10-Q 1 form10q.htm ESSEX PORTFOLIO, LP 10-Q 9-30-2013
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2013

OR

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

For the transition period from ________to _________

Commission file number 333-44467-01

ESSEX PORTFOLIO, L.P.
(Exact name of Registrant as Specified in its Charter)

California
 
77-0369575
(State or Other Jurisdiction of Incorporation or Organization)
 
(I.R.S. Employer Identification Number)

925 East Meadow Drive
Palo Alto, California    94303
(Address of Principal Executive Offices including Zip Code)

(650) 494-3700
(Registrant's Telephone Number, Including Area Code)
 

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 12 months (or for such shorter period that the registrant was required to file reports), and (2) has been subject to such filing requirements for the past 90 days. YES  x 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 (§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 x NO o

Indicate by check mark whether the 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):
 
Large accelerated filer  o   
Accelerated filer  o
Non-accelerated filer  x
Smaller reporting company  o
 
(Do not check if a smaller reporting company)
                                                       
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o No  x

ESSEX PORTFOLIO, L.P.
FORM 10-Q
INDEX

 
 
Page No.
PART I. FINANCIAL INFORMATION
 
 
 
 
Item 1.
3
 
 
 
 
4
 
 
 
 
5
 
 
 
 
6
 
 
 
 
7
 
 
 
 
9
 
 
 
Item 2.
21
 
 
 
Item 3.
29
 
 
 
Item 4.
30
 
 
 
PART II. OTHER INFORMATION
 
 
 
 
Item 1.
31
 
 
 
Item 1A.
31
 
 
 
Item 6.
32
 
 
 
33
2
Part I -- Financial Information

Item 1: Condensed Financial Statements (Unaudited)

Essex Portfolio, L.P., a California limited partnership, (the "Operating Partnership") effectively holds the assets and liabilities and conducts the operating activities of Essex Property Trust, Inc. (the “Company”).   Essex Property Trust, Inc., a real estate investment trust incorporated in the State of Maryland, is the sole general partner of the Operating Partnership.

The information furnished in the accompanying unaudited condensed consolidated balance sheets, statements of operations and comprehensive income, capital, and cash flows of the Operating Partnership reflects all adjustments which are, in the opinion of management, necessary for a fair presentation of the aforementioned condensed consolidated financial statements for the interim periods and are normal and recurring in nature, except as otherwise noted.

The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the notes to such unaudited condensed consolidated financial statements and Management's Discussion and Analysis of Financial Condition and Results of Operations herein.  Additionally, these unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Operating Partnership's Amendment No. 1 on Form S-4 filed with the Securities and Exchange Commission (“SEC”) on March 12, 2013.
3
ESSEX PORTFOLIO, L.P. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
(Unaudited)
(Dollars in thousands, except unit amounts)

 
  
September 30,
2013
    
December 31,
2012
  
Assets
  
   
 
Real estate:
  
   
 
Rental properties:
  
   
 
Land and land improvements
  
$
1,057,355
    
$
1,003,171
  
Buildings and improvements
    
4,237,557
      
4,030,501
  
 
    
5,294,912
      
5,033,672
  
Less accumulated depreciation
    
(1,214,092
)
    
(1,081,517
)
 
    
4,080,820
      
3,952,155
  
Real estate under development
    
45,804
      
66,851
  
Co-investments
    
674,075
      
571,345
  
 
    
4,800,699
      
4,590,351
  
Cash and cash equivalents-unrestricted
    
9,509
      
18,606
  
Cash and cash equivalents-restricted
    
46,485
      
23,520
  
Marketable securities
    
89,899
      
92,713
  
Notes and other receivables
    
67,628
      
66,163
  
Prepaid expenses and other assets
    
49,270
      
35,003
  
Deferred charges, net
    
22,112
      
20,867
  
Total assets
  
$
5,085,602
    
$
4,847,223
  
 
                
Liabilities and Capital
                
Mortgage notes payable
  
$
1,495,521
    
$
1,565,599
  
Unsecured debt
    
1,409,883
      
1,112,084
  
Lines of credit
    
15,352
      
141,000
  
Accounts payable and accrued liabilities
    
83,844
      
64,858
  
Construction payable
    
6,936
      
5,392
  
Distributions payable
    
50,486
      
45,052
  
Derivative liabilities
    
3,161
      
6,606
  
Other liabilities
    
22,366
      
22,167
  
Total liabilities
    
3,087,549
      
2,962,758
  
Commitments and contingencies
                
Cumulative convertible Series G preferred interest (liquidation value of $4,456)
    
4,349
      
4,349
  
Capital:
                
General Partner:
                
Common equity (37,323,297 and 36,442,994 units issued and outstanding at September 30, 2013 and December 31, 2012, respectively)
    
1,871,580
      
1,762,856
  
Preferred interest (liquidation value of $73,750)
    
71,209
      
71,209
  
 
    
1,942,789
      
1,834,065
  
Limited Partners:
                
Common equity (2,146,293 and 2,122,381 units issued and outstanding at September 30, 2013 and December 31, 2012, respectively)
    
45,854
      
45,593
  
Accumulated other comprehensive loss, net
    
(61,178
)
    
(68,231
)
Total partners' capital
    
1,927,465
      
1,811,427
  
Noncontrolling interest
    
66,239
      
68,689
  
Total capital
    
1,993,704
      
1,880,116
  
Total liabilities and capital
  
$
5,085,602
    
$
4,847,223
  
 
See accompanying notes to the unaudited condensed consolidated financial statements.
4
ESSEX PORTFOLIO, L.P. AND SUBSIDIARIES
Condensed Consolidated Statements of Operations and Comprehensive Income
(Unaudited)
(Dollars in thousands, except unit and per unit amounts)

 
  
Three Months Ended
September 30,
    
Nine Months Ended
September 30,
  
 
  
2013
    
2012
    
2013
    
2012
  
Revenues:
  
   
   
   
 
Rental and other property
  
$
152,945
    
$
134,518
    
$
448,318
    
$
388,642
  
Management and other fees from affiliates
    
2,957
      
3,072
      
9,139
      
8,312
  
 
    
155,902
      
137,590
      
457,457
      
396,954
  
Expenses:
                                
Property operating, excluding real estate taxes
    
36,002
      
32,763
      
102,790
      
91,828
  
Real estate taxes
    
14,561
      
12,310
      
42,852
      
35,326
  
Depreciation
    
48,438
      
42,897
      
143,320
      
125,137
  
General and administrative
    
6,075
      
5,276
      
18,925
      
16,440
  
Cost of management and other fees
    
1,613
      
1,642
      
5,047
      
4,893
  
 
    
106,689
      
94,888
      
312,934
      
273,624
  
 
                                
Earnings from operations
    
49,213
      
42,702
      
144,523
      
123,330
  
 
                                
Interest expense before amortization
    
(26,187
)
    
(25,064
)
    
(77,724
)
    
(74,380
)
Amortization expense
    
(3,005
)
    
(2,927
)
    
(8,937
)
    
(8,681
)
Interest and other income
    
2,387
      
3,003
      
9,326
      
10,869
  
Equity income in co-investments
    
40,802
      
3,547
      
52,295
      
8,998
  
(Loss) gain on early retirement of debt
    
(178
)
    
(1,211
)
    
846
      
(2,661
)
Gain on sale of land
    
-
      
-
      
1,503
      
-
  
Gain on remeasurement of co-investment
    
-
      
-
      
-
      
21,947
  
Income from continuing operations
    
63,032
      
20,050
      
121,832
      
79,422
  
Income from discontinued operations
    
12,843
      
172
      
13,321
      
10,528
  
Net income
    
75,875
      
20,222
      
135,153
      
89,950
  
Net income attributable to noncontrolling interest
    
(1,730
)
    
(1,558
)
    
(5,075
)
    
(4,658
)
Net income attributable to controlling interest
    
74,145
      
18,664
      
130,078
      
85,292
  
Preferred interest distributions - Series G & H
    
(1,368
)
    
(1,368
)
    
(4,104
)
    
(4,104
)
Net income available to common units
  
$
72,777
    
$
17,296
    
$
125,974
    
$
81,188
  
 
                                
Comprehensive income
  
$
76,112
    
$
16,462
    
$
142,206
    
$
86,034
  
Comprehensive income attributable to noncontrolling interest
    
(1,730
)
    
(1,558
)
    
(5,075
)
    
(4,658
)
Comprehensive income attributable to controlling interest
  
$
74,382
    
$
14,904
    
$
137,131
    
$
81,376
  
 
                                
Per unit data:
                                
Basic:
                                
Income from continuing operations available to common units
  
$
1.52
    
$
0.45
    
$
2.86
    
$
1.91
  
Income from discontinued operations
    
0.32
      
0.01
      
0.34
      
0.29
  
Net income available to common units
  
$
1.84
    
$
0.46
    
$
3.20
    
$
2.20
  
Weighted average number of common units outstanding during the period
    
39,467,492
      
37,836,555
      
39,333,100
      
36,976,298
  
 
                                
Diluted:
                                
Income from continuing operations available to common units
  
$
1.52
    
$
0.44
    
$
2.86
    
$
1.91
  
Income from discontinued operations
    
0.32
      
0.01
      
0.34
      
0.28
  
Net income available to common units
  
$
1.84
    
$
0.45
    
$
3.20
    
$
2.19
  
Weighted average number of common units outstanding during the period
    
39,583,913
      
37,935,449
      
39,421,896
      
37,074,063
  
 
See accompanying notes to the unaudited condensed consolidated financial statements.
5
ESSEX PORTFOLIO, L.P. AND SUBSIDIARIES
Condensed Consolidated Statement of Capital for the nine months ended September 30, 2013
(Unaudited)
(Dollars and units in thousands)

 
General Partner
Limited Partners
Accumulated
 
  
   
   
Preferred
    
   
   
other
    
   
 
 
  
Common Equity
    
Equity
    
Common Equity
    
comprehensive
    
Noncontrolling
    
 
 
  
Units
    
Amount
    
Amount
    
Units
    
Amount
    
(loss) income
    
Interest
    
Total
  
Balances at December 31, 2012
    
36,443
    
$
1,762,856
    
$
71,209
      
2,122
    
$
45,593
    
$
(68,231
)
  
$
68,689
    
$
1,880,116
  
Net income
    
-
      
118,937
      
4,104
      
-
      
7,037
      
-
      
5,075
      
135,153
  
Reversal of unrealized gains upon the sale of marketable securities
    
-
      
-
      
-
      
-
      
-
      
(1,767
)
    
-
      
(1,767
)
Change in fair value of cash flow hedges and amortization of gain on settlement of swap
    
-
      
-
      
-
      
-
      
-
      
9,976
              
9,976
  
Changes in fair value of marketable securities
    
-
      
-
      
-
      
-
      
-
      
(1,156
)
    
-
      
(1,156
)
Issuance of common units under:
                                                                
Stock and unit based compensation plans
    
63
      
6,411
      
-
      
-
      
-
      
-
      
-
      
6,411
  
Sale of common stock by the general partner
    
817
      
122,905
      
-
      
-
      
-
      
-
      
-
      
122,905
  
Stock and unit based compensation costs
    
-
      
(759
)
    
-
      
24
      
1,626
      
-
      
-
      
867
  
Redemptions
    
-
      
-
      
-
      
-
      
(528
)
    
-
      
(1,291
)
    
(1,819
)
Distributions to noncontrolling interests
    
-
      
-
      
-
      
-
      
-
      
-
      
(6,234
)
    
(6,234
)
Distributions declared
    
-
      
(138,770
)
    
(4,104
)
    
-
      
(7,874
)
    
-
      
-
      
(150,748
)
Balances at September 30, 2013
    
37,323
    
$
1,871,580
    
$
71,209
      
2,146
    
$
45,854
    
$
(61,178
)
  
$
66,239
    
$
1,993,704
  
 
See accompanying notes to the unaudited condensed consolidated financial statements.
6
ESSEX PORTFOLIO, L.P. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(Dollars in thousands)
 
 
  
Nine Months Ended
September 30,
  
 
  
2013
    
2012
  
Cash flows from operating activities:
  
   
 
Net income
  
$
135,153
    
$
89,950
  
Adjustments to reconcile net income to net cash provided by operating activities:
                
Gain on sale of marketable securities
    
(1,767
)
    
(521
)
Gain on remeasurement of co-investment
    
-
      
(21,947
)
Operating partnership's share of gain on the sales of co-investment
    
(41,252
)
    
-
  
Gain on the sales of real estate
    
(14,161
)
    
(10,870
)
(Gain) loss on early retirement of debt
    
(846
)
    
2,661
  
Co-investments
    
(1,892
)
    
5,141
  
Amortization expense
    
8,955
      
8,681
  
Amortization of discount on notes receivables
    
(844
)
    
(1,373
)
Amortization of discount on marketable securities
    
(4,664
)
    
(3,808
)
Depreciation
    
143,662
      
125,669
  
Equity-based compensation
    
3,137
      
2,880
  
Changes in operating assets and liabilities:
                
Prepaid expenses and other assets
    
(19,689
)
    
(3,653
)
Accounts payable and accrued liabilities
    
19,091
      
26,167
  
Other liabilities
    
199
      
358
  
Net cash provided by operating activities
    
225,082
      
219,335
  
Cash flows from investing activities:
                
Additions to real estate:
                
Acquisitions of real estate
    
(205,539
)
    
(157,011
)
Improvements to recent acquisitions
    
(14,374
)
    
(6,662
)
Redevelopment
    
(32,488
)
    
(31,277
)
Revenue generating capital expenditures
    
(2,165
)
    
(4,405
)
Lessor required capital expenditures
    
(4,320
)
    
-
  
Non-revenue generating capital expenditures
    
(21,885
)
    
(15,776
)
Acquisitions of and additions to real estate under development
    
(13,963
)
    
(22,505
)
Acquisition of membership interest in co-investment
    
-
      
(85,000
)
Dispositions of real estate
    
33,666
      
27,800
  
Changes in restricted cash and deposits
    
(17,246
)
    
(13,370
)
Purchases of marketable securities
    
(16,442
)
    
(73,735
)
Sales and maturities of marketable securities
    
22,830
      
6,322
  
Purchases of and advances under notes and other receivables
    
(56,750
)
    
-
  
Collections of notes and other receivables
    
53,438
      
7,977
  
Contributions to co-investments
    
(150,852
)
    
(158,769
)
Distributions from co-investments
    
117,103
      
8,345
  
Net cash used in investing activities
    
(308,987
)
    
(518,066
)
Cash flows from financing activities:
                
Borrowings under debt agreements
    
641,892
      
1,347,973
  
Repayment of debt
    
(536,926
)
    
(1,196,977
)
Additions to deferred charges
    
(3,836
)
    
(6,415
)
Equity related issuance cost.
    
(616
)
    
(309
)
Net proceeds from stock options exercised
    
4,756
      
2,169
  
Net proceeds from issuance of common stock
    
122,905
      
268,858
  
Contributions from noncontrolling interest
    
-
      
2,400
  
Distributions to noncontrolling interest
    
(6,234
)
    
(5,480
)
Redemption of limited partners common units and noncontrolling interests
    
(1,819
)
    
(906
)
Common units and preferred interest distributions paid
    
(145,314
)
    
(123,528
)
Net cash provided by financing activities
    
74,808
      
287,785
  
Net decrease in cash and cash equivalents
    
(9,097
)
    
(10,946
)
Cash and cash equivalents at beginning of year
    
18,606
      
12,889
  
Cash and cash equivalents at end of period
  
$
9,509
    
$
1,943
  

(Continued)
7
ESSEX PORTFOLIO, L.P. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(Dollars in thousands)

 
  
2013
    
2012
  
Supplemental disclosure of cash flow information:
  
   
 
Cash paid for interest, net of $12.7 million, and $6.8 million capitalized in 2013 and 2012, respectively
  
$
76,596
    
$
68,555
  
Supplemental disclosure of noncash investing and financing activities:
                
Transfer from real estate under development to rental properties
  
$
68
    
$
5,648
  
Transfer from real estate under development to co-investments
  
$
27,906
    
$
148,053
  
Mortgage notes assumed in connection with purchases of real estate including the loan premiums recorded
  
$
-
    
$
71,340
  
Contribution of note receivable to co-investment
  
$
-
    
$
12,325
  
Change in accrual of distributions
  
$
5,434
    
$
4,766
  
Change in fair value of derivative liabilities
  
$
3,649
    
$
5,100
  
Change in fair value of marketable securities
  
$
2,958
    
$
4,542
  
Change in construction payable.
  
$
1,544
    
$
2,239
  
 
See accompanying notes to the unaudited condensed consolidated financial statements
8
ESSEX PORTFOLIO, L.P. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
September 30, 2013 and 2012
(Unaudited)

(1)  Organization and Basis of Presentation

The accompanying unaudited condensed consolidated financial statements present the accounts of Essex Portfolio, L.P. (the “Operating Partnership”) and its subsidiaries, prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and in accordance with the instructions to Form 10-Q.  In the opinion of management, all adjustments necessary for a fair presentation of the financial position, results of operations and cash flows for the periods presented have been included and are normal and recurring in nature.  These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Operating Partnership's Amendment No. 1 on Form S-4 filed with the SEC on March 12, 2013.

All significant intercompany balances and transactions have been eliminated in the condensed consolidated financial statements.  Certain reclassifications have been made to conform to the current year’s presentation. Such reclassification had no effect on previously reported financial statements.

The unaudited condensed consolidated financial statements for the three and nine months ended September 30, 2013 and 2012 include the accounts of the Operating Partnership.  Essex Propery Trust, Inc. (the “Company”) is the sole general partner in the Operating Partnership, with a 94.6% general partnership interest as of September 30, 2013.  Total Operating Partnership limited partner common units outstanding were 2,146,293 and 2,122,381 as of September 30, 2013 and December 31, 2012, respectively, and the redemption value of the units, based on the closing price of the Company’s common stock totaled $317.0 million and $311.2 million, as of September 30, 2013 and December 31, 2012, respectively.

As of September 30, 2013, the Operating Partnership owned or had ownership interests in 163 apartment communities, aggregating 34,416  units, excluding the Operating Partnership’s ownership in preferred interest co-investments,  (collectively, the “Communities”, and individually, a “Community”), five commercial buildings and eleven active development projects (collectively, the “Portfolio”).  The Communities are located in Southern California (Los Angeles, Orange, Riverside, San Diego, Santa Barbara, and Ventura counties), Northern California (the San Francisco Bay Area) and the Seattle metropolitan area.

Marketable Securities

The Operating Partnership reports its available for sale securities at fair value, based on quoted market prices (Level 2 for the unsecured bonds and Level 1 for the common stock and investment funds, as defined by the Financial Accounting Standards Board (“FASB”) standard for fair value measurements as discussed later in Note 1), and any unrealized gain or loss is recorded as other comprehensive income (loss).  Realized gains and losses, interest and dividend income, and amortization of purchase discounts are included in interest and other income on the condensed consolidated statement of operations and comprehensive income.

As of September 30, 2013 and December 31, 2012, marketable securities consisted primarily of investment-grade unsecured bonds, common stock, investments in mortgage backed securities and investment funds that invest in U.S. treasury or agency securities.  As of September 30, 2013 and December 31, 2012, the Operating Partnership classified its investments in mortgage backed securities, which mature in November 2019 and September 2020, as held to maturity, and accordingly, these securities are stated at their amortized cost.
9
ESSEX PORTFOLIO, L.P. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
September 30, 2013 and 2012
(Unaudited)

As of September 30, 2013 and December 31, 2012 marketable securities consist of the following ($ in thousands):

 
  
September 30, 2013
  
 
  
Cost/
Amortized
 Cost
    
Gross
Unrealized
 Gain (Loss)
    
Carrying Value
  
Available for sale:
  
   
   
 
Investment-grade unsecured bonds
  
$
15,378
    
$
647
    
$
16,025
  
Investment funds - US treasuries
    
5,020
      
3
      
5,023
  
Common stock
    
13,104
      
(975
)
    
12,129
  
Held to maturity:
                        
Mortgage backed securities
    
56,722
      
-
      
56,722
  
Total
  
$
90,224
    
$
(325
)
  
$
89,899
  

 
  
December 31, 2012
  
 
  
Cost/
Amortized
Cost
    
Gross
Unrealized
 Gain
    
Carrying Value
  
Available for sale:
  
   
   
 
Investment-grade unsecured bonds
  
$
15,475
    
$
826
    
$
16,301
  
Investment funds - US treasuries
    
3,788
      
1
      
3,789
  
Common stock
    
18,917
      
1,704
      
20,621
  
Held to maturity:
                        
Mortgage backed securities
    
52,002
      
-
      
52,002
  
Total
  
$
90,182
    
$
2,531
    
$
92,713
  
 
The Operating Partnership uses the specific identification method to determine the cost basis of a security sold and to reclassify amounts from accumulated other comprehensive income for securities sold.  For the three months ended September 30, 2013 and 2012, there were no sales of available for sale securities. For the nine months ended September 30, 2013, and 2012,  the proceeds from sales of available for sale securities totaled $20.3 million and $6.3 million, respectively, which resulted in gains of $1.8 million and $0.5 million, respectively.

Variable Interest Entities

The Operating Partnership consolidates 19 DownREIT limited partnerships (comprising twelve communities) since the Operating Partnership is the primary beneficiary of these variable interest entities (“VIEs”).  Total DownREIT units outstanding were 1,011,071 and 1,039,431 as of September 30, 2013 and December 31, 2012, respectively, and the redemption value of the units, based on the closing price of the Company’s common stock totaled $149.3 million and $152.4 million, as of September 30, 2013 and December 31, 2012, respectively.  The consolidated total assets and liabilities related to these VIEs, net of intercompany eliminations, were approximately $201.6 million and $185.5 million, respectively, as of September 30, 2013 and $201.1 million and $178.6 million, respectively, as of December 31, 2012.  Interest holders in VIEs consolidated by the Operating Partnership are allocated income equal to the cash payments made to those interest holders.  The remaining results of operations are allocated to the Operating Partnership.  As of September 30, 2013 and December 31, 2012, the Operating Partnership did not have any other VIEs of which it was deemed to be the primary beneficiary.

Equity Based Compensation

The Operating Partnership accounts for equity based compensation using the fair value method of accounting.  The estimated fair value of stock options granted by the Company is being amortized over the vesting period of the stock options.  The estimated grant date fair values of the long term incentive plan units are being amortized over the expected service periods.

Stock-based compensation expense for options and restricted stock totaled $0.5 million and $0.4 million for the three months ended September 30, 2013 and 2012, respectively, and $1.6 million and $1.2 million for the nine months ended September 30, 2013 and 2012, respectively.  The intrinsic value of the stock options exercised during the three months ended September 30, 2013 and 2012 totaled $0.1 million and $0.5 million, respectively, and $2.9 million and $2.4 million for the nine months ended September 30, 2013 and 2012, respectively.  As of September 30, 2013, the intrinsic value of the stock options outstanding totaled $11.2 million.  As of September 30, 2013, total unrecognized compensation cost related to unvested share-based compensation granted under the stock option and restricted stock plans totaled $4.7 million.  The cost is expected to be recognized over a weighted-average period of 1 to 5 years for the stock option plans and is expected to be recognized straight-line over a period of 1 to 7 years for the restricted stock awards.

10
ESSEX PORTFOLIO, L.P. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
September 30, 2013 and 2012
(Unaudited)
 
The Operating Partnership has adopted an incentive program involving the issuance of Series Z-1 Incentive Units of limited partnership interest in the Operating Partnership.  Stock-based compensation expense for Z-1 Units totaled $0.5 million and $0.5 million for the three months ended September 30, 2013 and 2012, respectively, and $1.5 million and $1.6 million for the nine months ended September 30, 2013 and 2012, respectively.  Stock-based compensation for Z-1 units capitalized totaled $0.1 million for the three months ended September 30, 2013, and 2012 and $0.3 million and $0.4 million for the nine months ended September 30, 2013, and 2012, respectively.  As of September 30, 2013, the intrinsic value of the Z-1 Units subject to future vesting totaled $15.8 million.  As of September 30, 2013, total unrecognized compensation cost related to Z-1 Units subject to future vesting totaled $5.6 million.  The unamortized cost is expected to be recognized up to 14 years subject to the achievement of the stated performance criteria.

Fair Value of Financial Instruments

Management believes that the carrying amounts of outstanding lines of credit, notes receivable and notes and other receivables approximate fair value as of September 30, 2013 and December 31, 2012, because interest rates, yields and other terms for these instruments are consistent with yields and other terms currently available for similar instruments.  Management has estimated that the fair value of the Operating Partnership’s $2.37 billion of fixed rate debt, including unsecured bonds, at September 30, 2013 is approximately $2.43 billion and the fair value of the Operating Partnership’s $537.2 million of variable rate debt, excluding borrowings under the lines of credit, at September 30, 2013 is $517.5 million based on the terms of existing mortgage notes payable, unsecured bonds and variable rate demand notes compared to those available in the marketplace.  Management believes that the carrying amounts of cash and cash equivalents, restricted cash, accounts payable and accrued liabilities, construction payables, other liabilities and dividends payable approximate fair value as of September 30, 2013 due to the short-term maturity of these instruments.  Marketable securities, except mortgage backed securities, and derivatives are carried at fair value as of September 30, 2013.

At December 31, 2013, the Operating Partnership’s investments in mortgage backed securities had a carrying value of $56.7 million and the Operating Partnership estimated the fair value to be approximately $83.8 million. At December 31, 2012, the estimated fair values of the mortgage backed securities were approximately equal to the carrying values.  The Operating Partnership determines the fair value of the mortgage backed securities based on unobservable inputs (level 3 of the fair value hierarchy) considering the assumptions that market participants would make in valuing these securities.  Assumptions such as estimated default rates and discount rates are used to determine expected, discounted cash flows to estimate the fair value.

Capitalization of Costs

The Operating Partnership’s capitalized internal costs related to development and redevelopment projects totaled $1.8 million and $1.5 million during the three months ended September 30, 2013 and 2012, respectively, and  $5.1 million and $4.5 million during the nine months ended September 30, 2013 and 2012, respectively,  most of which relates to development projects.  These totals include capitalized salaries of $0.8 million and $0.5 million for the three months ended September 30, 2013 and 2012, respectively, and $2.0 million and $1.9 million for the nine months ended September 30, 2013 and 2012, respectively.  The Operating Partnership capitalizes leasing commissions associated with the lease-up of a development community and amortizes the costs over the life of the leases.  The amounts capitalized are immaterial for all periods presented.

Co-investments

The Operating Partnership owns investments in joint ventures (“co-investments”) in which it has significant influence, but its ownership interest does not meet the criteria for consolidation in accordance with the accounting standards.  Therefore, the Operating Partnership accounts for these investments using the equity method of accounting.  Under the equity method of accounting, the investment is carried at the cost of assets contributed, plus the Operating Partnership’s equity in earnings less distributions received and the Operating Partnership’s share of losses.  The significant accounting policies of the Operating Partnership’s co-investment entities are consistent with those of the Operating Partnership in all material respects.  For preferred equity investments the Operating Partnership recognizes its preferred interest as equity in earnings.

11
ESSEX PORTFOLIO, L.P. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
September 30, 2013 and 2012
(Unaudited)
 
Upon the acquisition of a controlling interest of a co-investment, the co-investment entity is consolidated and a gain or loss is recognized upon the remeasurement of co-investments in the consolidated statement of operations equal to the amount by which the fair value of the co-investment interest the Operating Partnership previously owned exceeds its carrying value.

A majority of the co-investments, excluding the preferred equity investments, compensate the Operating Partnership for its asset management services and may provide promote distributions if certain financial return benchmarks are achieved.  Asset management fees are recognized when earned, and promote fees are recognized when the earnings events have occurred and the amount is determinable and collectible.

Changes in Accumulated Other Comprehensive Loss Net, by Component

 
  
Change in fair
 value and amortization
 of derivatives
    
Unrealized
gains/(losses) on
 available for sale
 securities
    
Total
  
Balance at December 31, 2012
  
$
(70,762
)
  
$
2,531
    
$
(68,231
)
Other comprehensive income (loss) before reclassification
    
3,612
      
(1,156
)
    
2,456
  
Amounts reclassified from accumulated other comprehensive loss
    
6,364
      
(1,767
)
    
4,597
  
Net other comprehensive income (loss)
    
9,976
      
(2,923
)
    
7,053
  
Balance at September 30, 2013
  
$
(60,786
)
  
$
(392
)
  
$
(61,178
)

Amounts reclassified from accumulated other comprehensive loss in connection with derivatives are recorded in interest expense before amortization on the condensed consolidated statement of operations and comprehensive income.  Realized gains and losses on available for sale securities are included in interest and other income on the condensed consolidated statement of operations and comprehensive income.

Accounting Estimates

The preparation of condensed consolidated financial statements, in accordance with U.S. generally accepted accounting principles, requires the Operating Partnership to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. On an on-going basis, the Operating Partnership evaluates its estimates, including those related to acquiring, developing and assessing the carrying values of its real estate portfolio, its investments in and advances to joint ventures and affiliates, and its notes receivables. The Operating Partnership bases its estimates on historical experience, current market conditions, and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may vary from those estimates and those estimates could be different under different assumptions or conditions.

(2)  Significant Transactions During the Third Quarter of 2013 and Subsequent Events

Acquisitions

In September 2013, the Operating Partnership purchased Slater 116, located in Kirkland, Washington for $29.6 million.  Construction of the 108 apartment homes and 10,100 square feet of retail space was completed in August 2013.  The community is currently 44% occupied or leased and is expected to have stabilized operations in early 2014.

In October 2013, the Operating Partnership purchased Vox Apartments, located in Seattle, Washington, for $22.2 million.  The community was built in 2013 and contains 58 apartment homes.  The property is stabilized.  Vox Apartments is located in the Capital Hill district in close proximity to other Essex communities.   

12
ESSEX PORTFOLIO, L.P. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
September 30, 2013 and 2012
(Unaudited)
 
Dispositions

During the third quarter of 2013, the Essex Apartment Value Fund II L.P. (“Fund II”) of which the Operating Partnership has a 28.2% ownership interest, sold four properties for gross proceeds of $294.0 million.  In connection with the sale, Fund II incurred a prepayment penalty on debt of which the Operating Partnership’s pro rata share was $0.2 million.  The total GAAP gain on the sale was $137.8 million of which the Operating Partnership’s share is $36.4 million, net of internal disposition costs.  There are two remaining properties in the Fund II portfolio that are expected to be sold in 2014. 

In August 2013, the Operating Partnership sold Linden Square, located in Seattle, Washington, for $25.3 million.  The net proceeds from the sale were used as a 1031 exchange for the Slater 116 acquisition noted above.  The total GAAP gain on the sale was $12.7 million.

Secured Debt

In August 2013, the Operating Partnership replaced the construction loan on Expo, located in Seattle, Washington with a new 7 year, $45.0 million term loan.  The loan has a variable interest rate of 150 basis points over LIBOR.  The Operating Partnership has entered into a $45.0 million swap to fix the effective rate at 3.7% for the entire seven year period.

During the third quarter of 2013, the Operating Partnership repaid a secured loan totaling $10.1 million.  At the end of the quarter, the Operating Partnership had $609.6 million in undrawn capacity on its unsecured credit facilities.  Subsequent to the quarter end, the Operating Partnership repaid a secured loan totaling $19.4 million.

Structured Financing

In August 2013, the Operating Partnership made an $8.5 million preferred equity investment in a multifamily development project located in San Jose, California.  The investment has a preferred return of 12% for a 3 year term.

During the third quarter of 2013, the Operating Partnership restructured the terms of a preferred equity investment on a property located in Anaheim, California, reducing the rate from 13% to 9%, while extending the maximum term by one year.  The Operating Partnership recorded $0.4 million of income related to the restructured investment.

13
ESSEX PORTFOLIO, L.P. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
September 30, 2013 and 2012
(Unaudited)
 
(3) Co-investments

The Operating Partnership has co-investments, which are accounted for under the equity method.  The co-investments own, operate and develop apartment communities.  The following table details the Operating Partnership's co-investments (dollars in thousands):

 
  
September 30,
2013
    
December 31,
2012
  
 
  
   
 
 
  
   
 
Membership interest in Wesco I
  
$
142,362
    
$
143,874
  
Membership interest in Wesco III
    
37,766
      
9,941
  
Partnership interest in Fund II
    
4,301
      
53,601
  
Membership interest in a limited liability company that owns Expo
    
18,356
      
18,752
  
Total operating co-investments
    
202,785
      
226,168
  
 
                
Membership interests in limited liability companies that own and are developing Epic, Connolly Station, Mosso I & II, Elkhorn, and The Village
    
294,573
      
186,362
  
Membership interests in limited liability companies that own and are developing The Huxley and The Dylan
    
17,894
      
16,552
  
Membership interest in a limited liability company that owns and is developing One South Market
    
17,009
      
-
  
Total development co-investments
    
329,476
      
202,914
  
 
                
Membership interest in Wesco II that owns a preferred equity interest in Parkmerced with a preferred return of 10.1%
    
93,983
      
91,843
  
Preferred interest in related party limited liability company that owns Sage at Cupertino with a preferred return of  9.5%
    
16,159
      
14,438
  
Preferred interest in a related party limited liability company that owns Madison Park at Anaheim with a preferred return of 9%
    
13,824
      
13,175
  
Preferred interest in related party limited liability company that owns an apartment development in Redwood City with a preferred return of 12%
    
9,234
      
-
  
Preferred interest in a limited liability company that owns an apartment development in San Jose with a preferred return of 12%
    
8,614
      
-
  
Preferred interests in limited liability companies that own apartment communities in downtown Los Angeles with preferred returns of 9% and 10% repaid in 2013
    
-
      
22,807
  
Total preferred interest investments
    
141,814
      
142,263
  
 
                
Total co-investments
  
$
674,075
    
$
571,345
  

In January 2013, the Operating Partnership invested $8.6 million as a preferred equity interest investment in an apartment development in Redwood City, California.  The investment has a preferred return of 12% and matures in January 2016.

In March 2013, the Operating Partnership received the redemption of $9.7 million of preferred equity related to two properties located in downtown Los Angeles.  The Operating Partnership recorded $0.4 million in redemption penalties due to the early redemption of these preferred equity investments. 

In June 2013, the Operating Partnership received the redemption of $13.1 million of preferred equity related to a property located in downtown Los Angeles.  The Operating Partnership recorded $0.5 million of income from redemption penalties due to the early redemption of these preferred equity investments. 

In August 2013, the Operating Partnership made an $8.5 million preferred equity investment in a multifamily development project located in San Jose, California.  The investment has a preferred return of 12% and matures in 3 years.

14
ESSEX PORTFOLIO, L.P. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
September 30, 2013 and 2012
(Unaudited)
 
During the third quarter of 2013, the Operating Partnership restructured the terms of a preferred equity investment on a property located in Anaheim, California, reducing the rate from 13% to 9%, while extending the maximum term by one year.  The Operating Partnership recorded $0.4 million of income related to the restructured investment.

The combined summarized balance sheet and statements of operations for co-investments are as follows (dollars in thousands).

 
  
September 30,
2013
    
December 31,
2012
  
Balance sheets:
  
   
 
Rental properties and real estate under development
  
$
1,698,072
    
$
1,745,147
  
Other assets
    
86,081
      
168,061
  
 
                
Total assets
  
$
1,784,153
    
$
1,913,208
  
 
                
Debt
  
$
651,818
    
$
820,895
  
Other liabilities
    
114,405
      
91,922
  
Equity
    
1,017,930
      
1,000,391
  
 
                
Total liabilities and equity
  
$
1,784,153
    
$
1,913,208
  
 
                
Operating Partnership's share of equity
  
$
674,075
    
$
571,345
  
 
 
  
Three Months Ended
September 30,
    
Nine Months Ended
September 30,
  
 
  
2013
    
2012
    
2013
    
2012
  
Statements of operations:
  
   
   
   
 
Property revenues
  
$
24,796
    
$
34,425
    
$
78,913
    
$
96,981
  
Property operating expenses
    
(10,170
)
    
(12,686
)
    
(29,872
)
    
(35,852
)
Net property operating income
    
14,626
      
21,739
      
49,041
      
61,129
  
 
                                
Gain on sale of real estate
    
137,845
      
-
      
146,663
      
-
  
Interest expense
    
(6,052
)
    
(9,453
)
    
(18,924
)
    
(25,790
)
General and administrative
    
(1,419
)
    
(916
)
    
(4,472
)
    
(2,632
)
Depreciation and amortization
    
(8,718
)
    
(12,821
)
    
(29,314
)
    
(35,593
)
 
                                
Net (loss) income
  
$
136,282
    
$
(1,451
)
  
$
142,994
    
$
(2,886
)
 
                                
Operating Partnership's share of net income
  
$
40,802
    
$
3,547
    
$
52,295
    
$
8,998
  

15
ESSEX PORTFOLIO, L.P. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
September 30, 2013 and 2012
(Unaudited)
 
(4) Notes and Other Receivables
 
Notes receivable secured by real estate, and other receivables consist of the following as of September 30, 2013 and December 31, 2012 (dollars in thousands):
 
 
  
September 30,
2013
    
December 31,
2012
  
 
  
   
 
Note receivable, secured, bearing interest at 4.0%, due December 2014 (1)
  
$
3,212
    
$
3,212
  
Notes and other receivables from affiliates (2)
    
60,820
      
28,896
  
Other receivables
    
3,596
      
3,785
  
Note receivable, secured, bearing interest at 8.0%, paid in full in May 2013
    
-
      
971
  
Note receivable, secured, bearing interest at 8.8%, paid in full March 2013
    
-
      
10,800
  
Note receivable, secured, effective interest at 9.6%, paid in full March 2013
    
-
      
18,499
  
 
  
$
67,628
    
$
66,163
  

(1) The borrower funds an impound account for capital replacement.
(2) During the second quarter of 2013, the Operating Partnership provided short-term bridge loans to Fund II and Wesco III aggregating $42.4 million and $56.8 million, respectively, at rates of LIBOR + 1.75% and LIBOR + 2.50%, respectively. In July 2013, Fund II repaid the $42.4 million loan.

During the nine months ended September 30, 2013,  the Operating Partnership received the repayment of three notes receivables totaling $30.5 million.  One of the notes was repaid early, and as such the Operating Partnership recorded $0.8 million of income related to a change in estimate on the discount to the note receivable.

In March 2013, Wesco III repaid the Operating Partnership for a $26.0 million short-term bridge loan to assist with the purchase of Haver Hill.  Wesco III used the proceeds from a $27.3 million loan secured by Haver Hill at 3.1% for a term of seven years to repay the bridge loan.

(5) Related Party Transactions

Fees earned from affiliates include management, development and redevelopment fees from co-investments of $3.0 million and $2.9 million during the three months ended September 30, 2013 and 2012, respectively, and $9.1 million and $7.9 million during the nine months ended September 30, 2013 and 2012, respectively.  All of these fees are net of intercompany amounts eliminated by the Operating Partnership.

The Company’s Chairman and founder, Mr. George Marcus, is the Chairman of The Marcus & Millichap Company (“TMMC”), which is a holding company for certain real estate brokerage services and other subsidiary companies.  Fund II paid a brokerage commission totaling $0.6 million to an affiliate of TMMC related to the sale of a property in July 2013.  No brokerage commissions were paid to TMMC by the Operating Partnership during the three and nine months ended September 30, 2013 and 2012, respectively.

As described in Note 3, the Operating Partnership restructured the terms of a preferred equity investment on a property located in Anaheim, California, reducing the rate from 13% to 9%, while extending the maximum term by one year.  The Operating Partnership recorded $0.4 million of income related to the restructured investment.  The entity that owns the property is an affiliate of TMMC.  Independent members of the Company’s Board of Directors that serve on the Nominating and Corporate Governance and Audit Committees approved the restructuring of the investment in this entity.

In January 2013, the Operating Partnership invested $8.6 million as a preferred equity interest investment in an entity affiliated with TMMC that owns an apartment development in Redwood City, California.  Independent members of the Company’s Board of Directors that serve on the Nominating and Corporate Governance and Audit Committees approved the investment in this entity.

As described in Note 4, the Operating Partnership has provided short-term bridge loans to affiliates.  As of July 31, 2013, two loans have been repaid and two loans remain outstanding totaling $56.8 million.  The bridge loans to Wesco III are expected to be repaid by December 31, 2013.

16
ESSEX PORTFOLIO, L.P. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
September 30, 2013 and 2012
(Unaudited)
 
(6) Unsecured Debt and Lines of Credit
 
Unsecured debt and lines of credit consist of the following as of September 30, 2013 and December 31, 2012 ($ in thousands):

 
  
 
September 30,
2013
    
 
December 31,
2012
    
Weighted Average
 Maturity
In Years
  
 
  
   
   
 
Bonds private placement - fixed rate
  
$
465,000
    
$
465,000
      
5.5
  
Term loan - variable rate
    
350,000
      
350,000
      
3.4
  
Bonds public offering - fixed rate
    
594,883
      
297,084
      
9.2
  
Unsecured debt
    
1,409,883
      
1,112,084
          
Lines of credit
    
15,352
      
141,000
      
0.3
  
Total unsecured debt and lines of credit
  
$
1,425,235
    
$
1,253,084
          
 
                        
Weighted average interest rate on fixed rate unsecured bonds
    
4.0
%
    
4.2
%
        
Weighted average interest rate on variable rate term loan
    
2.5
%
    
2.7
%
        
Weighted average interest rate on line of credit
    
2.2
%
    
2.3
%
        
 
In April 2013, the Operating Partnership issued $300 million aggregate principal amount of its 3.25% Senior Notes due on May 1, 2023 and such amount is included in the line item “Bonds public offering-fixed rate”, in the table above.

(7) Segment Information

The Operating Partnership defines its reportable operating segments as the three geographical regions in which its apartment communities are located: Southern California, Northern California and Seattle Metro.  Excluded from segment revenues are properties classified in discontinued operations, management and other fees from affiliates, and interest and other income.  Non-segment revenues and net operating income included in the following schedule also consist of revenue generated from commercial properties.  Other non-segment assets include real estate under development, co-investments, cash and cash equivalents, marketable securities, notes and other receivables, prepaid expenses and other assets and deferred charges.

17
ESSEX PORTFOLIO, L.P. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
September 30, 2013 and 2012
(Unaudited)
 
The revenues, net operating income, and assets for each of the reportable operating segments are summarized as follows for the three and nine months ended September 30, 2013 and 2012 (dollars in thousands):
 
 
  
Three Months Ended
September 30,
    
Nine Months Ended
September 30,
  
 
  
2013
    
2012
    
2013
    
2012
  
Revenues:
  
   
   
   
 
Southern California
  
$
67,114
    
$
64,339
    
$
199,177
    
$
184,255
  
Northern California
    
54,755
      
43,605
      
158,614
      
127,797
  
Seattle Metro
    
27,212
      
23,559
      
79,443
      
67,436
  
Other real estate assets
    
3,864
      
3,015
      
11,084
      
9,154
  
Total property revenues
  
$
152,945
    
$
134,518
    
$
448,318
    
$
388,642
  
 
                                
Net operating income:
                                
Southern California
  
$
44,084
    
$
41,932
    
$
132,983
    
$
122,868
  
Northern California
    
37,822
      
29,572
      
109,567
      
87,740
  
Seattle Metro
    
18,047
      
15,411
      
52,453
      
44,481
  
Other real estate assets
    
2,429
      
2,530
      
7,673
      
6,399
  
Total net operating income
    
102,382
      
89,445
      
302,676
      
261,488
  
 
                                
Management and other fees
    
2,957
      
3,072
      
9,139
      
8,312
  
Depreciation
    
(48,438
)
    
(42,897
)
    
(143,320
)
    
(125,137
)
General and administrative
    
(6,075
)
    
(5,276
)
    
(18,925
)
    
(16,440
)
Cost of management and other fees
    
(1,613
)
    
(1,642
)
    
(5,047
)
    
(4,893
)
Interest expense before amortization
    
(26,187
)
    
(25,064
)
    
(77,724
)
    
(74,380
)
Amortization expense
    
(3,005
)
    
(2,927
)
    
(8,937
)
    
(8,681
)
Interest and other income
    
2,387
      
3,003
      
9,326
      
10,869
  
Equity income from co-investments
    
40,802
      
3,547
      
52,295
      
8,998
  
Gain (loss) on early retirement of debt
    
(178
)
    
(1,211
)
    
846
      
(2,661
)
Gain on sale of land
    
-
      
-
      
1,503
      
-
  
Gain on remeasurement of co-investment
    
-
      
-
      
-
      
21,947
  
Income from continuing operations
  
$
63,032
    
$
20,050
    
$
121,832
    
$
79,422
  

Total assets for each of the reportable operating segments are summarized as follows as of September 30, 2013 and December 31, 2012:
 
 
  
September 30,
2013
    
December 31,
2012
  
Assets:
  
   
 
Southern California
  
$
1,650,435
    
$
1,675,265
  
Northern California
    
1,620,434
      
1,489,095
  
Seattle Metro
    
723,175
      
699,465
  
Other real estate assets
    
86,776
      
88,330
  
Net reportable operating segment  - real estate assets
    
4,080,820
      
3,952,155
  
Real estate under development
    
45,804
      
66,851
  
Co-investments
    
674,075
      
571,345
  
Cash and cash equivalents, including restricted cash
    
55,994
      
42,126
  
Marketable securities
    
89,899
      
92,713
  
Notes and other receivables
    
67,628
      
66,163
  
Other non-segment assets
    
71,382
      
55,870
  
Total assets
  
$
5,085,602
    
$
4,847,223
  

18
ESSEX PORTFOLIO, L.P. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
September 30, 2013 and 2012
(Unaudited)
 
(8)  Net Income Per Common Unit
 
(Amounts in thousands, except per unit and unit data)
 
 
  
Three Months Ended
September 30, 2013
    
Three Months Ended
September 30, 2012
  
 
  
Income
    
Weighted-
average
Common
Units
    
Per
Common
 Unit
 Amount
    
Income
    
Weighted-
average
 Common
 Units
    
Per
Common
 Unit
Amount
  
Basic:
  
   
   
   
   
   
 
Income from continuing operations available to common unitholders
  
$
59,934
      
39,467
    
$
1.52
    
$
17,124
      
37,837
    
$
0.45
  
Income from discontinued operations available to common unitholders
    
12,843
      
39,467
      
0.32
      
172
      
37,837
      
0.01
  
 
    
72,777
            
$
1.84
      
17,296
            
$
0.46
  
 
                                                
Effect of Dilutive Securities (1)
    
54
      
116
              
-
      
99
          
 
                                                
Diluted:
                                                
Income from continuing operations available to common unitholders
    
59,988
      
39,583
    
$
1.52
      
17,124
      
37,936
    
$
0.44
  
Income from discontinued operations available to common unitholders
    
12,843
      
39,583
      
0.32
      
172
      
37,936
      
0.01
  
 
  
$
72,831
            
$
1.84
    
$
17,296
            
$
0.45
  
 
 
  
Nine Months Ended
September 30, 2013
    
Nine Months Ended
September 30, 2012
  
 
  
Income
    
Weighted
Average
 Common
Shares
    
Per
Common
 Share
 Amount
    
Income
    
Weighted
Average
 Common
Shares
    
Per
 Common
 Share
Amount
  
Basic:
  
   
   
   
   
   
 
Income from continuing operations available to common unitholders
  
$
112,653
      
39,333
    
$
2.86
    
$
70,660
      
36,976
    
$
1.91
  
Income from discontinued operations available to common unitholders
    
13,321
      
39,333
      
0.34
      
10,528
      
36,976
      
0.29
  
 
    
125,974
            
$
3.20
      
81,188
            
$
2.20
  
 
                                                
Effect of Dilutive Securities (1)
    
-
      
89
              
-
      
98
          
 
                                                
Diluted:
                                                
Income from continuing operations available to common unitholders
    
112,653
      
39,422
      
2.86
    
$
70,660
      
37,074
      
1.91
  
Income from discontinued operations available to common unitholders
    
13,321
      
39,422
      
0.34
      
10,528
      
37,074
      
0.28
  
 
  
$
125,974
            
$
3.20
    
$
81,188
            
$
2.19
  

The instruments granted in equity-based payment transactions are considered participating securities prior to vesting and, therefore, are considered in computing basic earnings per unit under the two-class method. The two-class method is an earnings allocation method for calculating earnings per unit when a company’s capital structure includes either two or more classes of common equity or common equity and participating shares. The Company’s stock options of 38,825 for both the three and nine months ended September 30, 2013, respectively, were not included in the diluted earnings per unit calculation because the effects on earnings per unit were anti-dilutive. The Operating Partnership has the ability to redeem DownREIT limited partnership units for cash and does not consider them to be potentially dilutive securities.

Shares of Series G cumulative convertible preferred interests have been excluded in diluted earnings per unit for the nine months ended September 30, 2013 and 2012, respectively, and the three months ended Setpember 30, 2012 as the effect was anti-dilutive.
19
ESSEX PORTFOLIO, L.P. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
September 30, 2013 and 2012
(Unaudited)
 
(9)  Derivative Instruments and Hedging Activities

The Operating Partnership has entered into interest rate swap contracts with an aggregate notional amount of $300 million that effectively fixed the interest rate on $300 million of the $350 million unsecured term loan at 2.29%.  These derivatives qualify for hedge accounting.

As of September 30, 2013 the Operating Partnership also had ten interest rate cap contracts totaling a notional amount of $176.3 million that qualify for hedge accounting as they effectively limit the Operating Partnership’s exposure to interest rate risk by providing a ceiling on the underlying variable interest rate for substantially all of the Operating Partnership’s tax exempt variable rate debt.

As of September 30, 2013 and December 31, 2012 the aggregate carrying value of the interest rate swap contracts was a liability of $3.2 million and $6.6 million, respectively. The aggregate carrying value of the interest rate cap contracts was zero on the balance sheet as of September 30, 2013 and December 31, 2012, respectively.

(10)  Discontinued Operations

The Operating Partnership classifies real estate as "held for sale" when the sale is considered to be probable. In August 2013, the Operating Partnership sold Linden Square, located in Seattle, Washington, for $25.3 million resulting in a gain of $12.7 million.

During the first quarter of 2012, the Operating Partnership sold Tierra Del Sol/Norte, a 156 unit community located in San Diego, California for $17.2 million for a gain of $7.0 million.  Also in the first quarter of 2012, the Operating Partnership sold Alpine Country, a 108 unit community located in San Diego metropolitan area, for $11.1 million for a gain of $3.9 million.

The components of discontinued operations are outlined below and include the results of operations for the respective periods that the Operating Partnership owned such assets, as described above (dollars in thousands).

 
  
Three Months Ended
September 30,
    
Nine Months Ended
September 30,
  
 
  
2013
    
2012
    
2013
    
2012
  
 
  
   
   
   
 
Rental revenues
  
$
385
    
$
552
    
$
1,578
    
$
2,275
  
Property operating expenses
    
(151
)
    
(236
)
    
(573
)
    
(997
)
Depreciation and amortization
    
(49
)
    
(144
)
    
(342
)
    
(533
)
Income from real estate sold
    
185
      
172
      
663
      
745
  
Gain on sale
    
12,658
      
-
      
12,658
      
10,870
  
Internal disposition costs and taxes
    
-
      
-
      
-
      
(1,087
)
 
                                
Income from discontinued operations
  
$
12,843
    
$
172
    
$
13,321
    
$
10,528
  

(11)  Commitments and Contingencies

As of September 30, 2013, the Operating Partnership had six non-cancelable ground leases for certain apartment communities and buildings that expire between 2027 and 2080.  Ground lease payments are typically the greater of a stated minimum or a percentage of gross rents generated by these apartment communities.  Total minimum lease commitments, under ground leases and operating leases, are approximately $1.7 million per year for the next five years.

To the extent that an environmental matter arises or is identified in the future that has other than a remote risk of having a material impact on the financial statements, the Operating Partnership will disclose the estimated range of possible outcomes, and, if an outcome is probable, accrue an appropriate liability for remediation and other potential liability. The Operating Partnership will consider whether such occurrence results in an impairment of value on the affected property and, if so, impairment will be recognized.

The Operating Partnership provided a payment guarantee to the counterparties in relation to the total return swaps entered into by the joint venture responsible for the development of The Huxley (formerly Fountain at La Brea) and The Dylan (formerly Santa Monica at La Brea) communities.  Further the Operating Partnership has guaranteed completion of development and made certain debt service guarantees for The Huxley and The Dylan.  The outstanding balance for the loans is included in the debt line item in the summarized balance sheet of the co-investments included in Note 3.  The payment guarantee is for the payment of the amounts due to the counterparty related to the total return swaps which are scheduled to mature in September and December 2016.  The maximum exposure of the guarantee as of September 30, 2013 was $88.9 million based on the aggregate outstanding debt amount.

20
ESSEX PORTFOLIO, L.P. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
September 30, 2013 and 2012
(Unaudited)
 
The Operating Partnership is subject to various other lawsuits in the normal course of its business operations.  Such lawsuits are not expected to have a material adverse effect on the Operating Partnership’s financial condition, results of operations or cash flows.

Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion should be read in conjunction with the Operating Partnership’s Condensed Consolidated Financial Statements and accompanying Notes thereto included elsewhere herein and with the Operating Partnership’s 2012 Consolidated Financial Statements included in Amendment No. 1 on Form S-4 filed wth the SEC on March 12, 2013.

The Operating Partnership acquires, develops, redevelops, and manages apartment communities in the selected residential areas located primarily in the West Coast of the United States. The Company owns all of its interests in its real estate investments, directly or indirectly, through the Operating Partnership. The Company is the sole general partner of the Operating Partnership and, as of September 30, 2013, has an approximarely 94.6% general partnership interest in the Operating Partnership.

The Operating Partnership’s investment strategy has two components:  constant monitoring of existing markets, and evaluation of new markets in the Operating Partnership’s current three geographical regions to identify areas with the characteristics that underlie rental growth.  The Operating Partnership’s strong financial condition supports its investment strategy by enhancing its ability to quickly shift the Operating Partnership’s acquisition, development, and disposition activities to markets that will optimize the performance of the portfolio.

As of September 30, 2013, the Operating Partnership had ownership interests in 163 apartment communities, comprising 34,416 apartment units, excluding the Operating Partnership’s ownership in preferred equity interest co-investments, and the Operating Partnership also had ownership interests in five commercial buildings with approximately 323,600 square feet.  The Operating Partnership’s apartment communities are located in the following major West Coast regions:

Southern California (Los Angeles, Orange, Riverside, San Diego, Santa Barbara, and Ventura counties)
Northern California (the San Francisco Bay Area)
Seattle Metro (Seattle metropolitan area)

As of September 30, 2013, the Operating Partnership’s development pipeline was comprised of two consolidated projects under development, nine unconsolidated joint venture projects under development, and one consolidated predevelopment project, all aggregating 2,701 units, with total incurred costs of $618.2 million, and estimated remaining project costs of approximately $484.8 million for total estimated project costs of $1.1 billion.

The Operating Partnership’s consolidated apartment communities are as follows:

 
  
As of September 30, 2013
    
As of September 30, 2012
  
 
  
Apartment Units
    
%
    
Apartment Units
    
%
  
Southern California
    
13,656
      
46
%
    
13,656
      
48
%
Northern California
    
9,427
      
32
%
    
8,332
      
29
%
Seattle Metro
    
6,645
      
22
%
    
6,508
      
23
%
Total
    
29,728
      
100
%
    
28,496
      
100
%


Co-investments, including Essex Apartment Value Fund II, L.P. ("Fund II"), and Wesco I, LLC ("Wesco I")  and Wesco III, LLC ("Wesco III")  communities, and preferred equity interest co-investment communities are not included in the table presented above for both periods.
21
Comparison of the Three Months Ended September 30, 2013 to the Three Months Ended September 30, 2012

The Operating Partnership’s average financial occupancies for the Operating Partnership’s stabilized apartment communities or “Quarterly Same-Property” (stabilized properties consolidated by the Operating Partnership for the quarters ended September 30, 2013 and 2012) decreased 30 basis points to 95.7% as of September 30, 2013 from 96.0% as of September 30, 2012.  Financial occupancy is defined as the percentage resulting from dividing actual rental revenue by total possible rental revenue.  Actual rental revenue represents contractual rental revenue pursuant to leases without considering delinquency and concessions.  Total possible rental revenue represents the value of all apartment units, with occupied units valued at contractual rental rates pursuant to leases and vacant units valued at estimated market rents.  We believe that financial occupancy is a meaningful measure of occupancy because it considers the value of each vacant unit at its estimated market rate.

Market rates are determined using the recently signed effective rates on new leases at the property and are used as the starting point in the determination of the market rates of vacant units.  The Operating Partnership may increase or decrease these rates based on the supply and demand in the apartment community’s market.  The Operating Partnership will check the reasonableness of these rents based on its position within the market and compare the rents against the asking rents by comparable properties in the market.  Financial occupancy may not completely reflect short-term trends in physical occupancy and financial occupancy rates, as disclosed by other REITs, may not be comparable to the Operating Partnership’s calculation of financial occupancy.

The Operating Partnership does not take into account delinquency and concessions to calculate actual rent for occupied units and market rents for vacant units.  The calculation of financial occupancy compares contractual rates for occupied units to estimated market rents for unoccupied units, thus the calculation compares the gross value of all apartment units excluding delinquency and concessions. For apartment communities that are development properties in lease-up without stabilized occupancy figures, the Operating Partnership believes the physical occupancy rate is the appropriate performance metric.  While an apartment community is in the lease-up phase, the Operating Partnership’s primary motivation is to stabilize the property which may entail the use of rent concessions and other incentives, and thus financial occupancy which is based on contractual revenue is not considered the best metric to quantify occupancy.

The regional breakdown of the Operating Partnership’s Quarterly Same-Property portfolio for financial occupancy for the three months ended September 30, 2013 and 2012 is as follows:
 
 
  
Three months ended September 30,
  
 
  
2013
    
2012
  
Southern California
    
95.7
%
    
95.9
%
Northern California
    
95.8
%
    
96.4
%
Seattle Metro
    
95.8
%
    
95.7
%
 
The following table provides a breakdown of revenue amounts, including revenues attributable to the Quarterly Same-Property portfolio:
 
 
  
   
Three Months Ended
    
   
 
 
  
Number of
    
September 30,
    
Dollar
    
Percentage
  
 
  
Properties
    
2013
    
2012
    
Change
    
Change
  
Property Revenues (dollars in thousands)
  
   
   
   
 
Quarterly Same-Property:
  
   
   
   
   
 
Southern California
    
60
    
$
59,854
    
$
57,382
    
$
2,472
      
4.3
%
Northern California
    
35
      
46,838
      
43,096
      
3,742
      
8.7
  
Seattle Metro
    
29
      
23,663
      
21,865
      
1,798
      
8.2
  
Total Quarterly Same-Property revenues
    
124
      
130,355
      
122,343
      
8,012
      
6.5
  
Quarterly Non-Same Property Revenues (1)
            
22,590
      
12,175
      
10,415
      
85.5
  
Total property revenues
          
$
152,945
    
$
134,518
    
$
18,427
      
13.7
%

(1) Includes thirteen communities acquired after January 1, 2012, two redevelopment communities and one commercial building.

22
Quarterly Same-Property Revenues increased by $8.0 million or 6.5% to $130.4 million in the third quarter of 2013 from $122.3 million in the third quarter of 2012.  The increase was primarily attributable to an increase in scheduled rents of $7.7 million as reflected in an increase of 6.4% in average rental rates from $1,519 per unit in the third quarter of 2012 to $1,616 per unit in the second quarter of 2013.  Scheduled rents increased by 4.2%, 8.7%, and 7.8% in Southern California, Northern California, and Seattle Metro, respectively.  Quarterly Same-Property financial occupancy decreased 30 basis points from the third quarter of 2012 which offset the increase in Quarterly Same-Property Revenues by $0.8 million.  On a sequential basis the Operating Partnership experienced Quarterly Same-Property revenue growth from the second quarter of 2013 to the third quarter of 2013 of $2.9 million or 2.3%, resulting from sequential revenue growth in all three regions mainly driven by a 2.4% increase in scheduled rents and an offset by a decrease of 40 basis points in occupancy compared to the second quarter of 2013.

Quarterly Non-Same Property Revenues increased by $10.4 million or 85.5% to $22.6 million in the third quarter of 2013 from $12.2 million in the third quarter of 2012.  The increase was primarily due to revenue generated from thirteen communities acquired or consolidated since January 1, 2012 (Reed Square, Essex Skyline at MacArthur Place, Park Catalina, The Huntington, Montebello, Park West, Domaine, Ascent, Willow Lake, Bennett Lofts, Annaliese, Fox Plaza and Slater 116).

Management and other fees decreased by $0.1 million in the third quarter of 2013 as compared to the third quarter of 2012.  The decrease is primarily due to a reduction of $0.7 million in asset and property management fees from the sale of eight Fund II communities since the fourth quarter of 2012.  Four communities owned by Fund II were sold in the third quarter of 2013, and the remaining two communities are expected to be sold in the 2014. The decrease was offset by asset and property management fees earned from Wesco I and III co-investments formed during 2012, and development fees earned from the joint ventures formed in 2012 and 2013 to develop Epic, Connolly Station, Elkhorn, Mosso I and II, The Huxley, The Dylan, The Village, and One South Market.

Property operating expenses, excluding real estate taxes increased $3.2 million or 9.9% to $36.0 million in the third quarter of 2013 from $32.8 million in the third quarter of 2012, primarily due to the acquisition of thirteen communities.  Quarterly Same-Property operating expenses, excluding real estate taxes, increased by $0.4 million or 1.3% for the third quarter of 2013 compared to the third quarter of 2012, due to a $0.2 million increase in utility expense and administrative costs.

Real estate taxes increased by $2.3 million or 18.3% for the third quarter of 2013 compared to the third quarter of 2012, due primarily to the acquisition of thirteen communities.  Quarterly Same-Property real estate taxes increased by $0.8 million or 7.1% for third quarter of 2013 compared to the third quarter of 2012 due to $0.3 million or a 17.7% increase in property taxes for the Seattle Metro due to higher assessed values for 2013, and an increase of 2% in property taxes for the majority of the properties located in California.

Depreciation expense increased by $5.5 million or 12.9% for the third quarter of 2013 compared to the third quarter of 2012, due to the acquisition of thirteen communities.  Also, the increase is due to the capitalization of approximately $75.0 million in additions to rental properties through the third quarter of 2013, including $32.5 million spent on redevelopment, and $14.4 million on improvements to recent acquisitions, and the capitalization of approximately $97.9 million in additions to rental properties in 2012, including $40.2 million spent on redevelopment, $13.7 million spent on improvement to recent acquisitions, and $7.7 million spent on revenue generating capital expenditures.

General and administrative expense increased $0.8 million or 15.1% for third quarter of 2013 compared to the third quarter of 2012 primarily due to annual compensation increases for merit, investments in technology, and the addition of staff.

Interest expense before amortization increased $1.1 million or 4.5% for third quarter of 2013 compared to the third quarter of 2012 due to an increase in average outstanding debt for the funding of 2012 and 2013 acquisitions and development pipeline.

Interest and other income decreased by $0.6 million for the third quarter of 2013 compared to 2012 primarily due to a decrease in interest income in 2013 due to the repayment of $30.5 million of three note receivables in the first half of 2013.

Equity income in co-investments increased $37.3 million in the third quarter of 2013 compared to the third quarter of 2012 primarily due to the Operating Partnership’s share of the gain on the sale of four Fund II communities, net of internal disposition costs, of $36.4 million and $0.4 million income earned from the restructuring of a preferred equity investment.  Additionally, equity income increased with our share of income earned from four communities acquired by the Wesco joint ventures in the second half of 2012 and two communities in the second quarter of 2013.

The increase in equity income in the third quarter of 2013 from the Wesco joint ventures communities were offset by the sale of four Fund II communities sold in the third quarter of 2013.
23
Income from discontinued operations increased by $12.7 million for the three months ended September 30, 2013 compared to the three months ended September 30, 2012 and such increase is primarily due to the a gain of $12.7 million from the sale of Linden Square along with the operating results for the property.

Comparison of the Nine Months Ended September 30, 2013 to the Nine Months Ended September 30, 2012

Our average financial occupancies for the Operating Partnership’s stabilized apartment communities or “2013/2012 Same-Property” (stabilized properties consolidated by the Operating Partnership for the nine months ended September 30, 2013 and 2012) decreased 30 basis points to 96.1% for the nine months ended September 30, 2013 from 96.4% for the nine months ended September 30, 2012.

The regional breakdown of the Operating Partnership’s 2013/2012 Same-Property portfolio for financial occupancy for the nine months ended September 30, 2013 and 2012 is as follows:
 
 
  
Nine Months Ended
September 30,
  
 
  
2013
    
2012
  
Southern California
    
96.0
%
    
96.2
%
Northern California
    
96.3
%
    
96.8
%
Seattle Metro
    
96.1
%
    
96.2
%

The following table provides a breakdown of revenue amounts, including revenues attributable to the 2013/2012 Same-Property portfolio:
 
 
  
   
Nine Months Ended
    
   
 
 
  
Number of
    
September 30,
    
Dollar
    
Percentage
  
 
  
Properties
    
2013
    
2012
    
Change
    
Change
  
Property Revenues (dollars in thousands)
  
   
   
   
 
2013/2012 Same-Properties:
  
   
   
   
   
 
Southern California.
    
60
    
$
177,538
    
$
170,314
    
$
7,224
      
4.2
%
Northern California.
    
35
      
136,835
      
126,560
      
10,275
      
8.1
  
Seattle Metro
    
29
      
69,146
      
64,234
      
4,912
      
7.6
  
Total 2013/2012 Same-Property revenues
    
124
      
383,519
      
361,108
      
22,411
      
6.2
  
2013/2012 Non-Same Property Revenues (1)
            
64,799
      
27,534
      
37,265
      
135.3
  
Total property revenues
          
$
448,318
    
$
388,642
    
$
59,676
      
15.4
%

(1) Includes thirteen communities acquired after January 1, 2012, two redevelopment communities and one commercial building.

2013/2012 Same-Property Revenues increased by $22.4 million or 6.2% to $383.5 million for the nine months ended September 30, 2013 from $361.1 million for the nine months ended September 30, 2012.  The increase was primarily attributable to an increase in scheduled rents of $22.0 million as reflected in an increase of 6.2% in average rental rates from $1,489 per unit for the nine months ended September 30, 2012 to $1,582 per unit for the nine months ended September 30, 2013.  Scheduled rents increased by 4.1%, 8.4%, and 7.8% in Southern California, Northern California, and Seattle Metro, respectively.  Income from utility billings and other income also increased $1.8 million, compared to the nine months ended September 30, 2012.  2013/2012 Same-Property financial occupancy decreased 30 basis points from the first nine months ended September 30, 2012 which offset the increase in 2013/2012 Same-Property Revenues by $2.5 million.  Vacancy loss increased $0.7 million, due to additional redevelopment activity at the properties compared to the nine months ended September 30, 2012.

2013/2012 Non-Same Property Revenues increased by $37.3 million or 135% to $64.8 million for the nine months ended September 30, 2013 from $27.5 million for the nine months ended September 30, 2012.  The increase was primarily due to revenue generated from thirteen communities acquired or consolidated since January 1, 2012 (Reed Square, Essex Skyline at MacArthur Place, Park Catalina, The Huntington, Montebello, Park West, Domaine, Ascent, Willow Lake, Bennett Lofts, Annaliese, Fox Plaza and Slater 116).

Management and other fees increased by $0.8 million for the nine months ended September 30, 2013 as compared to the nine months ended September 30, 2012.  The increase is primarily due to the asset and property management fees earned from Wesco I and III co-investments formed during 2012, and development fees earned from the development joint ventures formed in 2013 and 2012 to develop Epic, Expo, Connolly Station, Elkhorn, Mosso I and II, The Huxley, The Dylan, The Village, and One South Market.  The increase in management fees was offset by a reduction of $1.5 million in asset and property management fees from the sale of eight Fund II communities since the fourth quarter of 2012.  Four communities owned by Fund II were sold in the third quarter of 2013, and the remaining two communities are expected to be sold in 2014.

24
Property operating expenses, excluding real estate taxes increased $11.0 million or 11.9% to $102.8 million for the nine months ended September 30, 2013 from $91.8 million for the nine months ended September 30, 2012, primarily due to the acquisition of thirteen communities.  2013/2012 Same-Property operating expenses, excluding real estate taxes, increased by $2.8 million or 3.3% for the nine months ended September 30, 2013 compared to the same period in 2012, due to a $1.2 million increase in repairs and maintenance expense, a $0.8 million increase in administrative costs and a $0.7 million increase in utility expense.

Real estate taxes increased by $7.5 million or 21.3% for the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012, due primarily to the acquisition of thirteen communities.  2013/2012 Same-Property real estate taxes increased by $2.2 million or 6.8% for the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012 due to $1.2 million or a 21.4% increase in property taxes for the Seattle Metro due to higher assessed values for 2013, and an increase of 2% in property taxes for the majority of the properties located in California.

Depreciation expense increased by $18.2 million or 14.5% for the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012, due to the acquisition of thirteen communities.  Also, the increase is due to the capitalization of approximately $75.0 million in additions to rental properties through the third quarter of 2013, including $32.5 million spent on redevelopment, and $14.4 million on improvements to recent acquisitions, and the capitalization of approximately $97.9 million in additions to rental properties in 2012, including $40.2 million spent on redevelopment, $13.7 million spent on improvement to recent acquisitions, and $7.7 million spent on revenue generating capital expenditures.

General and administrative expense increased $2.5 million or 15.1% for nine months ended September 30, 2013 compared to the nine months ended September 30, 2012, primarily due to annual compensation increases for merit, investments in technology, and the addition of staff.

Interest expense before amortization increased $3.3 million or 4.5% for nine months ended September 30, 2013 compared to the nine months ended September 30, 2012, due to an increase in average outstanding debt for the funding of 2012 and 2013 acquisitions and development pipeline.

Interest and other income decreased by $1.5 million for the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012, due to $2.3 million of promote income earned from achieving certain performance hurdles related to the Essex Skyline co-investment and the sale of marketable securities for a gain of $0.5 million for the nine months ended September 30, 2012, compared to a gain of $1.8 million earned from the sale of marketable securities in the nine months ended September 30, 2013, and lower interest income in 2013 due to the repayment of $30.5 million of three note receivables in the first half of 2013.

Equity income (loss) in co-investments increased $43.3 million for the nine months ended September 30, 2013 compared to the nine months ended September 30, 2012, primarily due to the Operating Partnership’s share of the gain on the sale of five Fund II communities, net of internal disposition costs, of $38.8 million and $0.9 million income earned from the early prepayment of a preferred equity investments in 2013.  Additionally, equity income increased with income earned from four communities acquired by the Wesco joint ventures in the second half of 2012 and two communities in the second quarter of 2013.  The increase in equity income in 2013 by the Wesco joint ventures were offset by the sale of eight Fund II communities since the fourth quarter of 2012 and four communities sold in the third quarter of 2013.

Gain (loss) on early retirement of debt was a gain of $0.8 million for the nine months ended September 30, 2013 compared to a loss of $2.7 million for the nine months ended September 30, 2012.  In the second quarter of 2013, a gain of $1.5 million was earned from the redemption of the Mello Roos bonds related to one community.  This gain was offset by $0.6 million of losses incurred from the prepayment of three secured debt loans in the nine months ended September 30, 2013.

Gain on remeasurement of co-investment of $21.9 million for the first nine months of September 30, 2012 was due to the Operating Partnership’s acquisition of the joint venture partner’s membership interest in Essex Skyline at MacArthur Place which the Operating Partnership subsequently consolidated.  Upon consolidation, a gain was recorded equal to the amount by which the fair value of the Operating Partnership’s noncontrolling interest exceeded its carrying value.
25
Income from discontinued operations for the first nine months of September 30, 2013 was $13.3 million and included a gain of $12.7 million from the sale of Linden Square.  Income for discontinued operations for the nine months ended September 30, 2012 included a gain of $9.8 million, net of internal disposition costs, from the sale of Tierra del Sol/Norte and Alpine Country.  The operating results for these properties are recorded in the respective periods that the Operating Partnership owned such assets.

Liquidity and Capital

As of November 1, 2013, Fitch Ratings ("Fitch"), Moody’s Investor Service, and Standard and Poor's (“S&P”) credit agencies rated Essex Property Trust, Inc. and Essex Portfolio, L.P. BBB+/Stable, Baa2/Stable, and BBB/Stable, respectively.

As of September 30, 2013, the Operating Partnership had $9.5 million of unrestricted cash and cash equivalents and $89.9 million in marketable securities, of which $33.2 million were available for sale.  We believe that cash flows generated by our operations, existing cash, cash equivalents, and marketable securities balances, availability under existing lines of credit, access to capital markets and the ability to generate cash from the disposition of real estate are sufficient to meet all of our reasonably anticipated cash needs during the next twelve months.  The timing, source and amounts of cash flows provided by financing activities and used in investing activities are sensitive to changes in interest rates and other fluctuations in the capital markets environment, which can affect our plans for acquisitions, dispositions, development and redevelopment activities.

The Operating Partnership has two lines of unsecured credit aggregating $625.0 million.  As of September 30, 2013 there was no balance outstanding on the $600 million unsecured line.  The underlying interest rate on the $600 million line is based on a tiered rate structure tied to the Operating Partnership's credit ratings on the credit facility and the rate was LIBOR + 1.075% as of September 30, 2013.  This facility matures in December 2015 with two one-year extensions, exercisable by the Operating Partnership.  The Operating Partnership has a working capital unsecured line of credit agreement for $25.0 million.  This facility matures in January 2014, with a one year extension option.  As of September 30, 2013, there was a $15.4 million outstanding balance on the $25 million unsecured line.  The underlying interest rate on the $25.0 million line is based on a tiered rate structure tied to Fitch and S&P ratings on the credit facility of LIBOR plus 1.075%.

On March 29, 2013, the Company entered into equity distribution agreements with Cantor Fitzgerald & Co, Barclays Capital Inc., BMO Capital Markets Corp., BNP Paribas Securities Corp., Liquidnet, Inc., Mitsubishi UFJ Securities (USA), Inc., and Citigroup Global Markets Inc., which superseded the equity distribution agreements entered into in March 2012 with Cantor Fitzgerald & Co, KeyBanc Capital Markets Inc., Barclays Capital Inc., BMO Capital Markets Corp., Liquidnet, Inc., Mitsubishi UFJ Securities (USA), Inc., and Citigroup Global Markets Inc.  For the nine months ended September 30, 2013, the Company sold 817,445 shares of common stock for $122.9 million, net of commissions, at an average per share price of $151.82 and the Company contributed such net proceeds to the Operating Partnership for a number of common units in the Operating Partnership that equaled the number of shares sold..  During the third quarter of 2013 and October 2013, the Company did not sell any shares of common stock.  Under this program, the Company may from time to time sell shares of common stock into the existing trading market at current market prices, and the Operating Partnership anticipates using the net proceeds to potentially acquire, develop, or redevelop properties, which primarily will be apartment communities, to make other investments and for working capital or general corporate purposes, which may include the repayment of indebtedness.  As of November 1, 2013, the Company may sell an additional 5,000,000 shares under the current equity distribution program.

During March 2013, the Company and the Operating Partnership filed a new shelf registration statement with the SEC, allowing the Company to sell an undetermined number or amount of certain equity and debt securities as defined in the prospectus. Under the shelf registration, the Operating Partnership may offer debt securities guaranteed by the Company. The debt securities may be non-convertible or convertible into or exercisable or exchangeable for securities of the Company or the Operating Partnership.

During April 2013, the Operating Partnership, issued $300 million of senior unsecured bonds due May 1, 2023 with a coupon rate of 3.25% per annum.  The interest is payable semi-annually in arrears on May 1 and November 1 of each year, commencing November 1, 2013 until the maturity date of May 1, 2023.  The Operating Partnership used the net proceeds of this offering to repay indebtedness under the Operating Partnership’s $600 million unsecured line of credit facility and for other general corporate and working capital purposes.

As of September 30, 2013, the Operating Partnership’s mortgage notes payable totaled $1.5 billion which consisted of $1.3 billion in fixed rate debt with interest rates varying from 4.3% to 6.4% and maturity dates ranging from 2014 to 2021 and $187.2 million of tax exempt variable rate debt with a weighted average interest rate of 1.6%.  The tax-exempt variable rate demand notes have maturity dates ranging from 2013 to 2039, and $176.3 million are subject to interest rate caps.

26
The Company pays quarterly dividends from cash available for distribution. Until it is distributed, cash available for distribution is invested by the Operating Partnership primarily in investment grade securities held available for sale or is used by the Operating Partnership to reduce balances outstanding under its line of credit.
 
The Operating Partnership has benefited from borrowing from Fannie Mae and Freddie Mac, and there are no assurances that these entities will lend to the Operating Partnership in the future.  To the extent that the Operating Partnership’s access to capital and credit is at a higher cost than the Operating Partnership has experienced in recent years (reflected in higher interest rates for debt financing or a lower stock price for equity financing) the Operating Partnership’s ability to make acquisitions, develop communities, obtain new financing, and refinance existing borrowing at competitive rates could be adversely impacted.  For the past two years the Operating Partnership has primarily issued unsecured debt and repaid secured debt when it has matured to place less reliance on mortgage debt financing, and to unencumber more of the Operating Partnership's communities.

Derivative Activity

The Operating Partnership uses interest rate swaps and interest rate cap contracts to manage certain interest rate risks. The valuation of these instruments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves. The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts). The variable cash payments (or receipts) are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. The Operating Partnership 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 of September 30, 2013 and December 31, 2012 the aggregate carrying value of the interest rate swap contracts was a liability of $3.2 million and $6.6 million, respectively. The aggregate carrying value of the interest rate cap contracts was zero on the balance sheet as of September 30, 2013 and December 31, 2012, respectively.

Development and Predevelopment Pipeline

The Operating Partnership defines development activities as new properties that are being constructed, or are newly constructed and, in the case of development communities, are in a phase of lease-up and have not yet reached stabilized operations.  As of September 30, 2013, the Operating Partnership had two consolidated development projects, and nine unconsolidated joint venture development projects aggregating 2,501 units for an estimated cost of $1.09 billion, of which $484.8 million remains to be expended.

The Operating Partnership had one predevelopment project aggregating 200 units with an aggregate carrying value of $11.5 million as of September 30, 2013.  The Operating Partnership expects to fund the development and predevelopment pipeline by using a combination of some or all of the following sources: its working capital, amounts available on its lines of credit, net proceeds from public and private equity and debt issuances, and proceeds from the disposition of properties, if any.

Alternative Capital Sources

Fund II has eight institutional investors, and the Operating Partnership, with combined partner equity contributions of $265.9 million.  The Operating Partnership contributed $75.0 million to Fund II, which represents a 28.2% interest as general partner and limited partner, and the Operating Partnership uses the equity method of accounting for its investment in Fund II.  Fund II utilized leverage equal to approximately 55% upon the initial acquisition of the underlying real estate.  Fund II invested in apartment communities in the Operating Partnership’s targeted West Coast markets and, as of December 31, 2012, owned seven apartment communities.  The Operating Partnership records revenue for its asset management, property management, development and redevelopment services when earned, and promote income when realized if Fund II exceeds certain financial return benchmarks.  Seven communities were sold during 2012 from Fund II, five additional properties were sold through September 2013, and the Operating Partnership expects to sell the remaining two communities in 2014.  The Operating Partnership has exercised its one-year extension option which provides for the liquidation of Fund II by September 2014.  In July 2013, Fund II repaid the Operating Partnership for $42.4 million in short-term bridge loans at LIBOR + 1.75% from the proceeds from the sale of two properties.

27
Wesco I is a 50/50 programmatic joint venture with an institutional partner formed in 2011 for a total equity commitment of $300.0 million.  Each partner’s equity commitment is $150.0 million.  Wesco I utilizes debt as leverage equal to approximately 50% of the underlying real estate.  The Operating Partnership has contributed $150.0 million to Wesco I, and as of September 30, 2013, Wesco I owned nine apartment communities with 2,713 units with an aggregate carrying value of $667.6 million.

Wesco III is a 50/50 programmatic joint venture with an institutional partner formed in 2012 for a total equity commitment of $120.0 million.  Each partner’s commitment is $60.0 million.  Wesco III utilizes debt as leverage equal to approximately 50% of the underlying real estate.  The Operating Partnership has contributed $38.4 million to Wesco III, and as of September 30, 2013, Wesco III owned three apartment communities with 657 units with an aggregate carrying value of $162.3 million.

In March 2013, Wesco III repaid a $26.0 million short-term bridge loan.  Wesco III used the proceeds from a $27.3 million loan secured by Haver Hill at 3.1% for a term of seven years to repay the bridge loan.  In the second quarter of 2013, the Operating Partnership provided short-term bridge loans to Wesco III of $56.8 million at a rate of LIBOR + 2.50% to assist with the purchase of Regency at Mountain View and Gas Company Lofts apartment communities.  The bridge loans to Wesco III are expected to be repaid by the end of the fourth quarter when secured financing is originated for these properties.
 
Critical Accounting Policies and Estimates
 
The preparation of consolidated financial statements, in accordance with U.S. generally accepted accounting principles requires the Operating Partnership to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. The Operating Partnership defines critical accounting policies as those accounting policies that require the Operating Partnership’s management to exercise their most difficult, subjective and complex judgments. The Operating Partnership’s critical accounting policies and estimates relate principally to the following key areas: (i) consolidation under applicable accounting standards for entities that are not wholly owned; (ii) assessing the carrying values of our real estate properties and investments in and advances to joint ventures and affiliates; and (iii) internal cost capitalization. The Operating Partnership bases its estimates on historical experience, current market conditions, and on various other assumptions that are believed to be reasonable under the circumstances.  Actual results may differ from those estimates made by management.
 
The Operating Partnership’s critical accounting policies and estimates have not changed materially from information reported in Note 2, “Summary of Critical and Significant Accounting Policies,” in the Operating Partnership’s 2012 Consolidated Financial Statements included in Amendment No. 1 on Form S-4 filed with the SEC on March 12, 2013.
 
Forward Looking Statements
 
Certain statements in this "Management's Discussion and Analysis of Financial Condition and Results of Operations," and elsewhere in this quarterly report on Form 10-Q which are not historical facts may be considered forward looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities and Exchange Act of 1934, as amended, including statements regarding the Operating Partnership's expectations, hopes, intentions, beliefs and strategies regarding the future. Forward looking statements include statements regarding the Operating Partnership’s expectations as to the total projected costs of predevelopment, development and redevelopment projects, the Operating Partnership’s reduced risk of loss from mold cases, beliefs as to our ability to meet our cash needs during the next twelve months, expectations as to the sources for funding the Operating Partnership’s development and redevelopment pipeline, the timing and proceeds of the sale of the Fund II properties, repayments of bridge loans and statements regarding the Operating Partnership's financing activities.

Such forward-looking statements involve known and unknown risks, uncertainties and other factors including, but not limited to, that the Operating Partnership will fail to achieve its business objectives, that the total projected costs of current predevelopment, development and redevelopment projects exceed expectations, that such development and redevelopment projects will not be completed, that development and redevelopment projects and acquisitions will fail to meet expectations, that estimates of future income from an acquired property may prove to be inaccurate, that future cash flows will be inadequate to meet operating requirements, that there may be a downturn in the markets in which the Operating Partnership's properties are located, that the terms of any refinancing may not be as favorable as the terms of existing indebtedness, and that mold lawsuits will be more costly than anticipated, as well as those risks, special considerations, and other factors referred to in Item 1A, “Risk Factors,” of the Operating Partnership's Amendment No. 1 on Form S-4 filed with the SEC on March 12, 2013, and those risk factors and special considerations set forth in the Operating Partnership's other filings with the Securities and Exchange Commission (the “SEC”) which may cause the actual results, performance or achievements of the Operating Partnership to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements.  All forward-looking statements are made as of the date hereof, and the Operating Partnership assumes no obligation to update this information.

28
Net Operating Income (“NOI”)

Same-property net operating income (“NOI”) is considered by management to be an important supplemental performance measure to earnings from operations included in the Operating Partnership’s consolidated statements of operations and comprehensive income. The presentation of same-property NOI assists with the presentation of the Operating Partnership’s operations prior to the allocation of depreciation and any corporate-level or financing-related costs.  NOI reflects the operating performance of a community and allows for an easy comparison of the operating performance of individual communities or groups of communities.  In addition, because prospective buyers of real estate have different financing and overhead structures, with varying marginal impacts to overhead by acquiring real estate, NOI is considered by many in the real estate industry to be a useful measure for determining the value of a real estate asset or group of assets.  The Operating Partnership defines same-property NOI as same-property revenue less same-property operating expenses, including property taxes.  Please see the reconciliation of earnings from operations to same-property NOI, which in the table below is the NOI for stabilized properties consolidated by the Operating Partnership for the periods presented:

 
  
Three months ended September 30,
    
Nine months ended September 30,
  
 
  
2013
    
2012
    
2013
    
2012
  
Earnings from operations
  
$
49,213
    
$
42,702
    
$
144,523
    
$
123,330
  
Adjustments:
                                
General and administrative
    
6,075
      
5,276
      
18,925
      
16,440
  
Cost of management and other fees
    
1,613
      
1,642
      
5,047
      
4,893
  
Depreciation
    
48,438
      
42,897
      
143,320
      
125,137
  
Management and other fees
    
(2,957
)
    
(3,072
)
    
(9,139
)
    
(8,312
)
NOI
    
102,382
      
89,445
      
302,676
      
261,488
  
Less: Non same-property NOI
    
(14,130
)
    
(8,044
)
    
(41,055
)
    
(17,304
)
Same-property NOI
  
$
88,252
    
$
81,401
    
$
261,621
    
$
244,184
  

 Item 3: Quantitative and Qualitative Disclosures About Market Risks

Interest Rate Hedging Activities

The Operating Partnership’s objective in using derivatives is to add stability to interest expense and to manage its exposure to interest rate movements or other identified risks.  To accomplish this objective, the Operating Partnership uses interest rate swaps as part of its cash flow hedging strategy.  As of September 30, 2013, the Operating Partnership has entered into ten interest rate swap contracts to mitigate the risk of changes in the interest-related cash outflows on $300.0 million of the variable rate five-year unsecured term debt.  As of September 30, 2013, the Operating Partnership also had $187.2 million of variable rate indebtedness, of which $176.3 million is subject to interest rate cap protection.   All of the Operating Partnership’s derivative instruments are designated as cash flow hedges, and the Operating Partnership does not have any fair value hedges as of September 30, 2013.  The following table summarizes the notional amount, carrying value, and estimated fair value of the Operating Partnership’s derivative instruments used to hedge interest rates as of September 30, 2013.  The notional amount represents the aggregate amount of a particular security that is currently hedged at one time, but does not represent exposure to credit, interest rates or market risks.  The table also includes a sensitivity analysis to demonstrate the impact on the Operating Partnership's derivative.

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The table also includes a sensitivity analysis to demonstrate the impact on the Operating Partnership’s derivative instruments from an increase or decrease in 10-year Treasury bill interest rates by 50 basis points, as of September 30, 2013.
 
 
  
   
   
Carrying and
    
Estimated Carrying Value
  
 
  
Notional
    
Maturity
    
Estimated Fair
     + 50     - 50  
(Dollars in thousands)
  
Amount
    
Date Range
    
Value
    
Basis Points
    
Basis Points
  
Cash flow hedges:
  
   
   
                 
Interest rate swaps
  
$
300,000
      
2016-2017
    
$
(3,161
)
  
$
1,865
    
$
(7,334
)
Interest rate caps
    
176,324
      
2013-2018
      
-
      
66
      
3
  
Total cash flow hedges
  
$
476,324
      
2013-2018
    
$
(3,161
)
  
$
1,931
    
$
(7,331
)

Interest Rate Sensitive Liabilities

The Operating Partnership is exposed to interest rate changes primarily as a result of its lines of credit and long-term tax exempt variable rate debt and unsecured term debt.  The Operating Partnership’s interest rate risk management objective is to limit the impact of interest rate changes on earnings and cash flows and to lower its overall borrowing costs. To achieve its objectives the Operating Partnership borrows primarily at fixed rates and may enter into derivative financial instruments such as interest rate swaps, caps and treasury locks in order to mitigate its interest rate risk on a related financial instrument. The Operating Partnership does not enter into derivative or interest rate transactions for speculative purposes.
 
The Operating Partnership’s interest rate risk is monitored using a variety of techniques. The table below presents the principal amounts and weighted average interest rates by year of expected maturity to evaluate the expected cash flows.
 
For the Years Ended
2013
    
2014
  
2015
  
2016
    
2017
    
Thereafter
    
Total
  
Fair value
  
 
   
 
 
   
   
   
 
 
(In thousands)
   
 
 
   
   
   
 
 
Fixed rate debt
$
-
      
47,179
    
67,837
    
162,459
      
223,389
      
1,867,326
    
$
2,368,190
  
$
2,428,485
  
Average interest rate
  
-
      
5.2
%
  
5.2
%
  
4.5
%
    
5.5
%
    
5.1
%
    
5.1
%
      
Variable rate debt
$
19,420
 (1)   
15,352
    
-
    
200,000
 (2)   
150,000
 (2)   
167,794
(1) 
$
552,566
  
$
532,894
  
Average interest rate
  
1.3
%
    
2.2
%
  
-
    
2.5
%
    
2.5
%
    
1.6
%
    
2.2
%
      
 
(1) $176.3 million subject to interest rate caps.
(2) $300.0 million subject to interest rate swap agreements.

The table incorporates only those exposures that exist as of September 30, 2013; it does not consider those exposures or positions that could arise after that date. As a result, our ultimate realized gain or loss, with respect to interest rate fluctuations and hedging strategies would depend on the exposures that arise prior to settlement.

Item 4: Controls and Procedures

As of September 30, 2013, we carried out an evaluation, under the supervision and with the participation of management, including our General Partner’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)).  Based upon that evaluation, our General Partner’s Chief Executive Officer and Chief Financial Officer concluded that as of September 30, 2013, our disclosure controls and procedures were effective to ensure that the information required to be disclosed by us in the reports that we file or submit under the Exchange Act was recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms and that such disclosure controls and procedures were also effective to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is accumulated and communicated to our management, including our General Partner’s Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosure.

There were no changes in the Operating Partnership's internal control over financial reporting, that occurred during the quarter ended September 30, 2013, that have materially affected, or are reasonably likely to materially affect, the Operating Partnership's internal control over financial reporting.

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Part II -- Other Information

Item 1: Legal Proceedings

Recently there has been an increasing number of lawsuits against owners and managers of apartment communities alleging personal injury and property damage caused by the presence of mold in residential real estate.  Some of these lawsuits have resulted in substantial monetary judgments or settlements.  The Operating Partnership has been sued for mold related matters and has settled some, but not all, of such matters.  Insurance carriers have reacted to mold related liability awards by excluding mold related claims from standard policies and pricing mold endorsements at prohibitively high rates.  The Operating Partnership has, however, purchased pollution liability insurance, which includes some coverage for mold.  The Operating Partnership has adopted policies for promptly addressing and resolving reports of mold when it is detected, and to minimize any impact mold might have on residents of the property.  The Operating Partnership believes its mold policies and proactive response to address any known existence, reduces its risk of loss from these cases.  There can be no assurances that the Operating Partnership has identified and responded to all mold occurrences, but the Operating Partnership promptly addresses all known reports of mold.  Liabilities resulting from such mold related matters are not expected to have a material adverse effect on the Operating Partnership’s financial condition, results of operations or cash flows.  As of September 30, 2013, no potential liabilities for mold and other environmental liabilities are quantifiable and an estimate of possible loss cannot be made.

The Operating Partnership carries comprehensive liability, fire, extended coverage and rental loss insurance for each of the Operating Partnership’s communities.  Insured risks for comprehensive liability covers claims in excess of $100,000 per incident, and property insurance covers losses in excess of a $5.0 million deductible per incident.  There are, however, certain types of extraordinary losses, such as, for example, losses for earthquake, for which the Operating Partnership does not have insurance. Substantially all of the Operating Partnership’s properties are located in areas that are subject to earthquakes.

The Operating Partnership is subject to various other lawsuits in the normal course of its business operations.  Such lawsuits could, but are not expected to, have a material adverse effect on the Operating Partnership’s financial condition, results of operations or cash flows.

Item 1A: Risk Factors

There were no material changes to the Risk Factors disclosed in Item IA of the Operating Partnership’s Amendment No. 1 on Form S-4 filed with the SEC on March 12, 2013  and available at www.sec.gov.

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Item 6: Exhibits

A. Exhibits
 
10.1  Forms of equity award agreements for officers under the 2013 Stock Award and Incentive Compensation Plan*
 
10.2  Company’s Non-Employee Director Equity Award Program and forms of equity award agreements thereunder*
 
12.1 Ratio of Earnings to Fixed Charges.
 
31.1 Certification of Michael J. Schall, Chief Executive Officer of General Partner, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2 Certification of Michael T. Dance, Chief Financial Officer of General Partner, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1 Certification of Michael J. Schall, Chief Executive Officer of General Partner, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

32.2 Certification of Michael T. Dance, Chief Financial Officer of General Partner, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

* Management contract or compensatory plan or arrangement
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SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 
ESSEX PORTFOLIO, L.P.
 
(Registrant)
 
 
By ESSEX PROPERTY TRUST, INC.
 
Its general partner
 
 
 
Date: November 6, 2013
 
 
 
By:  /S/ MICHAEL T. DANCE
 
Michael T. Dance
 
Executive Vice President, Chief Financial Officer
 
(Authorized Officer, Principal Financial Officer)
 
 
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