following the sale of the partnership’s real estate. As the general partner in these partnerships, we ordinarily control the execution of real estate sales and other events that could lead to the liquidation, redemption or other settlement of minority interests. The aggregate carrying value of minority interests in consolidated real estate partnerships is approximately $218.7 million at December 31, 2005. The aggregate fair value of these interests varies based on the fair value of the real estate owned by the partnerships. Based on the number of classes of finite-life minority interests, the number of properties in which there is direct or indirect minority ownership, complexities in determining the allocation of liquidation proceeds among partners and other factors, we believe it is impracticable to determine the total required payments to the minority interests in an assumed liquidation at December 31, 2005. As a result of real estate depreciation that is recognized in our financial statements and appreciation in the fair value of real estate that is not recognized in our financial statements, we believe that the aggregate fair value of our minority interests exceeds their aggregate carrying value. As a result of our ability to control real estate sales and other events that require payment of minority interests and our expectation that proceeds from real estate sales will be sufficient to liquidate related minority interests, we anticipate that the eventual liquidation of these minority interests will not have an adverse impact on our financial condition.
Revenue Recognition
Our properties have operating leases with apartment residents with terms generally of twelve months or less. We recognize rental revenue related to these leases, net of any concessions, on a straight-line basis over the term of the lease. We recognize revenues from property management, asset management, syndication, development and other services when the related fees are earned and are realized or realizable.
Stock-Based Compensation
Effective January 1, 2003, Aimco adopted the accounting provisions of Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation, or SFAS 123, as amended by Statement of Financial Accounting Standards No. 148, Accounting for Stock-Based Compensation-Transition and Disclosure-an amendment of FASB Statement No. 123, or SFAS 148, and applied the prospective method set forth in SFAS 148 with respect to the
transition. Under this method, Aimco applies the fair value recognition provisions of SFAS 123 to all employee awards granted, modified, or settled on or after January 1, 2003, which has resulted in recognition of compensation expense related to stock options based on the fair value of the stock options. For stock options granted prior to January 1, 2003, Aimco applies Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees, or APB 25, and related interpretations. Under APB 25, because the exercise price of Aimco’s employee stock options equaled the market price of the underlying stock on the date of grant, no compensation expense related to such options has been recognized. Aimco recognizes compensation expense for stock options accounted for under SFAS 123 and restricted stock awards ratably over the period the awards vest. Compensation expense is reversed as forfeitures occur.
For purposes of the pro forma disclosures below, the estimated fair values for all awards made prior to January 1, 2003 are amortized over the respective vesting period for each such option and are shown as expense as if SFAS 123 had been applied to all such awards. Pro forma information regarding net income and earnings per unit is required by SFAS 123, which also requires that the information be determined as if Aimco had accounted for its employee stock options granted subsequent to December 31, 1994 under the fair value method. The fair value for these options granted over the last three years was estimated at the date of grant using a Black-Scholes valuation model. The estimated fair value of Aimco’s stock options and underlying assumptions are as follows:
The Black-Scholes valuation model was developed for use in estimating the fair value of traded options and does not take into account vesting requirements or restrictions on transferability. In addition, the valuation model requires the input of highly subjective assumptions including the expected stock price volatility. Aimco’s employee stock options have characteristics significantly different from those of traded options, and changes in the subjective input assumptions can materially affect the fair value estimate.
The following table illustrates the effect on net income and earnings per unit if the fair value based method had been applied to all outstanding and unvested awards in each period presented. Our pro forma information for the years ended December 31, 2005, 2004 and 2003 is as follows (in thousands, except per unit data):
The effects of applying SFAS 123 in calculating pro forma income attributable to common unitholders and pro forma basic and diluted earnings per unit may not necessarily be indicative of the effects of applying SFAS 123 to
future years’ earnings. As discussed in Note 19, Aimco will change its method of accounting for share-based compensation in 2006.
Discontinued Operations
In accordance with SFAS 144, we classify certain properties and related liabilities as held for sale (see Note 14). The operating results of such properties are presented in discontinued operations in both current periods and all comparable periods presented. Depreciation is not recorded on properties held for sale; however, depreciation expense recorded prior to classification as held for sale is included in discontinued operations. The net gain on sale and any impairment losses are presented in discontinued operations when recognized.
Derivative Financial Instruments
We primarily use long-term, fixed-rate and self-amortizing non-recourse debt to avoid, among other things, risk related to fluctuating interest rates. For our variable-rate debt, we are sometimes required by our lenders to limit our exposure to interest rate fluctuations by entering into interest rate swap or cap agreements. The interest rate swap agreements moderate our exposure to interest rate risk by converting the variable-rate debt to a fixed rate. The interest rate cap agreements effectively limit our exposure to interest rate risk by providing a ceiling on the underlying variable interest rate. The fair values of these instruments are reflected as assets or liabilities in the balance sheet, and periodic changes in fair value are included in interest expense. In 2005, we entered into a natural gas commodity swap agreement to limit our exposure to increases in the price of natural gas purchases for certain properties. These instruments are not material to our financial position and results of operations.
Insurance
We believe that our insurance coverages insure our properties adequately against the risk of loss attributable to fire, earthquake, hurricane, tornado, flood, and other perils. In addition, we reinsure substantial portions of our property, workers’ compensation, health, and general liability insurance coverage. Losses are accrued based upon our estimates of the aggregate liability for claims incurred using certain actuarial assumptions followed in the insurance industry and based on our experience.
Income Taxes
Aimco has elected to be taxed as a REIT, as defined under the Internal Revenue Code of 1986, as amended. As a REIT, Aimco generally will not be subject to United States Federal income taxes at the corporate level on its net income that is distributed to its stockholders if Aimco distributes at least 90% of its REIT taxable income to its stockholders. If Aimco’s taxable income exceeds its dividends in a tax year, REIT tax rules allow Aimco to “throw back” dividends from the subsequent tax year in order to avoid current taxation on undistributed income. Throwing back of dividends can result in excise taxes. REITs are also subject to a number of other organizational and operational requirements. If Aimco fails to qualify as a REIT in any taxable year, its taxable income will be subject to United States Federal income tax at regular corporate rates (including any applicable alternative minimum tax). Even if Aimco qualifies as a REIT, it may be subject to certain state and local income taxes and to United States Federal income tax. Aimco also will be required to pay a 100% tax on non-arms length transactions between it and a taxable REIT subsidiary and on any net income from sales of property that was property held for sale to customers in the ordinary course.
Certain of Aimco’s operations (property management, asset management, risk, etc.) are conducted through taxable REIT subsidiaries, which are subsidiaries of the Partnership and each of which we refer to as a TRS. A TRS is a C-corporation that has not elected REIT status and as such is subject to United States Federal corporate income tax. Aimco uses the TRS format to facilitate its ability to offer certain services and activities to its residents, which services and activities are not generally considered to be qualifying REIT activities.
For our taxable REIT subsidiaries, deferred income taxes result from temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for Federal income tax purposes, and are measured using the enacted tax rates and laws that are expected to be in effect when the differences reverse. We reduce deferred tax assets by recording a valuation allowance when we determine based on available evidence that it is more likely than not that the assets will not be realized.
Earnings per Unit
We calculate earnings per unit based on the weighted average number of common OP Units, common unit equivalents and dilutive convertible securities outstanding during the period. Diluted earnings per unit also includes the effect of potential issuances of additional common OP Units if stock options and warrants were exercised or converted into Aimco Class A Common Stock (see Note 15).
Fair Value of Financial Instruments
The aggregate fair value of our cash and cash equivalents, receivables, payables and short-term secured debt as of December 31, 2005 approximates their carrying value due to their relatively short-term nature. We further believe that the fair value of our variable rate secured tax-exempt bond debt and secured long-term debt also approximate their carrying value. For notes receivable, fixed rate secured tax-exempt bond debt and secured long-term debt, fair values have been based on estimates using present value techniques. Present value calculations vary significantly depending on the assumptions used, including the discount rate and estimates of future cash flows. We estimate fair value for our fixed rate debt agreements based on the market rate for debt with the same or similar terms. In many cases, the fair value estimates may not be realized in immediate settlement of the instruments. The estimated combined fair value of our notes receivable at December 31, 2005 and December 31, 2004, was approximately $211 million and $201 million, respectively. See Note 5 for further details on notes receivable. The estimated combined fair value of our secured tax-exempt bonds and secured notes payable, including amounts within liabilities related to assets held for sale, at December 31, 2005 and December 31, 2004, was approximately $5.8 billion and $5.9 billion, respectively. The combined carrying value of our secured tax-exempt bonds and secured notes payable, including amounts within liabilities related to assets held for sale, at both December 31, 2005 and December 31, 2004, was approximately $5.7 billion. See Note 6 for further details on secured tax-exempt bonds and secured notes payable.
Concentration of Credit Risk
Financial instruments that potentially could subject us to significant concentrations of credit risk consist principally of notes receivable. Concentrations of credit risk with respect to notes receivable are limited due to the large number of partnerships comprising our partnership base, and the geographic diversity of the underlying properties.
Use of Estimates
The preparation of our consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts included in the financial statements and accompanying notes thereto. Actual results could differ from those estimates.
Reclassifications
Certain items included in the 2004 and 2003 financial statements amounts have been reclassified to conform to the 2005 presentation.
NOTE 3 - Acquisitions
Real Estate Acquisitions
On February 28, 2005, Aimco completed the acquisition of Palazzo East at Park La Brea, a mid-rise apartment community with 610 units, for approximately $199.3 million. The purchase of Palazzo East at Park La Brea, was funded with cash of approximately $86.8 million and a variable rate secured property note of $112.5 million. In order to fund the acquisition of the Palazzo East at Park La Brea, we loaned $85.4 million to Aimco in exchange for a note receivable. Upon completion of the purchase, Aimco contributed the assets and liabilities of Palazzo East at Park La Brea to us in exchange for 3,416,478 Class Thirteen Partnership Preferred Units.
Additionally during the year ended December 31, 2005, we completed the acquisition of four properties in New York City and one in New Jersey with a total of 396 residential units and six retail spaces for an aggregate purchase price of approximately $84.3 million, including transaction costs. The purchases were primarily funded with new debt of $17.8 million, assumption of existing debt of $38.7 million and the remainder in cash.
On January 30, 2004, Aimco completed the acquisition of The Palazzo at Park La Brea located in Los Angeles, California, a mid-rise apartment community with 521 units, for $162.9 million, which included $0.5 million in transaction costs. Aimco paid approximately $69.7 million in cash and was required to repay existing construction loan financing of approximately $92.7 million. The repayment of existing mortgage indebtedness was funded primarily through a non-recourse, long-term, variable rate, partially amortizing property note of $88.1 million, with an interest rate of 1.50% over 30-day LIBOR. In order to fund the acquisition of The Palazzo at Park La Brea, we loaned $69.7 million to Aimco in exchange for a note receivable, which we refer to as The Palazzo at Park La Brea Note. The note bore interest at the rate of 5.25% per annum, with interest payments due on December 31 of each year, with all unpaid principal and interest due on December 31, 2014. Upon completion of the purchase, Aimco contributed the assets and liabilities of The Palazzo at Park La Brea to us in exchange for 2,787,111 Class Twelve Partnership Preferred Units, or the Class Twelve Preferred Units. The Class Twelve Preferred Units paid distributions of $1.3125 per unit on December 31 of each year, with the first distribution being prorated from the date of issuance. Aimco repaid The Palazzo at Park La Brea Note on March 24, 2004 with the proceeds from the issuance of Class U Cumulative Preferred Stock and concurrently all Class Twelve Preferred Units were converted into Class U Partnership Preferred Units.
Additionally during the year ended December 31, 2004, we completed the acquisitions of 10 properties containing approximately 1,359 residential units and some ground floor retail space for an aggregate purchase price of approximately $197.8 million. Of the 10 properties acquired, six are located in the New York City area, two in Massachusetts, one in Florida and one in the Chicago area. The purchases were funded with cash, tax-free exchange funds, new debt and the assumption of existing debt.
Acquisitions of Partnership Interests
During 2005 and 2004, we acquired limited partnership interests in 84 partnerships and 147 partnerships, respectively, in which our affiliates served as general partner. In connection with such acquisitions in both consolidated and unconsolidated real estate partnerships, during 2005 we paid approximately $56.0 million, including transaction costs, of which $55.6 million was in cash and the remainder in OP Units, and during 2004 we paid approximately $50.0 million, including transaction costs, of which $47.8 million was in cash and the remainder in OP Units. The 2005 and 2004 amounts were approximately $60.6 million and $89.2 million, respectively, in excess of the carrying amount of minority interest in such limited partnerships, which excess we generally assigned to real estate.
NOTE 4 - Investments in Unconsolidated Real Estate Partnerships
We owned general and limited partner interests in unconsolidated real estate partnerships owning approximately 264, 330 and 441 properties at December 31, 2005, 2004 and 2003, respectively. We acquired these interests through various transactions, including large portfolio acquisitions and offers to individual limited partners. Our total ownership interests in these unconsolidated real estate partnerships ranges typically from less than 1% to 50%.
The following table provides selected combined financial information for unconsolidated real estate partnerships as of and for the years ended December 31, 2005, 2004 and 2003 (in thousands):
The decrease in the amounts in the above table from year to year was primarily due to dispositions of real estate owned by the unconsolidated real estate partnerships and our purchase of additional interests in, and resulting consolidation of, various partnerships previously accounted for under the equity method.
As a result of our acquisition of interests in unconsolidated real estate partnerships, the investment in these partnerships at December 31, 2005 and 2004 of $166.7 million and $206.7 million, respectively, is approximately $234.9 million and $271.2 million, respectively, in excess of our share of the underlying historical partners’ deficit of the partnerships. The excess of the cost of the investments acquired over the equity in the underlying historical partners’ deficit is primarily ascribed to the fair values of land and buildings owned by the unconsolidated real estate partnerships. We amortize the excess basis related to the buildings over the estimated useful lives of the buildings. Such amortization is recorded as a component of equity in losses of unconsolidated real estate partnerships.
NOTE 5 - Notes Receivable
The following table summarizes our notes receivable at December 31, 2005 and 2004 (in thousands):
Included in notes receivable from unconsolidated real estate partnerships at December 31, 2005 and 2004, are $28.8 million and $31.3 million, respectively, in notes that were secured by interests in real estate or interests in real estate partnerships. We earn interest on these secured notes receivable at various annual interest rates ranging between 6.0% and 12.0% and averaging 10.3%.
Included in the notes receivable from non-affiliates at December 31, 2005 and 2004, are $6.4 million and $9.1 million, respectively, in notes that were secured by interests in real estate or interests in real estate partnerships. We earn interest on these secured notes receivable at various annual interest rates ranging between 4.0% and 7.3% and averaging 6.1%.
Additionally, included in notes receivable from non-affiliates at December 31, 2005 and 2004 are notes receivable from Alan I. Casden for an aggregate of $2.5 million and $9.4 million, respectively. The notes were part of the settlement of litigation involving NAPICO that was underway prior to the March 2002 acquisition of Casden Properties, Inc. by Aimco (which we refer to as the Casden Transactions) in which Aimco acquired NAPICO. The notes were secured by certain shares of Aimco Class A Common Stock and certain settlement cash proceeds. In 2004, Aimco entered into an agreement with respect to certain proceeds to be received by Alan I. Casden and his right to deliver Aimco Class A Common Stock at an agreed-upon value of $47 per share in satisfaction of the Notes. Pursuant to this agreement, in 2004 Aimco received $20 million in cash as payment in full on three notes due in 2004, 2005 and 2006. In 2005, Aimco received cash payments of $7.0 million in satisfaction of the note due in 2007 and in partial satisfaction of the note due in 2008. In 2006, Aimco will receive a final payment of $2.5 million in satisfaction of the note due in 2008. This transaction resolved a contingency based on the price of Aimco Class A Common Stock related to the Casden Transactions. In accordance with SFAS 141, in 2004 Aimco recorded a $4.8 million charge to additional paid-in capital, representing the difference between the $29.1 million fair value of the consideration to be paid pursuant to the settlement and the $33.9 million book value of the notes.
Interest income from total non-impaired par value and certain discounted notes for the years ended December 31, 2005, 2004 and 2003 totaled $19.2 million, $20.5 million and $15.5 million, respectively. For the years ended December 31, 2005, 2004, and 2003, we recognized accretion income on certain discounted notes of approximately $2.5 million, $6.3 million and $3.3 million, respectively.
The activity in the allowance for loan losses in total for both par value notes and discounted notes for the years ended December 31, 2005 and 2004, is as follows (in thousands):
During the years ended December 31, 2005 and 2004, we determined that an allowance for loan losses of $2.4 million and $3.7 million, respectively, was required on certain of our par value notes that had carrying values of $6.5 million and $17.1 million, respectively. The average recorded investment in the impaired par value notes for the years ended December 31, 2005 and 2004 was $6.7 million and $11.8 million, respectively. The remaining $105.8 million in par value notes receivable at December 31, 2005 is estimated to be collectible and, therefore, interest income on these par value notes is recognized as it is earned.
As of December 31, 2005 and 2004, we determined that an allowance for loan losses of $2.5 million and $3.4 million, respectively, was required on certain of our discounted notes that had carrying values of $5.0 million and $6.0 million, respectively. The average recorded investment in the impaired discounted notes for the years ended December 31, 2005 and 2004 was $5.0 million and $5.9 million, respectively.
NOTE 6 - Secured Tax-Exempt Bond Financings and Secured Notes Payable
The following table summarizes our secured tax-exempt bond financings at December 31, 2005 and 2004, the majority of which is non-recourse to us (in thousands):
Fixed rate secured tax-exempt bonds payable mature at various dates through October 2045. Variable rate secured tax-exempt bonds payable mature at various dates through June 2034. Principal and interest on these bonds are generally payable in semi-annual installments or in monthly interest-only payments with balloon payments due at maturity. Certain of our tax-exempt bonds at December 31, 2005 are remarketed periodically by a remarketing agent to maintain a variable yield. If the remarketing agent is unable to remarket the bonds, then the remarketing agent can put the bonds to us. We believe that the likelihood of this occurring is remote. At December 31, 2005, our secured tax-exempt bond financings were secured by 81 properties with a combined net book value of $1,661.0 million.
The following table summarizes our secured notes payable at December 31, 2005 and 2004, the majority of which are non-recourse to us (in thousands):
Fixed rate secured notes payable mature at various dates through August 2053. Variable rate secured notes payable mature at various dates through August 2011. Principal and interest are generally payable monthly or in monthly interest-only payments with balloon payments due at maturity. At December 31, 2005, our secured notes payable were secured by 515 properties with a combined net book value of $7,012.7 million.
We have a secured revolving credit facility that provides for borrowings of up to $250 million primarily to be used for financing properties that we generally intend to hold for the intermediate term, as well as properties that are designated for redevelopment. In addition to
the amounts in the above table, there were approximately $4 million and $10 million of notes that were provided through this facility that are obligations of unconsolidated real estate partnerships and not included within secured notes payable at December 31, 2005 and 2004, respectively. The interest rate on the notes provided through this facility is the Fannie Mae Discounted Mortgage-Backed Security index plus 0.85%, which interest rate resets monthly. Each such loan under this facility is treated as a separate borrowing and is collateralized by a specific property, and none of the loans is cross-collateralized or cross-defaulted. This facility matures in September 2007, but can be terminated and repaid in full without penalty.
Our consolidated debt instruments generally contain covenants common to the type of facility or borrowing, including financial covenants establishing minimum debt service coverage ratios and maximum leverage ratios. At December 31, 2005, we were in material compliance with all financial covenants pertaining to our consolidated debt instruments.
As of December 31, 2005, the scheduled principal amortization and maturity payments for our secured tax-exempt bonds and secured notes payable are as follows (in thousands):
NOTE 7 - Mandatorily Redeemable Preferred Securities
In connection with the Insignia merger in 1998, we assumed the obligations under Trust Based Convertible Preferred Securities, which we refer to as TOPRS, with an aggregate liquidation amount of $149.5 million. Prior to 2005, approximately $134.5 million of these securities were converted into Aimco Class A Common Stock, resulting in $15.0 million remaining as of December 31, 2004, which also represented the redemption value. On January 11, 2005, we redeemed for cash all outstanding TOPRS for a total redemption price of $50 per security, or $15.0 million, plus any accrued and unpaid distributions through the redemption date. For the years ended December 31, 2005, 2004 and 2003, $30,000, $1.0 million and $1.0 million, respectively, of distributions have been recorded in interest expense.
NOTE 8 - Term Loans and Credit Facility
On November 2, 2004, we entered into an Amended and Restated Senior Secured Credit Agreement, which we refer to as the Credit Agreement, with a syndicate of financial institutions. In addition to Aimco, the Partnership and an Aimco subsidiary are also borrowers under the Credit Agreement. The Credit Agreement replaced our previous two separate credit agreements.
The Credit Agreement includes customary financial covenants, including the maintenance of specified ratios with respect to total indebtedness to gross asset value, total secured indebtedness to gross asset value, aggregate recourse indebtedness to gross asset value, variable rate debt to total indebtedness, debt service coverage and fixed charge coverage; the maintenance of a minimum adjusted tangible net worth; and limitations regarding the amount of cross-collateralized debt. The Credit Agreement includes other customary covenants, including a restriction on distributions and other restricted payments, but permits distributions during any four consecutive fiscal quarters in an aggregate amount of up to 95% of our funds from operations for such period or such amount as may be necessary to maintain Aimco’s REIT status. The Credit Agreement also permits Aimco to repurchase Aimco Class A Common Stock using up to 80% of sales proceeds in any trailing four-quarter period.
The original aggregate commitment under the Credit Agreement was $750 million, comprised of $450 million of revolving loan commitments and a $300 million term loan tranche. The revolving loans bear interest at a rate equal to (i) the LIBOR rate plus a margin that can range from 1.50% to 2.00% (for LIBOR loans) or (ii) the base rate plus a margin that can range from 0% to 0.25% (for base rate loans), in each case, depending on our leverage ratio. The original $300 million term loan bears interest at a rate equal to (i) the LIBOR rate plus 2.00% (for LIBOR loans) or (ii) the base rate plus 0.25% (for base rate loans). The default rate of interest for the loan is equal to the applicable rate described above plus 3%. The revolving loans mature on November 2, 2007, and the term loan matures on November 2, 2009.
On June 16, 2005, we amended the Credit Agreement to provide for $100.0 million in additional term loan borrowings from a syndicate of financial institutions. The additional $100.0 million term loan matures on November 2, 2009 and bears interest at a rate of either LIBOR plus 1.75% or a base rate (determined by reference to the federal funds rate or Bank of America’s prime rate) plus 0.25%. The proceeds from the additional term loan were used to repay outstanding revolving loans.
The lenders under the Credit Agreement may accelerate any outstanding loans if, among other things: we fail to make payments when due (subject to applicable grace periods); material defaults occur under other debt agreements; certain bankruptcy or insolvency events occur; material judgments are entered against us; we fail to comply with certain covenants, such as the requirement to deliver financial information or the requirement to provide notices regarding material events (subject to applicable grace periods in some cases); indebtedness is incurred in violation of the covenants; or prohibited liens arise.
At December 31, 2005, the outstanding principal balance of the term loans was $400.0 million at a weighted average interest rate of 6.18%. At December 31, 2005, the outstanding principal balance of the revolving loans was $217.0 million at a weighted average interest rate of 6.26% (based on various weighted average LIBOR and base rate borrowings outstanding with various maturities). The amount available under the revolving facility at December 31, 2005 was $208.3 million (after giving effect to $24.7 million outstanding for undrawn letters of credit issued under the revolving facility). As of December 31, 2005, we were in compliance with all financial covenant requirements.
NOTE 9 - Commitments and Contingencies
Commitments
In connection with the Casden Transactions, we and Aimco made commitments to:
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invest up to $50 million for a 20% limited liability company interest in Casden Properties LLC. As of December 31, 2005, we had invested $44.8 million. Casden Properties LLC intends to pursue new development opportunities in Southern California and other markets. We have an option, but not an obligation, to purchase at completion all multifamily rental projects developed by Casden Properties LLC; and
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pay $2.5 million per quarter for five years (for an aggregate amount of $50 million) to Casden Properties LLC as a retainer on account for redevelopment services on our assets. As of December 31, 2005, $37.5 million has been paid.
In connection with our redevelopment and capital improvement activities, we have commitments of approximately $99.6 million related to construction projects that are due to be completed by early 2007. Additionally, there are times we may enter into certain commitments for future purchases of goods and services in connection with the operations of our properties. Those commitments generally have terms of one year or less and reflect expenditure levels comparable to our historical expenditures.
Tax Credit Syndication
We are required to manage certain consolidated real estate partnerships in compliance with various laws, regulations and contractual provisions that apply to our syndication of historic and low-income housing tax credits. In some instances, noncompliance with applicable requirements could result in projected tax benefits not being realized and require a refund or reduction of investor capital contributions, which are reported as minority interests in our consolidated balance sheet. The remaining compliance period for our tax credit syndication arrangements range from less than one year to 15 years. At December 31, 2005, we do not anticipate that any material refunds or reductions of investor capital contributions will be required in connection with these arrangements.
Legal Matters
In addition to the matters described below, we are a party to various legal actions and administrative proceedings arising in the ordinary course of business, some of which are covered by liability insurance, and none of which we expect to have a material adverse effect on our consolidated financial condition or results of operations.
Limited Partnerships
In connection with our acquisitions of interests in real estate partnerships, we are sometimes subject to legal actions, including allegations that such activities may involve breaches of fiduciary duties to the partners of such real estate partnerships or violations of the relevant partnership agreements. We may incur costs in connection with the defense or settlement of such litigation. We believe that we comply with our fiduciary obligations and relevant partnership agreements. Although the outcome of any litigation is uncertain, we do not expect any such legal actions to have a material adverse affect on our consolidated financial condition or results of operations.
Environmental
Various Federal, state and local laws subject property owners or operators to liability for management, and the costs of removal or remediation, of certain hazardous substances present on a property. Such laws often impose liability without regard to whether the owner or operator knew of, or was responsible for, the release or presence of the hazardous substances. The presence of, or the failure to manage or remedy properly, hazardous substances may adversely affect occupancy at affected apartment communities and the ability to sell or finance affected properties. In addition to the costs associated with investigation and remediation actions brought by government agencies, and potential fines or penalties imposed by such agencies in connection therewith, the presence of hazardous substances on a property could result in claims by private plaintiffs for personal injury, disease, disability or other infirmities. Various laws also impose liability for the cost of removal, remediation or disposal of hazardous substances through a licensed disposal or treatment facility. Anyone who arranges for the disposal or treatment of hazardous substances is potentially liable under such laws. These laws often impose liability whether or not the person arranging for the disposal ever owned or operated the disposal facility. In connection with the ownership, operation and management of properties, we could potentially be liable for environmental liabilities or costs associated with our properties or properties we acquire or manage in the future.
We have determined that our legal obligations to remove or remediate hazardous substances may be conditional asset retirement obligations as defined in FIN 47. Except in limited circumstances where the asset retirement activities are expected to be performed in connection with a planned construction project or property casualty, we believe that the fair value of our asset retirement obligations cannot be reasonably estimated due to significant uncertainties in the timing and manner of settlement of those obligations. Asset retirement obligations that are reasonably estimable as of December 31, 2005 are immaterial to our consolidated financial condition and results of operations.
Mold
Aimco has been named as a defendant in lawsuits that have alleged personal injury and property damage as a result of the presence of mold. In addition, we are aware of lawsuits against owners and managers of multifamily properties asserting claims of personal injury and property damage caused by the presence of mold, some of which have resulted in substantial monetary judgments or settlements. We have only limited insurance coverage for property damage loss claims arising from the presence of mold and for personal injury claims related to mold exposure. We have implemented policies, procedures, third-party audits and training, and include a detailed moisture intrusion and mold assessment during acquisition due diligence. We believe these measures will prevent or eliminate mold exposure from our properties and will minimize the effects that mold may have on our residents. To date, we have not incurred any material costs or liabilities relating to claims of mold exposure or to abate mold conditions. Because the law regarding mold is unsettled and subject to change we can make no assurance that liabilities resulting from the presence of or exposure to mold will not have a material adverse effect on our consolidated financial condition or results of operations.
Unclaimed Property and Use Taxes
Based on inquiries from several states, we are reviewing our historic forfeiture of unclaimed property pursuant to applicable state and local laws. We are also reviewing our historic filing of use tax returns in certain state and local jurisdictions that impose such taxes. At this time, we do not have sufficient information available to determine the extent or potential effect of any non-compliance on our consolidated financial condition or results of operations.
National Union Litigation
National Program Services, Inc. and Vito Gruppuso (collectively “NPS”) were insurance agents who sold to Aimco property insurance issued by National Union Fire Insurance Company of Pittsburgh, Pennsylvania (“National Union”). The financial failure of NPS resulted in defaults under two agreements by which NPS indemnified Aimco from losses relating to the matters described below. As a result of such defaults, Aimco had a $16.7 million insurance-related receivable that was subsequently reduced to $6.7 million following Aimco’s settlement with Lumbermens Mutual Casualty Company (“Lumbermens”) and an insurance agency. In addition, Aimco has pending litigation against National Union, First Capital Group, a New York based insurance wholesaler, NPS and other agents of National Union, for a refund of at least $10 million of the prepaid premium plus other damages. Trial is set for May 30, 2006. The contingent liabilities arising from the NPS defaults also resulted in litigation against Aimco by Cananwill, Inc. (“Cananwill”), a premium funding company, regarding an alleged balance due of $5.7 million on a premium finance agreement that funded premium payments made to National Union. Aimco is also a plaintiff in litigation against Cananwill and Combined Specialty Insurance Company, formerly known as Virginia Surety Company, Inc., alleging Cananwill’s conversion of $1.6 million of unearned premium belonging to Aimco and misapplication of such funds to the alleged debt asserted in the lawsuit initiated by Cananwill. The matter in which Aimco is a plaintiff has been stayed by the court pending resolution of the action filed by Cananwill against us. The previously disclosed litigation brought by WestRM - West Risk Markets, Ltd. (“WestRM”) against XL Reinsurance America, Inc. (“XL”), Greenwich Insurance Company (“Greenwich”) and Lumbermens in which Aimco had been made a third party defendant continues. Summary judgment has been entered against defendants XL and Greenwich. Similarly, the previously disclosed litigation brought by Highlands Insurance Company (“Highlands”) against Cananwill, XL, Greenwich and Aimco also continues. In those cases in which Aimco is a defendant, Aimco believes that it has meritorious defenses to assert, and will vigorously defend itself against claims brought against it. In addition, Aimco will vigorously prosecute its own claims. Although the outcome of any claim or matter in litigation is uncertain, we do not believe that we will incur any material loss in connection with the insurance-related receivable or that the ultimate outcome of these separate but related matters will have a material adverse effect on our consolidated financial condition or results of operations.
FLSA Litigation
We and NHP Management Company (“NHPMN”), our subsidiary, are defendants in a lawsuit alleging that they willfully violated the Fair Labor Standards Act (“FLSA”) by failing to pay maintenance workers overtime for all hours worked in excess of forty per week. The complaint, filed in the United States District Court for the District of Columbia, attempts to bring a collective action under the FLSA and seeks to certify state subclasses in California, Maryland, and the District of Columbia. Specifically, the plaintiffs contend that we and NHPMN failed to compensate maintenance workers for time that they were required to be “on-call.” Additionally, the complaint alleges we and NHPMN failed to comply with the FLSA in compensating maintenance workers for time that they worked in excess of 40 hours in a week. In June 2005, the court conditionally certified the collective action on both the on-call and overtime issues, which allows the plaintiffs to provide notice of the collective action to all non-exempt maintenance workers from August 7, 2000 through the present. Notices have been sent out to all current and former hourly maintenance workers. The opt-in period has not yet closed. When it does, we and NHPMN will have the opportunity to move to decertify the collective action. Because the court denied plaintiffs’ motion to certify state subclasses, on September 26, 2005, the plaintiffs filed a class action with the same allegations in the Superior Court of California (Contra Costa County), and on November 5, 2005 in Montgomery County Maryland Circuit Court. Although the outcome of any litigation is uncertain, we do not believe that the ultimate outcome will have a material adverse effect on our consolidated financial condition or results of operations.
SEC Investigation
The Central Regional Office (the “Regional Office”) of the United States Securities and Exchange Commission (the “Commission”) conducted a formal investigation relating to certain matters. We believe the areas of investigation included Aimco’s miscalculated monthly net rental income figures in third quarter 2003, forecasted guidance, accounts payable, rent concessions, vendor rebates, capitalization of payroll and certain other costs, and tax credit transactions. On December 19, 2005, Aimco announced that the Regional Office informed them that its investigation has been recommended for termination and no enforcement action has been recommended to the Commission.
Operating Leases
We are obligated under office space and equipment non-cancelable operating leases. In addition, we sublease certain of our office space to tenants under non-cancelable subleases. Approximate minimum annual rentals under operating leases and approximate minimum payments to be received under annual subleases are as follows (in thousands):
Substantially all of the office space and equipment subject to the operating leases described above are for the use of our corporate offices and regional operating centers. Rent expense recognized totaled $7.4 million, $5.8 million, and $6.1 million for the years ended December 31, 2005, 2004 and 2003, respectively. Sublease receipts that offset rent expense totaled approximately $0.7 million, $0.9 million and $1.1 million for the years ended December 31, 2005, 2004 and 2003, respectively.
NOTE 10 - Income Taxes
Deferred income taxes reflect the net effects of temporary differences between the carrying amounts of assets and liabilities of the taxable REIT subsidiaries for financial reporting purposes and the amounts used for income tax purposes. Significant components of our deferred tax liabilities and assets are as follows (in thousands):
During the year ended December 31, 2005, we identified approximately $12.2 million in previously unrecorded net deferred tax assets that were acquired in connection with business combinations in prior years. We recorded adjustments to recognize these net assets and reduce goodwill and real estate acquired in the corresponding business combinations by $6.2 million and $6.0 million, respectively. At December 31, 2005 and 2004, we maintained a $1.9 million valuation allowance for deferred tax assets primarily related to alternative minimum tax credits totaling approximately $1.9 million. At December 31, 2004, we also maintained a $1.2 million valuation allowance for certain low income housing credits and rehabilitation credits. That allowance was reversed in 2005 based on our determination that it is more likely than not that the credits will be realized.
Significant components of the provision (benefit) for income taxes are as follows and are classified within other expenses (income), net in continuing operations and income from discontinued operations, net in our statements of income for 2005, 2004 and 2003 (in thousands):
Consolidated income (loss) subject to tax, consisting of pretax income of our taxable REIT subsidiaries and gains on certain property sales that are subject to income tax under section 1374 of the Internal Revenue Code, is $(36.9) million for 2005, $20.5 million for 2004, and ($4.0) million for 2003. The reconciliation of income tax attributable to continuing and discontinued operations computed at the U.S. statutory rate to income tax expense (benefit) is shown below (dollars in thousands):
During the quarter ended March 31, 2003, in an effort to streamline business processes and operational efficiencies of our property management and services businesses, we contributed all of the capital stock of NHP Management Company to AIMCO/Bethesda Holdings, Inc. (both of which are wholly-owned taxable REIT subsidiaries). In connection with this transaction, we reversed a valuation allowance related to future deductions and tax loss carryforwards of NHP Management Company and thereby recognized approximately $8.0 million of deferred tax benefits within other expenses (income), net. This deferred tax benefit increased net income by approximately $8.0 million and resulted in an increase in basic and diluted earnings per unit of $0.08 for the year ended December 31, 2003.
Income taxes paid totaled approximately $4.8 million, $2.7 million, and $3.8 million in the years ended December 31, 2005, 2004 and 2003, respectively.
At December 31, 2005, we had net operating loss carryforwards (NOLs) of approximately $87.0 million for income tax purposes that expire in years 2020 to 2023. Subject to certain separate return limitations, we may use these NOLs to offset all or a portion of taxable income generated by our taxable REIT subsidiaries. Additionally, at December 31, 2005, we had low-income housing and rehabilitation tax credit carryforwards of approximately $6.0 million for income tax purposes that expire in years 2012 to 2024.
Note 11 - Related Party Notes Receivable
In exchange for the sale of certain real estate assets to Aimco in December 2000, we received notes receivable, which we refer to as the Notes, totaling $10.1 million. The Notes bear interest at the rate of 5.7% per annum. Of the $10.1 million total, $7.6 million is due upon demand, and the remainder is due in scheduled semi-annual payments with all unpaid principal and interest due on December 31, 2010. At December 31, 2005 and 2004, the balance of the Notes totaled $13.3 million and $12.6, respectively, which includes accrued and unpaid interest.
On February 28, 2005, in connection with the acquisition of Palazzo East at Park La Brea, the Partnership loaned $85.4 million to Aimco in exchange for a note receivable, which is presented as a deduction from partners’ capital. The note bears interest at the rate of 5.25% per annum, with interest payments due on December 31 of each year.
NOTE 12 - Partners’ capital
Preferred OP Units
All classes of preferred OP Units are pari passu with each other and are senior to the common OP Units. None of the classes of preferred OP Units have any voting rights, except the right to approve certain changes to the Partnership Agreement that would adversely affect holders of such class of units. Distributions on all preferred OP Units are subject to being declared by the General Partner.
At December 31, 2005 and 2004, we had the following classes of preferred OP Units outstanding (stated at their redemption values) owned by Aimco:
(1)
All classes of preferred units are redeemable by the Partnership only in connection with a concurrent redemption by Aimco of the corresponding preferred Aimco equity held by unrelated parties.
(2)
On January 21, 2005, Aimco redeemed for cash the remaining 1.25 million shares outstanding of the Class D Cumulative Preferred Stock for a total redemption price of $25.0425 per share, which included a redemption price of $25.0 per share, and $0.0425 per share of accumulated and unpaid dividends through January 21, 2005. Concurrently with this redemption, we redeemed for cash the remaining Class D Partnership Preferred Units. This redemption resulted in $1.1 million of related preferred OP Unit issuance costs being deducted from net income to arrive at net loss attributable to common unitholders and thereby increased by $0.01 our loss per basic and diluted common unit for the year ended December 31, 2005.
(3)
The Partnership’s agreement of limited partnership sets forth the relative rights and preferences of each class of securities and as shown above, the distribution rate on each class of convertible securities is the rate specified in the Partnership agreement for each class. Such rate can be increased to the rate of the distributions paid on the number of common OP Units into which one unit of such preferred security is convertible. The initial conversion price of each class was in excess of the fair market value of a common OP Unit
on the respective dates on which the purchasers of each class agreed to purchase such securities.
(4)
On February 28, 2005, in connection with the acquisition of Palazzo East at Park La Brea, Aimco contributed the assets and liabilities of Palazzo East at Park La Brea to us in exchange for 3,416,478 Class Thirteen Preferred Units, or the Class Thirteen Preferred Units. The Class Thirteen Preferred Units pay distributions of $1.3125 per unit on December 31 of each year, with the first distribution prorated from the date of issuance.
As of December 31, 2005 and 2004, the following classes of preferred OP Units (stated at their redemption values) owned by third parties were outstanding (in thousands, except unit data):
For all preferred OP Units that are redeemable for Aimco Class A Common Stock, upon redemption, we will issue a common OP Unit to Aimco for each share of Aimco Class A Common Stock issued. In addition, subject to certain conditions, the Class Four, Class Five, Class Six and Class Eight Partnership Preferred Units are convertible into common OP Units, two years from issuance, after December 21, 2000, three years from issuance, and after November 16, 2001, respectively.
During the years ended December 31, 2005 and 2004 approximately 1,700 and 10,400 preferred OP Units were tendered for redemption in exchange for approximately 1,100 and 7,900 shares of Aimco Class A Common Stock, respectively. Additionally, during the years ended December 31, 2005 and 2004, approximately 12,800 and 1,600 preferred OP Units were tendered for redemption in exchange for cash.
The distributions paid on each class of preferred OP Units classified as partners’ capital for the years ended December 31, 2005, 2004, and 2003 are as follows (in thousands, except per unit data):
Common OP Units
Common OP Units are redeemable by common OP Unitholders (other than the General Partner and Special Limited Partner) at their option, subject to certain restrictions, on the basis of one common OP Unit for either one share of Aimco Class A Common Stock or cash equal to the fair value of a share of Aimco Class A Common Stock at the time of redemption. We have the option to deliver shares of Aimco Class A Common Stock in exchange for all or any portion of the cash requested. When a Limited Partner redeems a common OP Unit for Aimco Class A Common Stock, Limited Partners’ Capital is reduced and Special Limited Partners’ capital is increased. Common OP Units held by Aimco are not redeemable.
During the years ended December 31, 2005 and 2004, approximately 77,000 and 160,000 common OP Units, respectively, were redeemed in exchange for cash, and approximately 425,000 and 735,000 common OP Units, respectively, were redeemed in exchange for shares of Aimco Class A Common Stock. Additionally, we completed tender offers for limited partnership interests resulting in the issuance of approximately 3,000 and 82,000 common OP Units in 2005 and 2004, respectively.
During 2005 and 2004, Aimco issued approximately 37,000 shares and 45,000 shares, respectively, of Aimco Class A Common Stock to certain of its non-executive officers at market prices. In exchange for the shares purchased, the officers executed notes payable totaling $1.4 million and $1.5 million, respectively. These notes, which are 25% recourse to the borrowers, have a 10-year maturity and bear interest either at a fixed rate of 6% annually or a floating rate based on the one-month LIBOR plus 3.85%, which is subject to an annual interest rate cap of typically 7.25%. The notes were contributed by Aimco to us in exchange for approximately 37,000 and 45,000 common OP Units, respectively. Total payments on such notes from officers in 2005 and 2004 were $12.3 million and $4.6 million, respectively.
In addition, in 2005 and 2004, we issued approximately 393,000 and 532,000 common OP Units to Aimco and Aimco issued approximately 393,000 and 532,000 restricted shares of Aimco Class A Common Stock, respectively, to certain officers and employees. The restricted stock was recorded at the fair market value of Aimco Class A Common Stock on the date of issuance. These restricted shares of Aimco Class A Common Stock may not be sold, assigned, transferred, pledged, hypothecated or otherwise disposed of and are subject to a risk of forfeiture prior to the expiration of the applicable vesting period (typically ratably over a period of three or five years). Certain shares of restricted stock issued during 2005 are subject to accelerated vesting upon the achievement of a specified calendar year performance measure target. As of December 31, 2005, achievement of the specified target is not considered probable.
There were no shares of Aimco Class A Common Stock repurchased during the year ended December 31, 2005. On February 18, 19 and 24, 2004, Aimco purchased on the open market 30,000, 60,000 and 20,000 shares of Aimco Class A Common Stock, respectively, at an average price per share of approximately $32.03, $32.17 and $31.26, respectively. Concurrently, we purchased 30,000, 60,000 and 20,000 common OP Units from Aimco. Additionally, on February 24, 2004, Aimco completed the purchase of 287,272 shares of Class A Common Stock in a privately negotiated transaction at a price of $31.60 per share. Concurrently, we purchased 287,272 common OP Units from Aimco.
High Performance Partnership Units
In January 1998, Aimco shareholders approved the sale by the Partnership of an aggregate of 15,000 Class I High Performance Partnership Units to a joint venture comprised of fourteen members of Aimco’s senior management and to three of Aimco’s independent directors for $2.1 million in cash. The value of these units was determined on December 31, 2000 and the 15,000 units were adjusted to 2,379,084 units in January 2001. The holders of these units receive distributions and allocations of income and loss from us in the same amounts and at the same times as would holders of the same number of common OP Units.
On April 29, 2005, Aimco stockholders approved the sale by the Partnership of up to 5,000 of its Class VIII High Performance Units, or the Class VIII Units, for which the valuation period began on January 1, 2005 and will end on December 31, 2007. On May 31, 2005, we issued 5,000 Class VIII Units to a limited liability company owned by a limited number of employees for an aggregate offering price of $780,000. Additionally, at December 31, 2005, we had outstanding 5,000 Class VI High Performance Partnership Units, or the Class VI Units, for which the valuation period began on January 1, 2003 and ended on December 31, 2005 and 4,109 Class VII High Performance Partnership Units, or the Class VII Units, for which the valuation period began on January 1, 2004 and will end on December 31, 2006.
At December 31, 2005, we did not meet the required measurement benchmarks for the Class VI Units, Class VII Units, or Class VIII Units and therefore, we have not recorded any value to such High Performance Units in the consolidated financial statements as of December 31, 2005 and such High Performance Units have no dilutive effect.
Investment in Aimco
In 1998, Aimco issued 1.0 million shares of Class J Cumulative Convertible Preferred Stock, which we refer to as Class J Preferred Stock, for proceeds of $100.0 million. The proceeds were contributed by Aimco to us in exchange for 1.0 million Class J Partnership Preferred Units, which we refer to as Class J Preferred Units. Concurrently, we issued 250,000 Class J Preferred Units valued at $25.0 million to Aimco, in exchange for 250,000 shares of Class J Preferred Stock. In June 2000, we converted 250,000 shares of Aimco Class J Preferred Stock, with a liquidation value of $25 million, into 625,000 shares of Aimco Class A Common Stock. In connection with this conversion, 41,991 shares of Aimco Class A Common Stock, valued at $1.5 million, were exchanged by us for common OP Units held by a limited partner. In 2001, 198,269 shares of Aimco Class A Common Stock, valued at $7.1 million, were exchanged by us for common OP Units held by a limited partner. The investment in Aimco’s Class A Common Stock is presented in the accompanying financial statements as a reduction to partners’ capital.
Registration Statements
As of December 31, 2005, under the shelf registration statement filed by Aimco and the Partnership, which was declared effective in April 2004, Aimco had available for issuance approximately $876.6 million of debt and equity securities, and the Partnership had available for issuance $500.0 million of debt securities.
NOTE 13 - Employee Benefit and Stock Plans
Aimco, from time to time, issues stock options. Upon exercise of the stock options, Aimco must contribute to us the proceeds received in exchange for the same number of common OP Units as shares of Aimco Class A Common Stock issued in connection with the exercised stock options. Therefore, the following disclosures are made pertaining to Aimco’s stock options.
401K Plan
We provide a 401(k) defined-contribution employee savings plan. Employees who have completed 30 days of service and are age 18 or older are eligible to participate. Our matching contributions are made in the following manner: (1) a 100% match on the first 3% of the participant’s contribution; (2) a 50% match on the next 2% of the participant’s contribution. We incurred costs in connection with this plan of approximately $4.1 million, $3.2 million and $2.4 million in 2005, 2004 and 2003, respectively.
Stock Award and Incentive Plan and Stock Warrants
Aimco’s board of directors adopted the Apartment Investment and Management Company 1997 Stock Award and Incentive Plan, or the 1997 Plan to attract and retain officers, key employees and independent directors. The 1997 Plan reserves for issuance a maximum of 20,000,000 shares, which may be in the form of incentive stock options, non-qualified stock options and restricted stock, or other types of awards as authorized under the 1997 Plan. At December 31, 2005, there were approximately 4,200,000 shares available for issuance. The 1997 Plan is administered by the Compensation and Human Resources Committee of Aimco’s board of directors. In the case of incentive stock options, the exercise price of the options granted may not be less than the fair market value of the Aimco Class A Common Stock at the date of grant. The term of the incentive and non-qualified options is ten years from the date of grant. The options typically vest over a period of one to five years from the date of grant. Terms may be modified at the discretion of the Compensation and Human Resources Committee of Aimco’s board of directors.
The 1997 Plan also authorizes grants of restricted stock awards as part of Aimco’s equity compensation plan. For the years ended December 31, 2005, 2004 and 2003, Aimco granted restricted stock awards of approximately 393,000, 532,000 and 235,000 shares, respectively, with weighted average fair values per share of $38.46, $29.56, and $38.09, respectively. Compensation cost related to these awards is being recognized ratably over the applicable vesting period (typically three or five years). Dividends paid on restricted stock awards (whether vested or unvested) are charged to partners’ capital. We evaluate quarterly the previously paid dividends on restricted stock awards that are forfeited to determine whether a reclassification between partners’ capital and compensation expense should be recorded. Dividends paid on restricted stock awards that were forfeited were immaterial for the years ended December 31, 2005, 2004 and 2003.
On December 2, 1997, Aimco issued warrants, which are referred to as the Oxford Warrants, exercisable through December 31, 2006 to purchase up to an aggregate of 500,000 shares of Aimco Class A Common Stock at $41 per share. The Oxford Warrants were issued to affiliates of Oxford Realty Financial Group, Inc., a Maryland corporation, or Oxford, in connection with the amendment of certain agreements pursuant to which we manage properties formerly controlled by Oxford or its affiliates. During the year ended December 31, 2005, Aimco purchased from the holders thereof all outstanding Oxford Warrants for an aggregate purchase price of $1.05 million, which was determined to be fair value.
The following table summarizes the option and warrant activity for the years ended December 31, 2005, 2004 and 2003 (in thousands, except price data):
As of December 31, 2005, outstanding and exercisable options have the following ranges of exercise prices and remaining weighted average contractual terms (in thousands, except for price data):
NOTE 14 - Discontinued Operations and Assets Held for Sale
In accordance with SFAS 144 we report as discontinued operations real estate assets that meet the definition of a component of an entity and have been sold or meet the criteria to be classified as held for sale under SFAS 144. We included all results of these discontinued operations, less applicable income taxes, in a separate component of income on the consolidated statements of income under the heading “discontinued operations.” This treatment resulted in certain reclassifications of 2004 and 2003 financial statement amounts.
At December 31, 2005, we had eight properties with an aggregate of 1,756 units classified as held for sale. For the years ended December 31, 2005, 2004 and 2003, discontinued operations includes the results of operations of these properties. During the year ended December 31, 2005, we sold 83 properties with an aggregate of 16,835 units and our interest in one partnership. For the years ended December 31, 2005, 2004, and 2003, discontinued operations includes the results of operations of these 83 properties and one partnership for periods prior to the date of sale. During 2004, we sold 54 properties with an aggregate of 12,248 units. For the years ended December 31, 2004 and 2003, discontinued operations includes the results of operations of these 54 properties for periods prior to the date of sale. During 2003, we sold 72 properties with an aggregate of 18,291 units. For the year ended December 31, 2003, discontinued operations includes the results of operations of these 72 properties for periods prior to the date of sale.
The following is a summary of the components of income from discontinued operations for the years ended December 31, 2005, 2004, and 2003 (dollars in thousands):
We are currently marketing for sale certain real estate properties that are inconsistent with our long-term investment strategy. We expect that all properties classified as held for sale will sell within one year from the date classified as held for sale. Assets classified as held for sale of $55.0 million at December 31, 2005 include real estate net book value of $53.0 million and restricted cash and other assets of $2.0 million. Liabilities related to assets classified as held for sale of $39.5 million at December 31, 2005 include mortgage debt of $33.7 million. Assets classified as held for sale of
$618.7 million at December 31, 2004 include real estate net book value of $608.5 million, represented by 145 properties with 30,839 units that were classified as assets held for sale during 2004 and 2005. Liabilities related to assets classified as held for sale of $426.8 million at December 31, 2004 include mortgage debt of $419.8 million. The estimated proceeds, less anticipated costs to sell, for certain of these assets were less than the related net book value, and therefore we recorded impairment losses of $3.8 million, $7.3 million and $9.0 million for the years ended December 31, 2005, 2004 and 2003, respectively. We are also marketing for sale certain other properties that do not meet all of the criteria to be classified as held for sale.
NOTE 15 - Earnings per Unit
We calculate earnings per unit based on the weighted average number of common OP Units, common OP Unit equivalents and dilutive convertible securities outstanding during the period. The following table illustrates the calculation of basic and diluted earnings per unit for the years ended December 31, 2005, 2004 and 2003 (in thousands, except per unit data):
The Class W Partnership Preferred Units, Class X Partnership Preferred Units and Class Thirteen Preferred Units are convertible into common OP Units (see Note 12). All of our convertible preferred OP Units are anti-dilutive on an “as converted” basis, therefore, we deduct all of the distributions payable on the convertible preferred OP Units to arrive at the numerator and no additional units are included in the denominator when calculating basic and diluted earnings per common unit. We have excluded from diluted earnings per unit the common OP Unit equivalents related to approximately 12.6 million, 12.4 million and 11.8 million of vested and unvested stock options, units issued for non-
recourse notes receivable, and restricted stock awards for the years ended December 31, 2005, 2004 and 2003, respectively, because their effect would be anti-dilutive. For purposes of calculating diluted earnings per unit in accordance with Statement of Financial Accounting Standards No. 128, Earnings per Share, we treat the dilutive impact of the unvested portion of restricted shares as common OP Unit equivalents.
NOTE 16 - Unaudited Summarized Consolidated Quarterly Information
Summarized unaudited consolidated quarterly information for 2005 and 2004 is provided below (amounts in thousands, except per unit amounts).
NOTE 17 - Business Segments
We have two reportable segments: real estate (owning and operating apartments) and investment management business (providing property management and other services relating to the apartment business to third parties and affiliates). We own and operate properties throughout the United States and Puerto Rico that generate rental and other property related income through the leasing of apartment units to a diverse base of residents. We separately evaluate the performance of each of our properties. However, because each of our properties has similar economic characteristics, the properties have been aggregated into a single apartment communities, or real estate, segment. All real estate revenues are from external customers and no revenues are generated from transactions with other segments. No single resident or related group of residents contributed 10% or more of total revenues during the years ended December 31, 2005, 2004 or 2003.
Statement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related Information, or SFAS 131, requires that segment disclosures present the measure(s) used by the chief operating decision maker for purposes of assessing such segments’ performance. Our chief operating decision maker is comprised of several members of our executive management team who use several generally accepted industry financial measures to assess the performance of the business including net operating income, free cash flow, funds from operations, and adjusted funds from operations. In 2005 and 2004, the chief operating decision maker emphasized net operating income as a key measurement of segment profit or loss. Accordingly, below we disclose net operating income for each of our segments. Net operating income is defined as segment revenues (after the elimination of intersegment revenues) less direct segment operating expenses. In 2003, we reported free cash flow as the primary basis for measurement of segment profit or loss. Certain reclassifications have been made to 2004 and 2003 amounts to conform to the 2005 presentation. These reclassifications primarily represent presentation changes related to discontinued operations.
The following table presents revenues and net operating income for the years ended December 31, 2005, 2004 and 2003, from these segments, and reconciles net operating income of reportable segments to operating income as reported (in thousands):
ASSETS (in thousands):
(1)
Total assets for reportable segments include assets associated with both the real estate and investment management business segments, as well as our investment in unconsolidated real estate partnerships.
Our capital expenditures primarily relate to the real estate segment, and totaled $443.9 million, $301.9 million and $245.5 million for the years ended December 31, 2005, 2004 and 2003, respectively.
NOTE 18 - Transactions with Affiliates
We earn revenue from affiliated real estate partnerships. These revenues include fees for property management services, partnership and asset management services, risk management services and transactional services such as syndication and acquisition, development, refinancing, construction supervisory and disposition. In addition, we are reimbursed for our costs in connection with the management of the unconsolidated real estate partnerships. These fees and reimbursements for the years ended December 31, 2005, 2004 and 2003 totaled $73.6 million, $89.6 million and $93.1 million, respectively. The total accounts receivable due from affiliates was $43.1 million, net of allowance for doubtful accounts of $4.7 million, at December 31, 2005, and $39.2 million, net of allowance for doubtful accounts of $4.4 million, at December 31, 2004.
Additionally, we earn interest income on notes from real estate partnerships, in which we are the general partner and hold either par value or discounted notes. Interest income earned on par value notes from unconsolidated real estate partnerships totaled $17.4 million, $16.8 million, and $14.3 million for the years ended December 31, 2005, 2004 and 2003, respectively. Accretion income earned on discounted notes from unconsolidated real estate partnerships totaled $0.7 million, $6.2 million, and $2.7 million for the years ended December 31, 2005, 2004 and 2003, respectively. See Note 5 for additional information on notes receivable from unconsolidated real estate partnerships.
NOTE 19 - Recent Accounting Developments
In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004), Share-Based Payment, or SFAS 123R, which supersedes the existing SFAS 123, which we adopted in 2003 using the prospective method of transition as described therein. SFAS 123R requires all share-based employee compensation, including grants of employee stock options, to be recognized in the financial statements based on fair value and requires a modified prospective application method of adoption. Under this method, the provisions of SFAS 123R will be applied prospectively to new and modified awards granted on or after the required effective date. In addition, compensation cost is required to be recognized over the remaining vesting period for the unvested portion of outstanding awards granted prior to the effective date. The measurement and recognition provisions of SFAS 123R that apply to our stock option plans are similar to those currently being followed by us for awards granted on or after January 1, 2003. The primary change in expense recognition requirements, which also applies to our unvested restricted stock awards, relates to the treatment of forfeitures. Under SFAS 123R, expected forfeitures are required to be estimated in determining periodic compensation cost, whereas we currently recognize forfeitures as they occur. Upon adoption of SFAS 123R, we will estimate forfeitures of unvested awards of stock options and restricted stock and record a cumulative effect of a change in accounting principle to reflect the compensation expense that would not have been recognized in prior periods had forfeitures been estimated prior to the date of adoption. Aimco is required to adopt SFAS 123R as of January 1, 2006. Upon adoption, our periodic compensation cost will increase over the remaining vesting period for stock options granted prior to January 1, 2003, for which no cost is currently being recognized. Based on preliminary estimates of such additional compensation cost, we do not anticipate that the adoption of SFAS 123R will have a material effect on our consolidated financial condition or results of operations.
In May 2005, the FASB issued Statement of Financial Accounting Standards No. 154, Accounting Changes and Error Corrections, or SFAS 154, which replaces APB Opinion No. 20 and Statement of Financial Accounting Standards No. 3, and changes the requirements for the accounting for and reporting of a change in accounting principle. This statement is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005, although early adoption is permitted for accounting changes and corrections of errors made in fiscal years beginning after the date SFAS 154 was issued. We do not anticipate that the adoption of SFAS 154 will have a material effect on our consolidated financial condition or results of operations.
As discussed under Principles of Consolidation in Note 2, we applied EITF 04-5 after June 29, 2005 to newly formed limited partnerships and to existing limited partnerships for which the partnership agreement was modified. EITF 04-5 is effective on January 1, 2006 for general partners in all other limited partnerships. We are analyzing the effects of EITF 04-5 on our investments in limited partnerships where we are a general partner and have tentatively identified certain unconsolidated partnerships that will be consolidated upon adoption of EITF 04-5. We plan to adopt EITF 04-5 using a transition method that does not involve retrospective application, but potentially involves an adjustment to opening retained earnings for the cumulative effect of the change in accounting principle. A charge to opening retained earnings will be required if we consolidate partnerships with deficits in partners’ equity that we were not required to recognize using the equity method of accounting for our investments in such partnerships. After adoption, we may be required to recognize losses for deficit distributions to minority partners in newly consolidated partnerships that would not be recognized using the equity method. We have not yet fully determined the effects that the adoption of EITF 04-5 will have on our financial condition or results of operations, but we anticipate that it will result in consolidation of additional partnerships.
NOTE 20 - Subsequent Events
Redemption of Class Q Partnership Preferred Units
On February 17, 2006, Aimco announced that it would redeem for cash all 2.53 million outstanding shares of 10.10% Class Q Cumulative Preferred Stock on March 19, 2006. The total redemption price of $25.035 per share, or $63.3 million, includes the redemption price of $25.00 per share and $0.035 per share of accumulated and unpaid dividends through March 19, 2006. Concurrently with this redemption, we will redeem for cash 2.53 million Class Q Partnership Preferred Units at $25.035 per unit.
Sale of a Portion of the Flamingo South Beach Property
On February 17, 2006, we closed the sale of a portion of the Flamingo South Beach property known as the South Tower. The South Tower sale price was $163.5 million and included 562 residential units and our rights to the property’s marina. Additionally, the buyer paid non-refundable funds of $5 million for the option to purchase the 614-unit North Tower for $169 million between September 1, 2006 and February 28, 2007, (subject to the right to extend for up to six months subject to certain conditions), and the option to purchase the 513-unit Central Tower, along with the remainder of improvements on the property, for $267.5 million between December 1, 2007 and May 31, 2008 (subject to the right to extend for up to four months subject to certain conditions and provided that the buyer has previously purchased the North Tower). The sales agreement also provides us with profit participation if certain thresholds are met. We will receive, through one of our taxable REIT subsidiaries, the first $19.8 million in proceeds in the proposed condominium conversion after certain development fees and certain returns on the buyer’s equity have been achieved, plus 20% of the buyer’s net profits thereafter. At December 31, 2005, the South Tower had a net book value of approximately $80 million and related property debt of approximately $77 million.
Schedule III
AIMCO PROPERTIES, L.P.
REAL ESTATE AND ACCUMULATED DEPRECIATION
December 31, 2005
(In Thousands Except Unit Data)
(1)
Date we acquired the property or first consolidated the partnership which owns the property.
(2)
Initial cost includes the tendering costs to acquire the minority interest share of our consolidated real estate partnerships.
(3)
Costs capitalized subsequent to acquisition includes costs capitalized since acquisition or first consolidation of the partnership/property.
(4)
Other includes land parcels and commercial properties.
AIMCO PROPERTIES, L.P.
REAL ESTATE AND ACCUMULATED DEPRECIATION
For the Years Ended December 31, 2005, 2004 and 2003
(In Thousands)
(1)
Includes acquisition of limited partnership interests and related activity.
(2)
Represents activity on properties that have been sold or classified as held for sale that is included in the line items above.
(3)
Effective in fourth quarter of 2003 and on a prospective basis, all properties sold were classified as held for sale and, therefore, reclassified in the prior period balances.
INDEX TO EXHIBITS (1) (2)
(1)
Schedule and supplemental materials to the exhibits have been omitted but will be provided to the Securities and Exchange Commission upon request.
(2)
The file reference number for all exhibits is 000-24497, and all such exhibits remain available pursuant to the Records Control Schedule of the Securities and Exchange Commission.
*
Management contract or compensatory plan or arrangement