UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2009

Commission file number 1-12672

2900 Eisenhower Avenue, Suite 300
Alexandria, Virginia 22314
(Address of principal executive offices, including zip code)

(703) 329-6300
(Registrant’s telephone number, including area code)

(Former name, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve (12) months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past ninety (90) days.

Yes þ       No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes þ       No o

Indicate by check mark whether the Exchange registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).

Yes o       No þ

APPLICABLE ONLY TO CORPORATE ISSUERS

Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date:

79,934,963 shares of common stock, par value $0.01 per share, were outstanding as of July 31, 2009

 

 

AVALONBAY COMMUNITIES, INC.
FORM 10-Q
INDEX

		Page
PART I — FINANCIAL INFORMATION
Item 1. Condensed Consolidated Financial Statements
Condensed Consolidated Balance Sheets as of June 30, 2009 (unaudited) and December 31, 2008			1
Condensed Consolidated Statements of Operations and Other Comprehensive Income (unaudited) for the three and six months ended June 30, 2009 and 2008			2
Condensed Consolidated Statements of Cash Flows (unaudited) for the six months ended June 30, 2009 and 2008			3-4
Notes to Condensed Consolidated Financial Statements (unaudited)			5-25
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			26-51
Item 3. Quantitative and Qualitative Disclosures About Market Risk			52
Item 4. Controls and Procedures			52
PART II — OTHER INFORMATION
Item 1. Legal Proceedings			52-53
Item 1a. Risk Factors			53
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			53
Item 3. Defaults Upon Senior Securities			54
Item 4. Submission of Matters to a Vote of Security Holders			54
Item 5. Other Information			54
Item 6. Exhibits			54-56
SIGNATURES			57

See accompanying notes to Condensed Consolidated Financial Statements.

See accompanying notes to Condensed Consolidated Financial Statements.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)

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

During the six months ended June 30, 2009:

•

As described in Note 4, “Stockholders’ Equity,” 2,624,641 shares of common stock valued at $139,058 were issued as part of the special dividend declared in the fourth quarter of 2008, 169,851 shares of common stock valued at $8,360 were issued in connection with stock grants, 5,623 shares valued at $307 were issued through the Company’s dividend reinvestment plan, 30,612 shares valued at $1,327 were withheld to satisfy employees’ tax withholding and other liabilities and 1,031 shares valued at $147 were forfeited, for a net value of $146,251. In addition, the Company granted 344,801 options for common stock at a value of $2,252.

•

The Company recorded a decrease to other liabilities and a corresponding increase to other comprehensive income of $797 to record the impact of the Company’s hedge accounting activity (as described in Note 5, “Derivative Instruments and Hedging Activities”).

•

Common dividends declared but not paid totaled $71,346.

•

The Company recorded a decrease of $2,827 in redeemable noncontrolling interests with a corresponding increase to accumulated earnings less dividends to adjust the redemption value associated with the put options held by joint venture partners and DownREIT partnership units. For further discussion of the nature and valuation of these items, see Note 11, “Fair Value.”

•

In May 2009, the Company obtained $93,440 in variable rate tax-exempt bond financing related to a Development Right, the proceeds of which will be held in escrow until requisitioned for construction funding. This loan provides an option for the Company to request an additional construction loan of up to $83,560 subject to the lender’s discretion.

During the six months ended June 30, 2008:

•

129,513 shares of common stock valued at $11,567 were issued in connection with stock grants, 2,070 shares valued at $181 were issued through the Company’s dividend reinvestment plan, 24,407 shares valued at $1,357 were issued to members of the Board of Directors in fulfillment of a deferred stock award, 1,101 shares valued at $109 were forfeited and 37,992 shares valued at $3,481 were withheld to satisfy employees’ tax withholding and other liabilities, for a net value of $9,515. In addition, the Company granted 401,212 options for common stock, net of forfeitures, at a value of $3,976.

•

The Company recorded an increase to other comprehensive income of $538 to record the impact of the Company’s hedge accounting activity.

•

Common and preferred dividends declared but not paid totaled $70,916.

•

The Company recorded a decrease of $4,065 in redeemable noncontrolling interests with a corresponding increase to accumulated earnings less dividends to adjust the redemption value associated with the put options held by joint venture partners and DownREIT partnership units.

AVALONBAY COMMUNITIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(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 consolidated 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 (“the Code”), as amended. The Company focuses on the development, acquisition, ownership and operation of apartment communities in high barrier to entry markets of the United States. These markets are located in the New England, Metro New York/New Jersey, Mid-Atlantic, Midwest, Pacific Northwest, and Northern and Southern California regions of the country.

At June 30, 2009, the Company owned or held a direct or indirect ownership interest in 162 operating apartment communities containing 46,476 apartment homes in ten states and the District of Columbia, of which seven communities containing 2,577 apartment homes were under reconstruction. In addition, the Company owned or held a direct or indirect ownership interest in 12 communities under construction that are expected to contain an aggregate of 4,035 apartment homes when completed. The Company also owned or held a direct or indirect ownership interest in rights to develop an additional 26 communities that, if developed as expected, will contain an estimated 6,688 apartment homes.

During the three months ended June 30, 2009:

•

The Company completed the redevelopment of two communities: Essex Place, located in Peabody, Massachusetts and Avalon Mountain View, located in Mountain View, California. These two communities contain an aggregate of 534 apartment homes and were redeveloped for a total capitalized cost of approximately $18,600, excluding costs incurred prior to redevelopment.

•

The Company commenced the redevelopment of two communities: Avalon Pleasanton, located in Pleasanton, California and Avalon Watch, located in West Windsor, New Jersey. These two communities contain an aggregate of 968 apartment homes and will be redeveloped for an estimated total capitalized cost of $38,300, excluding costs incurred prior to redevelopment.

•

The Company completed a 5.86% fixed rate, pooled secured financing transaction for aggregate borrowing of $741,140. The financing consists of fourteen separate mortgage loans each with a 10-year term. Each loan provides for payment of interest only during the first and second years of the loan term, with payment of principal and interest (based on a 30 year amortization schedule) thereafter and the remaining principal amount and any unpaid interest due at maturity on the tenth anniversary.

•

The Company announced the second and final closing of AvalonBay Value Added Fund II, LP (“Fund II”). In this closing, a new institutional investor was admitted and the Company reduced its net investment and equity interest, resulting in total equity commitments to Fund II increasing by $67,000.

•

Fund II acquired one community, see Note 6, “Investments in Real Estate Entities.”

The interim unaudited financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and in conjunction with the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements required by GAAP have been condensed or omitted pursuant to such rules and regulations. These unaudited financial statements should be read in conjunction with the financial statements and notes included in the Company’s 2008 Annual Report on Form 10-K. The results of operations for the three and six months ended June 30, 2009 are not necessarily indicative of the operating results for the full year. Management believes the disclosures are adequate to ensure the information presented is not misleading. In the opinion of management, all adjustments and eliminations, consisting only of normal, recurring adjustments necessary for a fair presentation of the financial statements for the interim periods, have been included.

Principles of Consolidation

The accompanying Condensed Consolidated Financial Statements include the accounts of the Company and its wholly owned partnerships, subsidiary companies, certain joint venture partnerships, subsidiary partnerships structured as DownREITs and any variable interest entities consolidated under FASB Interpretation No. 46 (“FIN 46(R)”), “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51,” as revised in December 2003. All significant intercompany balances and transactions have been eliminated in consolidation.

The Company assesses consolidation of variable interest entities under the guidance of FIN 46(R). The Company accounts for joint venture entities and subsidiary partnerships, including those structured as DownREITs, that are not variable interest entities, in accordance with Emerging Issues Task Force (“EITF”) Issue No. 04-5, “Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights,” Statement of Position (“SOP”) 78-9, “Accounting for Investments in Real Estate Ventures,” Accounting Principles Board (“APB”) Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock” and EITF Topic D-46, “Accounting for Limited Partnership Investments.” The Company uses EITF Issue No. 04-5 to evaluate the partnership of each joint venture entity and determine whether control over the partnership, as defined by the EITF, lies with the general partner, or the limited partners, when the limited partners have certain rights. In accordance with EITF Issue No. 04-5, the Company consolidates an investment when both (i) the Company is the general partner, and (ii) the limited partner interests do not overcome the Company’s presumption of control by having either substantive participating rights, the ability to remove the Company as the general partner or the ability to dissolve the partnership. Under all other potential scenarios, including (i) where the Company holds a general partner interest but the presumption of control by the Company is overcome by the limited partner interests as described in the preceding sentence, and (ii) where the Company holds a limited partner interest in a joint venture, the Company determines the accounting framework to apply to the investments in accordance with the guidance in SOP 78-9, APB No. 18 and EITF Topic D-46. The Company generally uses the equity method to account for investments that are not consolidated, unless its ownership interest is so minor that it has virtually no influence over the partnership’s operating and financial policies. Investments in which the Company has little or no influence are accounted for using the cost method.

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 of current cash flow 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. The holders of units of limited partnership interests 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 cash redemption, the Company may elect to exchange such units for an equal number of shares of the Company’s common stock. In the six months ended June 30, 2009, the Company redeemed 4,077 operating units for cash.

In conjunction with the acquisition and development of investments in unconsolidated entities, the Company may incur costs in excess of its equity in the underlying assets. These costs are capitalized and depreciated over the life of the underlying assets to the extent that the Company expects to recover the costs.

Revenue and Gain 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.

The Company accounts for sales of real estate assets and the related gain recognition in accordance with SFAS No. 66, “Accounting for Sales of Real Estate.”

Real Estate

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. Significant expenditures which improve or extend the life of an asset are capitalized. Expenditures for maintenance and repairs are charged to expense 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.

Project costs related to the development, construction and redevelopment of real estate projects (including interest and related loan fees, property taxes and other direct costs) are capitalized as a cost of the project. Indirect project costs that relate to several projects are capitalized and allocated to the projects to which they relate. Indirect costs not clearly related to development, construction and redevelopment activity are expensed as incurred. For development, capitalization (i) begins when the Company has determined that development of the future asset is probable, (ii) can be suspended if there is no current development activity underway, but future development is probable and (iii) ends when the asset, or a portion of an asset, is delivered and is ready for its intended use. For redevelopment efforts, we capitalize costs either (i) in advance of taking homes out of service when significant renovation of the common area has begun until the redevelopment is completed, or (ii) when an apartment home is taken out of service for redevelopment until the 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 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 the 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, making future development by the Company no longer probable, any capitalized pre-development costs are written off with a charge to expense. The Company expensed costs related to abandoned pursuits, which includes the abandonment of Development Rights, acquisition pursuits and disposition pursuits, in the amounts of $2,281 and $1,829 for the three months ended June 30, 2009 and 2008, respectively and $3,375 and $2,329 for the six months ended June 30, 2009 and 2008, respectively. These costs are included in operating expenses, excluding property taxes on the accompanying Condensed Consolidated Statements of Operations and Other Comprehensive Income. Abandoned pursuit costs can vary greatly, and the costs incurred in any given period may be significantly different in future years.

The Company acquired as Development Rights 11 land parcels improved with office buildings, industrial space and other commercial and residential ventures occupied by unrelated third parties. As of June 30, 2009 the Company is pursuing development of four of these parcels. For the seven parcels of land for which the Company does not intend to pursue development, rental revenue from the incidental operations are recognized as a component of rental and other income. For those land parcels for which the Company intends to pursue development, the Company will 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, allocating to each asset and liability acquired in such transaction, its estimated fair value at the date of acquisition in accordance with SFAS No. 141(R), “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 on the accompanying Condensed Consolidated Balance Sheets 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. For acquisitions subsequent to December 31, 2008, all costs incurred with these acquisitions will be expensed. Prior to January 1, 2009, third party costs directly associated with the acquisition were capitalized as part of the purchase price.

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.

Asset Impairment Evaluation

It is the Company’s policy to perform a quarterly qualitative analysis to determine if there are changes in circumstances that suggest the carrying value of a long-lived asset may not be recoverable. The Company applies the provisions of SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (“SFAS No. 144”) for consolidated operating apartment communities, Development Communities and Development Rights to determine the need for performing impairment analyses, as well as to measure the loss if an impairment has occurred, considering quantitative and qualitative economic factors. If an indication of impairment exists, and the Company’s net book value of the related assets are not recoverable based upon an analysis of its estimated undiscounted future cash flows, the assets are written down to their estimated fair value.

The Company also applies the provisions of SFAS No. 144 for assessing the need to perform an impairment analysis and measuring impairment losses on the underlying long-lived assets held by unconsolidated joint venture investments. In addition, if such impairment indicators are present, the Company estimates the fair value of its unconsolidated joint venture investment. If the Company’s carrying value of its unconsolidated joint venture investments exceeds the estimated fair value of the unconsolidated joint venture investment, the Company applies the provisions of APB No. 18 to determine if there has been an other than temporary decline in the value of investments in the Company’s unconsolidated joint ventures.

In the second quarter of 2009, the Company concluded that the continued economic downturn and the related decline in employment levels does not support the development and construction of certain new apartment communities previously in planning. As a result the Company recognized a charge of $20,302 related to the impairment of two land parcels for which the Company no longer intends to pursue development. The Company looked to third-party pricing estimates to determine the fair values of the land parcels considered to be impaired at June 30, 2009. Given the heterogeneous nature of multifamily real estate, the third party values incorporate significant other unobservable inputs and are therefore considered to be Level 3 prices in the fair value hierarchy under SFAS No. 157 “Fair Value Measurements”. In addition, the Company recognized a charge for severance and employment related costs associated with the reduction in planned development activity and general economic conditions of approximately $2,000, reported as a component of general and administrative expense.

Deferred Financing Costs

Deferred financing costs include fees and other expenditures necessary 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 charged to interest expense, net when debt is retired before the maturity date. Accumulated amortization of deferred financing costs was $23,376 at June 30, 2009 and was $24,264 at December 31, 2008.

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. Cash in escrow consists primarily of construction financing proceeds that are restricted for use in the construction of a specific community. The majority of the Company’s cash, cash equivalents and cash in escrows are held at major commercial banks.

Interest Rate Contracts

The Company uses derivative financial instruments to manage interest rate risk and generally designates these financial instruments as cash flow hedges under the guidance of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended. As of June 30, 2009 and December 31, 2008, the Company had approximately $60,320 and $61,298, respectively, in variable rate debt subject to cash flow hedges. Excluding debt on communities classified as held for sale, the Company did not apply hedge accounting for an additional $145,055 in variable rate debt which is subject to interest rate caps as of June 30, 2009. See Note 5, “Derivative Instruments and Hedging Activities,” for further discussion of derivative financial instruments.

Redeemable Noncontrolling Interests

Redeemable noncontrolling interests are comprised of potential future obligations of the Company, which allow the investors holding the noncontrolling interest to require the Company to purchase their interest. Under EITF Topic D-98, “Classification and Measurement of Redeemable Securities,” the Company classifies obligations under the redeemable noncontrolling interests at fair value, with a corresponding offset for changes in the fair value recorded in accumulated earnings less dividends. Reductions in fair value are recorded only to the extent that the Company has previously recorded increases in fair value above the redeemable noncontrolling interest’s initial basis. The redeemable noncontrolling interests are presented outside of permanent equity as settlement in the Company’s common shares, where permitted, may not be within the Company’s control. The nature and valuation of the Company’s redeemable noncontrolling interests are discussed further in Note 11, “Fair Value”.

Comprehensive Income

Comprehensive income, as reflected on the Condensed 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 in Note 4, “Stockholders’ Equity,” reflects the effective portion of the cumulative changes in the fair value of derivatives in qualifying cash flow hedge relationships attributable to controlling interests.

Earnings per Common Share

In accordance with the provisions of SFAS No. 128, “Earnings per Share,” basic earnings per share is computed by dividing net income attributable to common stockholders by the weighted average number of shares outstanding during the period. All outstanding unvested restricted share awards, which contain rights to non-forfeitable dividends, participate in undistributed earnings with common shareholders and, accordingly, are considered participating securities that are included in the two-class method of computing basic earnings per share (“EPS”) under the provisions of FASB Staff Position (“FSP”) EITF 03-6-1, as discussed below. All historical periods presented have been restated in accordance with FSP EITF 03-6-1 resulting in an impact of less than $0.01 for all periods presented. Both the unvested restricted shares and other potentially dilutive common shares, and the related impact to earnings, are considered when calculating earnings per share on a diluted basis. The Company’s earnings per common share are determined as follows:

Certain options to purchase shares of common stock in the amounts of 2,368,642 and 1,498,341 were outstanding at June 30, 2009 and 2008, respectively, but were not included in the computation of diluted earnings per share because in applying the treasury stock method under the provisions of SFAS No. 123(R), “Share Based Payments” as discussed below, such options are anti-dilutive.

Under the provisions of SFAS No. 123(R), the Company is required to estimate the forfeiture of stock options and recognize compensation cost net of the estimated forfeitures. The estimated forfeitures included in compensation cost are adjusted to reflect actual forfeitures at the end of the vesting period. The forfeiture rate at June 30, 2009 was 1.7%. The application of estimated forfeitures did not materially impact compensation expense for the three and six months ended June 30, 2009 or 2008.

Legal and Other Contingencies

The Company is currently involved in litigation alleging that 100 communities currently or formerly owned by the Company violated the accessibility requirements of the Fair Housing Act and the Americans with Disabilities Act. The lawsuit, Equal Rights Center v. AvalonBay Communities, Inc., was filed on September 23, 2005 in the federal district court in Maryland. The plaintiff seeks compensatory and punitive damages in unspecified amounts as well as injunctive relief (such as modification of existing communities), an award of attorneys’ fees, expenses and costs of suit. The Company has filed its answer in the lawsuit denying the allegations. In a separate matter related to FHA accessibility matters, on August 13, 2008 the U.S. Attorney’s Office for the Southern District of New York filed a civil lawsuit against the Company and the joint venture in which it has an interest that owns Avalon Chrystie Place. The lawsuit alleges that Avalon Chrystie Place was not designed and constructed in accordance with the accessibility requirements of the FHA. The Company designed and constructed the community to address compliance with New York City’s Local Law 58, which for more than 20 years has been New York City’s code regulating the accessible design and construction of apartments. As there are undetermined questions of law relating to these matters, (such as the applicable statute of limitations, the appropriate remedy if violations occurred, and the legal requirements to meet and demonstrate accessibility under the applicable statutes) and questions of fact (including the cost to remediate, if necessary), the Company cannot predict or determine the outcome of these lawsuits, nor is it reasonably possible at this time to estimate the amount of loss, if any, that would be associated with an adverse decision or settlement.

In addition, the Company is subject to various other 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 and can be reasonably estimated, the estimated amount of the loss is recorded in the financial statements. While the resolution of these other matters cannot be predicted with certainty, management currently 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. In instances where the Company has a gain contingency associated with legal proceedings, the Company records a gain in the financial statements when it is deemed probable to occur, can be reasonably estimated and is considered to be collectible. In connection with the resolution of several pending legal matters related to two former vendors, the Company recognized the receipt of $2,100 in settlement proceeds as a reduction in general and administrative expense for the three and six months ended June 30, 2009.

Assets Held for Sale & Discontinued Operations

The Company follows SFAS No. 144, which requires that the assets and liabilities of any communities which have been sold, or otherwise qualify as held for sale, be presented separately in the Condensed Consolidated Balance Sheets. In addition, the results of operations for those assets that meet the definition of discontinued operations are presented as such in the Company’s Condensed Consolidated Statements of Operations and Other Comprehensive Income. Held for sale and discontinued operations classifications are provided in both the current and prior periods presented. Real estate assets held for sale are measured at the lower of the carrying amount or the fair value less the cost to sell. Both the real estate assets and corresponding liabilities are presented separately in the accompanying Condensed Consolidated Balance Sheets. Subsequent to classification of a community as held for sale, no further depreciation is recorded. For those assets qualifying for classification as discontinued operations, the community specific components of net income presented as discontinued operations include net operating income, depreciation expense and interest expense, net. For periods prior to the asset qualifying for discontinued operations under SFAS No. 144, the Company reclassified the results of operations to discontinued operations in accordance with SFAS No. 144. 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 held for sale or discontinued operations will not have any impact on the Company’s financial condition or results of operations. The Company combines the operating, investing and financing portions of cash flows attributable to discontinued operations with the respective cash flows from continuing operations on the accompanying Condensed Consolidated Statements of Cash Flows.

Income Taxes

As of June 30, 2009, the Company did not have any unrecognized tax benefits as defined in FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an Interpretation of FASB Statement No. 109,” (“FIN 48”). We do not believe that there will be any material changes in our unrecognized tax positions over the next 12 months. The Company is subject to examination by the respective taxing authorities for the tax years 2005 through 2007.

Use of Estimates

The preparation of financial statements in conformity with GAAP 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 to current year presentations.

Recently Adopted Accounting Standards

In April 2009, the FASB issued FSP FAS No. 107-1 and APB Opinion No. 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (“FSP FAS No. 107-1 and APB Opinion No. 28-1”). FSP FAS No. 107-1 and APB Opinion No. 28-1 requires fair value disclosures for financial instruments that are not reflected in the Condensed Consolidated Balance Sheets at fair value. Prior to the issuance of FSP FAS No. 107-1 and APB Opinion No. 28-1, the fair values of those assets and liabilities were disclosed only in the Company’s Annual Report on Form 10-K. With the issuance of FSP FAS No. 107-1 and APB Opinion No. 28-1, the Company will now disclose this

information on a quarterly basis, providing quantitative and qualitative information about fair value estimates for all financial instruments not measured in the Condensed Consolidated Balance Sheets at fair value. The Company has included the required disclosure in this quarterly report. See Note 11, “Fair Value.”

In April 2009, the FASB issued FSP FAS No. 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly” (“FSP FAS No. 157-4”). FSP FAS No. 157-4 clarifies the methodology used to determine fair value when there is no active market or where the price inputs being used represent distressed sales. FSP FAS No. 157-4 also reaffirms the objective of fair value measurement, as stated in SFAS No. 157, which is to reflect how much an asset would be sold for in an orderly transaction. This pronouncement also reaffirms the need to use judgment to determine if a formerly active market has become inactive, as well as to determine fair values when markets have become inactive. The Company adopted the provisions of FSP FAS No. 157-4 on a prospective basis. The adoption did not have a material impact on the Company’s financial position or results of operations.

In May 2009, the FASB issued Statement No. 165, “Subsequent Events” (“SFAS No. 165”). SFAS No. 165 defines subsequent events as events or transactions that occur after the balance sheet date but before financial statements are issued or available to be issued. Under SFAS No. 165, the requirements for disclosing subsequent events remain unchanged from the previous requirements. However, SFAS No. 165 contains an additional requirement that companies must disclose the date through which subsequent events have been evaluated and the rationale for selecting that date. The Company has adopted the provisions of SFAS No. 165 in this quarterly report. See Note 12, “Subsequent Events.”

Recently Issued Accounting Guidance

In June 2009, the FASB approved the FASB Accounting Standards Codification (the “Codification”). In June 2009, the FASB also issued Statement No. 168, “The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles,” which replaces SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles.” SFAS No. 168 establishes the Codification as the single source of authoritative nongovernmental US GAAP (except for SEC rules and interpretive releases) and will be effective for interim and annual reporting periods ending after September 15, 2009. The Codification is intended to reorganize, rather than change, existing US GAAP. However, all existing accounting standard documents are superseded by the Codification and all accounting literature excluded from the Codification will become nonauthoritative upon the effective date of SFAS No. 168. Accordingly, beginning with the Company’s Form 10-Q for the quarter ending September 30, 2009, all references to currently existing US GAAP will be removed and will be replaced with references to the Codification or plain English explanations of our accounting policies. The Company does not expect that the adoption of the Codification will have a material impact on its financial position or results of operations.

In June 2009, the FASB issued Statement No. 167, “Amendments to FASB Interpretation No. 46(R)” (“SFAS No. 167”). SFAS No. 167 significantly amends the consolidation guidance applicable to variable interest entities (“VIEs”). SFAS No. 167 modifies the consolidation model to one based on control and economics, and replaces the current quantitative primary beneficiary analysis with a qualitative analysis. The primary beneficiary of a VIE will be the entity that has (1) the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and (2) the obligation to absorb losses or receive benefits that could potentially be significant to the VIE. If multiple unrelated parties share such power, as defined, no party will be required to consolidate the VIE. Further, SFAS No. 167 requires continual reconsideration of the primary beneficiary of a VIE and adds an additional reconsideration event for determination of whether an entity is a VIE. SFAS No. 167 also requires expanded disclosures related to VIEs which are largely consistent with the disclosure provisions of FSP FAS 140-4 and FIN 46(R)-8, “Disclosures by Public Entities (Enterprises) about Transfers of Financial Assets and Interests in Variable Interest Entities,” which the Company adopted in the fourth quarter of 2008. Upon adoption of SFAS No. 167, the provisions of FSP FAS 140-4 and FIN 46(R)-8 will be nullified. SFAS No. 167 is effective as of the beginning of the first fiscal year that begins after November 15, 2009, or January 1, 2010 for the Company. The Company is currently evaluating the impact that adoption of SFAS No. 167 will have on its financial statements.

2. Interest Capitalized

The Company capitalizes interest during the development and redevelopment of real estate assets in accordance with SFAS No. 34, “Capitalization of Interest Cost.” Capitalized interest associated with communities under development or redevelopment totaled $13,677 and $19,159 for the three months ended June 30, 2009 and 2008, respectively and $26,045 and $38,822 for the six months ended June 30, 2009 and 2008, 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 June 30, 2009 and December 31, 2008 are summarized below.

The following debt activity occurred during the six months ended June 30, 2009:

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In January 2009, the Company made a cash tender offer for any and all of its 7.5% medium-term notes due in August 2009 and December 2010. The Company purchased $37,438 principal amount of its $150,000, 7.5% medium-term notes due in August 2009 at par. In addition, the Company purchased $64,423 principal amount of its $200,000, 7.5% medium-term notes due December 2010 at 98% of par, for approximately $63,135, representing a yield to maturity of 8.66%. The Company recorded a gain of approximately $1,062 net of the write-off of related deferred financing costs during the first quarter of 2009 in conjunction with the purchase of the medium-term notes due December 2010 as a reduction in interest expense, net. All of the notes purchased in the tender offer were cancelled. The Company had previously acquired and cancelled an aggregate of $10,000 of the 7.5% medium-term notes due in August 2009.

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In April 2009, the Company completed a 5.86% fixed rate, pooled secured financing transaction for aggregate borrowing of $741,140. The financing consists of fourteen separate mortgage loans each with a 10-year term. Each loan provides for payment of interest only during the first and second years of the loan term, with payment of principal and interest (based on a 30 year amortization schedule) thereafter and the remaining principal amount and any unpaid interest due at maturity on the tenth anniversary.

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In April 2009, the Company repaid the $4,143 principal, 8.08% fixed rate loan secured by a real estate asset formerly classified as a Development Right in Alexandria, Virginia pursuant to its scheduled maturity.

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In May 2009, the Company repaid $19,470 in variable rate debt secured by Avalon at Flanders Hill, located in Westborough, Massachusetts.

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In May 2009, the Company repaid $105,600 in unsecured debt, representing the first tranche of its $330,000 unsecured variable rate term loan, pursuant to its scheduled maturity.

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In May 2009, the Company obtained $93,440 in variable rate tax exempt bond financing related to a Development Right, the proceeds of which will be held in escrow until requisitioned for construction funding. This loan provides an option for the Company to request an additional construction loan of up to $83,560 subject to the lender’s discretion.

In the aggregate, secured notes payable mature at various dates from December 2009 through July 2066 and are secured by certain apartment communities and improved land parcels (with a net carrying value of $1,878,726 as of June 30, 2009). As of June 30, 2009, the Company has guaranteed approximately $385,390 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 5.8% and 5.7% at June 30, 2009 and December 31, 2008, respectively. The weighted average interest rate of the Company’s variable rate mortgage notes payable, unsecured term loan and its unsecured credit facility, including the effect of certain financing related fees, was 1.8% at June 30, 2009 and 2.9% at December 31, 2008.

Scheduled payments and maturities of mortgage notes payable and unsecured notes outstanding at June 30, 2009 are as follows:

The Company’s unsecured notes are redeemable at our option, in whole or in part, at a redemption price equal to the greater of (i) 100% of their principal amount or (ii) the sum of the present value of the remaining scheduled payments of principal and interest discounted at a rate equal to the yield on U.S. Treasury securities with a comparable maturity plus a spread of 25 basis points, plus accrued and unpaid interest to the redemption date. The Company may also acquire its unsecured notes as part of a tender offer with the redemption terms set in conjunction with the tender offer.

The Company has a variable rate unsecured credit facility (the “Credit Facility”) in the amount of $1,000,000 with a syndicate of commercial banks, to whom the Company pays, in the aggregate, an annual facility fee of approximately $1,250. The Company did not have any amounts outstanding under the Credit Facility and $38,510 outstanding in letters of credit as of June 30, 2009. At December 31, 2008, there was $124,000 outstanding under the Credit Facility and $45,976 outstanding in letters of credit. The 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 0.40% per annum (0.71% at June 30, 2009). The stated spread over LIBOR can vary from LIBOR plus 0.325% to LIBOR plus 1.00% based on the Company’s credit ratings. In addition, the 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 Credit Facility for up to $650,000. The competitive bid option may result in lower pricing than the stated rate if market conditions allow. The Company did not have any amounts outstanding under this competitive bid option as of June 30, 2009. The Credit Facility matures in November 2011, assuming exercise of a one-year renewal option by the Company.

The Company was in compliance at June 30, 2009 with applicable financial and other covenants contained in the Credit Facility, the $224,400 variable rate unsecured term loan and the Company’s unsecured notes.

4. Stockholders’ Equity

The following summarizes the changes in stockholders’ equity for the six months ended June 30, 2009:

During the six months ended June 30, 2009, the Company:

	(i)		issued 42,950 shares of common stock in connection with stock options exercised;
	(ii)		issued 2,624,641 shares in connection with the dividend declared in December 2008;
	(iii)		issued 5,623 shares through the Company’s dividend reinvestment plan;
	(iv)		issued 169,851 common shares in connection with stock grants;
	(v)		withheld 30,612 shares to satisfy employees’ tax withholding and other liabilities; and
	(vi)		had 1,031 shares of restricted stock forfeited.

In addition, the Company granted 344,801 options for common stock to employees. As required under SFAS No. 123(R), any deferred compensation related to the Company’s stock option and restricted stock grants during the six months ended June 30, 2009 is not reflected on the Company’s Condensed Consolidated Balance Sheet as of June 30, 2009, and will not be reflected until earned as compensation cost.

The Company declared dividends per common share of $0.8925 and $1.785 for the three and six month periods ended June 30, 2008 and 2009. The Company also offers a Dividend Reinvestment and Stock Purchase Plan (the “DRIP”), which allows holders of the Company’s common 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.

5. Derivative Instruments and Hedging Activities

The Company enters into interest rate swap and interest rate cap agreements (collectively, the “Hedging Derivatives”) to reduce the impact of interest rate fluctuations on its variable rate, tax-exempt bonds and its variable rate conventional secured debt (collectively, the “Hedged Debt”). The Company has not entered into any interest rate hedge agreements for its conventional unsecured debt and does not enter into derivative transactions for trading or other speculative purposes. The following table summarizes the consolidated Hedging Derivatives at June 30, 2009, excluding derivatives executed to hedge debt on communities classified as held for sale:

Excluding derivatives executed to hedge debt on communities classified as held for sale, the Company had three derivatives designated as cash flow hedges and six derivatives not designated as hedges at June 30, 2009. For the derivative positions that the Company has determined qualify as effective cash flow hedges under SFAS No. 133, the Company has recorded the effective portion of cumulative changes in the fair value of the Hedging Derivatives in other comprehensive income. Amounts recorded in other comprehensive income will be reclassified into earnings in the periods in which earnings are affected by the hedged cash flow. To adjust the Hedging Derivatives to their fair value and recognize the impact of hedge accounting, the Company recorded an increase in other comprehensive income of $797 during the six months ended June 30, 2009 and an increase of $538 during the six months ended June 30, 2008. Amounts in other comprehensive income will be reclassified into earnings in conjunction with the periodic adjustment of the floating rates on the Hedged Debt, in interest expense, net. The amount reclassified into earnings for the six months ended June 30, 2009, as well as the estimated amount included in accumulated other comprehensive loss as of June 30, 2009, expected to be reclassified into earnings within the next twelve months to offset the variability of cash flows of the hedged items during this period are not material.

The Company assesses both at inception and on an on-going basis, the effectiveness of qualifying cash flow hedges. Hedge ineffectiveness, reported as a component of general and administrative expenses, did not have a material impact on earnings of the Company for any period presented, and the Company does not anticipate that it will have a material effect in the future. The fair values of the Hedging Derivatives are included in accrued expenses and other liabilities on the accompanying Condensed Consolidated Balance Sheets.

Derivative financial instruments expose the Company to credit risk in the event of nonperformance by the counterparties under the terms of the Hedging Derivatives. The Company minimizes its credit risk on these transactions by dealing with major, creditworthy financial institutions which have an A+ or better credit rating by the Standard & Poor’s Ratings Group. As part of its on-going control procedures, the Company monitors the credit ratings of counterparties and the exposure of the Company to any single entity, thus minimizing credit risk concentration. The Company believes the likelihood of realizing losses from counterparty non-performance is remote. Refer to Note 11, “Fair Value,” for further discussion of fair value measurements including the Company’s incorporation of credit valuation adjustments under SFAS No. 157.

6. Investments in Real Estate Entities

The Company accounts for its investments in unconsolidated real estate entities in accordance with the literature discussed in Note 1, “Organization and Significant Accounting Policies,” under Principles of Consolidation . During the six months ended June 30, 2009,

in conjunction with the second closing of Fund II, the Company’s equity ownership interest decreased to 31% from 45%. There were no other changes in the Company’s ownership interest in, or presentation of, its investments in unconsolidated real estate entities.

As of June 30, 2009, the Company had investments in the following unconsolidated real estate entities:

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a 20% limited liability company membership interest (with a right to 50% of distributions after achievement of a threshold return, which was achieved in the first quarter of 2009) in the limited liability company that owns the Avalon Chrystie Place community;

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a 25% limited liability company membership interest (with a right to 45% of distributions after achievement of a threshold return) in the limited liability company that owns the Avalon at Mission Bay North II community;

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a 30% limited liability company membership interest (with a right to 45% or the residual distribution after the joint venture partners receive both a return of their initial investment and an achievement of a threshold return on that investment) in the limited liability company that owns the Avalon Del Rey community;

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a 50% limited liability company membership interest (with a right to 95% of distributions until the Company receives a return of our invested capital and a threshold return thereon) in the limited liability company that is developing for-sale town homes adjacent to the Company’s Avalon Danvers community;

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a 15.2% combined general partner and indirect limited partner equity interest in the Fund (with the opportunity to receive as much as 20% of the Fund’s distributions in excess of return of capital, as an additional distribution, based on the achievement of certain threshold returns), which owns the following 19 communities: Avalon at Redondo Beach, Avalon Lakeside, Avalon Columbia, Avalon Sunset, Avalon at Poplar Creek, Avalon at Civic Center, Avalon Paseo Place, Avalon Yerba Buena, Avalon at Aberdeen Station, The Springs, Avalon Lombard, Avalon Cedar Place, Avalon Crystal Hill, Middlesex Crossing, Avalon Centerpoint, Skyway Terrace, Avalon Rutherford Station, South Hills Apartments and Weymouth Place; and

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a 31% combined general partner and indirect limited partner equity interest in Fund II (with the opportunity to receive as much as 20% of Fund II’s distributions in excess of return of capital, as an additional distribution, based on the achievement of certain threshold returns). During the three months ended June 30, 2009, Fund II acquired Verona Apartments located in Bellevue, WA for $33,100. Verona Apartments is a mid-rise style community containing 220 apartment homes.

In addition, as part of the formation of the Fund and Fund II, the Company provided separate and distinct guarantees to one of the limited partners in each of the ventures. These guarantees are specific to the respective fund and any impacts or obligation of the Company to perform under one of the guarantees has no impact on the Company’s obligations with respect to the other guarantee. The guarantees provide that, if, upon final liquidation of the Fund or Fund II, the total amount of all distributions to the guaranteed partner during the life of the respective fund (whether from operating cash flow or property sales) does not equal the total capital contributions made by that partner, then the Company will pay the guaranteed partner an amount equal to the shortfall, but in no event more than 10% of the total capital contributions made by the guaranteed partner (maximum of approximately $7,192 for the Fund and $413 for Fund II as of June 30, 2009). As of June 30, 2009, the expected realizable value of the real estate assets owned by the Fund and Fund II is considered adequate to cover such potential payments under a liquidation scenario. The estimated fair value of and the Company’s obligation under these guarantees, both at inception and as of June 30, 2009, was not significant and therefore the Company has not recorded any obligation for either of these guarantees as of June 30, 2009.

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

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

In conjunction with the acquisition and development of the investments in unconsolidated entities, the Company incurred costs in excess of its equity in the underlying net assets of the respective investments. These costs represent $11,267 at June 30, 2009 and $4,817 at December 31, 2008 of the respective investment balances.

7. Real Estate Disposition Activities

During the six months ended June 30, 2009, the Company did not sell any communities. As of June 30, 2009, the Company did not have any assets that qualified as discontinued operations and held for sale under the provisions of SFAS No. 144.

In accordance with the requirements of SFAS No. 144, the operations for any real estate assets sold from January 1, 2008 through June 30, 2009 and the real estate assets that qualified as discontinued operations and held for sale as of June 30, 2009 have been presented as such in the accompanying Condensed Consolidated Financial Statements. 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 periods presented:

8. Segment Reporting

The Company’s reportable operating segments include Established Communities, Other Stabilized Communities, and Development/ Redevelopment Communities. Annually as of January 1 ^st , 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.

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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 2009, the Established Communities are communities that are consolidated for financial reporting purposes, had stabilized occupancy and operating expenses as of January 1, 2008, 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.

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

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Development/Redevelopment Communities consists of communities that are under construction and have not received a final certificate of occupancy, communities where the company owns a majority interest and 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, 2009.

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

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 Communities and Other Stabilized Communities. NOI is defined by the Company as total revenue less direct property operating expenses. 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. NOI excludes a number of income and expense categories as detailed in the reconciliation of NOI to net income.

A reconciliation of NOI to net income for the three and six months ended June 30, 2009 and 2008 is as follows:

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 three and six months ended June 30, 2009 and 2008 have been adjusted for the communities that were sold from January 1, 2008 through June 30, 2009, or otherwise qualify as discontinued operations as of June 30, 2009, as described in Note 7, “Real Estate Disposition Activities.”

9. Stock-Based Compensation Plans

On May 21, 2009, the stockholders of the Company, upon the recommendation of the Board of Directors, approved the AvalonBay Communities, Inc. 2009 Stock Option and Incentive Plan (the “2009 Plan”). The 2009 Plan includes an authorization to issue up to 4,199,822 shares of the Company’s common stock, par value $0.01 per share, (2,930,000 newly authorized shares plus 1,269,822 shares that were available for grant as of May 21, 2009 under the Company’s 1994 Stock Option and Incentive Plan (the “1994 Plan”)), pursuant to awards under the 2009 Plan. The 2009 Plan provides for various types of equity awards to employees, officers, non-employee directors and agents of the Company and its subsidiaries. The types of awards that may be granted under the 2009 Plan include restricted and deferred stock, stock options that qualify as incentive stock options (“ISOs”) under Section 422 of the Internal Revenue Code, non-qualified options, and stock appreciation rights. The 2009 Plan will expire on May 21, 2019.

Effective as of the close of business on May 21, 2009, and as part of the proposal to approve the 2009 Plan described above, the Board of Directors terminated the 1994 Plan with respect to new awards. The 1994 Plan provided for the same types of equity awards as the 2009 Plan, and would have expired by its terms on May 8, 2011. Outstanding awards previously granted under the 1994 Plan will not be affected by termination of the 1994 Plan, the terms of which shall continue to govern such previously granted awards. In addition to the 4,199,822 shares available for awards under the 2009 Plan as described above, any awards that were outstanding under the 1994 Plan on May 21, 2009 that are subsequently forfeited, canceled, surrendered or terminated (other than by exercise) will become available for awards under the 2009 Plan.

     Information with respect to stock options granted under the 1994 Plan is as follows:

The weighted average fair value of the options granted during the six months ended June 30, 2009 is estimated at $6.53 per share on the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions: dividend yield of 8.5% over the expected life of the option, volatility of 36.57%, risk-free interest rate of 2.17% and an expected life of approximately seven years.

At June 30, 2009, the Company had 253,215 outstanding unvested shares granted under restricted stock awards. The Company issued 169,851 shares of restricted stock valued at $8,360 as part of its stock-based compensation plan during the six months ended June 30, 2009. Compensation cost is recognized over the requisite service period, which varies, but does not exceed five years. The fair value of restricted stock is the closing stock price on the date of the grant. Provisions of SFAS No. 123(R) require the Company to recognize compensation cost taking into consideration retirement eligibility. The cost related to stock-based compensation for restricted stock included in the determination of net income is based on actual forfeitures for the given year. Restricted stock awards typically vest over a five-year period with the exception of accelerated vesting provisions. Restricted stock vesting during the six months ended June 30, 2009 totaled 122,082 shares and had fair values ranging from $48.60 to $147.75 per share. The total fair value of shares vested was $10,103 and $10,422 for the six months ended June 30, 2009 and 2008, respectively.

Total employee stock-based compensation cost recognized in income was $6,212 and $8,705 for the six months ended June 30, 2009 and 2008, respectively, and total capitalized stock-based compensation cost was $3,095 and $2,970 for the six months ended June 30, 2009 and 2008, respectively. At June 30, 2009, there was a total of $3,543 and $9,852 in unrecognized compensation cost for unvested stock options and unvested restricted stock, respectively, which does not include estimated forfeitures. The unrecognized compensation cost for unvested stock options and restricted stock is expected to vest over a weighted average period of 1.71 years and 2.54 years, respectively.

Deferred Stock Performance Plan

In 2008 the Company’s Board of Directors and its Compensation Committee approved a multiyear performance plan (“the 2008 Performance Plan”) and granted awards in connection with this plan with an estimated compensation cost of $8,958 to senior management and other selected officers (“2008 Performance Plan Awards”). The 2008 Performance Plan Awards are initially in the form of deferred stock awards, with no dividend rights, granted under the Company’s 1994 Plan. These deferred stock awards will be forfeited in their entirety unless the Company’s total return to shareholders, consisting of stock price appreciation plus cumulative dividends without reinvestment or compounding over the measurement period, exceeds the thresholds specified in the 2008 Performance Plan. The measurement period of the 2008 Performance Plan began on June 1, 2008 and will end on May 31, 2011, or earlier, upon a change in control of the Company.

Earned deferred stock awards will convert into vested unrestricted common stock (50%), and unvested restricted common stock with a one-year vesting period (50%), subject to earlier forfeiture or acceleration under certain circumstances. Dividends will be paid on both the unrestricted common stock and the restricted common stock. As of June 30, 2009, the Company has reserved 633,179 shares within the 1994 Plan relating to deferred stock awards under the 2008 Performance Plan.

The Company is recognizing compensation expense for the 2008 Performance Plan over the three year measurement period for the 50% of each award which vests at the end of the measurement period. For the remaining 50% of each award, the Company is recognizing compensation expense over the four year period which includes the measurement period as well as the one-year vesting period subsequent to the end of the measurement period. The recognition of compensation cost will take into account actual forfeitures as well as retirement eligibility. During the three months ended June 30, 2009, the Company recognized the compensation expense associated with the 2008 Performance Plan of $439 and capitalized stock-based compensation costs of $249.

10. Related Party Arrangements

Unconsolidated Entities

The Company manages unconsolidated real estate entities for which it receives asset management, property management, development and redevelopment fee revenue. From these entities, the Company received fees of $2,077 and $1,579 in the three months ended June 30, 2009 and 2008, respectively and $3,545 and $3,217 for the six months ended June 30, 2009 and 2008, respectively. These fees are included in management, development and other fees on the accompanying Condensed Consolidated Statements of Operations and Other Comprehensive Income.

Director Compensation

Directors of the Company who are also employees receive no additional compensation for their service as a director. Following each annual meeting of stockholders starting with the 2008 annual meeting, non-employee directors receive (i) a number of shares of restricted stock (or deferred stock awards) having a value of $125 and (ii) a cash payment of $50, payable in quarterly installments of $12.5. The number of shares of restricted stock (or deferred stock awards) is calculated based on the closing price on the day of the award. Non-employee directors may elect to receive all or a portion of cash payments 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 non-employee director compensation expense relating to the restricted stock grants and deferred stock awards in the amount of $96 and $179 for the three and six months ended June 30, 2009 as a component of general and administrative expense. Deferred compensation relating to these restricted stock grants and deferred stock awards was $458 and $137 on June 30, 2009 and December 31, 2008, respectively.

11. Fair Value

Fair Value Methodology

As a basis for applying a market-based approach in fair value measurements, SFAS No. 157 establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity and the reporting entity’s own assumptions about market participant assumptions. The valuation of financial instruments can be determined using widely accepted valuation techniques.

To comply with the provisions of SFAS No. 157, the Company applies widely accepted valuation models such as discounted cash flow analysis on the expected cash flows of each instrument which considers the contractual terms of the instruments, including the period to maturity, and uses observable market-based inputs, including interest rate curves and market prices, as available and applicable. In addition, the Company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements as discussed below. When market-based inputs are not available in valuing the Company’s financial instruments, such as for valuing the redeemable noncontrolling interests, the Company uses unobservable inputs considering the assumptions that market participants would make in deriving the fair value. The use of different market assumptions and/or estimation methodologies may have a material effect on the Company’s estimates of fair value.

Financial Instruments Carried at Fair Value

Derivative Financial Instruments

Currently, the Company uses interest rate swap and interest rate cap agreements to manage its interest rate risk. These instruments are carried at fair value in the Company’s financial statements. See Note 5, “Derivative Instruments and Hedging Activities,” for derivative values at June 30, 2009 and a description of where these amounts are recorded in the financial statements. In adjusting the fair value of its derivative contracts for the effect of counterparty nonperformance risk, the Company has considered the impact of its net position with a given counterparty, as well as any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees. Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives use Level 3 inputs, such as estimates of current credit spreads, to evaluate the likelihood of default by itself and its counterparties. As of June 30, 2009, the Company assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined it is not significant. As a result, the Company has determined that its derivative valuations are classified in Level 2 of the fair value hierarchy.

Redeemable Noncontrolling Interests

Redeemable noncontrolling interests are reported at fair value, with reductions in fair value recorded only to the extent that the Company has previously recorded increases in fair value above the redeemable noncontrolling interest initial basis.

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Puts – The Company provided redemption options (the “Puts”) that allow two of our joint venture partners to require the Company to purchase their interests in the investments at the future fair market value. One Put is payable in cash or, at the Company’s option, common shares of the Company, and the second is payable in cash. The Company determines the fair value of the Puts based on unobservable inputs considering the assumptions that market participants would make in pricing the obligations, including applying discount factors to the estimated future cash flows of the asset underlying the associated joint venture, which in the case of the Puts is the NOI from an apartment community, as well as potential disposition proceeds utilizing market capitalization rates, to derive the fair value of the position. Given the significance of the unobservable inputs, the valuations are classified in Level 3 of the fair value hierarchy. At December 31, 2008, the Puts’ aggregate fair value was $9,057. At June 30, 2009, the aggregate fair value of the Puts was $5,273.

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DownREIT units – The Company issued units of limited partnership interest in DownREITs which provide the DownREIT limited partners the ability to present all or some of their units for redemption for a cash amount as determined by the applicable partnership

agreement. Under the DownREIT agreements, for each limited partnership unit, the limited partner is entitled to receive cash in the amount equal to the fair value of the Company’s common stock on or about the date of redemption. In lieu of cash redemption, the Company may elect to exchange such units for an equal number of shares in the Company’s common stock. The limited partnership units in DownREITs are valued using the market price of the Company’s common stock, a Level 1 price under the fair value hierarchy. At December 31, 2008, the fair value of the DownREIT units was $1,177. At June 30, 2009, the fair value of the DownREIT units was $859.

Financial Instruments Not Carried at Fair Value

Cash and Cash Equivalents

Cash and cash equivalent balances are held with various financial institutions within principal protected accounts. 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 related to cash and cash equivalent balances is remote. Cash and cash equivalents are carried at their face amounts, which reasonably approximate their fair values.

Other Financial Instruments

Rents receivable, accounts and construction payable and accrued expenses and other liabilities are carried at their face amounts, which reasonably approximate their fair values.

The Company values its bond indebtedness, notes payable and outstanding amounts under the Credit Facility using a discounted cash flow analysis on the expected cash flows of each instrument. This analysis reflects the contractual terms of the instrument, including the period to maturity, and uses observable market-based inputs, including interest rate curves. The process also considers credit valuation adjustments to appropriately reflect the Company’s nonperformance risk. The Company has concluded that the value of its bond indebtedness and notes payable are Level 2 prices as the majority of the inputs used to value its positions fall within Level 2 of the fair value hierarchy. Bond indebtedness, notes payable and outstanding amounts under the Company’s Credit Facility (as applicable) with an aggregate outstanding par amount of approximately $4,152,000 and $3,676,000 had an estimated aggregate fair value of $4,121,585 and $3,612,130 at June 30, 2009 and December 31, 2008, respectively.

12. Subsequent Events

Subsequent events have been evaluated through August 10, 2009, the date the financial statements were issued. Pursuant to the requirements of SFAS 165, there were no events or transactions subsequent to June 30, 2009 that required recognition or disclosure in the financial statements.

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

Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) is intended to help provide an understanding of our business and results of operations. This MD&A should be read in conjunction with our Condensed Consolidated Financial Statements and the accompanying Notes to Condensed Consolidated Financial Statements included elsewhere in this report. This report, including the following MD&A, contains forward-looking statements regarding future events or trends as described more fully under “Forward-Looking Statements” included in this report. Actual results or developments could differ materially from those projected in such statements as a result of the risk factors described in Item 1a, “Risk Factors,” of our Form 10-K for the year ended December 31, 2008 (our “Form 10-K”).

Executive Overview

Business Description

We are primarily engaged in developing, acquiring, owning and operating apartment communities in high barrier to entry markets of the United States. 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 believe that apartment communities are 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. However, throughout the real estate cycle, apartment market fundamentals, and therefore operating cash flows, are affected by overall economic conditions, such as the current economic downturn. 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 or when pricing is attractive.

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 New England, the New York/New Jersey metro area, the Mid-Atlantic, the Midwest, the Pacific Northwest, and the Northern and Southern California regions of the United States. Our strategy is to penetrate these markets with a broad range of products and services and an intense focus on our customer. Our communities are predominately 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.

Second Quarter 2009 Highlights

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Net income attributable to common stockholders for the quarter ended June 30, 2009 was $17,674,000, as compared to $125,159,000 for the quarter ended June 30, 2008, a decrease of 85.9%. The decrease is attributable primarily to gains on assets sold during 2008 not present in 2009, coupled with charges for an impairment of land parcels which we no longer intend to develop, the abandonment of development pursuits and an associated severance charge recognized in the second quarter of 2009.

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The results for the quarter ended June 30, 2009 reflect the current recessionary environment. Our Established Community portfolio (as defined later in this report) experienced a 5.5% decrease in net operating income (“NOI”) over the comparable period of 2008, driven by a 2.8% decrease in rental revenue and an increase in operating expenses of 3.4%. The rental revenue decline over the comparable period in 2008, attributable primarily to downward pressure on rental rates and increased job losses, was largely consistent with our expectations.

Financial Outlook

During the first six months of 2009, actual job losses materially exceeded those contained in the economic forecasts we used to prepare our initial 2009 financial outlook. Actual job losses nationwide through June 2009 totaled 3.2

million, a 70% increase over assumptions incorporated into the initial 2009 guidance provided in February 2009. We use a composite of third party economic forecasts to develop operating and financial plans, with a particular focus on employment forecasts. Changes in employment conditions have a significant impact on overall demand for rental housing and are highly correlated to changes in revenue growth. A composite of third party economic forecasts now projects a year over year decline in nationwide employment of 5.4 million jobs for 2009 with unemployment peaking between 10.5% to 11.0% by mid-2010.

Based on the revised employment projections, revenue from Established Communities is anticipated to decline by 3.5% to 4.5% for 2009. This compares to the 1.5% to 3.5% decline incorporated into the original financial outlook in February 2009. These projections are based on our outlook for economic conditions for the remainder of 2009, both nationally and in the markets where we operate. There can be no assurance that our outlook for economic conditions and/or their impact on our operating results will be accurate, and actual results could differ materially. Please see “Risk Factors,” “Forward Looking Statements” and other discussions in our Form 10-K for a discussion of factors which could affect our results of operations.

Longer-term, we expect apartment fundamentals to strengthen from a reduction in new supply, favorable demographic trends, declining homeownership and an economic recovery that we expect will eventually produce employment growth. Changes in any of the above factors, including if there is a more prolonged or increased deterioration in economic conditions than we currently expect, could materially change our expectations for the remainder of 2009 and future periods.

During 2009 we continue to benefit from a strong balance sheet that allows us to access capital at relatively attractive rates. In the second quarter of 2009, we successfully completed a 10-year, 5.86% fixed rate pooled financing transaction for $741,140,000. We used these proceeds to fund our development and redevelopment activities, repay secured and unsecured debt, prepay certain secured debt with higher interest costs and for other general corporate purposes. We believe that our overall modest level of secured and unsecured debt will continue to provide us with the financial flexibility to access both public and private capital on attractive terms.

During the second quarter of 2009, we added equity commitments for the AvalonBay Value Added Fund II, LP (“Fund II”), our private discretionary investment vehicle that was originally formed in August of 2008. Fund II now has equity commitments from five institutional investors who, with the Company, collectively committed $400,000,000, of which our commitment is $125,000,000. Total equity commitments to Fund II increased by $67,000,000 as a result of the following:

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a new institutional investor made an equity commitment of $75,000,000;

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an existing institutional investor increased its commitment by $17,000,000, based on terms of its existing commitment; and

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we decreased our commitment by $25,000,000, based on terms of our existing commitment, decreasing our equity interest to approximately 31%.

Fund II will acquire, operate and sometimes redevelop (but not develop) multifamily apartment communities primarily in our current markets with the objective of creating value through redevelopment, enhanced operations and/or improving market fundamentals. Fund II has a term that expires in August 2018, plus two one-year extension options. Fund II will serve as the exclusive vehicle through which we will acquire investment interests in apartment communities until August 2011 or, if earlier, until 90% of the committed capital of Fund II is invested, subject to limited exceptions. We will receive, in addition to any returns on our invested equity, asset management fees, property management fees and redevelopment fees. We will also receive a promoted interest if certain return thresholds are met. Fund II can employ leverage of up to 65%, allowing for an investment capacity of approximately $1,100,000,000. In April 2009, Fund II acquired one community, and as of July 31, 2009, Fund II has invested $33,100,000.

Reduced returns relative to the cost of capital and economic risk have resulted in a reduction in new development activity for 2009. We currently have 12 communities under construction with a total projected capitalized cost of approximately $1,396,400,000. As of June 30, 2009, approximately $1,000,800,000 of this development has been funded, with approximately $395,600,000 remaining to fund. We have arranged $112,000,000 of this required

funding through financing from third-party, tax-exempt and taxable debt. During the six months ended June 30, 2009, we did not start any new developments and we do not anticipate starting any development activity during the third quarter of 2009. If we start any new development activity in the fourth quarter of 2009, we do not expect it will have a significant impact on our liquidity, corporate cash flows or earnings. At June 30, 2009, there were seven communities under redevelopment, with an expected incremental capital investment of approximately $116,500,000, of which approximately $61,200,000 remains to be funded . We expect to maintain our current level of redevelopment activity through the end of 2009, taking the opportunity to reinvest and reposition our assets to meet the needs of our residents and ensure that our assets are competitively positioned when the economy recovers. We believe that we currently have sufficient committed capital to complete the development and redevelopment activities underway and meet other liquidity uses. See the discussion under Liquidity and Capital Resources.

Community Information Overview

Our real estate investments consist primarily of current operating apartment communities, Development Communities and Development Rights both as defined below. Our current operating communities are further distinguished as Established Communities, Other Stabilized Communities, Lease-Up Communities and Redevelopment Communities. The following is a description of each category:

Current Communities are categorized as Established, Other Stabilized, Lease-Up, or Redevelopment according to the following attributes:

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Established Communities (also known as Same Store Communities) are consolidated 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 period ended June 30, 2009, the Established Communities are communities that are consolidated for financial reporting purposes, had stabilized occupancy and operating expenses as of January 1, 2008, 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.

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Other Stabilized Communities are all other completed communities that we own or have a direct or indirect ownership interest in, and 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.

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Lease-Up Communities are communities where construction has been complete for less than one year and where physical occupancy has not reached 95%.

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Redevelopment Communities are communities where the Company owns a majority interest and where substantial redevelopment is in progress or is planned to begin during the current year. Redevelopment is considered substantial when capital invested during the reconstruction effort is expected to exceed either $5,000,000 or 10% of the community’s pre-development basis.

Development Communities are communities that are under construction and for which a certificate of occupancy has not been received. These communities may be partially complete and operating.

Development Rights are 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. We capitalize related pre-development costs incurred in pursuit of new developments for which we currently believe future development is probable.

In addition, we own approximately 60,000 square feet of office space in Alexandria, Virginia, for our corporate office, with all other regional and administrative offices leased under operating leases.

As of June 30, 2009, communities that we owned or held a direct or indirect interest in were classified as follows: