AvalonBay Communities Annual Report 2004

FY2004 Annual Report · AvalonBay Communities
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ANNUAL  REPORT 2004

AvalonBay  communities,  inc.  (nyse/pcx:  avb)  owns,  operates,  develops,  redevelops  and

acquires quality apartment communities in high barrier-to-entry markets in the northeast,

mid-atlantic,  midwest,  pacific  northwest  and  northern  and  southern  california  regions

of the united states. these markets are characterized by a limited supply of new apartment

LETTER TO
LETTER TO
SHAREHOLDERS
SHAREHOLDERS

WHERE?
WHERE?

homes and a high cost of single-family housing, leading to more favorable demand/supply

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2

8
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SUPERIOR VALUE CREATION.

fundamentals over the full business cycle. our strategy is to deeply penetrate our chosen 

markets  through  a  broad  range  of  products  and  services  with  an  intense  focus  on  our 

customer.  strong  execution  of  this  strategy  by  our  integrated  operating,  development,

redevelopment, investment and financial teams has resulted in a history of superior value

creation and financial performance.

we  own  or  hold  an  ownership  interest  in  148 communities  containing  42,810 apartment
homes in ten states and the district of columbia. More information about AvalonBay may

be found on our website at www.avalonbay.com.

WHAT?
WHAT?

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12

HOW?
HOW?

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16

WHY?
WHY?

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COVER PHOTO: AVALON GLENDALE, GLENDALE, CA

TO OUR SHAREHOLDERS

We  expected  2004  to  be  a  year  of  transition  and  indeed  it  was.  Job  growth  turned  positive,  apartment 

Rights to $3 billion—a significant source of future earnings 

fundamentals stabilized and capital flows to real estate accelerated. These factors, combined with strong execution 

and  value  creation.  Asset  sales  allowed  us  to  harvest 

harvesting value

by AvalonBay, led to a 2004 total shareholder return of 65%, the highest mark in our history and twice that of

the apartment sector.

In this letter I will review 2004 results and share our expectations for 2005. I will also expand on the theme 

of  this  year’s  report—“Superior  Value  Creation”—describing  how  our  focus  on  value  creation  guides  our 

decision making, keeping us centered on our overall goal of long-term outperformance.

2004 Year In Review
We began 2004 expecting revenue declines in our “Same-Store” portfolio to continue in the early months before

stabilizing later in the year, and we set goals and managed the business with this in mind. This initial assessment

2004 total shareholder
return  of  65%  was

the  highest  in  our

history and twice that 

of the apartment sector.

AVALON AT FLANDERS HILL
WESTBOROUGH, MA

proved  accurate,  enabling  us  to  meet  or  exceed

all aspects of our operating plan while completing 

initiatives that positioned us for growth. Excellent 

performance in portfolio operations, investment

activities and capital formation efforts contributed 

to our success in 2004, and we were recognized

for our efforts. Here are a few highlights:

■ We optimized portfolio performance, moving
occupancy to the highest levels in three years

and, by the second half of the year, registered

year-over-year “Same-Store” revenue growth for 

the first time since 2001. We managed operating 

expenses aggressively, limiting expense growth

to  less  than  2%. And  we  continued  to  focus

on the customer, improving service scores for

the fourth consecutive year.

Investment  activity  created  significant  value

for  shareholders  in  2004.  Development 

completions totaled approximately $365 million 

with Initial Yields approximately 250 to 300 basis 

points above market Cap Rates for apartment 

product.  We  started  $240  million  of  new

developments and increased our Development

embedded value and provided a source of capital to fund

new development opportunities. We sold approximately

$250  million  of  properties  in  2004,  recognizing 

Economic Gains of $103 million at a 4.8% Cap Rate.

This attractive pricing demonstrates the strong demand

for  our  product  and  the  desirability  of  our  markets— 

further validating our strategy of developing or acquiring 

high-quality  assets  in  supply-constrained  markets.

Finally, acquisition activities accelerated during the year

as  we  prepared  to  launch  the  AvalonBay Value  Added

Fund. This investment management fund will allow us

to  diversify  sources  of  capital  for  acquisitions  while 

providing incremental recurring income to AvalonBay. 

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In 2004, we were once again recognized by the industry for outstanding achievements. We were the recipient

of a number of awards, including: 

■ Multifamily Executive “Builder of the Year”

■ Multifamily Executive “Project of the Year” for Avalon at Mission Bay

■ NAHB “Best Luxury Apartment Community” for Avalon at Newton Highlands

■ Green Street Advisors “2004 REIT of the Year”

Overall, we are pleased with what turned out to be a busy but rewarding year. We executed our operating plan

successfully while seizing unique value creation opportunities. For the year, we reported FFO of $3.36 per share,

representing 2.4% growth from the prior year, and achieved a sector-leading total shareholder return of 65%.

Outlook
The transition to positive job growth and improving apartment fundamentals that began in 2004 should gain

momentum in 2005. The strengthening economy is expected to result in job growth in our markets at a rate

more than twice that of 2004. Employment is a key driver of overall housing demand and, when coupled with

likely higher home mortgage rates, should translate into relatively strong growth in renter households for the first

time in five years. Given increased rental demand and a constrained supply of new apartments in our markets, 

we  expect  modest  but  positive  revenue  increases  during  2005,  followed  by  more  robust  growth  in  2006  as 

fundamentals continue to improve. 

avalonbay Communities, Inc.

2

avalonbay Communities, Inc.

3

■
■
 
 
 
we  will  be  aggressive  in

building, selective in buying, 

and opportunistic in selling 

assets to ensure we continue 

to reward investors by delivering 

superior  value  creation  with 

strong risk-adjusted returns.

Based on this outlook, how will we respond? We

remain  committed  to  the  strategy  that  many  of

you have heard us speak about in the past:

“To deeply penetrate our chosen markets through

a broad range of products and services with an

intense focus on our customer.”

A  very  clear-cut  and  straightforward  strategy. 

The competitive advantage comes in how well we

execute  this  strategy.  Underlying  our  success  in

creating  superior  value  is  solid  day-to-day 

performance  in  three  principal  areas  of  the 

business—our  portfolio,  capital  allocation  and

our balance sheet.

Our acquisition activity in 2005 will be primarily funded through this source of capital. Our experience

and talents in identifying, evaluating, redeveloping, managing and repositioning assets are the keys to how

we will enhance the value of the capital invested.

Dispositions. After selling $700 million of assets over the past two years, we expect disposition activity will

likely be at lower levels in 2005 as we transition to a period of earnings and portfolio growth. Should the

transactions market pick up its pace, we will respond opportunistically, as we have in the past, to harvest

value and redeploy capital to the most attractive investment alternatives.

Securities redemptions will occur each year, whether due to the maturity of a debt offering or opportunistic

redemption of public equity. We will use our financial flexibility to access the most cost-effective source of

capital to create and preserve value for investors. 

Overall, capital allocation is an essential component of our value creation story. We will be aggressive in building, 

selective in buying, and opportunistic in selling assets to ensure we continue to reward investors by delivering 

superior value creation with strong risk-adjusted returns.

OUR PORTFOLIO is  comprised  of  more  than  40,000  high-quality  apartments  in  what  we  view  as  the  best 

OUR BALANCE SHEET strength  helps  ensure  we realize  the  potential  for  superior  value  creation  offered  by  our 

markets in the country. Our operating assets are an important source of future earnings growth, particularly as

we  enter  what  is  likely  to  be  a  period  of  accelerating  revenue  growth.  Our  seasoned  operations  team,  using

advanced,  integrated  management  systems  combined  with  experience  gained  during  the  past  cycle,  will  help

deliver portfolio earnings growth we expect will exceed the sector average.

CAPITAL ALLOCATION is another significant contributor to value, ensuring that capital is deployed to achieve the

highest possible risk-adjusted returns. And we enjoy many attractive capital allocation and recycling alternatives, 

including development, acquisitions, dispositions and securities redemptions.

Development is an important source of earnings growth and a key driver behind shareholder value creation.

During the downturn of 2001–2003, we maintained our core development capacity but limited development 

starts in response to the weak leasing environment. Anticipating recovery, we moved to accelerate development 

starts in 2004  and  2005,  allowing  us  to  deliver  product  in  more  robust  leasing  windows  and  to  achieve

stronger Initial Yields on our invested capital. These starts are planned to meet financial goals and to support

portfolio strategies. The $800 million of planned starts in 2005 will be varied geographically as well as by product 

type, as we continually make adjustments to attain our portfolio diversification and customer segmentation goals. 

Acquisitions. In early 2005, we launched the AvalonBay Value Added Fund, L.P., a discretionary institutional 
investment management fund that is focused on buying and repositioning existing apartment communities.

development pipeline and acquisition fund. The Company emerged from the recent downturn with one of the

strongest balance sheets in the sector. With modest and mostly fixed-rate debt levels and a dividend fully covered

strong balance sheet

AVALON BELLEVUE
BELLEVUE , WA

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AVALON ON THE SOUND
NEW ROCHELLE, NY

avalonbay Communities, Inc.

4

avalonbay Communities, Inc.

5

 
 
 
 
 
 
 
 
by recurring cash flow, we are well positioned to respond to

growth opportunities as they emerge. Floating-rate debt can

be used to enhance short-term earnings but can constrain

the pursuit of long-term value creation. So we avoid excessive 

use of floating-rate debt that can be an “earnings tax” as rates

rise.  A  well-positioned  balance  sheet  also  offers  tremendous

financial  flexibility  and  provides  access  to  a  broad  range 

of  cost-effective  capital  sources.  A  good  example  is  our

selective  use  of  development  joint  ventures  to  enhance 

operational leverage while mitigating risk. Another example 

is  the  AvalonBay  Value  Added  Fund,  through  which  we 

will  access  capital  directly  from  pension  funds  and  other 

institutional  investors.  Such  direct  access  to  institutional

capital is not easy to gain, and can require a long-term track

record of outperformance that few companies have attained.

AVALON AT CORTEZ HILL
SAN DIEGO, CA

AVALON AT NEWTON HIGHLANDS
NEWTON, MA 

AVALON ON STAMFORD HARBOR
STAMFORD, CT

Our strong financial position and the flexibility it affords demonstrates our ability and commitment to create value for

investors over both the short and long term. We recognize that earnings growth is an important measure of success, but we

value creation drives financial performance

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are also intensely driven to create long-term value for

investors. We are not interested in accounting policies

that increase reported earnings but do nothing to add real 

value, nor are we driven to be the biggest apartment

REIT or to have a presence in the most markets. We

continually strive to find ways to use our organization’s 

talents  to  maximize  value  creation  through  our 

operations,  development,  investment  and  finance

activities. With these guiding principles, we continuously 

improve  operations,  shrewdly  allocate  resources  and

capital,  and  maintain  financial  flexibility  so  that  we

are uniquely positioned to enhance performance and

generate value. Delivering current earnings is important, 

but making smart decisions that drive long-term value

creation is vital—and is what sets us apart.

In Conclusion
The  past  year  was  both  challenging  and  rewarding.  We  were  challenged  to  maintain  performance  during 

the  still  weak  early  quarters  while  setting  the  stage  for  growth  as  our  markets  strengthened.  As  apartment 

fundamentals  improved,  AvalonBay  executed  well,  capitalizing  on  opportunities  that  emerged  throughout 

the  year.  We  created  value  through  our  operational,  development,  investment  and  capital  markets  activities, 

ultimately delivering sector-leading returns to shareholders.

Looking  ahead,  I  am  excited  and  optimistic.  We  are  well  positioned  to  seize  market  growth  and  value 

creation opportunities. We are established in the best  apartment  markets in the country, with an exceptional

portfolio of existing communities. Our superior development pipeline provides a unique competitive advantage

that we will leverage with our outstanding team and strong balance sheet to execute at the highest levels.

As  always,  I  would  like  to  thank  our  shareholders  for  their  support,  our  associates  for  all  they  do,  and  our 

customers for choosing an AvalonBay community as their home.

BRYCE BLAIR

CHAIRMAN AND CHIEF EXECUTIVE OFFICER

LEFT TO RIGHT: 

TIM NAUGHTON, PRESIDENT; BRYCE BLAIR, CHAIRMAN AND CHIEF

EXECUTIVE OFFICER; TOM SARGEANT, CHIEF FINANCIAL OFFICER

avalonbay Communities, Inc.

6

avalonbay Communities, Inc.

7

 
 
 
 
 
 
 
 
WHERE?

WHAT?

HOW?

WHY?

Creating Value…WHERE?

IN PREMIER APARTMENT MARKETS THROUGHOUT THE COUNTRY

Value  creation  begins  with  market  selection.  We  operate  in  premier  apartment  markets  located  in  the  Northeast, 

Mid-Atlantic,  Midwest,  Pacific  Northwest  and  California.  These  markets  are  characterized  by  long  and 

arduous permitting and development processes that limit competition and restrict new apartment supply. Historically, new

supply as a percentage of inventory in our markets has been half that of new supply levels in the U.S. In addition, high 

single-family housing  costs  in  our  markets  lead  to  a  higher  propensity to rent,  with 37% of the population renting as 

compared to 31% in the U.S.(3)

lower levels of new apartment supply

higher cost of single family housing

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Source: Reis, Inc.

Source: Median Home Price—National Association of Realtors; 

Median Household Income—U.S. Department of Housing & Urban Development

avalonbay Communities, Inc.

9

 
 
 
 
 
 
 
 
 
 
 
 
Favorable demand and supply fundamentals have led to outsized performance in our markets over the last ten years.

outsized demand/supply(4)

outsized rental revenue growth(5)

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Source: AVB and Reis, Inc.

Source: Reis, Inc.

Importantly, we believe these markets are now beginning a new cycle of outperformance. Of our 16 markets, 12 are ranked
in  the  top  20  apartment  markets  nationwide  based  on  expected  total  revenue  growth,(6) and  we  expect  demand/supply 
fundamentals in AVB markets to outpace the U.S. in both 2005 and 2006.

Our long established presence in these markets allows us to get an early look at opportunities for new development as they

emerge, enabling us to establish a pipeline of future development rights that will provide value creation for years to come.

In-house market research gives us timely market data and analysis that helps us re-allocate capital to those markets with the

strongest demand/supply fundamentals, sustaining and optimizing value creation opportunities.

Our extensive local market knowledge and presence in premier markets of the U.S. differentiated by constrained supply

and steady demand helps ensure we maximize value creation while mitigating risk.

THE PROMENADE
BURBANK, CA

AVALON AT FLORHAM PARK
FLORHAM PARK, NJ

AVALON AT GALLERY PLACE
WASHINGTON, DC

C R E AT I N G   VA L U E
C R E AT I N G   VA L U E

BY DEVELOPING APARTMENT COMMUNITIES
BY DEVELOPING APARTMENT COMMUNITIES
IN HIGH BARRIER-TO-ENTRY MARKETS WHERE 
IN HIGH BARRIER-TO-ENTRY MARKETS WHERE 
PEOPLE WANT TO LIVE, WORK AND PLAY.
PEOPLE WANT TO LIVE, WORK AND PLAY.

10 avalonbay Communities, Inc.

AVALON AT THE PINEHILLS, PLYMOUTH, MA

 
 
 
 
 
 
WHERE?

WHAT?

HOW?

Creating Value…WHAT?

AN EXCEPTIONAL PORTFOLIO OF APARTMENT COMMUNITIES

After  market  selection,  the  quality  and  diversity  of  our  portfolio  become  the  next  key  components  to  creating  and 

sustaining shareholder value. The quality of our portfolio of more than 40,000 apartment homes in over 140 communities 

is among the highest in the multifamily sector. Our communities are generally young in age (eight years on average), with

locations and amenities that our residents value. These assets are largely unencumbered with debt or tax protection, allowing 

us to achieve higher prices upon sale.

young portfolio

unencumbered portfolio(7)

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AVB

Multifamily
Average

Source: Green Street Advisors, Inc.

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2000   2001  

2002 

2003   2004  

WHY?

These attributes combine to create highly desirable assets that command higher rents, produce higher recurring cash flows

and, when sold, sell at a premium. In 2004, we sold five communities and one land parcel for an aggregate gross sales

price of approximately $250 million at an average 4.8% Cap Rate. These sales resulted in an Economic Gain of $103 

million and a 16.5% Unleveraged IRR.

avalonbay Communities, Inc.

13

 
 
 
 
 
 
 
 
 
 
Our  communities  consist  of  a  diverse  mix  of  garden,  townhome,  mid-rise  and  high-rise  apartments  in  urban  and 

suburban locations. We use market and customer research to determine the products and amenities to offer. Customer

needs  are  always  changing.  We  use  our  core  competencies  to  develop,  redevelop,  acquire  and  sell  assets  to  adjust  our 

portfolio to help ensure our product meets current demand. In this way, we are able to quickly adapt to the changing

needs of the customer, improve quality, and position assets for maximum valuations. 

Our  Development  Rights  now  total  $3  billion. This  provides  a  steady  stream  of  new  development  communities  that 

we expect will offer attractive yields, enhancing the overall quality and diversity of our portfolio while maximizing value

creation opportunities at acceptable risk levels.

diverse portfolio(8)

Townhome  6%

Mid-rise

27%

High-rise

16%

51%

Garden

Urban

22%

78%

Suburban

AVALON AT MISSION BAY—SAN FRANCISCO, CALIFORNIA is a high-rise community that exemplifies the quality of our portfolio 

and the desirability of our markets. Located in the largest and fastest growing new development area in San Francisco,

Avalon at Mission Bay was named “Project of the Year, Resort/Luxury Category” by Multifamily Executive Magazine.

AVALON BELLTOWN
SEATTLE, WA

AVALON RIVERVIEW
LONG ISLAND CITY, NY

AVALON LEDGES
WEYMOUTH, MA

C R E AT I N G   VA L U E
C R E AT I N G   VA L U E

BY PROVIDING A DIVERSE MIX OF GARDEN,
BY PROVIDING A DIVERSE MIX OF GARDEN,
TOWNHOME, MID-RISE AND HIGH-RISE
TOWNHOME, MID-RISE AND HIGH-RISE
APARTMENTS TO MEET THE NEEDS OF 
APARTMENTS TO MEET THE NEEDS OF 
OUR CUSTOMERS.
OUR CUSTOMERS.

14 avalonbay Communities, Inc.

AVALON AT ARLINGTON SQUARE
ARLINGTON, VA 

AVALON AT MISSION BAY, SAN FRANCISCO, CA

WHERE?

WHAT?

HOW?

WHY?

Creating Value…HOW?

THROUGH OUR OPERATIONAL, INVESTMENT, DEVELOPMENT
AND FINANCIAL EXPERTISE

We are an integrated real estate investment and operating company that is ideally positioned to create value during all phases 

of the real estate cycle. Using advanced systems and processes, we optimize cash flow growth from our stabilized portfolio 

as well as from newly developed and acquired communities.

We are opportunistic in our investment and sales activity. Over the past 10 years, we have acquired over $2 billion of existing 

apartment  communities,  adding  significant  value  through  our  operating,  repositioning,  redeveloping  and  financing 

activities.  And  we  plan  to  continue  focusing  on  value-added  acquisitions  over  the  next  cycle  through  our  investment 

management activities and for our own account. We continued in 2004 with an aggressive disposition program in response

to a strong transactions climate, selling $250 million of assets. Over the past two years, we have sold over $710 million in

assets for Economic Gains totaling $235 million at an average Cap Rate of 5.8%. These net sales proceeds were redeployed

into new developments expected to have Initial Yields over 8.0%. This cost-effective source of capital is an important part of

achieving outsized returns. 

The timing of development activity also plays an essential role in creating and enhancing

value. In 2001–2003, we reduced the amount of capital allocated to development, adjusting 

deliveries to meet demand in a weak leasing environment. Anticipating recovery, we

accelerated new development starts in late 2003 and into 2004, with further development 

expansion planned for 2005. We began construction of six new communities in 2004

with total expected development costs of $240 million, completed seven communities

totaling approximately $365 million, and had $545 million under  construction at

year-end. We  also  expanded  our  Development  Pipeline  to  $3.5  billion,  the  largest

expanding pipeline(9)

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and  most  diverse  in  the  sector,  providing  AvalonBay  with  a  significant  source  of

2000   2001   2002   2003   2004  

future earnings growth and value creation.

avalonbay Communities, Inc.

17

 
 
 
 
Creating value requires continuous uninterrupted access to cost-effective capital during all phases of the business cycle.

Diversifying capital sources supports continuous access, and we have selectively turned to private capital to supplement

our capital needs and to keep our public currency scarce. We have the financial flexibility to be selective when sourcing

capital—be it through private joint ventures, discretionary investment funds, or public and private debt and equity. This

flexibility allows us to appropriately match capital to investment opportunities, maximizing risk-adjusted returns.

C A S E S T U D I E S

AVALON AT BALLSTON—VERMONT AND QUINCY TOWERS, 

avalon at ballston—vermont & quincy towers

C R E AT I N G   VA L U E
C R E AT I N G   VA L U E

ARLINGTON, VIRGINIA Acquired by the Company in 1997,

sale price

these  communities  constituted  a  total  investment  of

approximately  $48  million,  or  $106,000  per  apartment

home. We sold the communities to a condominium converter 

in  December  2004  for  an  aggregate  gross  sales  price  of

approximately $120 million, or  $265,000  per  apartment

home, generating a 20% Unleveraged IRR. From contract

to closing took less than 60 days, demonstrating our ability 

to create outsized value through opportunistic sales.

– total investment

= value created(10)

unleveraged irr

AVALON AT TRAVILLE—POTOMAC,  MARYLAND As  part 

avalon at traville

of  a  larger  master-planned  community,  development  of

Avalon at Traville presented unique design challenges and

regulatory  hurdles.  We  overcame  these  challenges, 

completing  the  520-apartment  home  community  during

the  fourth  quarter  of  2004  for  a  Total  Capital  Cost  of 

invested capital

estimated sales value 

implied value created(10)

$120m
$48m
$72m

20%

$70m
$100m
$30m

approximately $70 million. The community was built on one of the last remaining sites zoned for multifamily development

in the desirable North Potomac submarket, limiting future competition. It contains a broad range of product, including

one-,  two-  and  three-bedroom  apartment  homes  in  townhome,  manor  style  and  duplex  buildings.  With  the  largest 

floorplans in the submarket, Avalon at Traville is competitively positioned to outperform.

BALLSTON VERMONT TOWERS
ARLINGTON, VA

BALLSTON QUINCY TOWERS
ARLINGTON, VA

AVALON AT TRAVILLE
POTOMAC, MD

BY COMBINING OUR INTEGRATED INVESTMENT 
BY COMBINING OUR INTEGRATED INVESTMENT 
AND OPERATIONAL EXPERTISE WITH FINANCIAL 
AND OPERATIONAL EXPERTISE WITH FINANCIAL 
FLEXIBILITY TO DELIVER OUTSIZED 
FLEXIBILITY TO DELIVER OUTSIZED 
RISK-ADJUSTED RETURNS.
RISK-ADJUSTED RETURNS.

18 avalonbay Communities, Inc.

AVALON AT TRAVILLE, POTOMAC, MD

WHERE?

WHAT?

HOW?

WHY?

Creating Value…WHY?

TO GENERATE SUPERIOR LONG-TERM FINANCIAL PERFORMANCE

While  we  are  focused  on  current  earnings  growth,  we
emphasize  long-term  value  creation  over  short-term
earnings accretion. This leads to strong earnings growth
and financial outperformance over the full business cycle. 
Long-term value creation is the guiding principle behind
our decision-making and capital allocation strategies.

case study in capital recycling

2004 sales redeployed to development
estimated lost noi from 2004 sales 
projected noi from new development 

incremental noi 

$250m
($12m)
$20m
$8m

Our development activities offer a significant value creation 

proposition. We  continuously  identify  sites,  gain  entitlements  for  development,  and  build  our  own  communities. We 

selectively sell these assets to achieve capital allocation objectives or to harvest value. This life cycle of ownership delivers

outsized value creation. Economic Gains from the sale of five company-developed assets over the past two years totaled $91

million with an aggregate Unleveraged IRR of 18.7%. By redeploying proceeds from assets sold in 2004 at a 4.8% Cap Rate

to develop assets expected to yield 8% upon stabilization, we create a  profitable  spread  that  we  expect  will  generate  an 

additional $8 million in NOI—leading to substantial earnings accretion. Finally, our $3.5 billion Development Pipeline

offers a source of value creation and future earnings growth for years to come.

We seek to create value by allocating capital to the highest risk-adjusted returns available to the Company. Our development

activities appropriately receive a disproportionate capital allocation, yet we have not overlooked opportunities available

through  value-added  acquisitions,  especially  during  the  early  phase  of  the  economic  cycle  and  apartment  market 

recovery.  While  we  have  elected  to  fund  our  largest  value  creation  growth  lever—development—primarily  from  our

avalonbay Communities, Inc.

21

balance  sheet,  we  have  chosen  to  participate  with  private  equity  capital  to  accelerate  our  acquisition  growth  lever.

Accelerating acquisition activity in this manner allows us to fully deploy our investment and value-added expertise while

diversifying our capital sources. In the aggregate, more earnings growth will accrue to AvalonBay, and additional value will

be created for AvalonBay and our partners. This constant focus on value creation has led to strong financial performance

over the long term, and we believe it will continue to be a driver of future outperformance. 

estimated nav per share growth(1)
1995–2004

ffo per share growth(11)
1995–2004

total shareholder return(2)
1995–2004

C R E AT I N G   VA L U E
C R E AT I N G   VA L U E

%
4
.
1
1

%
2
.
8

h
t
w
o
r
G
e
r
a
h
S

r
e
P
V
A
N
d
e
t
a
m

i
t
s
E

%
7
.
6

%
4
.
3

h
t
w
o
r
G
e
r
a
h
S

r
e
P
O
F
F

%
8
.
0
2

%
2
.
6
1

n
r
u
t
e
R
h
t
w
o
r
G

l
a
u
n
n
A
d
n
u
o
p
m
o
C

AVB

Multifamily
Average

AVB

Multifamily
Average

AVB

Multifamily
Average

Source: Green Street Advisors, Inc.

Source: SEC Filings

Source: Bloomberg

AVALON REDONDO BEACH—REDONDO BEACH, CALIFORNIA is an example of a value-added acquisition. Avalon Redondo Beach 

is  located  in  a  highly  supply-constrained  coastal  community  in  the  Los  Angeles  area  with  median  single-family  home

prices  exceeding  $800,000.  Containing  105  apartment  homes,  this  B/B+  community  was  acquired  off-market  for 

approximately $24 million. In addition to increasing our presence in a favorable market, we believe this community offers

an opportunity for value creation through enhanced operations.

BY USING THE COMPANY’S BALANCE SHEET
BY USING THE COMPANY’S BALANCE SHEET
TO FUND DEVELOPMENT AND USING PRIVATE 
TO FUND DEVELOPMENT AND USING PRIVATE 
EQUITY TO ACCELERATE ACQUISITIONS GROWTH.
EQUITY TO ACCELERATE ACQUISITIONS GROWTH.

AVALON ESTATES
HULL, MA

AVALON TOWERS ON THE PENINSULA
MOUNTAIN VIEW, CA

AVALON AT GREYROCK PLACE
STAMFORD, CT

AVALON AT FREEHOLD
FREEHOLD, NJ 

22 avalonbay Communities, Inc.

AVALON REDONDO BEACH, REDONDO BEACH, CA

 
 
 
 
 
 
 
 
 
 
NOTES & NON-GAAP FINANCIAL MEASURES AND OTHER TERMS

NOTES

NON-GAAP FINANCIAL MEASURES AND OTHER TERMS

1. The compound annual growth rate of Estimated NAV Per

Share as estimated by Green Street Advisors, Inc. during the
periods indicated. Estimated NAV Per Share for each year
within these periods varies.

2. The compound annual growth rate, including reinvestment
of dividends, for the periods indicated. Total Shareholder
Return for any given year during the periods indicated varies.
The multifamily average is weighted based on equity market
capitalization.

The following non-GAAP financial measures and other terms, as
used in this Annual Report, including the Letter to Shareholders,
are  defined  and  further  explained  herein  on  page  76  in  the 
section  titled,  “Definitions  and  Reconciliations  of  Non-GAAP
Financial Measures and Other Terms”:

■ Development Rights and Development Pipeline

■ Economic Gain

3. Per Census Bureau Housing Vacancies and Homeownership

■ Established Communities (“Same-Store”)

Annual Statistics 2004.

4. Demand (total new jobs adjusted for propensity to rent by

market) divided by Supply (total new multifamily, market-rate 
rental completions), per AVB and Reis, Inc.

■ Estimated Net Asset Value (NAV) Per Share

Funds from Operations (FFO)

5. The annual change in occupancy rate, plus the annual 

percentage change in market rent per Reis, Inc.

Initial Year Market Cap Rate (Cap Rate)

■ Net Operating Income (NOI)

■ Projected NOI (Initial Yield)

Stabilized Operations

■ Total Capital Cost

■ Unencumbered NOI

■ Unleveraged IRR

FORWARD-LOOKING STATEMENTS

This Annual Report, including the Letter to Shareholders, 
contains “forward-looking statements” within the meaning of
the Securities Act of 1933 and the Securities Exchange Act of
1934. Please see our discussion titled “Forward-Looking Statements”
on page 42 of this report for a discussion regarding risks associated
with these statements.

6. Per Axiometrics. Forecasts based on annual potential revenue 
impact (combined 2005 and 2006). Annual potential revenue 
impact defined as the combination of annual rental rate
growth and the absolute change in the annual occupancy
rate from the prior year to the current period. Forecasts of
market rental rate growth and occupancy are a function of
the projected growth of the following market variables: (i)
employment growth, (ii) total residential permitting, (iii)
housing affordability, (iv) median family income, (v) the
CPI, and (vi) the Leading Economic Index for each MSA.

7. Reflects Unencumbered NOI as a percentage of total NOI
generated by real estate assets. See page 79 for a definition
and calculation of Unencumbered NOI.

8. Portfolio composition (based on Total Capital Cost) at
December 31, 2004, including planned disposition and
development activity for 2005.

9. The sum of the Total Capital Cost of communities under

construction and Development Rights at year-end.

10. Value created or implied value created is calculated as the
difference between sales price or estimated sales value,
excluding costs of sale, and total invested capital. For 
presentation purposes, estimated sales value of Traville is
based on a 6% Cap Rate applied against Projected NOI.

11. The compound annual growth in FFO Per Share as reported. 
FFO Per Share growth for each year within this period varies. 

24 avalonbay Communities, Inc.

2004 FINANCIAL REVIEW

26

28

45

46

47

48

50

73

75

76

Selected Financial Data

Management’s Discussion and
Analysis of Financial Condition 
and Results of Operations 

Consolidated Balance Sheets

Consolidated Statements of Operations 
and Other Comprehensive Income 

Consolidated Statements of 
Stockholders’ Equity 

Consolidated Statements of 
Cash Flows 

Notes to Consolidated 
Financial Statements

Report of Independent Auditors

Market for Registrant’s Common Equity 
and Related Stockholder Matters

Definitions and Reconciliations of Non-GAAP
Financial Measures and Other Terms

80

AvalonBay Corporate Information

■
■
■
SELECTED FINANCIAL DATA

The following table provides historical consolidated ﬁnancial, operating and other data for AvalonBay Communities,
Inc. You should read the table with our Consolidated Financial Statements and the Notes included in this report.

(Dollars in thousands, except per share information)

12-31-04

12-31-03

12-31-02

12-31-01

12-31-00

For the year ended

Revenue:
Rental and other income
Management, development and other fees
Total revenue
Expenses:
Operating expenses, excluding property taxes
Property taxes
Interest expense
Depreciation expense
General and administrative expense
Impairment loss
Total expenses
Equity in income of unconsolidated entities
Interest income
Venture partner interest in proﬁt-sharing
Minority interest in consolidated partnerships
Income before gain on sale of
real estate assets

Gain on sale of real estate assets
Income from continuing operations 
before cumulative effect of change in 
accounting principle

Discontinued operations:
Income from discontinued operations
Gain on sale of real estate assets
Total discontinued operations
Income before cumulative effect 
of change in accounting principle

Cumulative effect of change in 

accounting principle
Net income
Dividends attributable to preferred stock
Net income available to common stockholders
Per Common Share and Share Information:
Earnings per common share—basic
Income from continuing operations (net of 
dividends attributable to preferred stock)
Discontinued operations
Net income available to common stockholders
Weighted average common shares 

outstanding—basic

Earnings per common share—diluted
Income from continuing operations (net of 
dividends attributable to preferred stock)
Discontinued operations
Net income available to common stockholders
Weighted average common shares 
outstanding—diluted
Cash dividends declared

$ 647,850
604

$ 591,411
931

$ 568,352
2,145

$ 562,202
1,386

$ 503,228
1,107

648,454

592,342

570,497

563,588

504,335

189,223
62,665
131,314
160,815
18,074
—

562,091

1,100
194
(1,178)
(150)

86,329
—

172,393
56,120
133,637
147,658
14,830
—

524,638

25,535
3,440
(1,688)
(950)

94,041
—

155,799
50,767
118,288
130,488
13,449
6,800

475,591

55
3,978
(857)
(865)

140,295
45,873
99,456
115,082
14,705
—

415,411

856
6,823
1,158
(948)

126,051
40,872
78,927
107,833
13,013
—

366,696

2,428
4,764
—
(1,038)

97,217
—

156,066
62,852

143,793
40,779

86,329

94,041

97,217

218,918

184,572

6,444
122,425

128,869

16,494
160,990

177,484

27,508
48,893

76,401

30,079
—

30,079

26,032
—

26,032

215,198

271,525

173,618

248,997

210,604

4,547

219,745
(8,700)

—

271,525
(10,744)

—

173,618
(17,896)

—

248,997
(40,035)

—

210,604
(39,779)

$ 211,045

$ 260,781

$ 155,722

$ 208,962

$ 170,825

$

$
$

1.15

1.80
2.95

$

$
$

1.21

2.59
3.80

$

$
$

1.15

1.11
2.26

$

$
$

2.62

0.46
3.08

$

$
$

2.19

0.39
2.58

71,564,202

68,559,657

68,772,139

67,842,752

66,309,707

$

1.16

$

1.20

$

1.13

$

2.56

$

2.14

1.76
$
$
2.92
73,354,956

2.53
$
$
3.73
70,203,467

1.10
$
$
2.23
70,674,211

0.46
$
$
3.02
69,781,719

0.39
$
$
2.53
68,140,998

$

2.80

$

2.80

$

2.80

$

2.56

$

2.24

26

avalonbay Communities, Inc.

12-31-04

12-31-03

12-31-02

12-31-01

12-31-00

For the year ended

Other Information:
Net income
Depreciation—continuing operations
Depreciation—discontinued operations
Interest expense—continuing operations
Interest expense—discontinued operations
Interest income
EBITDA(1)
Funds from Operations(2)
Number of Current Communities(3)
Number of apartment homes

Balance Sheet Information:
Real estate, before accumulated depreciation
Total assets
Notes payable and unsecured credit facilities

Cash Flow Information:
Net cash ﬂows provided by operating activities
Net cash ﬂows provided by (used in) 
investing activities
Net cash ﬂows provided by (used in) 
ﬁnancing activities

$ 219,745
160,815
1,852
131,314
508
(194)

$ 271,525
147,658
6,138
133,637
2,380
(3,440)

$ 173,618
130,488
13,989
118,288
3,094
(3,978)

$ 248,997
115,082
14,997
99,456
3,747
(6,823)

$ 210,604
107,833 
14,777 
78,927 
4,682 
(4,764)

$ 514,040

$ 557,898

$ 435,499

$ 475,456

$ 412,059 

$ 246,247
138
40,142

$ 230,566
131
38,504

$ 251,410
137
40,179

$ 275,755
126
37,228

$ 252,013
126 
37,147 

$5,697,144
$5,068,281
$2,442,291

$5,431,757
$4,909,582
$2,337,817

$5,369,453
$4,950,835
$2,471,163

$4,837,869
$4,664,289
$2,082,769

$4,535,969
$4,397,255 
$1,729,924 

$ 275,678

$ 239,677

$ 307,810

$ 320,528

$ 302,083

$ (251,683)

$

33,935

$ (435,796)

$ (274,941)

$ (258,155)

$ (29,471)

$ (279,465)

$

68,008

$ (29,909)

$

5,685 

Notes to Selected Financial Data
(1) EBITDA is deﬁned by us as net income before interest income and expense, income taxes, depreciation and amortization from both continuing and
discontinued operations. Under this deﬁnition, which complies with the rules and regulations of the Securities and Exchange Commission, EBITDA
includes gains on sale of assets and gain on sale of partnership interests. Management generally considers EBITDA to be an appropriate supplemental
measure to net income of our operating performance because it helps investors to understand our ability to incur and service debt and to make capital
expenditures. EBITDA should not be considered as an alternative to net income (as determined in accordance with generally accepted accounting
principles, or “GAAP”), as an indicator of our operating performance, or to cash ﬂows from operating activities (as determined in accordance with
GAAP) as a measure of liquidity. Our calculation of EBITDA may not be comparable to EBITDA as calculated by other companies.

(2) We generally consider Funds from Operations, or “FFO,” to be an appropriate supplemental measure of our operating and ﬁnancial performance
because,  by  excluding  gains  or  losses  related  to  dispositions  of  property  and  excluding  real  estate  depreciation,  which  can  vary  among  owners  of
identical assets in similar condition based on historical cost accounting and useful life estimates, FFO can help one compare the operating performance
of a company’s real estate between periods or as compared to different companies. We believe that in order to understand our operating results, FFO
should be examined with net income as presented in the Consolidated Statements of Operations and Other Comprehensive Income included elsewhere
in  this  report.  Consistent  with  the  deﬁnition  adopted  by  the  Board  of  Governors  of  the  National  Association  of  Real  Estate  Investment Trusts,
(“NAREIT”), we calculate FFO as net income or loss computed in accordance with GAAP, adjusted for:
• gains or losses on sales of previously depreciated operating communities;
• extraordinary gains or losses (as deﬁned by GAAP);
• cumulative effect of change in accounting principle;
• depreciation of real estate assets; and
• adjustments for unconsolidated partnerships and joint ventures.

In 2004, we changed our methodology for the calculation of FFO to include gains or losses on undepreciated property (i.e., land). FFO includes gains
on  land  sales  of  $1,138  and  $1,234  in  2004  and  2003,  respectively,  and,  as  a  result,  FFO  for  2003  has  been  increased  from  amounts  previously
reported. The inclusion of these gains or losses is acceptable, but not required, under the deﬁnition of FFO adopted by NAREIT. The treatment of
these gains and losses varies within the REIT industry; however, we believe that inclusion of these gains and losses allows for a better comparison of
our reported FFO to FFO as reported by our peers in the apartment REIT industry. FFO does not represent net income in accordance with GAAP,
and therefore it should not be considered an alternative to net income, which remains the primary measure, as an indication of our performance. In
addition, FFO as calculated by other REITs may not be comparable to our calculation of FFO. The following is a reconciliation of net income to FFO:

Net income
Dividends attributable to preferred stock
Depreciation—real estate assets, 
including discontinued operations and 
joint venture adjustments
Minority interest expense, 
including discontinued operations
Cumulative effect of change in 
accounting principle
Gain on sale of operating communities
Funds from Operations 
attributable to common stockholders
Weighted average common shares 
outstanding—diluted
FFO per common share—diluted

For the year ended

12-31-04

12-31-03

12-31-02

12-31-01

12-31-00

$ 219,745
(8,700)

$ 271,525
(10,744)

$ 173,618
(17,896)

$ 248,997
(40,035)

$ 210,604
(39,779)

157,988

128,278

142,980

128,086

120,208 

3,048

1,263

1,601

1,559

1,759 

(4,547)
(121,287)

—
(159,756)

—
(48,893)

—
(62,852)

— 
(40,779)

$ 246,247

$ 230,566

$ 251,410

$ 275,755

$ 252,013

73,354,956
3.36
$

70,203,467
3.28
$

70,674,211
3.55
$

69,781,719
3.95
$

68,140,998 
3.70 
$

FFO also does not represent cash generated from operating activities in accordance with GAAP, and therefore should not be considered an alternative
to net cash ﬂows from operating activities, as determined by GAAP, as a measure of liquidity. Additionally, it is not necessarily indicative of cash available
to fund cash needs. A presentation of GAAP based cash ﬂow metrics is provided in “Cash Flow Information” in the table above.

(3) Current Communities consist of all communities other than those which are still under construction and have not received a certiﬁcate of occupancy.

avalonbay Communities, Inc.

27

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

We focus on the investment in and ownership and operation of apartment communities in high barrier-to-entry
markets of the United States. As of February 28, 2005, we had 138 current operating communities, which are
the primary contributors to our overall operating performance. The net operating income of these communities,
which is one of the ﬁnancial measures that we use to evaluate community performance, is affected by the demand
and  supply  dynamics  within  our  markets,  our  rental  rates  and  occupancy  levels,  and  our  ability  to  control
operating costs. Our overall ﬁnancial performance is also impacted by the general availability and cost of capital
and the performance of our newly developed and acquired apartment communities. We seek to create long-term
shareholder value by accessing capital on cost effective terms; deploying that capital to develop, redevelop and
acquire apartment communities in high barrier-to-entry markets; operating apartment communities; and selling
communities when they no longer meet our long-term investment strategy and when pricing is attractive. 

This report, including the following discussion and analysis of our ﬁnancial condition and results of operations,
contains  forward-looking  statements  that  predict  or  indicate  future  events  or  trends  and  that  do  not  report
historical matters. Actual results or developments could differ materially from those projected in such statements
as a result of the risk factors set forth on page 43 of this report. The following discussion and analysis of our
ﬁnancial  condition  and  results  of  operations  should  be  read  in  conjunction  with  our  Consolidated  Financial
Statements and notes included elsewhere in this report.

Business Description and Community Information Overview

We believe that apartment communities present an attractive long-term investment opportunity compared to
other real estate investments because a broad potential resident base should help reduce demand volatility over a
real estate cycle. We intend to continue to pursue real estate investments in markets where constraints to new
supply exist, and where new rental household formations are expected to out-pace multifamily permit activity
over the course of the real estate cycle. Barriers-to-entry in our markets generally include a difﬁcult and lengthy
entitlement process with local jurisdictions and dense urban or suburban areas where zoned and entitled land is
in limited supply. 

We regularly evaluate the allocation of our investments by the amount of invested capital and by product type
within our individual markets, which are located in the Northeast, Mid-Atlantic, Midwest, Paciﬁc Northwest,
and Northern and Southern California regions of the United States. Our strategy is to deeply penetrate these
markets with a broad range of products and services and an intense focus on our customer. A substantial majority
of our communities are upscale, which generally command among the highest rents in their markets. However,
we also pursue the ownership and operation of apartment communities that target a variety of customer segments
and price points, consistent with our goal of offering a broad range of products and services. 

We believe that, over an entire business cycle, lower housing affordability and the limited new supply of apartment
homes in our markets will result in a higher propensity to rent and larger increases in cash ﬂow relative to other
markets. However, throughout the business cycle, apartment market fundamentals, and therefore operating cash
ﬂows, are affected by overall economic conditions. A number of our markets experienced economic contraction
due to job losses in 2002 and 2003, particularly in the technology, telecom and ﬁnancial services sectors. This
resulted in a prolonged period of weak apartment market fundamentals as reﬂected in declining rental rates and
demand. However, 2004 was a year of transition, where the economy showed signs of an early phase recovery, 
as  evidenced  by  modest  job  growth  and  declining  unemployment  claims. The  improvement  in  the  economic
environment  has  resulted  in  more  stabilized  apartment  market  fundamentals,  as  reﬂected  in  the  following

operating results achieved within our Established Community portfolio speciﬁcally during the last three months
of 2004: 

• we achieved both sequential and year-over-year revenue growth, our second year-over-year increase since 2001; 
• economic occupancy stabilized and remained at approximately 95% in each of our markets, despite a seasonal

decline in leasing; 

• concessions per move-in declined both sequentially and on a year-over-year basis; and 
• we achieved the ﬁrst sequential increase in average rental rates since 2001. 

Based on these results we believe that 2005 will be a year of continued growth. We expect that with continued
job  growth  in  our  markets,  apartment  market  fundamentals  (the  demand/supply  balance)  will  continue 
to improve such that apartment rental demand will outpace new supply by a ratio of almost two to one. The
improvement may not be experienced evenly throughout our markets, but is nevertheless expected to result in
overall revenue growth for our Established Community portfolio in 2005. 

In  anticipation  of  continued  improvement  in  apartment  fundamentals  and  stronger  apartment  demand,  we 
have  increased  our  development  and  acquisition  volume.  During  2004,  we  increased  our  level  of  acquisition
activity in preparation of the closing of a discretionary investment fund. In addition, we continued to secure new
Development  Rights,  as  discussed  below,  bringing  our  pipeline  for  potential  development  opportunities  to  a 
new high. However, we continued to dispose of communities in 2004 in response to opportunities to realize
value. In 2005, we expect to continue acquisitions for the discretionary investment fund, particularly potential
redevelopment opportunities, and to continue to be an opportunistic seller, while increasing our development
activity over 2004 levels.

Our real estate investments consist primarily of current operating apartment communities, communities in various
stages of development (“Development Communities”), and Development Rights (i.e., land or land options held
for development). Our current operating communities are further distinguished as Established Communities,
Other  Stabilized  Communities,  Lease-Up  Communities  and  Redevelopment  Communities.  Established
Communities are generally operating communities that were owned and had stabilized occupancy and operating
expenses as of the beginning of the prior year, which allows the performance of these communities and the markets 
in which they are located to be compared and monitored between years. Other Stabilized Communities are generally 
all other operating communities that have stabilized occupancy and operating expenses as of the beginning of the
current year, but had not achieved stabilization as of the beginning of the prior year. Lease-Up Communities consist 
of  communities  where  construction  is  complete  but  stabilization  has  not  been  achieved.  Redevelopment
Communities  consist  of  communities  where  substantial  redevelopment  is  in  progress  or  is  planned  to  begin 
during  the  current  year.  A  more  detailed  description  of  our  reportable  segments  and  other  related  operating 
information can be found in Note 9, “Segment Reporting,” of our Consolidated Financial Statements. 

Although each of these categories is important to our business, we generally evaluate overall operating, industry
and market trends based on the operating results of Established Communities, for which a detailed discussion
can be found in “Results of Operations” as part of our discussion of overall operating results. We evaluate our
current  and  future  cash  needs  and  future  operating  potential  based  on  acquisition,  disposition,  development,
redevelopment and ﬁnancing activities within Other Stabilized, Redevelopment and Development Communities,
for which detailed discussions can be found in “Liquidity and Capital Resources.”

As of December 31, 2004, we owned or held an ownership interest in 148 apartment communities containing
42,810  apartment  homes  in  ten  states  and  the  District  of  Columbia,  of  which  ten  communities  were  under
construction  and  four  communities  were  under  reconstruction.  In  addition,  we  owned  a  direct  or  indirect
ownership interest in Development Rights to develop an additional 49 communities that, if developed in the
manner expected, will contain an estimated 13,491 apartment homes.

28

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29

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

Critical Accounting Policies

The preparation of ﬁnancial statements in conformity with generally accepted accounting principles (“GAAP”)
requires management to use judgment in the application of accounting policies, including making estimates and
assumptions. If our judgment or interpretation of the facts and circumstances relating to various transactions had
been  different,  or  different  estimates  or  assumptions  had  been  made,  it  is  possible  that  different  accounting
policies would have been applied, resulting in different ﬁnancial results or a different presentation of our ﬁnancial
statements.  Below  is  a  discussion  of  accounting  policies  that  we  consider  critical  to  an  understanding  of  our
ﬁnancial condition and operating results and that may require complex judgment in their application or require
estimates about matters which are inherently uncertain. As a REIT that owns, operates and develops apartment
communities, our critical accounting policies relate to revenue recognition, cost capitalization, asset impairment
evaluation and REIT status. A discussion of all of our accounting policies, including further discussion of the
critical accounting policies described below, can be found in Note 1, “Organization and Signiﬁcant Accounting
Policies” of our Consolidated Financial Statements.

Revenue Recognition Rental income related to leases is recognized on an accrual basis when due from residents
in accordance with SEC Staff Accounting Bulletin No. 104, “Revenue Recognition” and Statement of Financial
Accounting  Standards  No.  13,  “Accounting  for  Leases.”  In  accordance  with  our  standard  lease  terms,  rental
payments  are  generally  due  on  a  monthly  basis.  Any  cash  concessions  given  at  the  inception  of  the  lease  are
amortized over the approximate life of the lease, which is generally one year. A discussion regarding the impact
of cash concessions on rental revenue for Established Communities can be found in “Results of Operations.”

Cost Capitalization We capitalize costs during the development of assets (including interest and related loan
fees, property taxes and other direct and indirect costs) beginning when active development commences until the
asset,  or  a  portion  of  the  asset,  is  delivered  and  is  ready  for  its  intended  use,  which  is  generally  indicated  by 
the  issuance  of  a  certiﬁcate  of  occupancy.  We  capitalize  costs  during  redevelopment  of  apartment  homes
(including interest and related loan fees, property taxes and other direct and indirect costs) beginning when an
apartment  home  is  taken  out-of-service  for  redevelopment  until  the  apartment  home  redevelopment  is
completed and the apartment home is available for a new resident. Rental income and operating costs incurred
during the initial lease-up or post-redevelopment lease-up period are fully recognized as they accrue.

We capitalize pre-development costs incurred in pursuit of Development Rights for which we currently believe
future  development  is  probable. These  costs  include  legal  fees,  design  fees  and  related  overhead  costs.  Future
development of these Development Rights is dependent upon various factors, including zoning and regulatory
approval, rental market conditions, construction costs and availability of capital. Pre-development costs incurred
in the pursuit of Development Rights for which future development is not yet considered probable are expensed
as incurred. In addition, if the status of a Development Right changes, deeming future development no longer
probable, any capitalized pre-development costs are written-off with a charge to expense.

We generally capitalize only non-recurring expenditures. We capitalize improvements and upgrades only if the
item: (i) exceeds $15,000; (ii) extends the useful life of the asset; and (iii) is not related to making an apartment
home ready for the next resident. Under this policy, virtually all capitalized costs are non-recurring, as recurring
make-ready  costs  are  expensed  as  incurred.  Recurring  make-ready  costs  include:  (i) carpet  and  appliance
replacements; (ii) ﬂoor coverings; (iii) interior painting; and (iv) other redecorating costs. Because we expense
recurring make-ready costs such as carpet replacements, our expense levels and volatility are greatest in the third
quarter of each year as this is when we experience our greatest amount of turnover. We capitalize purchases of
personal  property,  such  as  computers  and  furniture,  only  if  the  item  is  a  new  addition  and  the  item  exceeds
$2,500. We generally expense replacements of personal property. 

In 2004, 2003 and 2002, the amounts capitalized (excluding land costs) related to acquisitions, development and
redevelopment were $347,091,000, $296,764,000 and $457,851,000, respectively. For Established and Other
Stabilized Communities, we recorded non-revenue generating capital expenditures of $12,347,000 or $354 per
apartment  home  in  2004,  $11,064,000  or  $333  per  apartment  home  in  2003  and  $10,214,000  or  $302 
per apartment home in 2002. In addition, revenue generating capital expenditures, such as water submetering
equipment and cable installations, were $637,000, $529,000 and $697,000 in 2004, 2003 and 2002, respectively.
The  average  maintenance  costs  charged  to  expense  per  apartment  home,  including  carpet  and  appliance
replacements, related to these communities was $1,348 in 2004, $1,262 in 2003 and $1,224 in 2002. Historically,
we have experienced a gradual increase in capitalized costs and expensed maintenance costs per apartment home
as  the  average  age  of  our  communities  has  increased,  and  expensed  maintenance  costs  have  ﬂuctuated  with
turnover. We expect these trends to continue, with capitalized costs increasing in 2005 over prior year levels as
we embark on a number of community upgrades and improvements.

Asset Impairment Evaluation If there is an event or change in circumstance that indicates an impairment in
the value of a community, our policy is to assess the impairment by making a comparison of the current and
projected operating cash ﬂow of the community over its remaining useful life, on an undiscounted basis, to the
carrying amount of the community. If the carrying amount is in excess of the estimated projected operating cash
ﬂow of the community, we would recognize an impairment loss equivalent to an amount required to adjust the
carrying amount to its estimated fair market value. Real estate assets held for sale are measured at the lower of
the carrying amount or the fair value less the cost to sell.

We account for our investments in unconsolidated entities that are not variable interest entities in accordance
with  Statement  of  Position  78-9,  “Accounting  for  Investments  in  Real  Estate  Ventures”  and  Accounting
Principles  Board  Opinion  No.  18,  “The  Equity  Method  of  Accounting  for  Investments  in  Common  Stock.” 
If there is an event or change in circumstance that indicates a loss in the value of an investment, we record the
loss and reduce the value of the investment to its fair value. A loss in value would be indicated if we could not
recover the carrying value of the investment or if the investee could not sustain an earnings capacity that would
justify the carrying amount of the investment.

REIT Status We are a Maryland corporation that has elected to be treated, for federal income tax purposes, as
a real estate investment trust, or REIT. We elected to be taxed as a REIT under the Internal Revenue Code of
1986, as amended, for the year ended December 31, 1994 and have not revoked such election. A corporate REIT
is  a  legal  entity  which  holds  real  estate  interests  and  must  meet  a  number  of  organizational  and  operational
requirements, including a requirement that it currently distribute at least 90% of its adjusted taxable income to
stockholders. As a REIT, we generally will not be subject to corporate level federal income tax on taxable income
we distribute currently to our stockholders. If we fail to qualify as a REIT in any taxable year, we will be subject
to federal income taxes at regular corporate rates (including any applicable alternative minimum tax) and may
not be able to qualify as a REIT for four subsequent taxable years.

Results of Operations

Our year-over-year operating performance is primarily affected by changes in net operating income of our current
operating apartment communities due to market conditions, net operating income derived from acquisitions and
development completions, the loss of net operating income related to disposed communities and capital market,
disposition and ﬁnancing activity. A comparison of our operating results for the years 2004, 2003 and 2002 follows:

30

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31

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

Change

Change

(dollars in thousands)

2004

2003

$

%

2003

2002

$

%

Revenue:

Rental and other income
Management, development 
and other fees

$647,850

$591,411

$ 56,439

9.5% $591,411

$568,352

$23,059

4.1% 

604

931

(327)

(35.1%)

931

2,145

(1,214)

(56.6%)

Total revenue

648,454

592,342

56,112

9.5% 592,342

570,497

21,845

3.8% 

Expenses:

Direct property operating expenses, 
excluding property taxes
Property taxes

Total community 
operating expenses

156,576
62,665

142,322
56,120

14,254
6,545

10.0% 142,322
56,120
11.7%

125,247
50,767

17,075
5,353

13.6% 
10.5% 

219,241

198,442

20,799

10.5% 198,442

176,014

22,428

12.7% 

Net operating income

429,213

393,900

35,313

9.0% 393,900

394,483

(583)

(0.1%)

Corporate-level property 
management and other 
indirect operating expenses
Investments and investment 
management
Interest expense
Depreciation expense
General and administrative 
expense
Impairment loss

27,956

27,123

833

3.1%

27,123

25,894

1,229

4.7% 

4,691
131,314
160,815

2,948
133,637
147,658

1,743
(2,323)
13,157

2,948
59.1%
(1.7%)
133,637
8.9% 147,658

4,658
118,288
130,488

(1,710)
15,349
17,170

(36.7%)
13.0% 
13.2% 

18,074
—

14,830
—

3,244
—

21.9%
—

14,830
—

13,449
6,800

10.3% 
1,381
(6,800) (100.0%)

Total other expenses

342,850

326,196

16,654

5.1% 326,196

299,577

26,619

8.9% 

Equity in income of 
unconsolidated entities
Interest income
Venture partner interest 
in proﬁt-sharing
Minority interest in 
consolidated partnerships

Income from continuing operations 
before cumulative effect of change 
in accounting principle

Discontinued operations:

Income from discontinued 
operations
Gain on sale of real estate assets

1,100
194

25,535
3,440

(24,435)
(3,246)

(95.7%)
(94.4%)

25,535
3,440

55
3,978

25,480
(538)

n/a 
(13.5%)

(1,178)

(1,688)

510

(30.2%)

(1,688)

(857)

(831)

97.0% 

(150)

(950)

800

(84.2%)

(950)

(865)

(85)

9.8% 

86,329

94,041

(7,712)

(8.2%)

94,041

97,217

(3,176)

(3.3%)

6,444
122,425

16,494
160,990

(10,050)
(38,565)

(60.9%)
(24.0%)

16,494
160,990

27,508
48,893

(11,014)
112,097

(40.0%)
229.3% 

Total discontinued operations

128,869

177,484

(48,615)

(27.4%)

177,484

76,401

101,083

132.3% 

Income before cumulative effect 
of change in accounting principle
Cumulative effect of change in 

accounting principle

Net income
Dividends attributable to 
preferred stock

Net income available to 
common stockholders

215,198

271,525

(56,327)

(20.7%)

271,525

173,618

97,907

56.4% 

4,547

—

4,547

100.0%

—

—

—

— 

219,745

271,525

(51,780)

(19.1%)

271,525

173,618

97,907

56.4% 

(8,700)

(10,744)

2,044

(19.0%)

(10,744)

(17,896)

7,152

(40.0%)

$211,045

$260,781

$(49,736)

(19.1%) $260,781

$155,722

$105,059

67.5% 

Net income available to common stockholders decreased $49,736,000, or 19.1%, to $211,045,000 in 2004.
This decrease is primarily attributable to lower gains on sales as a result of reduced disposition activity from 
the historically high levels experienced in 2003, partially offset by increased net operating income from newly
developed and acquired communities. Net income available to common stockholders increased $105,059,000 or
67.5% to $260,781,000 in 2003. This increase is primarily attributable to gains on sales of communities due to
increased disposition activity, including gains reﬂected in equity in income of unconsolidated entities, and the
absence of impairment losses in 2003, partially offset by increases in interest and depreciation expense.

Net operating income (“NOI”) is considered by management to be an important and appropriate supplemental
measure to net income of the operating performance of our communities because it helps both investors and
management to understand the core operations of a community or communities prior to the allocation of any
corporate-level or ﬁnancing-related costs. NOI reﬂects the operating performance of a community, and allows
for an easy comparison of the operating performance of individual assets or groups of assets. In addition, because
prospective buyers of real estate have different ﬁnancing and overhead structures, with varying marginal impacts
to overhead by acquiring real estate, NOI is considered by many in the real estate industry to be a useful measure
for determining the value of a real estate asset or group of assets. 

NOI is deﬁned by us as total revenue less direct property operating expenses, including property taxes, and excludes: 

• corporate-level property management and other indirect operating expenses;
• investments and investment management;
• interest income and expense;
• general and administrative expense;
• impairment losses;
• equity in income of unconsolidated entities;
• minority interest in consolidated partnerships;
• venture partner interest in proﬁt-sharing;
• depreciation expense;
• gain on sale of real estate assets;
• cumulative effect of change in accounting principle; and
• income from discontinued operations.

NOI  does  not  represent  cash  generated  from  operating  activities  in  accordance  with  GAAP. Therefore,  NOI
should not be considered an alternative to net income as an indication of our performance. NOI should also not
be considered an alternative to net cash ﬂow from operating activities, as determined by GAAP, as a measure of
liquidity, nor is NOI necessarily indicative of cash available to fund cash needs. A calculation of NOI for 2004,
2003 and 2002, along with a reconciliation to net income for each year, is provided in the preceding table.

The NOI increase of $35,313,000 in 2004 and decrease of $583,000 in 2003, as compared to the prior years,
consist of changes in the following categories:

(dollars in thousands)

Established Communities
Other Stabilized Communities
Development and Redevelopment Communities
Non-allocated

Total

2004
Increase (Decrease)

2003
Increase (Decrease)(1)

$ (3,963)
16,818
23,138
(680)

$35,313

$(27,335)
9,145
18,727
(1,120)

$

(583)

(1) For purposes of this table, amounts have been restated from amounts previously reported for changes in discontinued operations as described in Note 7, 

“Discontinued Operations—Real Estate Assets Sold or Held for Sale,” of our Consolidated Financial Statements.

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avalonbay Communities, Inc.

33

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

The NOI decreases in Established Communities were largely due to the effects of the weakened economy in our
markets during 2003 and the ﬁrst half of 2004. The impact of historical job losses in many of our markets, in
addition to strong single-family home sales, aggravated a weak demand environment, which caused market rental
rates to decline. However, 2004 was a year of transition, where modest job growth and declining unemployment
claims  reﬂected  the  early  stages  of  an  economic  recovery.  Strengthening  apartment  fundamentals,  along  with
strong on-site execution, resulted in year-over-year increases in NOI during the latter half of 2004, as evidenced
in the diminishing decline in NOI in 2004 as compared to 2003. Based on economic forecasts that project an
acceleration in job growth in our markets in 2005 as compared to the modest job growth experienced in 2004, we
expect an improved demand/supply ratio in 2005. Our occupancy has reached stabilized levels, and we began to
increase rental rates and reduce concessions in the latter half of 2004. In 2005, we expect the positive momentum
from 2004 to continue, resulting in growth in revenue from our Established Communities of 2.0% to 4.0% in
2005 as compared to 2004. We aggressively manage operating expenses, which we expect to increase by 1.5% to
3.5% in 2005, resulting in NOI growth for our Established Community portfolio of 2.5% to 4.5% in 2005 as
compared to 2004.

Rental and other income increased in both 2004 and 2003 due to rental income generated from newly developed
and  acquired  communities,  as  well  as  increased  occupancy  for  our  Established  Communities,  partially  offset 
by  declines  in  effective  rental  rates  for  our  Established  Communities.  We  expect  continued  improvement  in
apartment fundamentals due largely to the job growth projected for 2005.

Overall Portfolio—The weighted average number of occupied apartment homes increased to 36,431 apartment
homes for 2004 as compared to 32,629 apartment homes for 2003 and 30,437 in 2002. This change is primarily
the result of increased homes available from newly developed and acquired communities and an increase in the
overall occupancy rate, partially offset by communities sold in 2003 and 2004. The weighted average monthly
revenue  per  occupied  apartment  home  decreased  to  $1,479  in  2004  as  compared  to  $1,508  in  2003  and 
$1,539 in 2002, primarily due to the poor demand/supply fundamentals in our markets that resulted in a high
concessionary environment in certain of our markets.

Established Communities—Rental revenue decreased $1,496,000, or 0.3%, in 2004 and $20,424,000, or 4.3%,
in 2003. These decreases are due to declining rental rates, partially offset by increased economic occupancy as
compared to the prior years. For 2004, the weighted average monthly revenue per occupied apartment home
decreased 1.8% to $1,418 compared to $1,444 in 2003, partially due to the impact of increased concessions
granted throughout 2003 and into 2004. The average economic occupancy increased from 93.8% in 2003 to
95.3% in 2004. Economic occupancy takes into account the fact that apartment homes of different sizes and
locations  within  a  community  have  different  economic  impacts  on  a  community’s  gross  revenue.  Economic
occupancy is deﬁned as gross potential revenue less vacancy loss, as a percentage of gross potential revenue. Gross
potential revenue is determined by valuing occupied homes at leased rates and vacant homes at market rents. We
expect rental revenue from Established Communities to increase 2.0% to 4.0% in 2005 as compared to 2004.

Although  rental  revenue  from  the  Established  Community  portfolio  as  a  whole  was  relatively  ﬂat  in  2004  as
compared to 2003, we had increases in Established Communities’ rental revenue in four of our six regions. The
largest increase was in the Mid-Atlantic with an increase in rental revenue of 2.4% between years, reﬂecting an
increase in both economic occupancy and average rental rates. In addition, in Southern California, we were able
to  increase  average  rental  rates  by  1.5%,  while  also  increasing  economic  occupancy  by  0.4%,  resulting  in  an
increase in rental revenue of 1.9% between years. The Midwest and Paciﬁc Northwest experienced increases in
rental revenue of 2.2% and 1.4%, respectively, during 2004 as compared to 2003, reﬂecting increased economic
occupancy partially offset by declining average rental rates.

However, our total rental revenue from Established Communities was impacted by the continued declines in
average rental rates in certain Northern California and Northeast markets. Northern California, which accounted
for approximately 31.1% of Established Community rental revenue during 2004, experienced a decline in rental
revenue of 3.1% in 2004 as compared to 2003, partially related to the continued impact of job losses experienced
in the technology sector in prior years. Although economic occupancy in Northern California increased to an
average of 95.6% in 2004, average rental rates dropped 3.4% to $1,365 from $1,413 during 2003. However, we

began to see signs of improvement in Northern California during the last three months of 2004, as average rental
rates and economic occupancy both increased sequentially. Therefore, we expect year-over-year revenue growth
in Northern California in 2005.

The  Northeast  region  accounted  for  approximately  34.2%  of  Established  Community  rental  revenue  during
2004.  Rental  revenue  remained  relatively  ﬂat  as  compared  to  2003,  as  the  region  entered  the  early  stages  of
economic  recovery  from  the  job  losses  experienced  in  the  ﬁnancial  services  sector  in  prior  years.  Economic
occupancy increased by 2.5% during 2004, while average rental rates dropped 2.5% to $1,800 from $1,847 in
2003. The Northeast region appears to be stabilizing, as reﬂected in year-over-year rental revenue growth during
the latter half of 2004. Although we expect pressure on rental rates to continue in the Northeast region, we expect
year-over-year revenue growth in the Northeast in 2005, but at a lesser pace than other regions.

In accordance with GAAP, cash concessions are amortized as an offset to rental revenue over the approximate
lease term, which is generally one year. As a supplemental measure, we also present rental revenue with concessions
stated  on  a  cash  basis  to  help  investors  evaluate  the  impact  of  both  current  and  historical  concessions  on 
GAAP based rental revenue and to more readily enable comparisons to revenue as reported by other companies.
Rental revenue with concessions stated on a cash basis also allows investors to understand historical trends in cash
concessions, as well as current rental market conditions.

The following table reconciles total rental revenue in conformity with GAAP to total rental revenue adjusted to
state concessions on a cash basis for our Established Communities for the years ended December 31, 2004 and
2003 (dollars in thousands). Information for the year ended December 31, 2002 is not presented, as Established
Community classiﬁcation is not applicable prior to January 1, 2003. See Note 9, “Segment Reporting,” of our
Consolidated Financial Statements.

Rental revenue (GAAP basis)
Concessions amortized
Concessions granted

Rental revenue adjusted to state
concessions on a cash basis

Year-over-year % change—GAAP revenue
Year-over-year % change—cash concession based revenue

For the year ended

12-31-04

12-31-03

$439,914
16,260
(16,418)

$441,410 
12,506 
(14,567)

$439,756

$439,349 

(0.3%)
0.1%

n/a 
n/a 

Concessions  granted  per  move-in  for  Established  Communities  averaged  $974  during  2004,  an  increase  of
15.5% from $843 in 2003. Concessions granted per move-in peaked at $1,109 during the three months ended
June  30,  2004,  before  subsiding  to  $861  during  the  three  months  ended  December  31,  2004. The  decrease 
in recent months is expected to continue into 2005 as demand/supply fundamentals improve with job growth
and we regain pricing power. However, because we amortize concessions over the lease term, the historically high
concessions from 2004 will continue to lower reported operating results in 2005.

Management, development and other fees decreased in both 2004 and 2003 as compared to prior years due to
a  decrease  in  the  number  of  communities  that  we  manage.  In  addition,  in  2002  we  recognized  $711,000  in
construction management fees in connection with the redevelopment of a community owned by a limited liability
company in which we have a membership interest. In 2005, we expect management, development and other fees
to  increase  as  we  begin  to  earn  asset  and  property  management  fees  from  the  discretionary  investment  fund
discussed elsewhere in this report. 

Direct  property  operating  expenses,  excluding  property  taxes  increased  in  both  2004  and  2003  due  to  the
addition of recently developed and acquired apartment homes, coupled with increased expenses due to salary
increases and leasing bonuses, as well as increased make-ready costs associated with increasing occupancy.

34

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avalonbay Communities, Inc.

35

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

For Established Communities, direct property operating expenses, excluding property taxes, increased $2,131,000,
or 2.2%, to $141,823,000 in 2004 due primarily to increased salaries and leasing bonuses, as well as increased
make-ready  costs  associated  with  increasing  occupancy  as  discussed  above.  During  2003,  operating  expenses
increased  $5,724,000,  or  6.1%,  due  primarily  to  inclement  weather,  increased  insurance  costs  and  bad  debt
expenses. We expect expense growth in 2005 to be consistent with growth levels in 2004 with pressure on salaries
and utilities, partially offset by moderation in bad debt expenses, marketing costs and insurance. 

Property taxes increased in both 2004 and 2003 as compared to prior years due to overall higher assessments and
the addition of newly developed and redeveloped apartment homes, partially offset by property tax refunds.

For Established Communities, property taxes increased in 2004 and 2003 by $333,000 and $1,470,000, respectively,
as  compared  to  the  prior  year,  due  to  overall  higher  assessments  throughout  all  regions,  partially  offset  by
successful tax appeals. We expect property taxes to increase in 2005 as local jurisdictions are expected to continue
to seek additional revenue sources to offset budget deﬁcits. We manage property tax increases internally, as well
as engage third-party consultants, and appeal increases when appropriate.

Corporate-level  property  management  and  other  indirect  operating  expenses  increased  in  2004  due  to
increased compensation costs. During 2003, corporate-level property management and other indirect operating
expenses increased due to associate separation costs, as well as increased corporate-level marketing and customer
service costs to respond to pressure on economic occupancy.

Investments  and  investment  management  reﬂects  the  costs  incurred  related  to  investment  acquisitions,
investment  management  and  abandoned  pursuit  costs,  which  include  the  abandonment  or  impairment  of
development pursuits, acquisition pursuits and technology investments. Investments and investment management
increased in 2004 as compared to 2003 due to costs incurred in forming a potential discretionary investment
fund,  increased  compensation  costs  and  increased  abandoned  pursuit  costs.  Investments  and  investment 
management decreased in 2003 as compared to 2002 due to decreases in abandoned pursuit costs. Abandoned
pursuit costs were $1,726,000, $1,180,000 and $2,800,000 in 2004, 2003 and 2002, respectively. Abandoned 
pursuit costs can be volatile, and the activity experienced in any given year may not be experienced in future
years. We expect investments and investment management costs to continue to increase in 2005 due to the costs
associated with operating and managing the investment fund.

Interest expense decreased in 2004 as compared to 2003 primarily due to the repayment of unsecured debt and
reissuance  at  lower  interest  rates,  overall  lower  interest  rates  and  lower  average  outstanding  balances  on  our
unsecured credit facility. Interest expense increased in 2003 as compared to 2002, primarily due to the issuance
in late 2002 of unsecured notes and higher average outstanding balances on our unsecured credit facility, partially
offset  by  the  repayment  of  certain  unsecured  notes  and  overall  lower  interest  rates  on  both  short-term  and 
long-term borrowings. We expect interest expense to increase in 2005 as interest rates rise and we increase our
leverage from current levels.

Depreciation expense increased in both 2004 and 2003 primarily due to the completion of development and
redevelopment activities, as well as the acquisition of new communities in 2002 and 2004.

General and administrative expense (“G&A”) increased in 2004 as a result of higher compensation expense,
increased litigation and settlement costs associated with certain community and corporate matters and additional
corporate governance costs, including costs relating to compliance with Sarbanes-Oxley. G&A increased in 2003
as  a  result  of  construction  litigation  relating  to  a  community  that  has  completed  development  and  increased
directors and ofﬁcers (“D&O”) insurance, which was renewed in March 2003. We expect G&A to continue to
increase in 2005 due to increased corporate governance (primarily Sarbanes-Oxley compliance) and compensation
costs, but at a reduced pace as compared to 2004.

Impairment loss of $6,800,000 was recorded during 2002 related to two land parcels that were determined not
likely to proceed to development and therefore were planned for disposition. No impairment losses were recorded
in either 2004 or 2003.

Equity in income of unconsolidated entities decreased in 2004 and increased in 2003 primarily due to our share
of the gain received on a community sold in 2003 which was accounted for under the equity method in which
we held a 50% interest.

Interest  income  decreased  in  2004  and  2003  as  compared  to  prior  years  due  to  lower  average  cash  balances
invested and lower interest rates. In addition, effective January 1, 2004, we consolidated an entity from which
we held a participating mortgage note due to the implementation of FASB Interpretation No. 46 (“FIN 46”),
“Consolidation of Variable Interest Entities, and Interpretation of ARB No. 51,” as revised in December 2003.
Therefore, interest income that we recognized in 2003 and 2002 is not reﬂected in 2004 as such amounts were
eliminated in consolidation. (See Note 1, “Organization and Signiﬁcant Accounting Policies,” of the Consolidated
Financial Statements). On October 15, 2004, we received payment in full of the outstanding mortgage note due
from this entity. The mortgage note was repaid prior to its scheduled maturity, and therefore the total proceeds
of $33,994,000 included an early prepayment premium of approximately $1,240,000 (net of related legal costs)
along  with  the  unpaid  principal  balance  and  accrued  interest.  Upon  repayment  of  the  mortgage  note,  our
economic interest in this entity ended, and therefore this entity was no longer considered a variable interest entity
under FIN 46 and we discontinued consolidation.

Venture  partner  interest  in  proﬁt-sharing  represents  the  income  allocated  to  our  venture  partner  in  a  proﬁt-
sharing  arrangement  as  discussed  in  Note  6,  “Investments  in  Unconsolidated  Entities,”  of  our  Consolidated
Financial  Statements.  Fluctuations  as  compared  to  prior  years  are  due  to  changes  in  the  net  income  of  the
underlying real estate. Effective December 31, 2004, we no longer account for our interest in this venture as a
proﬁt-sharing arrangement.

Minority interest in consolidated partnerships decreased in 2004 due to the consolidation of an entity under
FIN 46, as discussed above. We do not hold an equity interest in this entity, and therefore 100% of the entity’s
net income or loss is recognized as minority interest in consolidated partnerships.

Income  from  discontinued  operations  represents  the  net  income  generated  by  communities  sold  during  the
period from January 1, 2002 through December 31, 2004. The decreases in 2004 and 2003 are due to the timing
of the sale of ﬁve communities in 2004 and eleven communities in 2003.

Gain on sale of communities decreased in 2004 and increased in 2003 due to the volume of disposition activity
in each year. The amount of gains realized depends on many factors, including the number of communities sold,
the  size  and  carrying  value  of  those  communities  and  the  market  conditions  in  the  local  area.  We  expect  to
continue to sell communities based on overall portfolio allocation needs as well as to respond to opportunities in
the market to maximize risk adjusted returns.

Cumulative  effect  of  change  in  accounting  principle  in  2004  is  a  result  of  the  implementation  of  FIN  46,
discussed above, and represents the difference between the net assets consolidated under FIN 46 and the previously
recorded net assets.

Dividends  attributable  to  preferred  stock  decreased  during  2004  and  2003  primarily  as  a  result  of  several
preferred stock redemptions during 2003 and 2002.

Funds  from  Operations  (“FFO”)  is  considered  an  appropriate  supplemental  measure  of  our  operating  and
ﬁnancial  performance  because,  by  excluding  gains  or  losses  related  to  dispositions  of  previously  depreciated
property  and  excluding  real  estate  depreciation,  which  can  vary  among  owners  of  identical  assets  in  similar
condition based on historical cost accounting and useful life estimates, FFO can help one compare the operating
performance of a company’s real estate between periods or as compared to different companies. We believe that
in  order  to  understand  our  operating  results,  FFO  should  be  examined  with  net  income  as  presented  in  our
Consolidated  Financial  Statements.  For  a  more  detailed  discussion  and  presentation  of  FFO,  see  “Selected
Financial Data,” included elsewhere in this report.

36

avalonbay Communities, Inc.

avalonbay Communities, Inc.

37

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

Liquidity and Capital Resources

Factors affecting our liquidity and capital resources are our cash ﬂows from operations, ﬁnancing activities and
investing activities. Operating cash ﬂow has historically been determined by: (i) the number of apartment homes
currently owned, (ii) rental rates, (iii) occupancy levels and (iv) operating expenses with respect to apartment
homes.  The  timing,  source  and  amount  of  cash  ﬂow  provided  by  ﬁnancing  activities  and  used  in  investing
activities are sensitive to the capital markets environment, particularly to changes in interest rates. The timing
and type of capital markets activity in which we engage, as well as our plans for development, redevelopment,
acquisition and disposition activity, are affected by changes in the capital markets environment, such as changes
in interest rates or the availability of cost-effective capital.

We regularly review our liquidity needs, the adequacy of cash ﬂow from operations, and other expected liquidity
sources to meet these needs. We believe our principal short-term liquidity needs are to fund:

• normal recurring operating expenses;
• debt service and maturity payments;
• preferred stock dividends and DownREIT partnership unit distributions;
• the minimum dividend payments required to maintain our REIT qualiﬁcation under the Internal Revenue

Code of 1986;

• development and redevelopment activity in which we are currently engaged; and
• opportunities for the acquisition of improved property.

We anticipate that we can fully satisfy these needs from a combination of cash ﬂow provided by operating activities,
proceeds from asset dispositions and borrowing capacity under our variable rate unsecured credit facility. 

Cash and cash equivalents totaled $1,582,000 at December 31, 2004, a decrease of $5,476,000 from $7,058,000
on  December  31,  2003. 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 included elsewhere in
this report.

Operating  Activities—Net  cash  provided  by  operating  activities  increased  to  $275,678,000  in  2004  from
$239,677,000 in 2003, primarily due to additional NOI from recently acquired and developed communities, partially 
offset by the loss of NOI from the 16 communities sold in 2004 and 2003, as discussed earlier in this report.

Investing Activities—Net cash used in investing activities of $251,683,000 in 2004 related to investments in assets
through  development,  redevelopment  and  acquisition  of  apartment  communities,  partially  offset  by  proceeds
from asset dispositions and the receipt of payment on a participating mortgage note. During 2004, we invested
$498,020,000 in the purchase and development of real estate and capital expenditures:

• We began the development of six new communities. These communities, if developed as expected, will contain
a total of 1,310 apartment homes, and the total capitalized cost, including land acquisition costs, is projected
to be approximately $241,100,000. We completed the development of seven communities containing a total
of 2,135 apartment homes for a total capitalized cost, including land acquisition cost, of $363,700,000.

• We began the redevelopment of three communities, two of which were acquired prior to 1999, and one of
which was acquired in 2004 (as discussed below) with the intent of being owned by a discretionary investment
fund. These communities contain 649 apartment homes and, if redeveloped as expected, will be completed 
for a total capitalized cost of $69,300,000, of which $55,100,000 was incurred prior to redevelopment. We
completed the redevelopment of one community containing 308 apartment homes for a total capitalized cost
of $44,000,000, of which $35,700,000 was incurred prior to redevelopment.

• We acquired ﬁve communities containing a total of 1,165 apartment homes for an aggregate purchase price 
of $134,216,000, which included the assumption of $8,155,000 of ﬁxed rate mortgage debt. Four of these
communities were acquired with the intent of being owned by a discretionary investment fund.

• We acquired ten parcels of land, including three parcels of improved land, in connection with Development

Rights, for an aggregate purchase price of $122,775,000.

• We had capital expenditures relating to current communities’ real estate assets of $12,984,000 and non-real

estate capital expenditures of $860,000.

Financing Activities—Net cash used in ﬁnancing activities totaled $29,471,000 in 2004, consisting primarily of
dividends paid and certain debt repayments, partially offset by a decrease in borrowings under our unsecured
credit facility, issuance of mortgage notes payable, issuance of common stock for option exercises and issuance of
unsecured notes. See Note 3, “Notes Payable, Unsecured Notes and Credit Facility,” and Note 4, “Stockholders’
Equity,” of our Consolidated Financial Statements, for additional information.

Variable  Rate  Unsecured  Credit  Facility We  have  a  $500,000,000  revolving  variable  rate  unsecured  credit
facility  with  JPMorgan  Chase  Bank  and Wachovia  Bank,  N.A.  serving  as  banks  and  syndication  agents  for  a
syndicate of commercial banks. Under the terms of the credit facility, if we elect to increase the facility by up to
an additional $150,000,000, and one or more banks (from the syndicate or otherwise) voluntarily agree to provide
the additional commitment, then we will be able to increase the facility up to $650,000,000, and no member 
of the syndicate of banks can prohibit such increase; such an increase in the facility will only be effective to the
extent banks (from the syndicate or otherwise) choose to commit to lend additional funds. We pay participating
banks, in the aggregate, an annual facility fee of approximately $750,000 in quarterly installments. The unsecured
credit facility bears interest at varying levels based on the London Interbank Offered Rate (“LIBOR”), rating
levels achieved on our unsecured notes and on a maturity schedule selected by us. The current stated pricing 
is LIBOR plus 0.55% per annum (3.02% on February 28, 2005). The spread over LIBOR can vary from LIBOR
plus  0.50%  to  LIBOR  plus  1.15%  based  upon  the  rating  of  our  long-term  unsecured  debt.  In  addition,  a
competitive bid option is available for borrowings of up to $250,000,000. This option allows banks that are part
of the lender consortium to bid to provide us loans at a rate that is lower than the stated pricing provided by the
unsecured credit facility. The competitive bid option may result in lower pricing if market conditions allow. We
had $100,000,000 outstanding under this competitive bid option at February 28, 2005 priced at LIBOR plus
0.29%, or 2.78%. We are subject to (i) certain customary covenants under the unsecured credit facility, including,
but not limited to, maintaining certain maximum leverage ratios, a minimum ﬁxed charges coverage ratio and
minimum  unencumbered  assets  and  equity  levels,  and  (ii) prohibitions  on  paying  dividends  in  amounts  that
exceed 95% of our FFO, except as may be required to maintain our REIT status. The credit facility matures 
in  May  2008,  assuming  our  exercise  of  a  one-year  renewal  option.  At  February  28,  2005,  $291,500,000  was
outstanding, $27,251,000 was used to provide letters of credit and $181,249,000 was available for borrowing
under the unsecured credit facility.

Future Financing and Capital Needs—Debt Maturities One of our principal long-term liquidity needs is the
repayment of medium and long-term debt at the time that such debt matures. For unsecured notes, we anticipate
that no signiﬁcant portion of the principal of these notes will be repaid prior to maturity. If we do not have 
funds on hand sufﬁcient to repay our indebtedness as it becomes due, it will be necessary for us to reﬁnance the
debt. This reﬁnancing may be accomplished by uncollateralized private or public debt offerings, additional debt
ﬁnancing that is collateralized by mortgages on individual communities or groups of communities, draws on our
unsecured credit facility or by additional equity offerings. Although we believe we will have the capacity to meet
our long-term liquidity needs, we cannot assure you that additional debt ﬁnancing or debt or equity offerings
will be available or, if available, that they will be on terms we consider satisfactory.

The following debt activity occurred during 2004: 

• We repaid $125,000,000 in previously issued unsecured notes, along with any unpaid interest, pursuant to
their scheduled maturity, and no prepayment penalties were incurred. In addition, we issued $150,000,000 in
unsecured notes under our existing shelf registration statement at an annual interest rate of 5.375%. Interest
on these notes is payable semi-annually on April 15 and October 15, and they mature in April 2014;

• We repaid $24,251,000 in ﬁxed rate mortgage debt, secured by two current communities, repaid $10,400,000
in variable rate, tax-exempt debt related to the sale of a community and transferred $28,335,000 in variable
rate, tax-exempt debt related to the sale of two communities to the respective purchasers;

38

avalonbay Communities, Inc.

avalonbay Communities, Inc.

39

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

• We issued $82,800,000 in variable rate, conventional debt on three communities, and purchased interest rate
protection agreements that serve to effectively limit the level to which interest rates can rise on this debt to a
weighted average of 8.5%;

• We obtained a $50,000,000 secured construction loan for the construction of a development community that
will  be  owned  and  operated  in  a  joint  venture  entity  upon  completion.  Outstanding  draws  ($6,278,000  at
December 31, 2004) will bear interest at a variable rate and will come due in March 2008, assuming the exercise 
of two one-year extension options;

• We issued $16,765,000 in variable rate, conventional debt on one community;
• We assumed $8,155,000 in ﬁxed rate, conventional mortgage debt in conjunction with the acquisition of a

community;

• We assumed $20,141,000 in ﬁxed rate debt in connection with the acquisition of three parcels of improved

land related to three Development Rights;

• We  replaced  the  credit  enhancements,  including  interest  rate  swaps,  on  approximately  $87,000,000  of  our
variable rate, tax-exempt debt when such credit enhancements expired, of which $9,580,000 was transferred
upon the sale of a community to the respective purchaser. We put in place interest rate protection agreements
that serve to effectively limit the level to which interest rates can rise on the remaining debt to a range of 6.7%
to 9.0%; and

• We renegotiated the terms of a ﬁxed rate, tax-exempt bond on one community in the amount of $9,780,000

to decrease the annual interest rate from 7.0% to 4.9%.

In January 2005, we repaid $150,000,000 in previously issued unsecured notes, along with any unpaid interest,
pursuant  to  their  scheduled  maturity.  No  prepayment  penalty  was  incurred.  In  addition,  in  March  2005,  we
issued $100,000,000 in unsecured notes under our existing shelf registration statement at an annual effective
interest rate of 4.999%. Interest on these notes is payable semi-annually on March 15 and September 15, and
they mature in March 2013.

We currently have an effective shelf registration statement on ﬁle with the Securities and Exchange Commission.
The shelf registration statement originally provided $750,000,000 of debt and equity capacity, however, only
$370,984,000 remains outstanding (after consideration of the March 2005 issuance discussed above). We cannot 
assure you that market conditions will permit us to issue debt or equity securities on cost-effective terms or that
the registration statement will remain available and effective at all times.

Future Financing and Capital Needs—Portfolio and Other Activity As of December 31, 2004, we had ten
new communities under construction, for which a total estimated cost of $145,012,000 remained to be invested.
In addition, we had four communities under reconstruction, for which a total estimated cost of $15,710,000
remained  to  be  invested.  Substantially  all  of  the  capital  expenditures  necessary  to  complete  the  communities
currently under construction and reconstruction, as well as development costs related to pursuing Development
Rights, will be funded from:

• the remaining capacity under our current $500,000,000 unsecured credit facility;
• the net proceeds from sales of existing communities;
• retained operating cash; 
• the issuance of debt or equity securities; and/or
• private equity funding.

Before  planned  reconstruction  activity,  including  reconstruction  activity  related  to  a  discretionary  investment
fund discussed below, or the construction of a Development Right begins, we intend to arrange adequate ﬁnancing
to complete these undertakings, although we cannot assure you that we will be able to obtain such ﬁnancing. In
the event that ﬁnancing cannot be obtained, we may have to abandon Development Rights, write-off associated
pre-development costs that were capitalized and/or forego reconstruction activity. In such instances, we will not
realize the increased revenues and earnings that we expected from such Development Rights or reconstruction
activity and signiﬁcant losses could be incurred.

We have engaged in discussions with a limited number of institutional investors regarding the formation of a
discretionary fund that would acquire and operate apartment communities. This fund would serve, for a period
of three years from its initial closing date or until 80% of its committed capital is invested, as the exclusive vehicle
through  which  we  would  acquire  apartment  communities,  subject  to  certain  exceptions.  These  exceptions
include  signiﬁcant  individual  asset  and  portfolio  acquisitions,  properties  acquired  in  tax-deferred  transactions
and  acquisitions  that  are  inadvisable  or  inappropriate  for  the  fund,  if  any.  The  fund  would  not  restrict  our
development activities, and would terminate after a term of eight years, subject to two one-year extensions. As
of February 28, 2005, we have acquired four communities with the intent of being owned by the fund, but which
are  currently  consolidated  and  included  in  our  operating  results.  We  are  currently  targeting  acquisitions  for 
the fund where value creation opportunities are present through one or more of the following: redevelopment
activities,  market  cycle  opportunities  or  improved  property  operations.  We  expect  the  fund  to  have  equity
commitments of up to $330,000,000 and the ability to employ leverage through debt ﬁnancings up to 65% on
a portfolio basis, which would enable the fund to invest up to $940,000,000. We would contribute 20% of the
total equity up to $50,000,000. We expect closing on the equity funding during the ﬁrst quarter of 2005. There
can be no assurance as to when or if such a fund will be formed or, if formed, what its size, terms or investment
performance will be. 

We have also recently increased our use of joint ventures to hold individual real estate assets, pursuant to which
certain  developments  will  be  held  upon  completion  through  partnership  vehicles.  We  generally  employ  joint
ventures primarily to mitigate asset concentration or market risk and secondarily as a source of liquidity. Each
joint venture or partnership agreement has been and will continue to be individually negotiated, and our ability
to operate and/or dispose of a community in our sole discretion may be limited to varying degrees depending on
the terms of the joint venture or partnership agreement. However, we cannot assure you that we will continue to
enter into joint ventures in the future, or that, if we do, we will achieve our objectives.

The following joint venture activity occurred during 2004:

• We  entered  into  a  joint  venture  agreement  with  an  unrelated  third-party  for  the  development  of  Avalon
Chrystie Place I. We hold a 20% equity interest in this joint venture entity (with a right to 50% of distributions
after achievement of a threshold return), with the remaining 80% equity interest held by the third-party;
• We entered into an agreement with an unrelated third-party which provides that, after we complete construction
of Avalon Del Rey, the community will be owned and operated by a joint venture between us and the third-
party.  Upon  construction  completion,  the  third-party  venture  partner  will  invest  $49,000,000  and  will  be
granted a 70% ownership interest in the venture, while we retain a 30% equity interest;

• We  entered  into  an  agreement  to  develop  Avalon  at  Juanita Village  through  a  wholly-owned  taxable  REIT
subsidiary and, upon construction completion, contribute the community to a joint venture. Upon contribution
of  the  community  to  the  joint  venture,  we  expect  to  be  reimbursed  for  all  costs  incurred  to  develop  the
community. The  third-party  joint  venture  partner  will  receive  a  100%  equity  interest  in  the  joint  venture 
and will manage the joint venture. We will receive a residual proﬁts interest and will be engaged to manage
the community for a property management fee; and

• We  entered  into  a  joint  venture  agreement  with  an  unrelated  third-party  for  the  development  of  Avalon  at
Mission Bay North II, which is expected to begin construction in early 2005. We hold a 25% equity interest
in this joint venture entity, with the remaining 75% equity interest held by the third-party.

In evaluating our allocation of capital within our markets, we often sell assets that do not meet our long-term
investment criteria or when capital and real estate markets allow us to realize a portion of the value created over
the past business cycle and redeploy the proceeds from those sales to develop and redevelop communities. In
response to real estate and capital markets conditions, including strong institutional demand for product in our
markets, we sold ﬁve communities in 2004, and anticipate selling additional communities when opportunities
arise for harvesting value in 2005. However, we cannot assure you that assets can continue to be sold on terms
that  we  consider  satisfactory  or  that  market  conditions  will  continue  to  make  the  sale  of  assets  an  appealing
strategy. Because the proceeds from the sale of communities may not be immediately redeployed into revenue
generating assets, the immediate effect of a sale of a community for a gain is to increase net income, but reduce

40

avalonbay Communities, Inc.

avalonbay Communities, Inc.

41

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

future total revenues, total expenses, NOI and FFO. As of February 28, 2005, we have two communities classiﬁed
as held for sale under GAAP. We are actively pursuing the disposition of these communities and expect to close
on these dispositions in 2005. However, we cannot assure you that these communities will be sold as planned.

Off Balance Sheet Arrangements

We  own  interests  in  unconsolidated  real  estate  entities,  with  ownership  interests  up  to  50%. Three  of  these
unconsolidated real estate entities, Avalon Terrace, LLC, CVP I, LLC and AvalonBay Redevelopment, LLC, have
debt outstanding as of December 31, 2004. Avalon Terrace, LLC has $22,500,000 of variable rate debt which
matures in November 2005 and is payable by the unconsolidated real estate entity with operating cash ﬂow from
the underlying real estate. CVP I, LLC has a $117,000,000 construction loan which matures in February 2009,
assuming  exercise  of  two  one-year  renewal  options,  and  is  payable  by  the  unconsolidated  real  estate  entity.
AvalonBay  Redevelopment,  LLC  has  $36,124,000  of  variable  rate  debt  which  matures  in  April  2005  and  is
payable  by  the  unconsolidated  real  estate  entity  with  operating  cash  ﬂow  from  the  underlying  real  estate.  We 
have  not  guaranteed  the  debt  on  Avalon Terrace,  LLC  or  AvalonBay  Redevelopment,  LLC,  nor  do  we  have 
any  obligation  to  fund  this  debt  should  the  unconsolidated  real  estate  entities  be  unable  to  do  so.  However, 
in connection with the general contractor services that we provide to CVP I, LLC, the entity that owns and is
developing Avalon Chrystie Place I, we have provided a construction completion guarantee to the lender in order
to fulﬁll their standard ﬁnancing requirements related to the construction ﬁnancing. Our obligations under this
guarantee  will  terminate  following  construction  completion  once  all  of  the  lender’s  standard  completion 
requirements have been satisﬁed. We currently expect this to occur in 2006. There are no lines of credit, side
agreements, ﬁnancial guarantees or any other derivative ﬁnancial instruments related to or between us and our
unconsolidated  real  estate  entities.  In  evaluating  our  capital  structure  and  overall  leverage,  management  takes 
into  consideration  our  proportionate  share  of  this  unconsolidated  debt.  For  more  information  regarding  the
operations of our unconsolidated entities see Note 6, “Investments in Unconsolidated Real Estate Entities,” of
our Consolidated Financial Statements.

Contractual Obligations

We currently have contractual obligations consisting primarily of long-term debt obligations and lease obligations
for certain land parcels and regional and administrative ofﬁce space. Scheduled contractual obligations required
for the next ﬁve years and thereafter are as follows as of December 31, 2004:

Payments due by period

(dollars in thousands)

Total

Less than 1 
Year

1–3 Years

3–5 Years

More than 5 
Years 

Long-Term Debt Obligations(1)
Operating Lease Obligations

$2,442,843
393,075

$259,615
4,061

$433,035
8,162

$441,620
7,641

$1,308,573 
373,211 

Total

$2,835,918

$263,676

$441,197

$449,261

$1,681,784 

(1) Includes $102,000 outstanding under our variable rate unsecured credit facility as of December 31, 2004. The table of

contractual obligations assumes repayment of this amount in 2005—See “Liquidity and Capital Resources.”

Inﬂation and Deﬂation

Substantially all of our apartment leases are for a term of one year or less. In an inﬂationary environment, this may
allow us to realize increased rents upon renewal of existing leases or the beginning of new leases. Short-term leases
generally minimize our risk from the adverse effects of inﬂation, although these leases generally permit residents
to  leave  at  the  end  of  the  lease  term  and  therefore  expose  us  to  the  effect  of  a  decline  in  market  rents.  In  a
deﬂationary rent environment, we may be exposed to declining rents more quickly under these shorter-term leases.

Forward-Looking Statements

This Annual Report contains “forward-looking statements” as that term is deﬁned under the Private Securities
Litigation Reform Act of 1995. You can identify forward-looking statements by our use of the words “believe,”

“expect,” “anticipate,” “intend,” “estimate,” “assume,” “project,” “plan,” “may,” “shall,” “will” and other similar
expressions  in  this  Annual  Report,  that  predict  or  indicate  future  events  and  trends  and  that  do  not  report
historical  matters.  These  statements  include,  among  other  things,  statements  regarding  our  intent,  belief  or
expectations with respect to:

• our potential development, redevelopment, acquisition or disposition of communities;
• the timing and cost of completion of apartment communities under construction, reconstruction, development

or redevelopment;

• the timing of lease-up, occupancy and stabilization of apartment communities;
• the pursuit of land on which we are considering future development;
• the anticipated operating performance of our communities;
• cost, yield and earnings estimates;
• our declaration or payment of distributions;
• our joint venture and discretionary fund activities;
• our policies regarding investments, indebtedness, acquisitions, dispositions, ﬁnancings and other matters;
• our qualiﬁcation as a REIT under the Internal Revenue Code;
• the real estate markets in Northern and Southern California and markets in selected states in the Mid-Atlantic,

Northeast, Midwest and Paciﬁc Northwest regions of the United States and in general;

• the availability of debt and equity ﬁnancing;
• interest rates;
• general economic conditions; and
• trends affecting our ﬁnancial condition or results of operations.

We cannot assure the future results or outcome of the matters described in these statements; rather, these statements
merely reﬂect our current expectations of the approximate outcomes of the matters discussed. You should not
rely  on  forward-looking  statements  because  they  involve  known  and  unknown  risks,  uncertainties  and  other
factors, some of which are beyond our control. These risks, uncertainties and other factors may cause our actual
results,  performance  or  achievements  to  differ  materially  from  the  anticipated  future  results,  performance  or
achievements expressed or implied by these forward-looking statements. Some of the factors that could cause 
our  actual  results,  performance  or  achievements  to  differ  materially  from  those  expressed  or  implied  by  these 
forward-looking statements include, but are not limited to, the following:

• we may fail to secure development opportunities due to an inability to reach agreements with third parties or

to obtain desired zoning and other local approvals;

• we may abandon or defer development opportunities for a number of reasons, including changes in local market
conditions which make development less desirable, increases in costs of development and increases in the cost
of capital, resulting in losses;

• construction costs of a community may exceed our original estimates; 
• we  may  not  complete  construction  and  lease-up  of  communities  under  development  or  redevelopment  on
schedule, resulting in increased interest costs and construction costs and a decrease in our expected rental revenues; 
• occupancy rates and market rents may be adversely affected by competition and local economic and market

conditions which are beyond our control; 

• ﬁnancing may not be available on favorable terms or at all, and our cash ﬂow from operations and access to
cost effective capital may be insufﬁcient for the development of our pipeline which could limit our pursuit of
opportunities; 

• our cash ﬂow may be insufﬁcient to meet required payments of principal and interest, and we may be unable
to reﬁnance existing indebtedness or the terms of such reﬁnancing may not be as favorable as the terms of
existing indebtedness; 

• we may be unsuccessful in closing, managing or investing in the discretionary investment fund; and
• we may be unsuccessful in managing changes in our portfolio composition.

42

avalonbay Communities, Inc.

avalonbay Communities, Inc.

43

MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued)

CONSOLIDATED BALANCE SHEETS

These and other factors are discussed in our Annual Report on Form 10-K for 2004 and other reports and documents 
filed with the Securities and Exchange Commission. These forward-looking statements represent our estimates
and assumptions only as of the date of this report. We do not undertake to update these forward-looking statements, 
and therefore they may not represent our estimates and assumptions after the date of this report.

Quantitative and Qualitative Disclosures About Market Risk

We are exposed to certain ﬁnancial market risks, the most predominant being ﬂuctuations in interest rates. We
monitor interest rate ﬂuctuations as an integral part of our overall risk management program, which recognizes the
unpredictability of ﬁnancial markets and seeks to reduce the potentially adverse effect on our results of operations.
The effect of interest rate ﬂuctuations historically has been small relative to other factors affecting operating results,
such as rental rates and occupancy. The speciﬁc market risks and the potential impact on our operating results are
described below.

Our operating results are affected by changes in interest rates as a result of borrowings under our variable rate
unsecured  credit  facility  as  well  as  outstanding  bonds  with  variable  interest  rates. We  had  $217,174,000  and
$168,505,000 in variable rate debt outstanding as of December 31, 2004 and 2003, respectively. If interest rates
on the variable rate debt had been 100 basis points higher throughout 2004 and 2003, our annual interest costs
would have increased by approximately $3,682,000 and $2,665,000, respectively, based on balances outstanding
during the applicable years.

We  currently  use  interest  rate  protection  agreements  (consisting  of  interest  rate  swap  and  cap  agreements)  to
reduce the impact of interest rate ﬂuctuations on certain variable rate indebtedness. Under swap agreements:

• we agree to pay to a counterparty the interest that would have been incurred on a ﬁxed principal amount at a
ﬁxed interest rate (generally, the interest rate on a particular treasury bond on the date the agreement is entered
into, plus a ﬁxed increment), and

• the counterparty agrees to pay to us the interest that would have been incurred on the same principal amount

at an assumed ﬂoating interest rate tied to a particular market index.

As of December 31, 2004, the effect of swap agreements is to ﬁx the interest rate on approximately $69,000,000
of our variable rate, tax-exempt debt. Furthermore, a swap agreement to ﬁx the interest rate on approximately
$22,500,000 of unconsolidated variable rate debt existed as of December 31, 2004. The interest rate protection
provided by certain swap agreements on the consolidated variable rate, tax-exempt debt was not electively entered
into by us but, rather, was a requirement of either the bond issuer or the credit enhancement provider related to
certain of our tax-exempt bond ﬁnancings. Because the counterparties providing the swap agreements are major
ﬁnancial institutions which have an A+ or better credit rating by the Standard & Poor’s Ratings Group and the
interest rates ﬁxed by the swap agreements are signiﬁcantly higher than current market rates for such agreements,
we do not believe there is exposure at this time to a default by a counterparty provider. Had these swap agreements 
not been in place during 2004 and 2003, our annual interest costs would have been approximately $2,769,000
and  $6,027,000  lower,  respectively,  based  on  balances  outstanding  and  reported  interest  rates  during  the 
applicable years. However, if the variable interest rates on this debt had been 100 basis points higher throughout 
2004 and 2003 and these swap agreements had not been in place, our annual interest costs would have been
approximately $2,073,000 and $4,581,000 lower, respectively.

In addition, changes in interest rates affect the fair value of our ﬁxed rate debt, which impacts the fair value of
our  aggregate  indebtedness.  Debt  securities  and  notes  payable  (excluding  our  variable  rate  unsecured  credit
facility) with an aggregate carrying value of $2,340,843,000 at December 31, 2004 had an estimated aggregate
fair value of $2,532,620,000 at December 31, 2004. Fixed rate debt represented $2,123,669,000 of the carrying
value and $2,246,602,000 of the fair value at December 31, 2004. If interest rates had been 100 basis points higher
as of December 31, 2004, the fair value of this ﬁxed rate debt would have decreased by $101,157,000.

(Dollars in thousands, except per share data)

12-31-04

12-31-03

Assets
Real estate:
Land, including land held for development
Buildings and improvements
Furniture, ﬁxtures and equipment

Less accumulated depreciation

Net operating real estate
Construction in progress, including land
Real estate assets held for sale, net

Total real estate, net

Cash and cash equivalents
Cash in escrow
Resident security deposits
Investments in unconsolidated real estate entities
Deferred ﬁnancing costs, net
Deferred development costs
Participating mortgage note
Prepaid expenses and other assets

Total assets

Liabilities and Stockholders’ Equity
Unsecured notes
Variable rate unsecured credit facility
Mortgage notes payable
Dividends payable
Payables for construction
Accrued expenses and other liabilities
Accrued interest payable
Resident security deposits
Liabilities related to real estate assets held for sale

Total liabilities

$1,066,936
4,323,539
133,378

$ 901,404
4,011,590
124,017

5,523,853
(819,319)

5,037,011
(670,392)

4,704,534
173,291
—

4,366,619
253,158
116,612

4,877,825

4,736,389

1,582
13,075
23,478
41,379
21,859
37,007
—
52,076

7,058
11,825
20,891
19,735
17,362
31,334
21,483
43,505

$5,068,281

$4,909,582

$1,859,448
102,000
480,843
52,982
23,005
71,019
37,254
34,914
—

$1,835,284
51,100
412,698
51,831
26,967
84,962
38,880
31,701
40,073

2,661,465

2,573,496

Minority interest of unitholders in consolidated partnerships

21,525

24,752

Commitments and contingencies

Stockholders’ equity:
Preferred stock, $0.01 par value; $25 liquidation preference; 50,000,000 shares
authorized at both December 31, 2004 and 2003; 4,000,000 shares issued
and outstanding at both December 31, 2004 and 2003
Common stock, $0.01 par value; 140,000,000 shares authorized at both 
December 31, 2004 and 2003; 72,582,076 and 70,937,526 shares issued and 
outstanding at December 31, 2004 and 2003, respectively
Additional paid-in capital
Deferred compensation
Dividends less than accumulated earnings
Accumulated other comprehensive loss

Total stockholders’ equity

Total liabilities and stockholders’ equity

See accompanying notes to Consolidated Financial Statements.

40

40

726
2,389,511
(8,659)
10,769
(7,096)

709
2,322,581
(5,808)
2,024
(8,212)

2,385,291

2,311,334

$5,068,281

$4,909,582

44

avalonbay Communities, Inc.

avalonbay Communities, Inc.

45

CONSOLIDATED STATEMENTS OF OPERATIONS

AND OTHER COMPREHENSIVE INCOME

(Dollars in thousands, except per share data)

12-31-04

12-31-03

12-31-02

For the year ended

Revenue:
Rental and other income
Management, development and other fees

Total revenue

Expenses:
Operating expenses, excluding property taxes
Property taxes
Interest expense
Depreciation expense
General and administrative expense
Impairment loss

Total expenses

Equity in income of unconsolidated entities
Interest income
Venture partner interest in proﬁt-sharing
Minority interest in consolidated partnerships

Income from continuing operations before
cumulative effect of change in accounting principle

Discontinued operations:
Income from discontinued operations
Gain on sale of real estate assets

Total discontinued operations

Income before cumulative effect of
change in accounting principle
Cumulative effect of change in accounting principle

Net income
Dividends attributable to preferred stock

$647,850
604

$591,411
931

$568,352
2,145

648,454

592,342

570,497

189,223
62,665
131,314
160,815
18,074
—

172,393
56,120
133,637
147,658
14,830
—

155,799
50,767
118,288
130,488
13,449
6,800

562,091

524,638

475,591

1,100
194
(1,178)
(150)

25,535
3,440
(1,688)
(950)

55
3,978
(857)
(865)

86,329

94,041

97,217

6,444
122,425

16,494
160,990

128,869

177,484

215,198
4,547

219,745
(8,700)

271,525
—

271,525
(10,744)

27,508
48,893

76,401

173,618
—

173,618
(17,896)

Net income available to common stockholders

$211,045

$260,781

$155,722

Other comprehensive income (loss):
Unrealized gain (loss) on cash ﬂow hedges

Comprehensive income

Earnings per common share—basic:
Income from continuing operations
(net of dividends attributable to preferred stock)
Discontinued operations

Net income available to common stockholders

Earnings per common share—diluted:
Income from continuing operations
(net of dividends attributable to preferred stock)
Discontinued operations

Net income available to common stockholders

See accompanying notes to Consolidated Financial Statements.

1,116

4,428

(4,157)

$212,161

$265,209

$151,565

$

$

$

$

1.15
1.80

2.95

1.16
1.76

2.92

$

$

$

$

1.21
2.59

3.80

1.20
2.53

3.73

$

$

$

$

1.15
1.11

2.26

1.13
1.10

2.23

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(Dollars in thousands,
except share data)

Preferred
stock

Common
stock

Preferred Common

stock

stock

Shares issued

Dividends less Accumulated
Additional Deferred than (in excess  other com-
compen- of) accumulated prehensive
earnings
sation

paid-in
capital

loss

Stock-
holders’
equity

9,567,700
—

68,713,384
—

$96
—

$687
—

$2,340,779
—

$(7,489)
—

$(11,035)
173,618

$(8,483)
—

$2,314,555
173,618

—

—

—

—

(4,157)

(4,157)

Balance at 
December 31, 2001
Net income
Unrealized loss on 
cash ﬂow hedges
Dividends declared to 
common and preferred 
stockholders
Issuance of common stock, 
net of withholdings
Repurchase of common 
stock, including 
repurchase costs
Issuance of preferred stock, 
net of issuance costs
Redemption of 
preferred stock
Amortization of 
deferred compensation

Balance at 
December 31, 2002

Net income
Unrealized gain on 
cash ﬂow hedges
Dividends declared to 
common and preferred 
stockholders
Issuance of common stock, 
net of withholdings
Issuance of stock options
Repurchase of common stock, 
including repurchase costs
Issuance of preferred stock, 
net of issuance costs
Redemption of 
preferred stock
Amortization of 
deferred compensation

Balance at 
December 31, 2003

Net income
Unrealized gain on 
cash ﬂow hedges
Dividends declared to 
common and preferred 
stockholders
Issuance of common stock, 
net of withholdings
Issuance of stock options
Amortization of 
deferred compensation

Balance at 
December 31, 2004

—

—

—

—

771,142

— (1,281,600)

592,000

—

(2,892,000)

— (29)

—

—

—

7,267,700

68,202,926

—

—

—

—

—

—

— 3,833,600
—
—

— (1,099,000)

3,336,611

(6,604,311)

—

—

—

—

4,000,000

70,937,526

—

—

—

—

—

—

— 1,644,550
—
—

—

—

73

—

—

—

—
—

—

33

(66)

—

40

—

—

—

—
—

—

—

—

8

—

—

—

—

—

—

38
—

—

—

—

—

—

—

17
—

—

—

—

—

—

—

—

—

—

—

—

—

—

—

—

—

—

—

6

—

(209,996)

28,795

(4,463)

(508)

(13)

(38,281)

14,387

(72,012)

—

4,097

(11,467)

—

—

—

—

—

—

—

—

—

(209,996)

23,832

(49,761)

14,393

(72,041)

4,097

682

2,273,668

(7,855)

(59,388)

(12,640)

2,194,540

—

—

271,525

—

271,525

—

4,428

4,428

—

(202,694)

162,674
754

(1,383)
(754)

—

—
—

—

—

—

—

(202,694)

161,215
—

(39,877)

81,737

(163,724)

4,184

(114)
—

(7,025)

—

(280)

—

(11)

(32,841)

81,704

(163,378)

—

4,184

709

2,322,581

(5,808)

2,024

(8,212)

2,311,334

—

—

219,745

—

219,745

—

1,116

1,116

—

(210,338)

64,849
2,081

(5,702)
(2,081)

—

4,932

(662)
—

—

—

—
—

—

(210,338)

58,502
—

4,932

4,000,000

72,582,076

$40

$726

$2,389,511

$(8,659)

$ 10,769

$(7,096) $2,385,291

46

avalonbay Communities, Inc.

avalonbay Communities, Inc.

47

See accompanying notes to Consolidated Financial Statements.

CONSOLIDATED STATEMENTS OF CASH FLOWS

CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

For the year ended

Supplemental disclosures of non-cash investing and ﬁnancing activities (dollars in thousands):

(Dollars in thousands)

12-31-04

12-31-03

12-31-02

Cash ﬂows from operating activities:
Net income
Adjustments to reconcile net income to cash provided
by operating activities:
Depreciation expense
Depreciation expense from discontinued operations
Amortization of deferred ﬁnancing costs and debt premium/discount
Amortization of deferred compensation
Income allocated to minority interest in consolidated partnerships
including discontinued operations
Income allocated to venture partner interest in proﬁt-sharing
Gain on sale of real estate assets, net of impairment loss 
on planned dispositions
Gain on sale of joint venture community
Cumulative effect of change in accounting principle
Increase in cash in operating escrows
Decrease (increase) in resident security deposits, prepaid
expenses and other assets
Increase (decrease) in accrued expenses, other liabilities
and accrued interest payable

$ 219,745

$ 271,525

$ 173,618

160,815
1,852
3,962
4,932

187
1,178

(122,425)
—
(4,547)
(1,451)

(10,528)

21,958

147,658
6,138
3,850
4,184

1,388
1,688

(160,990)
(23,448)
—
(557)

(7,025)

(4,734)

130,488
13,989
3,913
4,097

1,713
857

(42,093)
—
—
(134)

18,311

3,051

During the year ended December 31, 2004:

• As described in Note 4, “Stockholders’ Equity,” 147,517 shares of common stock were issued in connection
with stock grants, 78,509 shares were issued in connection with non-cash stock option exercises, 1,545 shares
were  issued  through  the  Company’s  dividend  reinvestment  plan,  75,515  shares  were  withheld  to  satisfy
employees’ tax withholding and other liabilities and 3,012 shares were forfeited, for a net value of $6,138.
• 104,160  units  of  limited  partnership,  valued  at  $4,035,  were  presented  for  redemption  to  the  DownREIT
partnerships that issued such units and were acquired by the Company in exchange for an equal number of
shares of the Company’s common stock.

• The  Company  sold  two  communities  with  mortgage  notes  payable  of  $28,335  in  the  aggregate,  that  were

assumed by the respective buyers as part of the total sales price.

• The  Company  assumed  ﬁxed  rate  debt  of  $8,155  in  connection  with  the  acquisition  of  a  community  and

$20,141 in connection with the acquisition of three improved land parcels.

• The Company recorded a decrease to other liabilities and a corresponding gain to other comprehensive income
of $1,116 to adjust the Company’s Hedged Derivatives (as deﬁned in Note 5, “Derivative Instruments and
Hedging Activities”) to their fair value.

• Common and preferred dividends declared but not paid totaled $52,982.

Net cash provided by operating activities

275,678

239,677

307,810

During the year ended December 31, 2003:

Cash ﬂows from investing activities:
Development/redevelopment of real estate assets including
land acquisitions and deferred development costs
Acquisition of real estate assets
Capital expenditures—existing real estate assets
Capital expenditures—non-real estate assets
Proceeds from sale of communities and land, net of selling costs
Decrease in payables for construction
Decrease (increase) in cash in construction escrows
Repayment of participating mortgage note, including interest 
and prepayment premium
Decrease (increase) in investments in unconsolidated real estate entities

(355,938)
(128,238)
(12,984)
(860)
219,649
(3,962)
201

34,846
(4,397)

(357,520)
—
(11,593)
(274)
403,118
(331)
(1,040)

—
1,575

(426,830)
(106,300)
(10,930)
(1,142)
78,454
(9,353)
39,830

—
475

Net cash provided by (used in) investing activities

(251,683)

33,935

(435,796)

Cash ﬂows from ﬁnancing activities:
Issuance of common stock
Repurchase of common stock
Issuance of preferred stock, net of related costs
Redemption of preferred stock and related costs
Dividends paid
Net borrowings under unsecured credit facility
Issuance of mortgage notes payable and draws on construction loan
Repayments of mortgage notes payable
Issuance (repayment) of unsecured notes, net
Payment of deferred ﬁnancing costs
Redemption of units for cash by minority partners
Contributions from minority and proﬁt-sharing partners
Distributions to DownREIT partnership unitholders
Distributions to joint venture and proﬁt-sharing partners

54,031
—
—
—
(209,095)
50,900
105,843
(40,270)
25,000
(9,318)
(1,691)
—
(1,425)
(3,446)

146,934
(39,877)
81,737
(163,724)
(202,416)
22,130
38,829
(4,582)
(150,000)
(1,477)
(600)
—
(2,152)
(4,267)

22,296
(49,761)
14,393
(72,041)
(207,450)
28,970
—
(24,818)
350,342
(4,026)
(1,663)
17,275
(2,477)
(3,032)

Net cash provided by (used in) ﬁnancing activities

(29,471)

(279,465)

68,008

Net decrease in cash and cash equivalents

Cash and cash equivalents, beginning of year

(5,476)

7,058

(5,853)

12,911

(59,978)

72,889

Cash and cash equivalents, end of year

$

1,582

$

7,058

$ 12,911

Cash paid during year for interest, net of amount capitalized

$ 155,567

$ 131,266

$ 108,903

See accompanying notes to Consolidated Financial Statements.

48

avalonbay Communities, Inc.

• 114,895 shares of common stock were issued in connection with stock grants, 37,124 shares were withheld to
satisfy employees’ tax withholding and other liabilities and 12,102 shares were forfeited, for a net value of $2,419.
• 328,731 units of limited partnership, valued at $13,245, were presented for redemption to the DownREIT
partnerships that issued such units and were acquired by the Company in exchange for an equal number of
shares of the Company’s common stock.

• The Company sold two communities that were subject to mortgage notes payable of $39,665 in the aggregate,

that were assumed by the buyers as part of the total sales price.

• $260 of deferred stock units were converted into 6,989 shares of common stock.
• The  Company  recorded  a  reduction  to  other  liabilities  and  a  corresponding  gain  to  other  comprehensive

income of $4,428 to adjust the Company’s Hedged Derivatives to their fair value.

• Common and preferred dividends declared but not paid totaled $51,831.

During the year ended December 31, 2002:

• 144,718 shares of common stock were issued in connection with stock grants, 34,876 shares were withheld to
satisfy employees’ tax withholding and other liabilities and 2,818 shares were forfeited, for a net value of $5,999.
• The Company issued 102,756 units of limited partnership in DownREIT partnerships valued at $5,000 in
connection with the formation of a DownREIT partnership and the acquisition by that partnership of land.
• The Company assumed $33,900 in variable rate, tax-exempt debt related to the acquisition of one community.
• $140 of deferred stock units were converted into 3,410 shares of common stock.
• The Company recorded a liability and a corresponding charge to other comprehensive loss of $4,157 to adjust

the Company’s Hedged Derivatives to their fair value.

• Common and preferred dividends declared but not paid totaled $51,553.

avalonbay Communities, Inc.

49

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Dollars in thousands, except per share data)

1. Organization and Signiﬁcant Accounting Policies

Organization AvalonBay  Communities,  Inc.  (the  “Company,”  which  term,  unless  the  context  otherwise
requires, refers to AvalonBay Communities, Inc. together with its subsidiaries) is a Maryland corporation that
has elected to be taxed as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986, as
amended. The Company focuses on the ownership and operation of apartment communities in high barrier-to-
entry markets of the United States. These markets are located in the Northeast, Mid-Atlantic, Midwest, Paciﬁc
Northwest, and Northern and Southern California regions of the country.

At December 31, 2004, the Company owned or held a direct or indirect ownership interest in 138 operating
apartment  communities  containing  40,142  apartment  homes  in  ten  states  and  the  District  of  Columbia,  of
which  four  communities  containing  1,430  apartment  homes  were  under  reconstruction.  In  addition,  the
Company owned or held a direct or indirect ownership interest in ten communities under construction that are
expected to contain an aggregate of 2,668 apartment homes when completed. The Company also owned a direct
or indirect ownership interest in rights to develop an additional 49 communities that, if developed in the manner
expected, will contain an estimated 13,491 apartment homes.

Principles  of  Consolidation The  Company  is  the  surviving  corporation  from  the  merger  (the  “Merger”)  of 
Bay Apartment Communities, Inc. (“Bay”) and Avalon Properties, Inc. (“Avalon”) on June 4, 1998, in which
Avalon shareholders received 0.7683 of a share of common stock of the Company for each share owned of Avalon
common stock. The Merger was accounted for under the purchase method of accounting, with the historical
ﬁnancial statements for Avalon presented prior to the Merger. At that time, Avalon ceased to legally exist, and
Bay as the surviving legal entity adopted the historical ﬁnancial statements of Avalon. Consequently, Bay’s assets
were  recorded  in  the  historical  ﬁnancial  statements  of  Avalon  at  an  amount  equal  to  Bay’s  debt  outstanding 
at  that  time  plus  the  value  of  capital  stock  retained  by  the  Bay  stockholders,  which  approximates  fair  value. 
In  connection  with  the  Merger,  the  Company  changed  its  name  from  Bay  Apartment  Communities,  Inc.  to
AvalonBay Communities, Inc.

The  Company  assesses  consolidation  of  variable  interest  entities  under  the  guidance  of  FASB  Interpretation
No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51,” as revised in
December 2003. The Company accounts for joint venture partnerships and subsidiary partnerships structured
as DownREITs that are not variable interest entities in accordance with Statement of Position (“SOP”) 78-9,
“Accounting  for  Investments  in  Real  Estate  Ventures.”  Under  SOP  78-9,  the  Company  consolidates  joint 
venture and DownREIT partnerships when the Company controls the major operating and ﬁnancial policies 
of  the  partnership  through  majority  ownership  or  in  its  capacity  as  general  partner.  The  accompanying
Consolidated  Financial  Statements  include  the  accounts  of  the  Company  and  its  wholly-owned  partnerships,
certain joint venture partnerships, subsidiary partnerships structured as DownREITs and any variable interest
entities consolidated under FIN 46. All signiﬁcant intercompany balances and transactions have been eliminated
in consolidation.

In each of the partnerships structured as DownREITs, either the Company or one of the Company’s wholly-owned
subsidiaries is the general partner, and there are one or more limited partners whose interest in the partnership
is  represented  by  units  of  limited  partnership  interest.  For  each  DownREIT  partnership,  limited  partners  are
entitled to receive an initial distribution before any distribution is made to the general partner. Although the
partnership  agreements  for  each  of  the  DownREITs  are  different,  generally  the  distributions  per  unit  paid  to 
the holders of units of limited partnership interests have approximated the Company’s current common stock
dividend per share. Each DownREIT partnership has been structured so that it is unlikely the limited partners
will be entitled to a distribution greater than the initial distribution provided for in the partnership agreement.
The  holders  of  units  of  limited  partnership  interest  have  the  right  to  present  all  or  some  of  their  units  for
redemption for a cash amount as determined by the applicable partnership agreement and based on the fair value

of the Company’s common stock. In lieu of a cash redemption, the Company may elect to acquire such units for
an equal number of shares of the Company’s common stock.

The  Company  accounts  for  investments  in  unconsolidated  entities  that  are  not  variable  interest  entities  in
accordance with SOP 78-9 and Accounting Principles Board (“APB”) Opinion No. 18, “The Equity Method 
of  Accounting  for  Investments  in  Common  Stock.”  The  Company  uses  the  equity  method  to  account  for
investments  in  which  it  owns  greater  than  20%  of  the  equity  value  or  has  signiﬁcant  and  disproportionate
inﬂuence over that entity. Investments in which the Company owns 20% or less of the equity value and does not
have signiﬁcant and disproportionate inﬂuence are accounted for using the cost method. If there is an event or
change in circumstance that indicates a loss in the value of an investment, the Company’s policy is to record the
loss and reduce the value of the investment to its fair value. A loss in value would be indicated if the Company
could not recover the carrying value of the investment or if the investee could not sustain an earnings capacity
that  would  justify  the  carrying  amount  of  the  investment.  During  the  year  ended  December  31,  2004,  the
Company recorded an impairment loss of $1,002 related to a technology investment. The Company did not
recognize  an  impairment  loss  on  any  of  its  investments  in  unconsolidated  entities  during  the  years  ended
December 31, 2003 or 2002.

Revenue Recognition Rental income related to leases is recognized on an accrual basis when due from residents
in accordance with SEC Staff Accounting Bulletin No. 104, “Revenue Recognition” and Statement of Financial
Accounting Standards (“SFAS”) No. 13, “Accounting for Leases.” In accordance with the Company’s standard
lease terms, rental payments are generally due on a monthly basis. Any cash concessions given at the inception
of the lease are amortized over the approximate life of the lease, which is generally one year.

Real Estate
Signiﬁcant expenditures which improve or extend the life of an asset are capitalized. The operating
real  estate  assets  are  stated  at  cost  and  consist  of  land,  buildings  and  improvements,  furniture,  ﬁxtures  and
equipment, and other costs incurred during their development, redevelopment and acquisition. Expenditures for
maintenance and repairs are charged to operations as incurred.

The Company’s policy with respect to capital expenditures is generally to capitalize only non-recurring expenditures.
Improvements and upgrades are capitalized only if the item exceeds $15, extends the useful life of the asset and
is not related to making an apartment home ready for the next resident. Purchases of personal property, such as
computers and furniture, are capitalized only if the item is a new addition and exceeds $2.5. The Company
generally expenses purchases of personal property made for replacement purposes.

The capitalization of costs during the development of assets (including interest and related loan fees, property
taxes and other direct and indirect costs) begins when active development commences and ends when the asset,
or a portion of an asset, is delivered and is ready for its intended use, which is generally indicated by the issuance
of a certiﬁcate of occupancy. Cost capitalization during redevelopment of apartment homes (including interest
and related loan fees, property taxes and other direct and indirect costs) begins when an apartment home is taken
out-of-service  for  redevelopment  and  ends  when  the  apartment  home  redevelopment  is  completed  and  the
apartment home is available for a new resident. Rental income and operating costs incurred during the initial
lease-up or post-redevelopment lease-up period are fully recognized as they accrue.

In accordance with SFAS No. 67, “Accounting for Costs and Initial Rental Operations of Real Estate Projects,” the
Company  capitalizes  pre-development  costs  incurred  in  pursuit  of  new  development  opportunities  for  which 
the Company currently believes future development is probable (“Development Rights”). Future development
of these Development Rights is dependent upon various factors, including zoning and regulatory approval, rental
market conditions, construction costs and availability of capital. Pre-development costs incurred in the pursuit
of Development Rights for which future development is not yet considered probable are expensed as incurred.
In addition, if the status of a Development Right changes, deeming future development no longer probable, any

50

avalonbay Communities, Inc.

avalonbay Communities, Inc.

51

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

capitalized pre-development costs are written-off with a charge to expense. The Company expensed costs related
to  abandoned  pursuits,  which  includes  the  abandonment  or  impairment  of  Development  Rights,  acquisition
pursuits  and  technology  investments,  in  the  amounts  of  $1,726,  $1,180  and  $2,800  for  the  years  ended
December 31, 2004, 2003 and 2002, respectively.

The  Company  owns  three  parcels  of  land  improved  with  ofﬁce  buildings  and  industrial  space  occupied  by
unrelated  third-parties  in  connection  with  three  Development  Rights. The  Company  intends  to  manage  the
current  improvements  until  such  time  as  all  tenant  obligations  have  been  satisﬁed  or  eliminated  through
negotiation, and construction of new apartment communities is ready to begin. As provided under the guidance
of SFAS No. 67, the revenue from incidental operations received from the current improvements in excess of any
incremental costs are being recorded as a reduction of total capitalized costs of the Development Right and not
as part of net income.

In connection with the acquisition of an operating community, the Company performs a valuation and allocation
to each asset and liability acquired in such transaction, based on their estimated fair values at the date of acquisition
in accordance with SFAS No. 141, “Business Combinations.” The purchase price allocations to tangible assets, such
as land, buildings and improvements, and furniture, ﬁxtures and equipment, are reﬂected in real estate assets and
depreciated over their estimated useful lives. Any purchase price allocation to intangible assets, such as in-place
leases, is included in prepaid expenses and other assets and amortized over the average remaining lease term of
the acquired leases. The fair value of acquired in-place leases is determined based on the estimated cost to replace
such leases, including foregone rents during an assumed re-lease period, as well as the impact on projected cash
ﬂow of acquired leases with leased rents above or below current market rents.

Depreciation is calculated on buildings and improvements using the straight-line method over their estimated
useful lives, which range from seven to thirty years. Furniture, ﬁxtures and equipment are generally depreciated
using the straight-line method over their estimated useful lives, which range from three years (primarily computer-
related equipment) to seven years.

If there is an event or change in circumstance that indicates an impairment in the value of an operating community,
the Company’s policy is to assess any impairment in value by making a comparison of the current and projected
operating cash ﬂow of the community over its remaining useful life, on an undiscounted basis, to the carrying
amount of the community. If the carrying amount is in excess of the estimated projected operating cash ﬂow 
of the community, the Company would recognize an impairment loss equivalent to an amount required to adjust
the carrying amount to its estimated fair market value. The Company has not recognized an impairment loss on
any  of  its  operating  communities  during  the  years  ended  December  31,  2004,  2003  or  2002.  However,  the
Company recognized an impairment loss in 2002 related to two land parcels. See Note 14, “Subsequent Events.”

Income  Taxes The  Company  elected  to  be  taxed  as  a  REIT  under  the  Internal  Revenue  Code  of  1986,  as
amended, for the year ended December 31, 1994 and has not revoked such election. A corporate REIT is a legal
entity which holds real estate interests and must meet a number of organizational and operational requirements,
including a requirement that it currently distribute at least 90% of its adjusted taxable income to stockholders.
As a REIT, the Company generally will not be subject to corporate level federal income tax on taxable income it
distributes  currently  to  its  stockholders.  Management  believes  that  all  such  conditions  for  the  avoidance  of
income taxes have been met for the periods presented. Accordingly, no provision for federal and state income
taxes has been made. If the Company fails to qualify as a REIT in any taxable year, it will be subject to federal
income taxes at regular corporate rates (including any applicable alternative minimum tax) and may not be able
to qualify as a REIT for four subsequent taxable years. Even if the Company qualiﬁes for taxation as a REIT, the
Company may be subject to certain state and local taxes on its income and property, and to federal income and
excise taxes on its undistributed taxable income. In addition, taxable income from non-REIT activities managed
through taxable REIT subsidiaries is subject to federal, state and local income taxes.

The following reconciles net income available to common stockholders to taxable net income for the years ended
December 31, 2004, 2003 and 2002:

Net income available to common stockholders
Dividends attributable to preferred stock, not deductible for tax
GAAP gain on sale of communities less than (in excess of ) tax gain
Depreciation/Amortization timing differences on real estate
Tax compensation expense in excess of GAAP
Other adjustments

2004
Estimate

$211,045
8,700
8,093
(12,118)
(19,758)
(8,823)

2003
Actual

$260,781
10,744
(3,795)
(5,574)
(4,254)
(9,190)

2002
Actual

$155,722
17,896
5,164
(4,461)
(8,568)
916

Taxable net income

$187,139

$248,712

$166,669

The following summarizes the tax components of the Company’s common and preferred dividends declared for
the years ended December 31, 2004, 2003 and 2002:

Ordinary income
20% capital gain
15% capital gain
Unrecaptured §1250 gain

2004

39%
—
51%
10%

2003

11%
15%
56%
18%

2002

74%
23%
—
3%

Deferred Financing Costs Deferred ﬁnancing costs include fees and costs incurred to obtain debt ﬁnancing
and are amortized on a straight-line basis, which approximates the effective interest method, over the shorter of
the term of the loan or the related credit enhancement facility, if applicable. Unamortized ﬁnancing costs are
written-off when debt is retired before the maturity date. Accumulated amortization of deferred ﬁnancing costs
was $23,232 at December 31, 2004 and $19,266 at December 31, 2003.

Cash, Cash Equivalents and Cash in Escrow Cash and cash equivalents include all cash and liquid investments
with an original maturity of three months or less from the date acquired. The majority of the Company’s cash,
cash equivalents and cash in escrows is held at major commercial banks.

Interest Rate Contracts The Company utilizes derivative ﬁnancial instruments to manage interest rate risk and
has  designated  these  ﬁnancial  instruments  as  hedges  under  the  guidance  of  SFAS  No.  133,  “Accounting  for
Derivative Instruments and Hedging Activities,” and SFAS No. 138, “Accounting for Certain Instruments and
Certain Hedging Activities, an Amendment of Statement No. 133.” For fair value hedge transactions, changes
in the fair value of the derivative instrument and changes in the fair value of the hedged item due to the risk
being hedged are recognized in current period earnings. For cash ﬂow hedge transactions, changes in the fair
value of the derivative instrument are reported in other comprehensive income. For cash ﬂow hedges where the
changes in the fair value of the derivative exceed the change in fair value of the hedged item, the ineffective portion
is recognized in current period earnings. Derivatives which are not part of a hedge relationship are recorded at
fair value through earnings. As of December 31, 2004, the Company had approximately $236,000 in variable
rate debt subject to cash ﬂow hedges. See Note 5, “Derivative Instruments and Hedging Activities.”

Comprehensive Income Comprehensive income, as reﬂected on the Consolidated Statements of Operations
and Other Comprehensive Income, is deﬁned as all changes in equity during each period except for those resulting
from investments by or distributions to shareholders. Accumulated other comprehensive loss as reﬂected on the
Consolidated Statements of Stockholders’ Equity reﬂects the changes in the fair value of effective cash ﬂow hedges.

52

avalonbay Communities, Inc.

avalonbay Communities, Inc.

53

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

Earnings per Common Share
In accordance with the provisions of SFAS No. 128, “Earnings per Share,” basic
earnings per share is computed by dividing earnings available to common stockholders by the weighted average
number of shares outstanding during the period. Other potentially dilutive common shares, and the related impact
to earnings, are considered when calculating earnings per share on a diluted basis. The Company’s earnings per
common share are determined as follows:

Basic and diluted shares outstanding
Weighted average common shares—basic
Weighted average DownREIT units outstanding
Effect of dilutive securities

For the year ended

12-31-04

12-31-03

12-31-02

71,564,202
573,529
1,217,225

68,559,657
893,279
750,531

68,772,139
988,747
913,325

Weighted average common shares—diluted

73,354,956

70,203,467

70,674,211

Calculation of Earnings per Share—basic
Net income available to common stockholders

$

211,045

$

260,781

$

155,722

Weighted average common shares—basic

71,564,202

68,559,657

68,772,139

Earnings per common share—basic

$

2.95

$

3.80

$

2.26

Calculation of Earnings per Share—diluted
Net income available to common stockholders
Add: Minority interest of DownREIT unitholders
in consolidated partnerships, including discontinued operations

$

211,045

$

260,781

$

155,722

3,048

1,263

1,601

Adjusted net income available to common stockholders

$

214,093

$

262,044

$

157,323

Weighted average common shares—diluted

73,354,956

70,203,467

70,674,211

Earnings per common share—diluted

$

2.92

$

3.73

$

2.23

Certain options to purchase shares of common stock in the amounts of 6,000, 1,348,738 and 1,410,397 were
outstanding during the years ended December 31, 2004, 2003 and 2002, respectively, but were not included in
the computation of diluted earnings per share because the options’ exercise prices were greater than the average
market price of the common shares for the period and therefore, are anti-dilutive.

Stock-Based Compensation Prior to 2003, the Company applied the intrinsic value method as provided in
APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations, in accounting
for its employee stock options. No stock-based employee compensation cost related to employee stock options is
reﬂected in net income for the year ended December 31, 2002, as all options granted had an exercise price equal
to the market value of the underlying common stock on the date of grant. Effective January 1, 2003, the Company
adopted the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation,” as
amended  by  SFAS  No.  148,  “Accounting  for  Stock-Based  Compensation—Transition  and  Disclosure—an
amendment of FASB Statement No. 123,” prospectively to all employee awards granted, modiﬁed, or settled on
or after January 1, 2003. Awards under the Company’s stock option plans vest over periods ranging from one to
three  years.  Therefore,  the  cost  related  to  stock-based  employee  compensation  for  employee  stock  options
included in the determination of net income for the years ended December 31, 2004 and 2003, is less than that
which would have been recognized if the fair value based method had been applied to all awards since the original
effective date of SFAS No. 123.

The following table illustrates the effect on net income available to common stockholders and earnings per share
if the fair value based method had been applied to all outstanding and unvested awards in each period based on
the fair market value as determined on the date of grant:

Net income available to common stockholders, as reported
Add:

Actual compensation expense recorded under fair value
based method, net of related tax effects

Deduct: Total compensation expense determined under fair value

based method, net of related tax effects

For the year ended

12-31-04

12-31-03

12-31-02

$211,045

$260,781

$155,722

867

246

—

(1,834)

(2,335)

(2,904)

Pro forma net income available to common stockholders

$210,078

$258,692

$152,818

Earnings per share:
Basic—as reported

Basic—pro forma

Diluted—as reported

Diluted—pro forma

$

$

$

$

2.95

2.94

2.92

2.91

$

$

$

$

3.80

3.77

3.73

3.70

$

$

$

$

2.26

2.22

2.23

2.18

Insured  Loss During  2000,  a  ﬁre  occurred  at  one  of  the  Company’s  development  communities,  which  was
under  construction  and  unoccupied  at  the  time. The  Company  had  property  damage  and  insurance  for  lost
rental income which covered this event. Insurance proceeds totaling $30,300 were received, of which $22,000
was  disbursed  to  rebuild  the  community  for  property  damage.  Insurance  proceeds  for  lost  rental  income  of
$5,800 are included in rental and other income in the accompanying Consolidated Statements of Operations
and Other Comprehensive Income for the year ended December 31, 2002.

Variable Interest Entities under FIN 46 The Company adopted the ﬁnal provisions of FIN 46 as of January 1,
2004, which resulted in the consolidation of one entity during 2004 from which the Company held a participating
mortgage note, as discussed in Note 12, “Related Party Arrangements.” The consolidation of this entity resulted
in an increase to net real estate assets of approximately $33,000 and the elimination of the previously recorded
mortgage note and accrued interest of approximately $27,300. In addition, the Company recognized a cumulative
effect of change in accounting principle during the year ended December 31, 2004 in the amount of $4,547,
which increased earnings per common share—diluted by $0.06. The Company did not hold an equity interest
in this entity, and therefore 100% of the entity’s net income or loss was recognized by the Company as minority
interest in consolidated partnerships on the Consolidated Statements of Operations and Other Comprehensive
Income. In October 2004, the Company received payment in full of the outstanding mortgage note. Upon note
repayment, the Company did not continue to hold a variable interest in this entity and therefore the Company
discontinued consolidating the entity under the provisions of FIN 46.

Discontinued Operations On January 1, 2002, the Company adopted SFAS No. 144, “Accounting for the
Impairment or Disposal of Long-Lived Assets” which requires that the assets and liabilities and the results of
operations of any communities which have been sold since January 1, 2002, or otherwise qualify as held for sale,
be presented as discontinued operations in the Company’s Consolidated Financial Statements in both current
and prior years presented. The community speciﬁc components of net income that are presented as discontinued
operations include net operating income, depreciation expense, minority interest expense and interest expense.
In addition, the net gain or loss (including any impairment loss) on the eventual disposal of communities held
for sale will be presented as discontinued operations when recognized. A change in presentation for discontinued
operations will not have any impact on the Company’s ﬁnancial condition or results of operations. Real estate

54

avalonbay Communities, Inc.

avalonbay Communities, Inc.

55

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

assets held for sale are measured at the lower of the carrying amount or the fair value less the cost to sell, and are
presented separately in the accompanying Consolidated Balance Sheets. Subsequent to classiﬁcation of a community
as held for sale, no further depreciation is recorded.

Recently  Issued  Accounting  Standards
In  December  2004,  the  Financial  Accounting  Standards  Board
(“FASB”)  issued  SFAS  No.  123(R),  “Share  Based  Payment,”  a  revision  of  SFAS  No.  123,  which  is  similar  in
concept  to  SFAS  No.  123,  but  requires  all  share-based  payments  to  employees,  including  grants  of  employee
stock options, to be recognized in the ﬁnancial statements based on their fair values. Pro forma disclosure is no
longer  an  alternative. This  revision  is  effective  in  the  ﬁrst  interim  or  annual  reporting  period  beginning  after
June 15, 2005. As the Company has already adopted the fair value provisions of SFAS No. 123, this revision is
not expected to have a material impact on the Company’s ﬁnancial condition or results of operations.

Use of Estimates The preparation of ﬁnancial statements in conformity with generally accepted accounting
principles  (“GAAP”)  in  the  United  States  requires  management  to  make  certain  estimates  and  assumptions.
These  estimates  and  assumptions  affect  the  reported  amounts  of  assets  and  liabilities  and  disclosure  of 
contingent assets and liabilities at the dates of the ﬁnancial statements and the reported amounts of revenue and
expenses during the reporting periods. Actual results could differ from those estimates.

Reclassiﬁcations Certain  reclassiﬁcations  have  been  made  to  amounts  in  prior  years’  ﬁnancial  statements  to
conform with current year presentations.

2. Interest Capitalized

Capitalized  interest  associated  with  communities  under  development  or  redevelopment  totaled  $20,566,
$24,709 and $29,937 for the years ended December 31, 2004, 2003 and 2002, respectively.

3. Notes Payable, Unsecured Notes and Credit Facility

The  Company’s  mortgage  notes  payable,  unsecured  notes  and  variable  rate  unsecured  credit  facility  as  of
December 31, 2004 and 2003 are summarized as follows:

Fixed rate unsecured notes(1)
Fixed rate mortgage notes payable—conventional and tax-exempt
Variable rate mortgage notes payable—conventional and tax-exempt(2)

Total notes payable and unsecured notes

Variable rate secured short-term debt
Variable rate unsecured credit facility

12-31-04

12-31-03

$1,859,448
263,669
210,896

2,334,013
6,278
102,000

$1,835,284
334,028
80,879

2,250,191
36,526
51,100

Total mortgage notes payable, unsecured notes and unsecured credit facility

$2,442,291

$2,337,817

(1) Balances at December 31, 2004 and 2003 include $552 of debt discount and $284 of debt premium, respectively, from

issuance of unsecured notes.

(2) Balance at December 31, 2003 includes $38,735 related to real estate assets sold in 2004.

The following debt activity occurred during the year ended December 31, 2004:

• The Company repaid $125,000 in previously issued unsecured notes, along with any unpaid interest, pursuant
to  their  scheduled  maturity,  and  no  prepayment  penalties  were  incurred.  In  addition,  the  Company  issued
$150,000 in unsecured notes under its existing shelf registration statement at an annual interest rate of 5.375%.
Interest on these notes is payable semi-annually on April 15 and October 15, and they mature in April 2014;
• The Company repaid $24,251 in ﬁxed rate mortgage debt secured by two current communities, along with any
unpaid interest, repaid $10,400 in variable rate, tax-exempt debt related to the sale of one community and transferred 
$28,335 in variable rate, tax-exempt debt related to the sale of two communities to the respective buyers;

• The Company issued $82,800 in variable rate, conventional debt on three communities, including interest rate
protection agreements that serve to effectively limit the level to which interest rates can rise. This debt has a
weighted average variable interest rate of 3.8% as of December 31, 2004, and the Hedged Derivatives limit the
level to which interest rates can rise on this debt to a weighted average rate of 8.5%;

• The Company obtained a $50,000 secured construction loan for the construction of a development community
that  will  be  owned  and  operated  in  a  joint  venture  entity  upon  completion  (See  Note  6,  “Investments  in
Unconsolidated Real Estate Entities”). Outstanding draws will bear interest at a variable rate and will come due
in March 2008, assuming the exercise of two one-year extension options. The Company has $6,278 outstanding
under this construction loan as of December 31, 2004;

• The Company issued $16,765 in ﬁxed rate, conventional mortgage debt on one community;
• The Company assumed $8,155 in ﬁxed rate, conventional mortgage debt in conjunction with the acquisition

of a community;

• The  Company  assumed  $20,141  in  ﬁxed  rate  debt  in  connection  with  the  acquisition  of  three  parcels  of

improved land related to three Development Rights;

• The Company replaced the credit enhancements, including interest rate swaps, on approximately $87,000 of
its variable rate, tax-exempt debt when such credit enhancements expired, of which $9,580 was transferred
upon the sale of a community to the respective purchaser. The Company put in place interest rate protection
agreements that serve to effectively limit the level to which interest rates can rise on the remaining debt to a
range of 6.9% to 9.0%. This variable rate, tax-exempt debt ﬂoats at an average coupon interest rate of 2.5%
as of December 31, 2004; and

• The Company renegotiated the terms of a ﬁxed rate, tax-exempt bond on one community in the amount of

$9,780 to decrease the annual interest rate from 7.0% to 4.9%.

In  the  aggregate,  mortgage  notes  payable  mature  at  various  dates  from  April  2005  through  April  2043  and 
are secured by certain apartment communities (with a net carrying value of $782,498 as of December 31, 2004).
As of December 31, 2004, the Company has guaranteed approximately $109,000 of mortgage notes payable
held  by  wholly-owned  subsidiaries;  all  such  mortgage  notes  payable  are  consolidated  for  ﬁnancial  reporting 
purposes. The weighted average interest rate of the Company’s ﬁxed rate mortgage notes payable (conventional
and tax-exempt) was 6.7% at both December 31, 2004 and December 31, 2003. The weighted average interest
rate of the Company’s variable rate mortgage notes payable and its unsecured credit facility (as discussed on the
following page), including the effect of certain ﬁnancing related fees, was 3.9% at December 31, 2004 and 3.5%
at December 31, 2003.

Scheduled payments and maturities of mortgage notes payable and unsecured notes outstanding at December 31,
2004 are as follows:

Year

2005

2006
2007

2008

2009
2010
2011

2012
2013
2014
Thereafter

Secured notes 
payments

Secured notes 
maturities

Unsecured notes 
maturities

Stated interest rate of
unsecured notes

$

7,615

$

—

8,114
8,643

9,192

8,421
6,751
6,756

6,422
6,571
7,033
155,122

—
6,278

4,356

69,651
28,989
23,969

12,096
—
—
104,864

$230,640

$250,203

$ 100,000
50,000
150,000
110,000
150,000
50,000
150,000
150,000
200,000
300,000
50,000
250,000
—
150,000
—

$1,860,000

6.625%
6.500%
6.800%
6.875%
5.000%
6.625%
8.250%
7.500%
7.500%
6.625%
6.625%
6.125%
—
5.375%
—

56

avalonbay Communities, Inc.

avalonbay Communities, Inc.

57

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

The Company’s unsecured notes contain a number of ﬁnancial and other covenants with which the Company
must comply, including, but not limited to, limits on the aggregate amount of total and secured indebtedness
the Company may have on a consolidated basis and limits on the Company’s required debt service payments.

The Company has a $500,000 revolving variable rate unsecured credit facility with JPMorgan Chase Bank and
Wachovia  Bank,  N.A.  serving  as  banks  and  syndication  agents  for  a  syndicate  of  commercial  banks.  The
Company had $102,000 outstanding under the facility and $26,580 in letters of credit on December 31, 2004
and $51,100 outstanding and $19,901 in letters of credit on December 31, 2003. Under the terms of the credit
facility, if the Company elects to increase the facility by up to an additional $150,000, and one or more banks
(from the syndicate or otherwise) voluntarily agree to provide the additional commitment, then the Company
will be able to increase the facility up to $650,000, and no member of the syndicate of banks can prohibit such
increase; such an increase in the facility will only be effective to the extent banks (from the syndicate or otherwise)
choose to commit to lend additional funds. The Company pays participating banks, in the aggregate, an annual
facility fee of approximately $750 in quarterly installments. The unsecured credit facility bears interest at varying
levels based on the London Interbank Offered Rate (“LIBOR”), rating levels achieved on the Company’s unsecured
notes and on a maturity schedule selected by the Company. The current stated pricing is LIBOR plus 0.55% per
annum (2.95% on December 31, 2004). The spread over LIBOR can vary from LIBOR plus 0.50% to LIBOR
plus 1.15% based upon the rating of the Company’s long-term unsecured debt. In addition, the unsecured credit
facility includes a competitive bid option, which allows banks that are part of the lender consortium to bid to
make loans to the Company at a rate that is lower than the stated rate provided by the unsecured credit facility
for  up  to  $250,000. The  competitive  bid  option  may  result  in  lower  pricing  if  market  conditions  allow. The
Company has $20,000 outstanding under this competitive bid option as of December 31, 2004 priced at LIBOR
plus 0.29%, or 1.88%. The Company is subject to (i) certain customary covenants under the unsecured credit
facility, including, but not limited to, maintaining certain maximum leverage ratios, a minimum ﬁxed charges
coverage ratio and minimum unencumbered assets and equity levels and (ii) prohibitions on paying dividends in
amounts  that  exceed  95%  of  the  Company’s  Funds  from  Operations,  as  deﬁned  therein,  except  as  may  be
required to maintain the Company’s REIT status. The credit facility matures in May 2008, assuming exercise of
a one-year renewal option by the Company.

4. Stockholders’ Equity

As  of  both  December  31,  2004  and  2003,  the  Company  had  authorized  for  issuance  140,000,000  and
50,000,000 shares of common and preferred stock, respectively. As of December 31, 2004 the Company has the
following series of redeemable preferred stock outstanding at a stated value of $100,000. This series has no stated
maturity and is not subject to any sinking fund or mandatory redemptions.

Series

H

Shares outstanding
December 31, 2004

4,000,000

Payable
quarterly

March, June, September,
December

Annual
rate

8.70%

Liquidation
preference

Non-redeemable
prior to

$25.00

October 15, 2008

Dividends  on  the  preferred  stock  are  cumulative  from  the  date  of  original  issue  and  are  payable  quarterly  in
arrears on or before the 15th day of each month as stated in the table above. The preferred stock is not redeemable
prior to the date stated in the table above, but on or after the stated date, may be redeemed for cash at the option
of the Company in whole or in part at a redemption price of $25.00 per share, plus all accrued and unpaid
dividends, if any.

During  the  year  ended  December  31,  2004,  the  Company  (i) issued  1,455,379  shares  of  common  stock  in
connection  with  stock  options  exercised,  (ii) issued  104,160  shares  of  common  stock  in  exchange  for  the

redemption of an equal number of DownREIT limited partnership units, (iii) issued 14,476 shares to employees
under the Employee Stock Purchase Plan, (iv) issued 1,545 shares through the Company’s dividend reinvestment
plan,  (v) issued  147,517  common  shares  in  connection  with  stock  grants  to  employees  of  which  80%  are
restricted, (vi) had forfeitures of 3,012 shares of restricted stock grants to employees and (vii) withheld 75,515
shares to satisfy employees’ tax withholding and other liabilities.

Dividends per common share for each of the years ended December 31, 2004, 2003 and 2002 were $2.80 per
share. In 2004, average dividends for all non-redeemed preferred shares during the year were $2.18 per share,
and no preferred shares were redeemed. In 2003, average dividends for preferred shares redeemed during the year
were $0.27 per share and average dividends for all non-redeemed preferred shares were $2.18 per share. In 2002,
average dividends for preferred shares redeemed during the year were $0.92 per share and average dividends for
all non-redeemed preferred shares were $2.10 per share.

In March 2004, the Company announced that it would resume its Dividend Reinvestment and Stock Purchase 
Plan (the “DRIP”). The DRIP allows for holders of the Company’s common stock or preferred stock to purchase
shares  of  common  stock  through  either  reinvested  dividends  or  optional  cash  payments. The  purchase  price 
per  share  for  newly  issued  shares  of  common  stock  under  the  DRIP  will  be  equal  to  the  last  reported  sale 
price for a share of the Company’s common stock as reported by the New York Stock Exchange (“NYSE”) on
the applicable investment date. The DRIP was effective beginning with the Company’s common stock dividend
for the three months ended June 30, 2004.

5. Derivative Instruments and Hedging Activities

The Company has historically used interest rate swap and cap agreements (collectively, the “Hedged Derivatives”)
to  reduce  the  impact  of  interest  rate  ﬂuctuations  on  its  variable  rate,  tax-exempt  bonds  and  its  variable  rate
conventional secured debt. The Company has not entered into any interest rate hedge agreements or treasury
locks for its conventional unsecured debt and does not hold interest rate hedge agreements for trading or other
speculative  purposes.  As  of  December  31,  2004,  the  Hedged  Derivatives  ﬁx  approximately  $69,000  of  the
Company’s tax-exempt debt at a weighted average interest rate of 6.3% through interest rate swaps. In addition,
as of December 31, 2004, the Company has Hedged Derivatives on $166,733 of its variable rate debt, which
ﬂoats at a weighted average coupon interest rate of 3.2% and has been capped at a weighted average interest rate
of 8.0% through interest rate caps. These Hedged Derivatives have maturity dates ranging from 2007 to 2010.
In  addition,  one  of  the  Company’s  unconsolidated  real  estate  investments  (see  Note  6,  “Investments  in
Unconsolidated Real Estate Entities”) has $22,500 in variable rate debt outstanding as of December 31, 2004,
which is subject to an interest rate swap. This debt is not recourse to or guaranteed by the Company. The Hedged
Derivatives  are  accounted  for  in  accordance  with  SFAS  No.  133,  which  as  amended,  was  adopted  by  the
Company on January 1, 2001. SFAS No. 133 requires that every derivative instrument be recorded on the balance
sheet as either an asset or liability measured at its fair value, with changes in fair value recognized currently in
earnings unless speciﬁc hedge accounting criteria are met.

The  Company  has  determined  that  its  Hedged  Derivatives  qualify  as  effective  cash-ﬂow  hedges  under  SFAS
No. 133, resulting in the Company recording all changes in the fair value of the Hedged Derivatives in other
comprehensive  income.  Amounts  recorded  in  other  comprehensive  income  will  be  reclassiﬁed  into  earnings 
in  the  period  in  which  earnings  are  affected  by  the  hedged  cash  ﬂow.  To  adjust  the  Hedged  Derivatives  to 
their fair value, the Company recorded unrealized gains to other comprehensive income of $1,116 and $4,428
during the years ended December 31, 2004 and 2003, respectively, and an unrealized loss of $4,157 in the year
ended December 31, 2002. The estimated amount, included in accumulated other comprehensive income as of
December  31,  2004,  expected  to  be  reclassiﬁed  into  earnings  within  the  next  twelve  months  to  offset  the
variability of cash ﬂow during this period is not material.

58

avalonbay Communities, Inc.

avalonbay Communities, Inc.

59

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

The Company assesses, both at inception and on an on-going basis, the effectiveness of all hedges in offsetting
cash ﬂow of hedged items. Hedge ineffectiveness did not have a material impact on earnings and the Company
does not anticipate that it will have a material effect in the future. The fair values of the obligations under the
Hedged Derivatives are included in accrued expenses and other liabilities on the accompanying Consolidated
Balance Sheets.

By using derivative ﬁnancial instruments to hedge exposures to changes in interest rates, the Company exposes
itself to credit risk and market risk. The credit risk is the risk of a counterparty not performing under the terms
of the Hedged Derivatives. The counterparties to these Hedged Derivatives are major ﬁnancial institutions which
have an A+ or better credit rating by the Standard & Poor’s Ratings Group. The Company monitors the credit
ratings of counterparties and the amount of the Company’s debt subject to Hedged Derivatives with any one
party.  Therefore,  the  Company  believes  the  likelihood  of  realizing  material  losses  from  counterparty  non-
performance is remote. Market risk is the adverse effect of the value of ﬁnancial instruments that results from a
change in interest rates. The market risk associated with interest-rate contracts is managed by the establishment
and monitoring of parameters that limit the types and degree of market risk that may be undertaken. These risks
are managed by the Company’s Chief Financial Ofﬁcer and Senior Vice President - Finance.

6. Investments in Unconsolidated Entities

Investments in Unconsolidated Real Estate Entities As of December 31, 2004, the Company had investments
in the following unconsolidated real estate entities, which are accounted for under the equity method of accounting,
except as described below:

• Town  Run  Associates  was  formed  as  a  general  partnership  in  November  1994  to  develop,  own  and  operate
Avalon Run, a 426 apartment-home community located in Lawrenceville, New Jersey. Since formation of this
venture,  the  Company  has  invested  $1,803  and,  following  a  preferred  return  on  all  contributed  equity 
(which was not achieved in 2004), has a 40% ownership and cash ﬂow interest with a 49% residual economic
interest. The Company is responsible for the day-to-day operations of the Avalon Run community and is the
management agent subject to the terms of a management agreement. The development of Avalon Run was
funded entirely through equity contributions from Avalon as well as the other venture partner, and therefore
Avalon Run is not subject to any outstanding debt as of December 31, 2004.

• Town Grove, LLC was formed as a limited liability corporation in December 1997 to develop, own and operate
Avalon Grove, a 402 apartment-home community located in Stamford, Connecticut. Since formation of this
venture, the Company has invested $14,653 and, following a preferred return on all contributed equity (which
was  achieved  in  2004),  has  a  50%  ownership  and  a  50%  cash  ﬂow  and  residual  economic  interest.  The
Company is responsible for the day-to-day operations of the Avalon Grove community and is the management
agent subject to the terms of a management agreement. The development of Avalon Grove was funded through
contributions from the Company and the other venture partner, and therefore Avalon Grove is not subject to
any outstanding debt as of December 31, 2004.

• Avalon Terrace, LLC—The Company acquired Avalon Bedford, a 388 apartment-home community located in
Stamford, Connecticut in December 1998. In May 2000, the Company transferred Avalon Bedford to Avalon
Terrace, LLC and subsequently admitted a joint venture partner, while retaining a 25% ownership interest 
in this limited liability company for an investment of $5,394 and a right to 50% of cash ﬂow distributions
after  achievement  of  a  threshold  return  (which  was  not  achieved  in  2004).  The  Company  is  responsible 
for  the  day-to-day  operations  of  the  Avalon  Bedford  community  and  is  the  management  agent  subject  to 
the terms of a management agreement. As of December 31, 2004, Avalon Bedford has $22,500 in variable
rate  debt  outstanding,  which  came  due  in  November  2002,  but  was  extended  until  November  2005. The
interest rate on this debt is ﬁxed through a Hedged Derivative as discussed in Note 5, “Derivative Instruments
and Hedging Activities.”

• Arna Valley View LP—In connection with the municipal approval process for the development of a consolidated 
community, the Company agreed to participate in the formation of a limited partnership in February 1999 to

develop, ﬁnance, own and operate Arna Valley View, a 101 apartment-home community located in Arlington,
Virginia. This community has affordable rents for 100% of apartment homes related to the tax-exempt bond
ﬁnancing and tax credits used to ﬁnance construction of the community. A subsidiary of the Company is the
general partner of the partnership with a 0.01% ownership interest. The Company is responsible for the day-
to-day  operations  of  the  community  and  is  the  management  agent  subject  to  the  terms  of  a  management
agreement.  As  of  December  31,  2004,  Arna  Valley  View  has  $5,937  of  variable  rate,  tax-exempt  bonds 
outstanding, which mature in June 2032. In addition, Arna Valley View has $4,667 of 4% ﬁxed rate county
bonds outstanding that mature in December 2030. Due to the Company’s limited ownership and investment
in this venture, it is accounted for using the cost method.

• CVP I, LLC—In February 2004, the Company entered into a joint venture agreement with an unrelated third-party 
for the development of Avalon Chrystie Place I. Avalon Chrystie Place I, if developed as expected, will be a 361
apartment-home  community  located  in  New  York,  New  York.  In  connection  with  the  general  contractor 
services that the Company provides to CVP I, LLC, the entity that owns and is developing Avalon Chrystie
Place  I,  the  Company  has  provided  a  construction  completion  guarantee  to  the  lender  of  the  joint  venture
entity’s  $117,000  construction  loan  in  order  to  fulﬁll  their  standard  ﬁnancing  requirements  related  to  the 
construction  ﬁnancing.  The  obligation  of  the  Company  under  this  guarantee  will  terminate  following 
construction completion once all of the lender’s standard completion requirements have been satisﬁed, which
the Company expects to occur in 2006. The Company holds a 20% equity interest in this joint venture entity
(with a right to 50% of distributions after achievement of a threshold return), with the remaining 80% equity
interest held by the third-party.

• Avalon Del Rey Apartments, LLC—In March 2004, the Company entered into an agreement with an unrelated
third-party which provides that, after the Company completes construction of Avalon Del Rey, the community
will be owned and operated by a joint venture between the Company and the third-party. Avalon Del Rey, if
developed  as  expected,  will  be  a  309  apartment-home  community  located  in  Los  Angeles,  California.  Upon 
construction  completion,  the  third-party  venture  partner  will  invest  $49,000  and  will  be  granted  a  70% 
ownership  interest  in  the  venture,  with  the  Company  retaining  a  30%  equity  interest.  In  August  2004,  the
Company obtained a $50,000 secured construction loan for the construction of Avalon Del Rey. In conjunction 
with the general contractor services that the Company provides to Avalon Del Rey Apartments, LLC, the entity
that owns and is developing Avalon Del Rey, the Company has provided a construction completion guarantee
to the lender of the entity’s $50,000 construction loan in order to fulﬁll their standard ﬁnancing requirements
related to construction ﬁnancing. The obligation of the Company under this guarantee will terminate following
construction completion once all of the lender’s standard completion requirements have been satisﬁed, which
the Company expects to occur in 2006. The Company will consolidate this entity until the third-party venture
partner contributes its investment to the venture at construction completion.

• Juanita  Construction,  Inc.—In  April  2004,  the  Company  entered  into  an  agreement  to  develop  Avalon 
at  Juanita  Village  through  Juanita  Construction,  Inc.,  a  wholly-owned  taxable  REIT  subsidiary  and,  upon 
construction completion, contribute the community to a joint venture. Avalon at Juanita Village, if developed
as expected, will be a 211 apartment-home community located in Kirkland, Washington. Upon contribution
of the community to the joint venture, the Company expects to be reimbursed for all costs incurred to develop
the community. The third-party joint venture partner will receive a 100% equity interest in the joint venture
and will manage the joint venture. The Company will receive a residual proﬁts interest and will be engaged to
manage the community for a property management fee. The Company will consolidate this community until
it is contributed into the joint venture at construction completion.

• Mission Bay Venture Partners, LLC—In December 2004, the Company entered into a joint venture agreement 
with  an  unrelated  third-party  for  the  development  of  Avalon  at  Mission  Bay  North  II.  Avalon  at  Mission 
Bay North II, if developed as expected, will be a 313 apartment-home community located in San Francisco,
California. The Company holds a 25% equity interest in this joint venture entity with the remaining 75%
equity  interest  held  by  the  third-party. The  Company  expects  that  construction  of  Avalon  at  Mission  Bay
North II will begin in early 2005, with approximately 80% of the projected capitalized cost ﬁnanced through
a construction loan.

60

avalonbay Communities, Inc.

avalonbay Communities, Inc.

61

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

The following is a combined summary of the ﬁnancial position of the entities accounted for using the equity
method, as of the dates presented:

Assets:
Real estate, net
Other assets

Total assets

Liabilities and partners’ equity:
Mortgage notes payable
Other liabilities
Partners’ equity

Total liabilities and partners’ equity

12-31-04

12-31-03

$221,236
86,821

$119,339
2,605

$308,057

$121,944

$139,500
32,579
135,978

$ 22,500
2,158
97,286

$308,057

$121,944

The  following  is  a  combined  summary  of  the  operating  results  of  the  entities  accounted  for  using  the  equity
method, for the periods presented:

Rental income
Operating and other expenses
Interest expense, net
Depreciation expense

Net income

For the year ended

12-31-04

12-31-03

12-31-02

$21,148
(8,291)
(1,786)
(4,003)

$20,939
(8,038)
(1,688)
(3,986)

$21,863
(7,396)
(1,783)
(3,847)

$ 7,068

$ 7,227

$ 8,837

The  Company  also  holds  a  25%  limited  liability  company  membership  interest  in  AvalonBay  Redevelopment,
LLC, the limited liability company that owns Avalon on the Sound. The Company, which originally owned 100%
of  AvalonBay  Redevelopment,  LLC,  sold  a  75%  controlling  interest  in  AvalonBay  Redevelopment,  LLC  to  a
third-party in 2000. As part of the sale, the Company retained an option to repurchase the 75% interest. In
accordance with SFAS No. 66, “Accounting for Sales of Real Estate,” the sale of the 75% interest was not recognized 
due to the existence of the repurchase option, which expired in December 2004. Therefore, for periods prior to
December 31, 2004, the Company accounted for Avalon on the Sound as a proﬁt-sharing arrangement. As a
result,  the  revenues  and  expenses,  and  assets  and  liabilities  of  Avalon  on  the  Sound  were  included  in  the
Company’s Consolidated Financial Statements, with the 75% interest presented as part of accrued expenses and
other liabilities on the Company’s Consolidated Balance Sheet as of December 31, 2003. The income allocated
to the controlling partner is shown as venture partner interest in proﬁt-sharing on the Company’s Consolidated
Statements of Operations and Other Comprehensive Income for the years ended December 31, 2004, 2003 and
2002. Due to the expiration of the repurchase option, the Company stopped accounting for its interest in Avalon
on the Sound as a proﬁt-sharing arrangement effective December 31, 2004. The Company will account for its
interest in Avalon on the Sound under the equity method of accounting in future periods, unless the joint venture
arrangement  is  modiﬁed  to  require  consolidation,  and  therefore  the  Company’s  investment  in  Avalon  on  the
Sound is included in investment in unconsolidated real estate entities on its Consolidated Balance Sheet as of
December 31, 2004. Avalon on the Sound has net real estate of $80,685 and outstanding debt of $36,124 as 
of December 31, 2004, which is not reﬂected on the Company’s Consolidated Balance Sheet. The Company is
currently in negotiations with the third-party partner to repurchase its 75% equity interest, although there can be
no assurance that such repurchase will occur.

Investments  in  Unconsolidated  Non-Real  Estate  Entities At  December  31,  2004,  the  Company  held  a
minority interest investment in one non-real estate entity, which is a technology investment. Based on ownership
and control criteria, the Company accounts for this investment using the cost method. The aggregate carrying
value  of  the  Company’s  investment  in  unconsolidated  non-real  estate  entities  was  $454  and  $1,456  as  of
December  31,  2004  and  2003,  respectively.  Prior  to  December  31,  2004,  the  Company  held  an  ownership
interest in two additional non-real estate entities, one of which was accounted for under the equity method.
During 2004, the Company was notiﬁed that the technology investment in which it held a minority interest as
of December 31, 2004 was in negotiations to be acquired by a third-party. See Note 14, “Subsequent Events.”

The following is a summary of the Company’s equity in income of unconsolidated entities for the years presented:

Town Grove, LLC
Falkland Partners, LLC(1)
Town Run Associates
Avalon Terrace, LLC
Other unconsolidated entities

Total

For the year ended

12-31-04

12-31-03

12-31-02

$ 950
—
43
(28)
135

$ 1,158
24,255
214
(21)
(71)

$ 1,391
1,058
481
253
(3,128)

$1,100

$25,535

$

55

(1) The activity for the year ended December 31, 2003 includes the Company’s share of the GAAP gain reported by Falkland
Partners, LLC as a result of the sale of Falkland Chase in the amount of $21,816 and $1,632 for the liquidation of the
limited liability company’s assets. The sale of Falkland Chase resulted in net proceeds to the Company of $16,729.

7. Discontinued Operations—Real Estate Assets Sold or Held for Sale

During the year ended December 31, 2004, the Company sold ﬁve communities, one located in the Seattle,
Washington area, one located in San Jose, California, one located in Orange County, California and two located
in the Washington, DC metropolitan area. These ﬁve communities, which contained a total of 1,360 apartment
homes, were sold for an aggregate sales price of $241,050, resulting in the transfer of debt of $28,335, net proceeds
of $210,001 and a gain calculated in accordance with GAAP of $121,287. Details regarding the community asset
sales are summarized in the following table:

Community Name

Location

Period
of sale

Apartment
homes

Avalon Greenbriar
Avalon at Laguna Niguel
Avalon at Fox Mill
Fairway Glen
Avalon at Ballston—
Vermont & Quincy Towers

Renton, WA
2Q04
Laguna Niguel, CA 2Q04
3Q04
Herndon, VA
4Q04
San Jose, CA

Arlington, VA

4Q04

Total of all 2004 asset sales

Total of all 2003 asset sales

Total of all 2002 asset sales

421
176
165
144

454

1,360

3,184

Debt

$18,755
10,400
—
9,580

Gross sales
price

$ 34,100
27,000
38,500
20,950

Net
proceeds

$ 14,069
26,840
38,356
10,788

—

120,500

119,948

$38,735

$241,050

$210,001

$39,665

$424,650

$379,789

277

$ —

$ 80,100

$ 78,454

As of December 31, 2004, the Company did not have any communities that qualiﬁed as held for sale under the
provisions of SFAS No. 144. As required under SFAS No. 144, the operations for any communities sold from
January 1, 2002 through December 31, 2004 have been presented as discontinued operations in the accompanying
Consolidated Financial Statements.

62

avalonbay Communities, Inc.

avalonbay Communities, Inc.

63

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

Accordingly, certain reclassiﬁcations have been made in prior periods to reﬂect discontinued operations consistent
with current period presentation. The following is a summary of income from discontinued operations for the
years presented:

Rental income
Operating and other expenses
Interest expense, net
Minority interest expense
Depreciation expense

For the year ended

12-31-04

12-31-03

12-31-02

$13,408
(4,567)
(508)
(37)
(1,852)

$ 41,152
(15,702)
(2,380)
(438)
(6,138)

$ 69,587
(24,148)
(3,094)
(848)
(13,989)

Income from discontinued operations

$ 6,444

$ 16,494

$ 27,508

The Company’s Consolidated Balance Sheets include other assets (excluding net real estate) of $0 and $1,569,
other liabilities of $0 and $1,338 and mortgage notes payable of $0 and $38,735 as of December 31, 2004 and
December 31, 2003, respectively, relating to real estate assets sold.

As of December 31, 2003, the Company had one community that qualiﬁed as held for sale under the provisions of
SFAS No. 144. However, due to changes in economic conditions, the Company ceased pursuing the disposition
of the community during 2004. This community has been reclassiﬁed as held for operating purposes at its carrying
amount prior to being classiﬁed as held for sale, adjusted for suspended depreciation, which is less than the current
fair value.

During the year ended December 31, 2004, the Company sold one parcel of land, as well as certain transferable
development  rights  acquired  with  an  adjacent  parcel  of  land  on  which  a  current  operating  community  was
developed,  for  a  gross  sales  price  of  $9,927. The  sale  of  the  land  parcel  and  transferable  development  rights
resulted in an aggregate gain in accordance with GAAP of $1,138 and net proceeds of $9,648. In 2003, the
Company sold one land parcel, which was originally owned by the Company in connection with a development
right in Oakland, California, for which net proceeds of approximately $6,600 were received upon sale and a gain
in accordance with GAAP of $1,234 was recognized.

8. Commitments and Contingencies

Employment  Agreements  and  Arrangements As  of  December  31,  2004,  the  Company  had  employment
agreements with ﬁve executive ofﬁcers. The employment agreements provide for severance payments and generally
provide for accelerated vesting of stock options and restricted stock in the event of a termination of employment
(except for a termination by the Company with cause or a voluntary termination by the employee). The current
term of these agreements ends on dates that vary between April 2005 and November 2006. The employment
agreements provide for one-year automatic renewals (two years in the case of the Chief Executive Ofﬁcer (“CEO”))
after the initial term unless an advance notice of non-renewal is provided by either party. Upon a notice of non-
renewal by the Company, each of the ofﬁcers may terminate his employment and receive a severance payment.
Upon a change in control, the agreements provide for an automatic extension of up to three years from the date
of the change in control. The employment agreements provide for base salary and incentive compensation in the
form of cash awards, stock options and stock grants subject to the discretion of, and attainment of performance
goals established by, the Compensation Committee of the Board of Directors.

In  addition,  during  the  fourth  quarter  of  1999,  the  Company  adopted  an  Ofﬁcer  Severance  Program  (the
“Program”) for the beneﬁt of those ofﬁcers of the Company who do not have employment agreements. Under
the Program, in the event an ofﬁcer who is not otherwise covered by a severance arrangement is terminated (other
than for cause) within two years of a change in control (as deﬁned) of the Company, such ofﬁcer will generally
receive a cash lump sum payment equal to the sum of such ofﬁcer’s base salary and cash bonus, as well as accelerated 
vesting of stock options and restricted stock. Costs related to the Company’s employment agreements and the
Program are accounted for in accordance with SFAS No. 5, “Accounting for Contingencies,” and therefore are
recognized when considered by management to be probable and estimable.

Legal Contingencies The Company is subject to various legal proceedings and claims that arise in the ordinary
course of business. These matters are frequently covered by insurance. If it has been determined that a loss is
probable to occur, the estimated amount of the loss is expensed in the ﬁnancial statements. While the resolution
of these matters cannot be predicted with certainty, management believes the ﬁnal outcome of such matters will
not have a material adverse effect on the ﬁnancial position or results of operations of the Company.

The  Company  is  currently  involved  in  construction  litigation  with  a  general  contractor  and  a  security  bond
provider related to a community that has since completed development. A non-jury trial ended in April 2004,
and  in  May  2004,  the  court  issued  a  ruling,  ﬁnding  that  these  parties  were  liable  to  the  Company  for 
consequential  damages  due  to  breach  of  contract  and  other  failures  to  perform. The  court  issued  a  ruling  in
October  2004,  awarding  the  Company  approximately  $1,250  plus  interest.  However,  the  Company  has 
determined that it will ﬁle an appeal to seek an increase in the damage award. There is no guarantee that a higher,
or any, damage award, will be received by the Company after all appeals are ﬁled and a ﬁnal ruling is provided.

Lease  Obligations The  Company  owns  six  apartment  communities  which  are  located  on  land  subject  to 
land leases expiring between July 2029 and March 2142. In addition, the Company leases certain ofﬁce space.
These leases are accounted for as operating leases in accordance with SFAS No. 13, “Accounting for Leases.” The
Company incurred costs of $4,399, $3,348 and $1,931 in the years ended December 31, 2004, 2003 and 2002,
respectively, related to these leases.

The following table details the future minimum lease payments under the Company’s current operating leases:

Payments due by period

2005

$4,061

2006

$4,059

9. Segment Reporting

2007

$4,103

2008

$4,093

2009

$3,548

Thereafter

$373,211

The Company’s reportable operating segments include Established Communities, Other Stabilized Communities,
and  Development/Redevelopment  Communities.  Annually  as  of  January  1st,  the  Company  determines  which 
of  its  communities  fall  into  each  of  these  categories  and  maintains  that  classiﬁcation,  unless  disposition  plans
regarding a community change, throughout the year for the purpose of reporting segment operations.

• Established  Communities  (also  known  as  Same  Store  Communities)  are  communities  where  a  comparison  of
operating  results  from  the  prior  year  to  the  current  year  is  meaningful,  as  these  communities  were  owned 
and had stabilized occupancy and operating expenses as of the beginning of the prior year. For the year 2004,
the  Established  Communities  are  communities  that  had  stabilized  occupancy  and  operating  expenses  as  of
January 1,  2003,  are  not  conducting  or  planning  to  conduct  substantial  redevelopment  activities  and  are 
not  held  for  sale  or  planned  for  disposition  within  the  current  year.  A  community  is  considered  to  have
stabilized occupancy at the earlier of (i) attainment of 95% physical occupancy or (ii) the one-year anniversary
of completion of development or redevelopment.

• Other  Stabilized  Communities  includes  all  other  completed  communities  that  have  stabilized  occupancy,  as
deﬁned above. Other Stabilized Communities do not include communities that are conducting or planning to
conduct substantial redevelopment activities within the current year.

• Development/Redevelopment  Communities  consists  of  communities  that  are  under  construction  and  have  not
received  a  ﬁnal  certiﬁcate  of  occupancy,  communities  where  substantial  redevelopment  is  in  progress  or  is
planned  to  begin  during  the  current  year  and  communities  under  lease-up,  that  had  not  reached  stabilized
occupancy, as deﬁned above, as of January 1, 2004.

In addition, the Company owns land held for future development and has other corporate assets that are not
allocated to an operating segment.

64

avalonbay Communities, Inc.

avalonbay Communities, Inc.

65

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” requires that segment
disclosures  present  the  measure(s)  used  by  the  chief  operating  decision  maker  for  purposes  of  assessing  such
segments’ performance. The Company’s chief operating decision maker is comprised of several members of its
executive  management  team  who  use  Net  Operating  Income  (“NOI”)  as  the  primary  ﬁnancial  measure  for
Established  and  Other  Stabilized  Communities.  NOI  is  deﬁned  by  the  Company  as  total  revenue  less  direct
property operating expenses, including property taxes, and excludes corporate-level property management and other 
indirect operating expenses, investments and investment management, interest income and expense, general and
administrative  expense,  equity  in  income  of  unconsolidated  entities,  minority  interest  in  consolidated
partnerships,  venture  partner  interest  in  proﬁt-sharing,  depreciation  expense,  cumulative  effect  of  change  in
accounting principle, gain on sale of real estate assets and income from discontinued operations. Although the
Company  considers  NOI  a  useful  measure  of  a  community’s  or  communities’  operating  performance,  NOI
should not be considered an alternative to net income or net cash ﬂow from operating activities, as determined
in accordance with GAAP.

A reconciliation of NOI to net income for the years ended December 31, 2004, 2003 and 2002 is as follows:

Net income
Corporate-level property management

and other indirect operating expenses
Investments and investment management
Interest income
Interest expense
General and administrative expense
Equity in income of unconsolidated entities
Minority interest in consolidated partnerships
Venture partner interest in proﬁt-sharing
Depreciation expense
Impairment loss
Cumulative effect of change in accounting principle
Gain on sale of real estate assets
Income from discontinued operations

For the year ended

12-31-04

12-31-03

12-31-02

$ 219,745

$ 271,525

$ 173,618

27,956
4,691
(194)
131,314
18,074
(1,100)
150
1,178
160,815
—
(4,547)
(122,425)
(6,444)

27,123
2,948
(3,440)
133,637
14,830
(25,535)
950
1,688
147,658
—
—
(160,990)
(16,494)

25,894
4,658
(3,978)
118,288
13,449
(55)
865
857
130,488
6,800
—
(48,893)
(27,508)

Net operating income

$ 429,213

$ 393,900

$ 394,483

The primary performance measure for communities under development or redevelopment depends on the stage
of  completion.  While  under  development,  management  monitors  actual  construction  costs  against  budgeted
costs as well as lease-up pace and rent levels compared to budget.

The  following  table  provides  details  of  the  Company’s  segment  information  as  of  the  dates  speciﬁed.  The
segments are classiﬁed based on the individual community’s status as of the beginning of the given calendar year.
Therefore, each year the composition of communities within each business segment is adjusted. Accordingly, the
amounts between years are not directly comparable. The accounting policies applicable to the operating segments
described above are the same as those described in Note 1, “Organization and Signiﬁcant Accounting Policies.”
Segment  information  for  the  years  ending  December  31,  2004,  2003  and  2002  has  been  adjusted  for  the
communities  that  were  sold  from  January  1,  2002  through  December  31,  2004  as  described  in  Note  7,
“Discontinued Operations—Real Estate Assets Sold or Held for Sale.”

For the year ended December 31, 2004

Established
Northeast
Mid-Atlantic
Midwest
Paciﬁc Northwest
Northern California
Southern California

Total Established

Other Stabilized
Development / Redevelopment
Land Held for Future Development
Non-allocated(2)

Total
revenue

NOI

% NOI change
from prior year

Gross
real estate(1)

$150,752
53,735
10,734
31,852
136,948
56,124

440,145

114,698
93,096
n/a
515

$100,016
37,945
6,188
19,843
94,696
39,634

298,322

74,409
55,967
n/a
515

(0.4%)
2.6%
6.8%
1.8%
(5.9%)
1.8%

(1.3%)

n/a
n/a
n/a
n/a

$ 841,684
287,700
91,121
347,647
1,377,598
401,204

3,346,954

1,087,644
1,074,733
166,751
21,062

Total

$648,454

$429,213

9.0%

$5,697,144

For the year ended December 31, 2003

Established
Northeast
Mid-Atlantic
Midwest
Paciﬁc Northwest
Northern California
Southern California

Total Established

Other Stabilized
Development / Redevelopment
Land Held for Future Development
Non-allocated(2)

$151,902
59,436
16,141
27,342
137,686
43,225

$100,016
41,875
8,553
16,817
98,022
30,186

435,732

295,469

77,699
77,714
n/a
1,197

52,673
44,561
n/a
1,197

(8.9%)
(4.7%)
(16.7%)
(11.4%)
(10.4%)
(0.7%)

(8.5%)

n/a
n/a
n/a
n/a

$ 885,966
321,672
140,631
297,653
1,326,717
304,545

3,277,184

714,525
1,196,684
81,358
20,418

Total

$592,342

$393,900

(0.2%)

$5,290,169

For the year ended December 31, 2002

Established
Northeast
Mid-Atlantic
Midwest
Paciﬁc Northwest
Northern California
Southern California

Total Established

Other Stabilized
Development / Redevelopment
Land Held for Future Development
Non-allocated(2)

$142,333
60,499
17,082
6,210
148,262
42,386

$ 98,516
43,937
10,269
4,255
108,748
30,399

416,772

296,124

75,651
75,756
n/a
2,318

51,666
44,375
n/a
2,318

(7.8%)
(1.9%)
(8.2%)
(14.0%)
(18.1%)
2.6%

(10.3%)

n/a
n/a
n/a
n/a

$ 784,877
320,907
140,248
60,478
1,323,718
303,464

2,933,692

751,756
1,143,624
78,688
21,790

Total

$570,497

$394,483

(3.8%)

$4,929,550

(1) Does not include gross real estate assets for discontinued operations of $141,588 and $439,903 as of December 31, 2003

and 2002, respectively.

(2) Revenue and NOI amounts represent third-party management, accounting and developer fees which are not allocated to

a reportable segment.

66

avalonbay Communities, Inc.

avalonbay Communities, Inc.

67

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

10. Stock-Based Compensation Plans

The Company has a stock incentive plan (the “1994 Plan”), which was amended and restated on December 8, 2004.
Individuals who are eligible to participate in the 1994 Plan include ofﬁcers, other associates, outside directors and
other key persons of the Company and its subsidiaries who are responsible for or contribute to the management,
growth  or  proﬁtability  of  the  Company  and  its  subsidiaries. The  1994  Plan  authorizes  (i) the  grant  of  stock
options that qualify as incentive stock options under Section 422 of the Internal Revenue Code (“ISOs”), (ii) the
grant of stock options that do not so qualify, (iii) grants of shares of restricted and unrestricted common stock,
(iv) grants  of  deferred  stock  awards,  (v) performance  share  awards  entitling  the  recipient  to  acquire  shares  of
common stock and (vi) dividend equivalent rights.

Shares of common stock of 2,311,249, 2,358,393 and 2,084,207 were available for future option or restricted
stock  grant  awards  under  the  1994  Plan  as  of  December  31,  2004,  2003  and  2002,  respectively.  On  each
January 1, the maximum number available for issuance under the 1994 Plan is increased by between 0.48% and
1.00% of the total number of shares of common stock and DownREIT units actually outstanding on such date.
Notwithstanding the foregoing, the maximum number of shares of stock for which ISOs may be issued under the
1994 Plan shall not exceed 2,500,000 and no awards shall be granted under the 1994 Plan after May 11, 2011.
Options and restricted stock granted under the 1994 Plan vest and expire over varying periods, as determined by
the Compensation Committee of the Board of Directors.

Before  the  Merger,  Avalon  had  adopted  its  1995  Equity  Incentive  Plan  (the  “Avalon  1995  Incentive  Plan”).
Under the Avalon 1995 Incentive Plan, a maximum number of 3,315,054 shares (or 2,546,956 shares as adjusted
for the Merger) of common stock were issuable, plus any shares of common stock represented by awards under
Avalon’s 1993 Stock Option and Incentive Plan (the “Avalon 1993 Plan”) that were forfeited, canceled, reacquired
by  Avalon,  satisﬁed  without  the  issuance  of  common  stock  or  otherwise  terminated  (other  than  by  exercise).
Options granted to ofﬁcers, non-employee directors and associates under the Avalon 1995 Incentive Plan generally
vested over a three-year term, expire ten years from the date of grant and are exercisable at the market price on
the date of grant.

In connection with the Merger, the exercise prices and the number of options under the Avalon 1995 Incentive
Plan and the Avalon 1993 Plan were adjusted to reﬂect the equivalent Bay shares and exercise prices based on the
0.7683 share conversion ratio used in the Merger. Ofﬁcers, non-employee directors and associates with Avalon
1995  Incentive  Plan  or  Avalon  1993  Plan  options  may  exercise  their  adjusted  number  of  options  for  the
Company’s common stock at the adjusted exercise price. As of June 4, 1998, the date of the Merger, options and
other awards ceased to be granted under the Avalon 1993 Plan or the Avalon 1995 Incentive Plan. Accordingly,
there were no options to purchase shares of common stock available for grant under the Avalon 1995 Incentive
Plan or the Avalon 1993 Plan at December 31, 2004, 2003 or 2002.

Information with respect to stock options granted under the 1994 Plan, the Avalon 1995 Incentive Plan and the
Avalon 1993 Plan is as follows:

Options Outstanding, December 31, 2001
Exercised
Granted
Forfeited

Weighted
average
exercise price
per share

Avalon 1995
and Avalon
1993 Plan
shares

Weighted
average
exercise price
per share

$36.91
31.65
45.63
42.72

992,197
(350,157)
—
(1,534)

$36.03
37.39
—
39.86

1994 Plan
shares

2,893,278
(281,206)
719,198
(165,263)

Options Outstanding, December 31, 2002

3,166,007

$39.05

640,506

$35.27

Exercised
Granted
Forfeited

(454,843)
425,101
(157,000)

32.36
37.14
43.45

(165,264)
—
(1,280)

29.39
—
34.07

Options Outstanding, December 31, 2003

2,979,265

$39.57

473,962

$37.32

Exercised
Granted
Forfeited

(1,167,679)
545,809
(80,577)

39.06
50.71
43.98

(287,700)
—
—

37.05
—
—

Options Outstanding, December 31, 2004

2,276,818

$42.39

186,262

$36.23

Options Exercisable:
December 31, 2002

December 31, 2003

December 31, 2004

2,003,395

$35.95

640,506

$35.27

2,069,704

$38.51

473,962

$37.32

1,366,009

$39.72

186,262

$38.15

For  options  outstanding  at  December  31,  2004  under  the  1994  Plan,  945,976  options  had  exercise  prices
ranging between $25.38 and $39.99 and a weighted average contractual life of 5.2 years, 787,633 options had
exercise  prices  ranging  between  $40.00  and  $49.99  and  a  weighted  average  contractual  life  of  6.7  years,  and
543,209  options  had  exercise  prices  ranging  between  $50.00  and  $59.42  and  a  weighted  average  contractual 
life of 9.1 years. Options outstanding at December 31, 2004 for the Avalon 1993 and Avalon 1995 Plans had
exercise prices ranging from $28.15 to $36.61 and a weighted average contractual life of 3.0 years.

Effective January 1, 2003, the Company adopted the fair value recognition provisions of SFAS No. 123 prospectively
to all employee awards granted, modiﬁed, or settled on or after January 1, 2003. The effect on net income available
to common stockholders and earnings per share if the fair value based method had been applied to all outstanding
and unvested awards in each year based on the fair market value as determined on the date of grant is reﬂected in
Note 1, “Organization and Signiﬁcant Accounting Policies.”

The weighted average fair value of the options granted during 2004 is estimated at $3.87 per share on the date
of  grant  using  the  Black-Scholes  option  pricing  model  with  the  following  weighted  average  assumptions:
dividend yield of 6.05% over the expected life of the option, volatility of 17.28%, risk-free interest rates of 3.58%
and an expected life of approximately 7 years. The weighted average fair value of the options granted during 2003

68

avalonbay Communities, Inc.

avalonbay Communities, Inc.

69

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

is  estimated  at  $1.94  per  share  on  the  date  of  grant  using  the  Black-Scholes  option  pricing  model  with  the
following weighted average assumptions: dividend yield of 7.56% over the expected life of the option, volatility
of 18.68%, risk-free interest rates of 3.31% and an expected life of approximately 7 years. The weighted average
fair value of the options granted during 2002 is estimated at $4.52 per share on the date of grant using the Black-
Scholes option pricing model with the following weighted average assumptions: dividend yield of 6.15% over
the  expected  life  of  the  option,  volatility  of  18.90%,  risk-free  interest  rates  of  4.81%  and  an  expected  life  of
approximately  7  years.  The  cost  related  to  stock-based  employee  compensation  for  employee  stock  options
included in the determination of net income is based on actual forfeitures for the given year.

In October 1996, the Company adopted the 1996 Non-Qualiﬁed Employee Stock Purchase Plan (as amended,
the “ESPP”). Initially 1,000,000 shares of common stock were reserved for issuance under this plan. There are
currently 813,514 shares remaining available for issuance under the plan. Full-time employees of the Company
generally are eligible to participate in the ESPP if, as of the last day of the applicable election period, they have
been employed by the Company for at least one month. All other employees of the Company are eligible to
participate  provided  that  as  of  the  applicable  election  period  they  have  been  employed  by  the  Company  for
twelve months. Under the ESPP, eligible employees are permitted to acquire shares of the Company’s common
stock through payroll deductions, subject to maximum purchase limitations. The purchase period is a period of
seven  months  beginning  each  May  1  and  ending  each  November  30. The  purchase  price  for  common  stock
purchased under the plan is 85% of the lesser of the fair market value of the Company’s common stock on the
ﬁrst day of the applicable purchase period or the last day of the applicable purchase period. The offering dates,
purchase  dates  and  duration  of  purchase  periods  may  be  changed  by  the  Board  of  Directors,  if  the  change  is
announced prior to the beginning of the affected date or purchase period. The Company issued 14,476 shares,
14,393 shares and 29,345 shares and recognized compensation expense of $109, $95 and $152 under the ESPP
for the years ended December 31, 2004, 2003 and 2002, respectively. The Company accounts for transactions
under the ESPP using the fair value method prescribed under SFAS No. 123, as further discussed in Note 1,
“Organization and Signiﬁcant Accounting Policies.”

11. Fair Value of Financial Instruments

Cash  and  cash  equivalent  balances  are  held  with  various  ﬁnancial  institutions  and  may  at  times  exceed  the
applicable Federal Deposit Insurance Corporation limit. The Company monitors credit ratings of these ﬁnancial
institutions  and  the  concentration  of  cash  and  cash  equivalent  balances  with  any  one  ﬁnancial  institution 
and believes the likelihood of realizing material losses from the excess of cash and cash equivalent balances over
insurance limits is remote.

The  following  estimated  fair  values  of  ﬁnancial  instruments  were  determined  by  management  using  available
market information and established valuation methodologies, including discounted cash ﬂow. Accordingly, the
estimates presented are not necessarily indicative of the amounts the Company could realize on disposition of
the ﬁnancial instruments. The use of different market assumptions and/or estimation methodologies may have a
material effect on the estimated fair value amounts.

• Cash equivalents, rents receivable, accounts payable and accrued expenses, and other liabilities are carried at

their face amounts, which reasonably approximate their fair values.

• Bond  indebtedness  and  notes  payable  with  an  aggregate  carrying  value  of  approximately  $2,341,000  and
$2,286,000  had  an  estimated  aggregate  fair  value  of  $2,533,000  and  $2,556,000  at  December  31,  2004 
and 2003, respectively.

12. Related Party Arrangements

Purchase of Mortgage Note Concurrent with its initial public offering in November 1993, Avalon purchased
an  existing  participating  mortgage  note  made  to  Arbor  Commons  Associates  Limited  Partnership  (“Arbor
Commons  Associates”),  which  owns  Avalon  Arbor,  a  302  apartment  home  community  in  Shrewsbury,
Massachusetts. Prior to May 2004, the Company’s Chairman and CEO held an equity interest in the general
partner  of  Arbor  Commons  Associates;  in  May  2004,  the  Company’s  Chairman  and  CEO  fully  disposed  of 

his equity interests. This mortgage note accrued interest at a ﬁxed rate of 10.2% per annum, payable at 9.0% 
per  annum,  was  due  to  mature  in  November  2005  and  was  secured  by  the  interest  in  Avalon  Arbor.  As  of
December  31,  2003,  the  Company  reported  a  note  receivable  of  $21,483  and  accrued  interest  on  the  note 
of $5,834. Related interest income for the years ended December 31, 2003 and 2002 was $3,168 and $3,091,
respectively. Beginning January 1, 2004, the Company consolidated the ﬁnancial position and results of operations
of Arbor Commons Associates under the requirements of FIN 46 as discussed in Note 1, “Organization and
Signiﬁcant Accounting Policies.” As such, the related interest income during the year ended December 31, 2004
has  been  eliminated  in  consolidation.  On  October  15,  2004,  the  Company  received  payment  in  full  for  the
mortgage note and all accrued interest of $33,994, including a prepayment premium of approximately $1,240,
net of legal costs associated with the prepayment negotiations.

Unconsolidated Entities The Company manages several unconsolidated real estate joint venture entities for
which it receives management fee revenue. From these entities the Company received management fee revenue
of $683, $851 and $1,019 in the years ended December 31, 2004, 2003 and 2002 respectively.

In addition, in connection with the general contractor services that the Company provides to CVP I, LLC, the
entity  that  owns  and  is  developing  Avalon  Chrystie  Place  I  as  discussed  in  Note  6,  “Investments  in
Unconsolidated Entities,” the Company has funded certain construction costs on behalf of CVP I, LLC during
2004 and will be reimbursed through draws on the related construction loan. As of December 31, 2004, the
Company has recorded a receivable from CVP I, LLC in the amount of $19,983, which is included in prepaid
expenses and other assets on the accompanying Consolidated Balance Sheet.

Indebtedness of Management The Company had a recourse loan program under which the Company lent
amounts to or on behalf of employees (“Stock Loans”) equivalent to the estimated employees’ tax withholding
liabilities related to the vesting of restricted stock under the 1994 Plan. In accordance with the Sarbanes-Oxley
Act  of  2002,  no  loans  to  senior  ofﬁcers  were  renewed  after  January  1,  2003  and  all  were  repaid  in  full  by
March 31, 2003. The Company has phased out the Stock Loan program for all other participants, and all loans
were repaid by March 1, 2004.

Director  Compensation The  Company’s  1994  Plan  provides  that  directors  of  the  Company  who  are  also
employees receive no additional compensation for their services as a director. In accordance with the Company’s
1994  Plan,  as  then  in  effect,  on  the  ﬁfth  business  day  following  the  Company’s  May  2003  Annual  Meeting 
of  Stockholders,  each  of  the  Company’s  non-employee  directors  automatically  received  options  to  purchase 
7,000 shares of common stock at the last reported sale price of the common stock on the NYSE on such date,
and a restricted stock grant (or, in lieu thereof, a deferred stock award) of 2,500 shares of common stock. On
May 14, 2003, the Company’s Board of Directors approved an amendment to the 1994 Plan pursuant to which,
in lieu of the stock and option awards described above, each non-employee director would receive, following the
2004 Annual Meeting of Stockholders and each annual meeting thereafter, (i) a number of shares of restricted
stock (or deferred stock awards) having a value of $100 based on the last reported sale price of the common stock
on the NYSE on the ﬁfth business day following the prior year’s annual meeting and (ii) $30 cash, payable in
quarterly installments of $7.5. A non-employee director may elect to receive all or a portion of such cash payment
in the form of a deferred stock award. In addition, the Lead Independent Director receives an annual fee of $30
payable in equal monthly installments of $2.5. The Company recorded compensation expense relating to the
restricted stock grants, deferred stock awards and stock options in the amount of $940, $824 and $743 in the years
ended December 31, 2004, 2003 and 2002, respectively. Deferred compensation relating to these restricted stock
grants, deferred stock awards and stock options was $748 and $722 on December 31, 2004 and 2003, respectively.

Investment in Realeum, Inc. As an employee incentive and retention mechanism, the Company arranged for
ofﬁcers of the Company to hold direct or indirect interests in the common stock of Realeum, Inc (“Realeum”).
Realeum  is  a  company  involved  in  the  development  and  deployment  of  a  property  management  and  leasing
automation system in which the Company invested $2,300 in January 2002. In April 2004, Realeum was merged
into a third-party, and in connection with such merger, all shares of Realeum common stock (including those
held directly or indirectly by ofﬁcers of the Company) were cancelled without payment of consideration. The
Company still utilizes the property management and leasing automation system and has paid $516, $471 and
$480 to Realeum under the terms of its licensing arrangements during the years ended December 31, 2004, 2003
and 2002, respectively.

70

avalonbay Communities, Inc.

avalonbay Communities, Inc.

71

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders of
AvalonBay Communities, Inc.:

We have audited the accompanying consolidated balance sheets of AvalonBay Communities, Inc. and subsidiaries
as of December 31, 2004 and 2003, and the related consolidated statements of operations and other comprehensive
income, stockholders’ equity, and cash ﬂows for each of the three years in the period ended December 31, 2004.
These ﬁnancial statements are the responsibility of the Company’s management. Our responsibility is to express
an opinion on these ﬁnancial statements 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 ﬁnancial statements referred to above present fairly, in all material respects, the consolidated
ﬁnancial position of AvalonBay Communities, Inc. and subsidiaries at December 31, 2004 and 2003, and the
consolidated  results  of  their  operations  and  their  cash  ﬂows  for  each  of  the  three  years  in  the  period  ended
December 31, 2004, in conformity with U.S. generally accepted accounting principles. 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board
(United States), the effectiveness of AvalonBay Communities, Inc.’s internal control over ﬁnancial reporting as of
December  31,  2004,  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  9,  2005
expressed an unqualiﬁed opinion thereon.

McLean, Virginia
March 9, 2005

13. Quarterly Financial Information (Unaudited)

The following summary represents the quarterly results of operations for the years ended December 31, 2004
and 2003:

For the three months ended

3-31-04

6-30-04

9-30-04

12-31-04

Total revenue
Net income available to common stockholders
Net income per common share—basic
Net income per common share—diluted

$154,797
$ 23,102
0.33
$
0.32
$

$160,014
$ 32,859
0.46
$
0.46
$

$165,202
$ 43,191
0.60
$
0.60
$

$168,441
$111,894
1.55
$
1.52
$

For the three months ended

3-31-03

6-30-03

9-30-03

12-31-03

Total revenue
Net income available to common stockholders
Net income per common share—basic
Net income per common share—diluted

$145,019
$ 33,700
0.50
$
0.49
$

$146,489
$ 73,762
1.10
$
1.08
$

$148,902
$ 55,212
0.80
$
0.79
$

$151,932
$ 98,108
1.39
$
1.36
$

14. Subsequent Events

In January 2005, the Company repaid $150,000 of previously issued unsecured notes, along with any unpaid
interest, pursuant to their scheduled maturity and no prepayment penalties were incurred.

In  February  2005,  the  technology  investment  in  which  the  Company  held  an  ownership  interest  as  of
December 31, 2004 was acquired by a third-party. As a result of this transaction, the Company received net
proceeds of approximately $6,700 and expects to recognize a non-routine gain on the sale of this investment of
approximately $6,250.

In February 2005, the Company announced certain management changes, including the departure of a senior
executive. The Company is currently negotiating the deﬁnitive terms of this executive’s departure and on-going
relationship post-departure. The Company expects that it will enter into a consulting services arrangement with
this executive, pursuant to which he will provide consulting and transitional development services following his
departure;  however,  there  is  no  guarantee  that  such  a  consulting  arrangement  will  be  put  into  place.  The
Company expects that this executive will receive a cash payment of approximately $2,000, and he will retain and
receive accelerated vesting of his equity based compensation awards, as well as certain prorated compensation
through his expected departure date of April 30, 2005. The Company also expects that, in connection with the
payments and beneﬁts it will provide this executive, the Company will recognize a related expense during the
three months ended March 31, 2005.

As of February 28, 2005, two communities previously held for operating purposes were classiﬁed as held for sale
under SFAS No. 144. These communities have a net real estate carrying value of $40,675 as of December 31, 2004. The 
Company is actively pursuing the disposition of these communities and expects to close during the ﬁrst half of 2005.

As discussed in Note 1, “Organization and Signiﬁcant Accounting Policies,” the Company recorded an impairment
loss in the year ended December 31, 2002 related to two land parcels. As of December 31, 2002, the Company
determined that these two land parcels were not likely to proceed to development, and although they did not
qualify as held for sale under the provisions of SFAS No. 144, they were planned for disposition. Therefore, the
Company performed an analysis of the carrying value of these land parcels in connection with this change in
anticipated use. As a result, the Company recorded an impairment loss to reﬂect these parcels at fair market value,
based on their entitlement status as of December 31, 2002. As of February 28, 2005, the Company is under
contract to sell one of these parcels of land. Due to changes in economic conditions since 2002, the disposition
of this parcel of land at the current contracted sales price would result in the recovery of the previously recognized
impairment loss. However, there can be no assurance that such a sale will occur.

In addition, in March 2005, we issued $100,000 in unsecured notes under our existing shelf registration statement 
at an annual effective interest rate of 4.999%. Interest on these notes is payable semi-annually on March 15 and
September 15, and they mature in March 2013.

72

avalonbay Communities, Inc.

avalonbay Communities, Inc.

73

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders of
AvalonBay Communities, Inc.:

We  have  audited  management’s  assessment,  included  in  the  accompanying  Management’s  Report  on  Internal
Control Over Financial Reporting in Item 9a. of the Company’s Annual Report on Form 10-K for the year ended
December 31, 2004, that AvalonBay Communities, Inc. maintained effective internal control over ﬁnancial reporting
as of December 31, 2004, based on criteria established in Internal Control-Integrated Framework issued by the
Committee  of  Sponsoring  Organizations  of  the  Treadway  Commission  (the  COSO  criteria).  AvalonBay
Communities, Inc.’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 company’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  AvalonBay  Communities,  Inc.  maintained  effective  internal 
control over ﬁnancial reporting as of December 31, 2004, is fairly stated, in all material respects, based on the
COSO criteria. Also, in our opinion, AvalonBay Communities, Inc. maintained, in all material respects, effective
internal control over ﬁnancial reporting as of December 31, 2004, 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 AvalonBay Communities, Inc. as of December 31, 2004 and
2003,  and  the  related  consolidated  statements  of  operations  and  other  comprehensive  income,  stockholders’
equity,  and  cash  ﬂows  for  each  of  the  three  years  in  the  period  ended  December  31,  2004  of  AvalonBay
Communities, Inc. and our report dated March 9, 2005 expressed an unqualiﬁed opinion thereon.

McLean, Virginia
March 9, 2005

74

avalonbay Communities, Inc.

MARKET FOR REGISTRANT’S COMMON EQUITY
AND RELATED STOCKHOLDER MATTERS

Our common stock is traded on the New York Stock Exchange (NYSE) and the Paciﬁc Exchange (PCX) under
the ticker symbol AVB. The following table sets forth the quarterly high and low sales prices per share of our
common stock on the NYSE for the years 2004 and 2003, as reported by the NYSE. On February 28, 2005 there
were 675 holders of record of an aggregate of 72,725,148 shares of our outstanding common stock. The number
of holders does not include individuals or entities who beneﬁcially own shares but whose shares are held of record
by a broker or clearing agency, but does include each such broker or clearing agency as one recordholder.

2004

Sales Price

High

Low

Dividends
declared

Quarter ended March 31
Quarter ended June 30
Quarter ended September 30
Quarter ended December 31

$54.66
$57.80
$62.25
$75.93

$46.72
$48.30
$55.89
$59.90

$0.70
$0.70
$0.70
$0.70

2003

Sales Price

High

Low

$40.31
$44.45
$48.00
$49.71

$35.24
$37.08
$42.38
$44.67

Dividends
declared

$0.70
$0.70
$0.70
$0.70

We expect to continue our policy of paying regular quarterly cash dividends. However, dividend distributions
will be declared at the discretion of the Board of Directors and will depend on actual cash from operations, our
ﬁnancial  condition,  capital  requirements,  the  annual  distribution  requirements  under  the  REIT  provisions  of 
the  Internal  Revenue  Code  and  other  factors  as  the  Board  of  Directors  may  consider  relevant. The  Board  of
Directors  may  modify  our  dividend  policy  from  time  to  time.  In  February  2005,  we  announced  that  our 
Board of Directors declared a dividend on our common stock for the ﬁrst quarter of 2005 of $0.71 per share, a
1.4%  increase  over  the  previous  quarterly  dividend  of  $0.70  per  share. The  increased  dividend  is  payable  on
April 15, 2005 to all common stockholders of record as of April 1, 2005.

During the three months ended December 31, 2004, we issued 35,500 shares of common stock in exchange for
35,500 units of limited partnership held by certain limited partners of Avalon DownREIT V, L.P. and Bay Paciﬁc
Northwest, L.P. These shares were issued in reliance on an exemption from registration under Section 4(2) of the
Securities  Act  of  1933.  We  are  relying  on  the  exemption  based  on  factual  representations  received  from  the 
limited partners who received these shares.

avalonbay Communities, Inc.

75

DEFINITIONS AND RECONCILIATIONS OF NON-GAAP FINANCIAL MEASURES AND OTHER TERMS

This Annual Report, including the Letter to Shareholders, contains certain non-GAAP ﬁnancial measures and other
terms. The  deﬁnition  and  calculation  of  these  non-GAAP  ﬁnancial  measures  and  other  terms  may  differ  from  the
deﬁnitions and methodologies used by other REITs and, accordingly, may not be comparable. The non-GAAP ﬁnancial
measures referred to below should not be considered an alternative to net income as an indication of our performance.
In addition, these non-GAAP ﬁnancial measures do not represent cash generated from operating activities in accordance
with GAAP and therefore should not be considered as an alternative measure of liquidity or as indicative of cash available
to fund cash needs.

Development Rights and Development Pipeline

Development opportunities in the early phase of the development process for which we either have an option to
acquire land or enter into a leasehold interest, for which we are the buyer under a long-term conditional contract
to  purchase  land  or  where  we  own  land  to  develop  a  new  community. The  dollar  amount  for  Development
Rights  represents  the  projected Total  Capital  Cost  if  the  rights  were  developed  as  anticipated.  Development
Pipeline represents Development Rights plus communities currently under construction.

Economic Gain

The gain on sale in accordance with GAAP, less accumulated depreciation through the date of sale and any other
non-cash  adjustments  that  may  be  required  under  GAAP  accounting.  Management  generally  considers
Economic Gain to be an appropriate supplemental measure to gain on sale in accordance with GAAP because it
helps investors to understand the relationship between the cash proceeds from a sale and the cash invested in the
sold community. The Economic Gain for each community is estimated based on the respective ﬁnal settlement
statement. A reconciliation of Economic Gain to gain on sale in accordance with GAAP is included below. 

For the year ended

(Dollars in thousands)

12-31-04

12-31-03

12-31-02

12-31-01

12-31-00

GAAP Gain(1)
Accumulated depreciation and other

$122,425
(19,320)

$184,438
(52,613)

$48,893
(7,462)

$62,852
(21,623)

$40,779
(6,262)

Economic gain

$103,105

$131,825

$41,431

$41,229

$34,517

(1) 2004 GAAP Gain includes $1,138 related to the sale of a land parcel. 2003 GAAP Gain includes $23,448 related to the sale
of a community in which the Company held a 50% membership interest and $1,234 related to the sale of a land parcel.

Established Communities (“Same Store”)

Communities where a comparison of operating results from the prior year to the current year is meaningful, as
these communities were owned and had Stabilized Operations as deﬁned below, as of the beginning of the prior
year.  Therefore,  for  2004,  Established  Communities  are  communities  that  have  Stabilized  Operations  as  of
January 1, 2003 and are not conducting or planning to conduct substantial redevelopment activities within the
current year. Established Communities do not include communities that are currently held for sale or planned
for disposition during the current year.

Estimated Net Asset Value (NAV) Per Share 

The estimated market value of a Company’s assets less the estimated market value of all current and long-term
liabilities divided by the number of outstanding common shares and operating partnership units. 

Funds from Operations (FFO) 

FFO is determined based on a deﬁnition adopted by the Board of Governors of the National Association of Real
Estate Investment Trusts (“NAREIT”). See the section titled “Selected Financial Data” contained herein on page
27 for a deﬁnition and discussion of FFO. A reconciliation of FFO to Net Income is included below. 

(Dollars in thousands)

12-31-04

12-31-03

12-31-02

12-31-01

12-31-00

12-31-99

12-31-98

12-31-97

12-31-96

12-31-95

For the year ended

Net income
Dividends attributable to 
preferred stock
Depreciation—real estate assets, 
including discontinued operations 
and joint venture adjustments
Minority interest expense, 
including discontinued operations
Cumulative effect of change 
in accounting principle
Gain on sale of operating communities

Funds from Operations attributable 
to common stockholders

Weighted average common 
shares outstanding—diluted

EPS—diluted

FFO per common share—diluted

$ 219,745 $ 271,525 $ 173,618 $ 248,997 $ 210,604 $ 172,276 $ 123,535 $

64,916 $

51,651

$

30,937

(8,700)

(10,744)

(17,896)

(40,035)

(39,779)

(39,779)

(28,132)

(19,656)

(10,422)

—

157,988

128,278

142,980

128,086

120,208

108,679

76,339

27,759

18,887

14,784

3,048

1,263

1,601

1,559

1,759

1,975

1,770

(4,547)
(121,287)

—
(159,756)

—
(48,893)

—
(62,852)

—
(40,779)

—
(47,093)

—
(25,270)

—

—
(677)

—

—
(7,850)

—

—
—

$ 246,247 $ 230,566 $ 251,410 $ 275,755 $ 252,013 $ 196,058 $ 148,242 $

72,342 $

52,266

$

45,721

73,354,956 70,203,467

70,674,211

69,781,719

68,140,998

66,110,664

51,771,247

28,431,823

23,691,447

21,828,020

$

$

2.92 $

3.73 $

2.23 $

3.02 $

2.53 $

2.03 $

1.88 $

1.59 $

3.36 $

3.28 $

3.55 $

3.95 $

3.70 $

2.97 $

2.86 $

2.54 $

1.74

2.21

$

$

1.42

2.09

Initial Year Market Cap Rate (Cap Rate)

Projected NOI of a single community for the ﬁrst twelve months following the date of the buyer’s valuation, less
estimates for non-routine allowance of approximately $225–$300 per apartment home, divided by the gross sales
price  for  the  community.  For  this  purpose,  management’s  projection  of  stabilized  operating  expenses  for  the
community includes a management fee of approximately 2.5%–3.5%. The Initial Year Market Cap Rate, which
may be determined in a different manner by others, is a measure frequently used in the real estate industry when
determining the appropriate purchase price for a property or estimating the value for the property. Buyers may
assign different Initial Year Market Cap Rates to different communities when determining the appropriate value
because they (i) may project different rates of change in operating expenses and capital expenditure estimates and
(ii) may project different rates of change in future rental revenue due to different estimates for changes in rent
and occupancy levels. The weighted average Initial Year Market Cap Rate is weighted based on the gross sales
price of each community. 

Net Operating Income (NOI) 

Total  revenue  less  direct  property  operating  expenses  (including  property  taxes),  and  excludes  corporate-level
property  management  and  other  indirect  operating  expenses,  interest  income  and  expense,  general  and
administrative expense, joint venture income, minority interest and venture partner interest in proﬁt-sharing,
depreciation expense, gain on sale of real estate assets, impairment losses, cumulative effect of change in accounting
principle  and  income  from  discontinued  operations.  The  Company  considers  NOI  to  be  an  appropriate
supplemental measure to net income of operating performance of a community or communities because it helps
both investors and management to understand the core operations of a community or communities prior to the
allocation of any corporate-level property management overhead or general and administrative costs. This is more
reﬂective of the operating performance of a community, and allows for an easier comparison of the operating
performance of single assets or groups of assets. In addition, because prospective buyers of real estate have different

76

avalonbay Communities, Inc.

avalonbay Communities, Inc.

77

overhead structures, with varying marginal impact to overhead by acquiring real estate, NOI is considered by
many in the real estate industry to be a useful measure for determining the value of a real estate asset or groups
of assets. For further discussion and a reconciliation of NOI to Net Income see “Results of Operations” within
“Managements Discussion and Analysis of Financial Condition and Results of Operations” contained herein on
page 32. 

NOI as reported by the Company does not include the operating results from discontinued operations (i.e., assets
sold or held for sale as of December 31, 2004). A reconciliation of NOI from communities sold or held for sale
to net income for these communities for full year 2004 is as follows:

(Dollars in thousands)

Income from discontinued operations
Interest expense, net
Minority interest expense
Depreciation expense

NOI from discontinued operations

NOI from assets sold
NOI from assets held for sale

NOI from discontinued operations

2004

$6,444
508
37
1,852

$8,841

$8,841
—

$8,841

Projected NOI (Initial Yield)

Projected NOI used within this Annual Report for certain Development Communities and in calculating the
Initial Year Market Cap Rate for dispositions, represents management’s estimate, as of the date of the Company’s
fourth quarter 2004 quarterly earnings release, of projected stabilized rental revenue minus projected stabilized
operating  expenses.  For  Development  Communities,  Projected  NOI  is  calculated  based  on  the  ﬁrst  year  of
Stabilized Operations, as deﬁned below, following the completion of construction and Initial Yield is calculated
as Projected NOI as a percentage of Total Capital Cost. In calculating the Initial Year Market Cap Rate, Projected
NOI  for  dispositions  is  calculated  for  the  ﬁrst  twelve  months  following  the  date  of  the  buyer’s  valuation.
Projected stabilized rental revenue represents management’s estimate of projected gross potential (based on leased
rents  for  occupied  homes  and  Market  Rents,  as  deﬁned  below,  for  vacant  homes)  minus  projected  economic
vacancy and adjusted for concessions. Projected stabilized operating expenses do not include interest, income
taxes (if any), depreciation or amortization, or any allocation of corporate-level property management overhead
or general and administrative costs. The weighted average Projected NOI as a percentage of Total Capital Cost
is weighted based on the Company’s share of the Total Capital Cost of each community, based on its percentage
ownership.  In  this  report  the  Company  has  not  given  a  projection  of  NOI  on  a  company-wide  basis.
Management believes that Projected NOI of the development communities, on an aggregated weighted average
basis,  assists  investors  in  understanding  management’s  estimate  of  the  likely  impact  on  operations  of  the
Development  Communities  (before  allocation  of  any  corporate-level  property  management  overhead,  general
and administrative costs or interest expense) when they are complete and achieve stabilized occupancy. Given the
different dates and ﬁscal years at which stabilization is projected for these communities, the projected allocation
of  corporate-level  property  management  overhead,  general  and  administrative  costs  and  interest  expense  to
communities under development is complex, impractical to develop, and of uncertain meaningfulness. Projected
NOI of these communities is not a projection of the Company’s ﬁnancial performance or cash ﬂow. There can
be no assurance that the communities under development will achieve the Projected NOI used in the calculation
of weighted average Projected NOI to Total Capital Cost.

Stabilized Operations

The  earlier  of  (i) attainment  of  95%  physical  occupancy  or  (ii) the  one-year  anniversary  of  completion  of
development.

Total Capital Cost

All capitalized costs projected to be or actually incurred to develop the respective Development Community or
Development Right, including land acquisition costs, construction costs, real estate taxes, capitalized interest and
loan fees, permits, professional fees, allocated development overhead and other regulatory fees, all as determined
in accordance with GAAP. With respect to communities where development has been completed, Total Capital
Cost reﬂects the actual cost incurred, plus any contingency estimate made by management.

Unencumbered NOI

NOI generated by real estate assets unencumbered by outstanding secured debt as a percentage of total NOI
generated by real estate assets. The Company believes that current and prospective unsecured creditors of the
Company  view  Unencumbered  NOI  as  one  indication  of  the  borrowing  capacity  of  the  Company  and  that
investors and creditors view Unencumbered NOI as a useful supplemental measure for determining the ﬁnancial
ﬂexibility of an entity. A calculation of Unencumbered NOI for the years ended December 31, 2004, 2003 and
2002 follows:

(Dollars in thousands)

12-31-04

12-31-03

12-31-02

For the year ended

NOI for Established Communities
NOI for Other Stabilized Communities
NOI for Development/Redevelopment Communities
NOI for discontinued operations

Total NOI generated by real estate assets

NOI on encumbered assets

$298,322
74,409
55,967
8,841

437,539
78,231

$305,221
54,889
44,142
13,901

418,153
83,744

$318,754
55,953
44,956
20,435

440,098
90,154

NOI on unencumbered assets

$359,308

$334,409

$349,944

Unencumbered NOI

82.1%

80.0%

79.5%

Unleveraged IRR

The internal rate of return on sold communities calculated by the Company considering the timing and amounts
of (i) total revenue during the period owned by the Company and (ii) the gross sales price net of selling costs,
offset by (iii) the undepreciated capital cost of the communities at the time of sale and (iv) total direct operating
expenses  during  the  period  owned  by  the  Company.  Each  of  the  items  (i),  (ii),  (iii)  and  (iv)  are  calculated 
in  accordance  with  GAAP.  The  calculation  of  Unleveraged  IRR  does  not  include  an  adjustment  for  the
Company’s general and administrative expense, interest expense, or corporate-level property management and
other indirect operating expenses. Therefore, Unleveraged IRR is not a substitute for net income as a measure of
our performance. Management believes that the Unleveraged IRR achieved during the period a community is
owned  by  the  Company  is  useful  because  it  is  one  indication  of  the  gross  value  created  by  the  Company’s
acquisition, development or redevelopment, management and sale of the community, before the impact of indirect
expenses and Company overhead. The Unleveraged IRR achieved on the communities as cited in this release
should not be viewed as an indication of the gross value created with respect to other communities owned by the
Company, and the Company does not represent that it will achieve similar Unleveraged IRRs upon the disposition
of other communities. The weighted average Unleveraged IRR for sold communities is weighted based on all cash
ﬂows over the holding period for each respective community, including net sales proceeds.

78

avalonbay Communities, Inc.

avalonbay Communities, Inc.

79

AvalonBay Corporate Information

Board of Directors

Bryce Blair (4)
Chairman and CEO 
AvalonBay Communities, Inc.

Bruce A. Choate (2,4)
CEO and President
Watson Land Company

John J. Healy, Jr. (3,4)
Founder and CEO
Hyde Street Holdings, Inc.

Gilbert M. Meyer (4)
Founder and President
Greenbriar Homes Communities, Inc.

Charles D. Peebler, Jr. (3)
Managing Director
Plum Capital, LLC

Lance R. Primis (1,5)
Managing Partner
Lance R. Primis and Partners, LLC

Allan D. Schuster (2,4,5)
Private Investor

Amy P. Williams (2,3)
Vice President, Finance and Planning
Allstate Insurance Company

Officers

Bryce Blair
Chairman and CEO

Timothy J. Naughton
President

Thomas J. Sargeant
Chief Financial Ofﬁcer and Treasurer

Leo S. Horey
Executive Vice President
Operations

Charlene Rothkopf
Executive Vice President
Human Resources

1 Lead Independent Director
2 Audit Committee
3 Compensation Committee
4 Investment and Finance Committee
5 Nominating and Corporate Governance 

80

avalonbay Communities, Inc.

David W. Bellman
Senior Vice President
Construction–National

Jonathan B. Cox
Senior Vice President
Development–Mid-Atlantic, Mid-West

Lili F. Dunn
Senior Vice President
Investments

Frederick S. Harris
Senior Vice President
Development–NY

Dirk V. Herrman
Senior Vice President
Chief Marketing Ofﬁcer

Joanne M. Lockridge
Senior Vice President
Finance and Assistant Treasurer

William M. McLaughlin
Senior Vice President
Development–MA, RI, CT, NJ

J. Richard Morris
Senior Vice President
Construction–National

Edward M. Schulman
Senior Vice President
General Counsel and Secretary

Lawrence A. Scott
Senior Vice President
Development–Southern CA

Bernard J. Ward
Senior Vice President
Property Operations–West Coast

Stephen W. Wilson
Senior Vice President
Development–West Coast

Miguel A. Azua
Vice President
Controller

Shannon E. Brennan
Vice President
Property Operations–Mid-Atlantic, Mid-West

Sean J. Breslin
Vice President
Investments–West Coast

Alfred Brockunier III
Vice President
Construction–NY

Darren R. Carrington
Vice President
Investments–East Coast, Mid-West

Deborah A. Coombs
Vice President
Property Operations–Southern CA, 
Paciﬁc NW

Scott W. Dale
Vice President
Development–MA

Mark J. Forlenza
Vice President
Development–CT

Nathan K. Hong
Vice President
Development–Northern CA

Scott R. Kinter
Vice President
Construction–Northeast

Ronald S. Ladell
Vice President
Development–NJ

Lyn C. Lansdale
Vice President
Strategic Business Services

Janice A. Miner
Vice President
Property Operations–MA, RI, CT, NY

Kevin P. O’Shea
Vice President
Investment Management

Christopher L. Payne
Vice President
Development–Southern CA

Michael J. Roberts
Vice President
Development–MA

Mona R. Stahling
Vice President
Property Operations

Sean P. Sullivan
Vice President
Property Operations–NJ, Metro NYC

John E. Townsend
Vice President
Construction–CA

Matthew B. Whalen
Vice President
Development–Long Island

James R. Willden
Vice President
Engineering

Offices

Headquarters

Washington, DC
2900 Eisenhower Avenue
Suite 300
Alexandria, VA 22314
(703) 329-6300
Phone:
Fax:       (703) 329-1459

Regional Offices

Boston, MA
1250 Hancock Street
Suite 804N
Quincy, MA 02169
Phone:
Fax:

(617) 472-9491
(617) 472-5553

Chicago, IL
180 North Arlington Heights Road
Arlington Heights, IL 60004
Phone:
Fax:

(847) 342-0065
(847) 342-0075

Long Island, NY
135 Pinelawn Road
Suite #130 South
Melville, NY 11747
Phone:
Fax:

(631) 843-0736
(631) 843-0737

New Canaan, CT
220 Elm Street
Suite 200
New Canaan, CT 06840
(203) 801-3302
Phone:
(203) 801-3310
Fax:

Newport Beach, CA
4440 Von Karman Avenue
Suite 300
Newport Beach, CA 92660
Phone: 
Fax:

(949) 955-6200
(949) 955-6235

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New York, NY
535 Fifth Avenue
17th Floor
New York, NY 10017
Phone:
Fax:

(212) 370-9269
(212) 370-1511

San Francisco, CA
400 Race Street
Suite 200
San Jose, CA 95126
San Jose, CA 95129-1148
(408) 983-1500
Phone: 
(408) 287-9167
Fax: 

Seattle, WA
11808 Northup Way
Suite W311
Bellevue, WA 98005
Phone:
Fax:

(425) 576-2100
(425) 576-8447

Woodbridge, NJ
Woodbridge Place
517 Route One South
Suite 5500
Iselin, NJ 08830
Phone:
Fax:

(732) 404-4800
(732) 283-9101

Investor Relations

Investor Relations
AvalonBay Communities, Inc.
2900 Eisenhower Avenue 
Suite 300
Alexandria, VA 22314
Phone:
ir@avalonbay.com

(703) 329-6300 ext. 4632

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Website

www.avalonbay.com

Transfer Agent

Wachovia Bank, N.A.
1525 West W.T. Harris Boulevard, 3C3
Charlotte, NC 28288
(800) 829-8432

Independent Auditors

Ernst & Young, LLP
8484 Westpark Drive
McLean, VA 22102
(703) 747-1000

Form 10-K

A copy of the Company’s annual 
report on Form 10-K as ﬁled with the
Securities and Exchange Commission
may be obtained without charge by
contacting Investor Relations.

CEO and CFO Certiﬁcations

In 2004, the Company’s Chief Executive
Ofﬁcer provided to the New York Stock
Exchange the Annual CEO Certiﬁcation 
regarding the Company’s compliance with 
the New York Stock Exchange’s corporate 
governance listing standards. In addition, the
Company’s CEO and CFO ﬁled with the
Securities and Exchange Commission the 
certiﬁcations required by Sections 302 and 
404 of the Sarbanes-Oxley Act of 2002 
regarding the quality of the Company’s 
public disclosures in its 2004 annual report 
on Form 10-K.

Stock Listings

NYSE–AVB; PCX–AVB

This Annual Report, including the Letter to
Shareholders, contains “forward-looking 
statements” within the meaning of the
Securities Act of 1933 and the Securities
Exchange Act of 1934. Please see our 
discussion titled “Forward-Looking Statements” 
on page 42 of this report for a discussion 
regarding risks associated with these statements.
Non-GAAP ﬁnancial measures and other terms as
used in this report are deﬁned and reconciled
beginning on page 76 in the section titled,
“Deﬁnitions and Reconciliations of Non-GAAP
Financial Measures and Other Terms.”

 
 
 
 
 
 
2900 Eisenhower Avenue  Suite 300  Alexandria, VA  22314  www.avalonbay.com