424B3 1 supplementno9.htm 424B3 Supplement No. 9


Filed Pursuant To Rule 424(b)(3)
File No. 333-176604

PREFERRED APARTMENT COMMUNITIES, INC.
SUPPLEMENT NO. 9, DATED MAY 22, 2013,
TO THE PROSPECTUS, DATED NOVEMBER 18, 2011

This prospectus supplement (this "Supplement No. 9") is part of the prospectus of Preferred Apartment Communities, Inc., dated November 18, 2011 (the "Prospectus"), as supplemented by Supplement No. 1, dated May 3, 2012 ("Supplement No. 1"), Supplement No. 2, dated May 11, 2012 ("Supplement No. 2"), Supplement No. 3, dated August 23, 2012 ("Supplement No. 3"), Supplement No. 4, dated September 13, 2012 ("Supplement No. 4"), Supplement No. 5, dated December 31, 2012 ("Supplement No. 5"), Supplement No. 6, dated January 29, 2013 (“Supplement No. 6”), Supplement No. 7, dated April 11, 2013 (“Supplement No. 7”) and Supplement No. 8, dated April 26, 2013 (“Supplement No. 8”). This Supplement No. 9 supplements, modifies or supersedes certain information contained in the Prospectus. This Supplement No. 7 should be read, and will be delivered, with the Prospectus, Supplement No. 1, Supplement No. 2, Supplement No. 3, Supplement No. 4, Supplement No. 5, Supplement No. 6, Supplement No. 7 and Supplement No. 8. Except where the context suggests otherwise, the terms "company," "Company," "we," "us," and "our" refer to Preferred Apartment Communities, Inc., together with its consolidated subsidiaries.

On May 15, 2013, we filed with the United States Securities and Exchange Commission our Quarterly Report on Form 10-Q for the quarter ended March 31, 2013. The Quarterly Report (excluding the exhibits thereto) is attached as Annex A to this Supplement No. 9.

This Supplement No. 9 also updates, as follows, the description of the manner in which the Warrants offered as part of the Units may be issued pursuant to this offering:

Description of Securities

The following language replaces in its entirety the first sentence of the second paragraph under the section entitled "Description of Securities - Common Stock Warrants - Amended and Restated Warrant Agreement" beginning on page S-2 of Supplement No. 7.

“The Warrants shall be issued either in certificated form or by “book-entry” form, in either case to the Depository Trust Company (“DTC”) and evidenced by one or more global warrants.”

1



Annex A


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 March 31, 2013
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File No. 001-34995
 

Preferred Apartment Communities, Inc.
(Exact name of registrant as specified in its charter)
 

Maryland
27-1712193
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
3625 Cumberland Boulevard, Suite 400, Atlanta, GA 30339
(Address of principal executive offices) (Zip Code)
Registrant’s telephone number, including area code: (770) 818-4100

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 such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No   ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Sec. 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   ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company (as defined in Rule 12b-2 of the Exchange Act).
Large accelerated filer  ¨            Accelerated filer  ¨            Non-accelerated filer  x            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 ¨ No  x
The number of shares outstanding of the registrant’s Common Stock, as of May 15, 2013 was 5,323,605.

2


 
 
INDEX
 
 
 
 
 
 
Page No. 
 
PART I - FINANCIAL INFORMATION
 
 
 
 
Item 1.
Financial Statements
 
 
 
 
 
Consolidated Balance Sheets (unaudited) – as of March 31, 2013 and December 31, 2012
1

 
 
 
 
Consolidated Statements of Operations (unaudited) – Three Months Ended March 31, 2013 and 2012
2

 
 
 
 
Consolidated Statements of Stockholders' Equity (unaudited) – Three Months Ended March 31, 2013 and 2012
3

 
 
 
 
Consolidated Statements of Cash Flows (unaudited) – Three Months Ended March 31, 2013 and 2012
4

 
 
 
 
Notes to Consolidated Financial Statements (unaudited)
6

 
 
 
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
31

 
 
 
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
54

 
 
 
Item 4.
Controls and Procedures
54

 
 
PART II - OTHER INFORMATION
 
 
 
 
Item 1.
Legal Proceedings
55

 
 
 
Item 1A
Risk Factors
55

 
 
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
56

 
 
 
Item 3.
Defaults Upon Senior Securities
56

 
 
 
Item 4.
Mine Safety Disclosures
56

 
 
 
Item 5.
Other Information
56

 
 
 
Item 6.
Exhibits
56

 
 
SIGNATURES     
57

 
 
EXHIBIT INDEX     
58






i

PART I - FINANCIAL INFORMATION


Item 1. Financial Statements
Preferred Apartment Communities, Inc.
Consolidated Balance Sheets
(Unaudited)
 
 
 
 
 
 
 
March 31, 2013
 
December 31, 2012
Assets
 
 
 
 
 
 
 
 
 
Real estate
 
 
 
 
Land
 
$
29,752,000

 
$
13,052,000

Building and improvements
 
120,566,475

 
60,284,587

Furniture, fixtures, and equipment
 
16,871,128

 
8,771,346

Construction in progress
 
145,033

 
3,023

Gross real estate
 
167,334,636

 
82,110,956

Less: accumulated depreciation
 
(8,017,865
)
 
(6,288,998
)
Net real estate
 
159,316,771

 
75,821,958

Real estate loans, net
 
39,476,875

 
35,106,197

Total real estate and real estate loans, net
 
198,793,646

 
110,928,155

 
 
 
 
 
Cash and cash equivalents
 
5,447,498

 
2,973,509

Restricted cash
 
1,507,340

 
540,232

Notes receivable
 
4,148,864

 
2,450,000

Revolving line of credit to related party
 
926,221

 
936,827

Deferred interest receivable on real estate loans
 
1,162,264

 
718,901

Tenant receivables, net of allowance of $13,817 and $18,623
 
17,391

 
11,453

Acquired intangible assets, net of amortization of $2,382,255 and $5,537,067
 
3,954,897

 

Deferred loan costs, net of amortization of $396,253 and $258,492
 
1,459,411

 
681,632

Deferred offering costs
 
3,529,895

 
3,347,965

Other assets
 
816,684

 
703,256

 
 
 
 
 
Total assets
 
$
221,764,111

 
$
123,291,930

 
 
 
 
 
Liabilities and equity
 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
Mortgage notes payable
 
$
114,682,000

 
$
55,637,000

Accounts payable and accrued expenses
 
2,803,512

 
1,110,964

Revolving credit facility
 

 
14,801,197

Accrued interest payable
 
340,569

 
202,027

Dividends and partnership distributions payable
 
1,610,515

 
851,484

Security deposits and prepaid rents
 
517,244

 
330,108

Other deferred income
 
34,926

 
301,575

Total liabilities
 
119,988,766

 
73,234,355

 
 
 
 
 
Commitments and contingencies (Note 11)
 
 
 
 
 
 
 
 
 
Series B Mandatorily Convertible Preferred Stock, $0.01 par value per share; 40,000 shares authorized,
 
 
 
 
40,000 and 0 shares issued and outstanding at March 31, 2013 and December 31, 2012, respectively
 
37,000,649

 

 
 
 
 
 
Equity
 
 
 
 
 
 
 
 
 
Stockholders' equity
 
 
 
 
Series A Redeemable Preferred Stock, $0.01 par value per share; 150,000 shares authorized;
 
 
 
 
41,522 and 19,762 shares issued and 41,492 and 19,762 shares outstanding at March 31, 2013
 
 
 
 
 and December 31, 2012, respectively
 
415

 
198

Common Stock, $0.01 par value per share; 400,066,666 shares authorized; 5,290,559 and
 
 
 
 
5,288,444 shares issued and outstanding at March 31, 2013 and December 31, 2012, respectively
 
52,906

 
52,885

Additional paid in capital
 
76,851,128

 
59,412,744

Accumulated deficit
 
(12,532,596
)
 
(9,408,253
)
Total stockholders' equity
 
64,371,853

 
50,057,574

Non-controlling interest
 
402,843

 
1

Total equity
 
64,774,696

 
50,057,575

 
 
 
 
 
Total liabilities and equity
 
$
221,764,111

 
$
123,291,930


The accompanying notes are an integral part of these consolidated financial statements.
1



Preferred Apartment Communities, Inc.
Consolidated Statements of Operations
(Unaudited)
 
 
 
 
 
 
 
 
 
Three months ended March 31,
 
 
 
2013
 
2012
Revenues:
 
 
 
 
 
Rental revenues
 
 
$
4,300,239

 
$
2,231,722

Other property revenues
 
 
378,790

 
264,181

Interest income on loans and notes receivable
 
 
1,311,930

 
138,998

Total revenues
 
 
5,990,959

 
2,634,901

 
 
 
 
 
 
Operating expenses:
 
 
 
 
 
Property operating and maintenance
 
 
1,069,464

 
564,754

Property management fees to related party
 
 
187,642

 
100,013

Real estate taxes
 
 
449,779

 
182,240

General and administrative
 
 
115,424

 
85,704

Equity compensation to directors and executives
 
 
308,921

 
319,580

Depreciation and amortization
 
 
4,112,303

 
977,402

Acquisition costs
 
 
1,107,011

 
912

Management fees to related party
 
 
383,868

 
180,555

Insurance, professional fees, and other expenses
 
 
300,441

 
162,303

Total operating expenses
 
 
8,034,853

 
2,573,463

 
 
 
 
 
 
Operating (loss) income
 
 
(2,043,894
)
 
61,438

Less interest expense
 
 
1,141,935

 
538,075

 
 
 
 
 
 
Net loss
 
 
(3,185,829
)
 
(476,637
)
 
 
 
 
 
 
Net loss attributable to non-controlling interests
 
 
61,486

 

 
 
 
 
 
 
Net loss attributable to the Company
 
 
(3,124,343
)
 
(476,637
)
 
 
 
 
 
 
Dividends to preferred stockholders
 
 
(1,050,515
)
 
(718
)
 
 
 
 
 
 
Earnings attributable to unvested restricted stock
 
 
(4,792
)
 
(3,380
)
 
 
 
 
 
 
Net loss attributable to common stockholders
 
 
$
(4,179,650
)
 
$
(480,735
)
 
 
 
 
 
 
Net loss per share of Common Stock attributable to
 
 
 
 
 
 common stockholders, basic and diluted
 
 
$
(0.79
)
 
$
(0.09
)
 
 
 
 
 
 
Dividends declared on Common Stock
 
 
$
771,923

 
$
673,181

Dividends per share declared on Common Stock
 
 
$
0.145

 
$
0.13

 
 
 
 
 
 
Weighted average number of shares of Common
 
 
 
 
 
 Stock outstanding, basic and diluted
 
 
5,289,690

 
5,151,164


The accompanying notes are an integral part of these consolidated financial statements.
2


Preferred Apartment Communities, Inc.
Consolidated Statements of Stockholders' Equity
For the three months ended March 31, 2013 and 2012
(Unaudited)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Series A Redeemable Preferred Stock
 
Common Stock
 
Additional Paid in Capital
 
Accumulated (Deficit)
 
Total Stockholders' Equity
 
Non Controlling Interest
 
Total Equity
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at January 1, 2012
 
$

 
$
51,493

 
$
43,828,030

 
$
(9,261,623
)
 
$
34,617,900

 
$
1

 
$
34,617,901

Issuance of Units
 
22

 

 
2,154,978

 

 
2,155,000

 

 
2,155,000

Syndication and offering costs
 

 

 
(218,035
)
 

 
(218,035
)
 

 
(218,035
)
Equity compensation to executives and directors
 

 
30

 
319,550

 

 
319,580

 

 
319,580

Net loss
 

 

 

 
(476,637
)
 
(476,637
)
 

 
(476,637
)
Dividends to series A preferred stockholders
 
 
 
 
 
 
 
 
 
 
 
 
 
 
($5.00 per share per month)
 

 

 
(718
)
 

 
(718
)
 

 
(718
)
Dividends to common stockholders ($0.13 per share)
 

 

 
(673,181
)
 

 
(673,181
)
 

 
(673,181
)
Balance at March 31, 2012
 
$
22

 
$
51,523

 
$
45,410,624

 
$
(9,738,260
)
 
$
35,723,909

 
$
1

 
$
35,723,910


 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at January 1, 2013
 
$
198

 
$
52,885

 
$
59,412,744

 
$
(9,408,253
)
 
$
50,057,574

 
$
1

 
$
50,057,575

Issuance of Units
 
217

 

 
20,840,428

 

 
20,840,645

 

 
20,840,645

Syndication and offering costs
 

 

 
(1,408,665
)
 

 
(1,408,665
)
 

 
(1,408,665
)
Equity compensation to executives and directors
 

 
21

 
308,900

 

 
308,921

 

 
308,921

Vesting of Class B Units and conversion to Class A Units
 

 

 
(479,841
)
 

 
(479,841
)
 
479,841

 

Net loss
 

 

 

 
(3,124,343
)
 
(3,124,343
)
 
(61,486
)
 
(3,185,829
)
Distributions to non-controlling interests
 

 

 

 

 

 
(15,513
)
 
(15,513
)
Dividends to series A preferred stockholders
 
 
 
 
 
 
 
 
 
 
 
 
 
 
($5.00 per share per month)
 

 

 
(360,039
)
 

 
(360,039
)
 

 
(360,039
)
Dividends to series B preferred stockholders
 
 
 
 
 
 
 
 
 
 
 
 
 
 
($17.26 per share)
 

 

 
(690,476
)
 

 
(690,476
)
 

 
(690,476
)
Dividends to common stockholders ($0.145 per share)
 

 

 
(771,923
)
 

 
(771,923
)
 

 
(771,923
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at March 31, 2013
 
$
415

 
$
52,906

 
$
76,851,128

 
$
(12,532,596
)
 
$
64,371,853

 
$
402,843

 
$
64,774,696


3


Preferred Apartment Communities, Inc.
Consolidated Statements of Cash Flows
(Unaudited)
 
 
 
 
 
 
 
 
Three months ended March 31,
 
 
2013
 
2012
Operating activities:
 
 
 
 
Net loss attributable to the Company
 
$
(3,185,829
)
 
$
(476,637
)
Reconciliation of net loss to net cash provided by operating activities:
 
 
 
 
Depreciation expense
 
1,728,867

 
976,251

Amortization expense
 
2,383,436

 
1,151

Amortization of below market lease
 
(115,498
)
 

Deferred fee income amortization
 
(37,031
)
 
(5,121
)
Deferred loan cost amortization
 
137,761

 

Deferred interest income on real estate loans
 
(443,362
)
 
21,493

Equity compensation to executives and directors
 
308,921

 
319,580

Deferred cable income amortization
 
(2,733
)
 

Changes in operating assets and liabilities:
 
 
 
 
(Increase) in tenant receivables
 
(5,939
)
 
(2,190
)
(Increase) in other assets
 
(4,237
)
 
(140,292
)
Increase in accounts payable and accrued expenses
 
39,630

 
106,529

Decrease in accrued interest payable
 
(51,796
)
 
(837
)
Increase in security deposits
 
4,016

 
5,343

Increase in prepaid rents
 
184

 
105,849

Increase in deferred income
 

 
16,275

Net cash provided by operating activities
 
756,390

 
927,394

 
 
 
 
 
Investing activities:
 
 
 
 
Investment in real estate loans
 
(4,776,376
)
 

Notes receivable issued
 
(2,155,529
)
 
(650,000
)
Notes receivable repaid
 
456,665

 

Draw on line of credit by related party
 
(1,410,778
)
 

Repayments of line of credit by related party
 
1,421,384

 

Acquisition fees received on real estate loans
 
308,348

 

Acquisition fees paid on real estate loans
 
(154,174
)
 

Acquisition of properties, net
 
(21,647,242
)
 

Additions to real estate assets - improvements
 
(103,482
)
 
(156,545
)
Decrease (increase) in restricted cash
 
77,006

 
(47,852
)
Net cash used in investing activities
 
(27,984,178
)
 
(854,397
)
 
 
 
 
 
Financing activities:
 
 
 
 
Proceeds from mortgage notes payable
 
59,045,000

 

Payments for mortgage extinguishment
 
(69,428,389
)
 

Payments for mortgage loan costs
 
(907,477
)
 

Proceeds from revolving lines of credit
 
12,943,000

 

Payments on revolving lines of credit
 
(27,744,197
)
 

Proceeds from sales of Series B Preferred Stock, net of offering costs
 
37,238,896

 

Proceeds from sales of Units, net of offering costs
 
19,983,826

 
1,955,662

Common Stock dividends paid
 
(771,616
)
 
(646,916
)
Preferred stock dividends paid
 
(307,304
)
 

Payments for deferred offering costs
 
(349,962
)
 
(692,391
)
Net cash provided by financing activities
 
29,701,777

 
616,355

 
 
 
 
 
Net increase in cash and cash equivalents
 
2,473,989

 
689,352

Cash and cash equivalents, beginning of period
 
2,973,509

 
4,548,020

Cash and cash equivalents, end of period
 
$
5,447,498

 
$
5,237,372

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

The accompanying notes are an integral part of these consolidated financial statements.
4


 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Preferred Apartment Communities, Inc.
Consolidated Statements of Cash Flows (unaudited) - continued
 
Supplemental cash flow information:
 
 
 
 
Cash paid for interest
 
$
1,142,715

 
$
514,538

 
 
 
 
 
Supplemental disclosure of non-cash activities:
 
 
 
 
Accrued capital expenditures
 
$
131,463

 
$
33,623

Dividends payable - common
 
$
771,923

 
$
673,181

Dividends payable - preferred
 
$
823,079

 
$
718

Partnership distributions to non-controlling interest
 
$
15,513

 
$

Accrued deferred offering costs
 
$
479,599

 
$
370,476

Reclass of offering costs from deferred asset to equity
 
$
85,220

 
$
25,139

Mortgage loans assumed on acquisitions
 
$
69,428,389

 
$


The accompanying notes are an integral part of these consolidated financial statements.
5

Preferred Apartment Communities, Inc.
Notes to Consolidated Financial Statements
March 31, 2013
(Unaudited)


1.
Organization

Preferred Apartment Communities, Inc. was formed as a Maryland corporation on September 18, 2009, and elected to be taxed as a real estate investment trust, or REIT, under the Internal Revenue Code of 1986, as amended, or the Code, effective with its tax year ended December 31, 2011. Unless the context otherwise requires, references to the "Company", "we", "us", or "our" refer to Preferred Apartment Communities, Inc., together with its consolidated subsidiaries, including Preferred Apartment Communities Operating Partnership, L.P., or the Operating Partnership. The Company was formed primarily to acquire and operate multifamily properties in select targeted markets throughout the United States. As part of its business strategy, the Company may enter into forward purchase contracts or purchase options for to-be-built multifamily communities and may make mezzanine loans, provide deposit arrangements, or provide performance assurances, as may be necessary or appropriate, in connection with the construction of multifamily communities and other properties. As a secondary strategy, the Company also may acquire or originate senior mortgage loans, subordinate loans or mezzanine debt secured by interests in multifamily properties, membership or partnership interests in multifamily properties and other multifamily related assets and invest not more than 10% of its total assets in other real estate related investments, as determined by its Manager (as defined below) as appropriate for the Company. The Company is externally managed and advised by Preferred Apartment Advisors, LLC, or its Manager, a Delaware limited liability company and related party (see Note 6).

The Company completed its initial public offering, or IPO, on April 5, 2011. As of March 31, 2013, the Company had 5,290,559 shares of common stock, par value $0.01 per share, or Common Stock, issued and outstanding and owned the same number of units in the Operating Partnership, which represented a weighted-average ownership percentage of 98.07% for the three-month period ended March 31, 2013. The number of partnership units not owned by the Company totaled 106,988 at March 31, 2013 and represent Class B Unit awards to the Company's four executive officers that vested and became earned on January 3, 2013, and automatically converted to Class A Units of the Operating Partnership at that date. The Class A Units are convertible to shares of Common Stock at any time at the option of the holder.

The consolidated financial statements include the accounts of the Company and the Operating Partnership. The Company controls the Operating Partnership through its sole general partner interest and plans to conduct substantially all of its business through the Operating Partnership.

2.
Summary of Significant Accounting Policies

Basis of Presentation

The unaudited consolidated financial statements include all of the accounts of the Company and the Operating Partnership presented in accordance with accounting principles generally accepted in the United States of America, or GAAP. All significant intercompany transactions have been eliminated in consolidation. Certain adjustments have been made consisting of normal recurring accruals, which, in the opinion of management, are necessary for a fair presentation of the Company's financial condition and results of operations. These financial statements should be read in conjunction with our audited financial statements and notes thereto included in our 2012 Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 15, 2013.

Use of Estimates

The preparation of the financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

Acquisitions and Impairments of Real Estate Assets

The Company generally records its initial investments in income-producing real estate at fair value at the acquisition date in accordance with ASC 805-10, Business Combinations. Acquisition costs, which include fees and expenses for due diligence, legal, environmental and consulting services, generally will be expensed as incurred.


6

Preferred Apartment Communities, Inc.
Notes to Consolidated Financial Statements – (continued)
March 31, 2013
(Unaudited)

The aggregate purchase price of acquired properties is apportioned to the tangible and identifiable intangible assets and liabilities acquired at their estimated fair values. The value of acquired land, buildings and improvements is estimated by formal appraisals, observed comparable sales transactions, and information gathered during pre-acquisition due diligence activities and the valuation approach considers the value of the property as if it were vacant. The values of furniture, fixtures, and equipment are estimated by calculating their replacement cost and reducing that value by factors based upon estimates of their remaining useful lives.
Intangible assets include the values of in-place leases and customer relationships. In-place lease values are estimated by calculating the estimated time to fill a hypothetically empty apartment complex to its stabilization level (estimated to be 92% occupancy) based on historical observed move-in rates for each property. Carrying costs during these hypothetical expected lease-up periods are estimated, considering current market conditions and include real estate taxes, insurance and other operating expenses and estimates of lost rentals at market rates. The intangible assets are calculated by estimating the net cash flows of the in-place leases to be realized, as compared to the net cash flows that would have occurred had the property been vacant at the time of acquisition and subject to lease-up. The acquired in-place lease values are amortized to operating expense over the average remaining non-cancelable term of the respective in-place leases. The values of customer relationships are estimated by calculating the product of the avoided hypothetical lost revenue and the average renewal probability and are amortized to operating expense over the average remaining historical period of residency, plus an estimate of the average expected renewal period. The above-market or below-market lease values are recorded as a reduction or increase, respectively, to rental income over the remaining average non-cancelable term of the respective leases. Acquired intangible assets have no residual value.

The Company evaluates its tangible and identifiable intangible real estate assets for impairment when events such as declines in a property’s operating performance, deteriorating market conditions, or environmental or legal concerns bring recoverability of the carrying value of one or more assets into question. The total undiscounted cash flows of the asset, including proceeds from disposition, are compared to the net book value of the asset. If this test indicates that impairment exists, an impairment loss is recorded in earnings equal to the shortage of the book value to the discounted net cash flows of the asset.

Loans Held for Investment

The Company carries its investments in real estate loans at amortized cost with assessments made for impairment in the event recoverability of the principal amount becomes doubtful. If, upon testing for impairment, the fair value result is lower than the carrying amount of the loan, a valuation allowance is recorded to lower the carrying amount to fair value, with a loss recorded in earnings. Recoveries of valuation allowances are only recognized in the event of maturity or a sale or disposition in an amount above carrying value. The balances of real estate loans presented on the consolidated balance sheets consist of drawn amounts on the loans, net of deferred loan fee revenue. See the ‘Revenue Recognition’ section of this note for other loan-related policy disclosures required by ASC 310-10-50-6.

Cash and Cash Equivalents and Restricted Cash

The Company considers all highly liquid investments with an original maturity of three months or less when purchased to be cash equivalents. Restricted cash includes cash restricted by state law or contractual requirement and relates primarily to tax and insurance escrows and resident security deposits.

Fair Value Measurements

Certain assets and liabilities are required to be carried at fair value, or if they are deemed impaired, to be adjusted to reflect this condition. The Company follows the guidance provided by ASC 820, Fair Value Measurements and Disclosures, in accounting and reporting for real estate assets where appropriate, as well as debt instruments both held for investment and as liabilities. The standard requires disclosure of fair values calculated under each level of inputs within the following hierarchy:

Level 1 – Quoted prices in active markets for identical assets or liabilities at the measurement date.
Level 2 – Inputs other than quoted prices that are observable for the asset or liability, either directly or
indirectly.
Level 3 – Unobservable inputs for the asset or liability.


7

Preferred Apartment Communities, Inc.
Notes to Consolidated Financial Statements – (continued)
March 31, 2013
(Unaudited)

Deferred Loan Costs

Deferred loan costs are amortized using the straight-line method, which approximates the effective interest method, over the terms of the related indebtedness.

Deferred Offering Costs

Deferred offering costs represent costs incurred by the Company related to current equity offerings, excluding costs specifically identifiable to a closing, such as commissions, dealer-manager fees, and other registration fees. For issuances of equity that occur on one specific date, associated offering costs are reclassified as a reduction of proceeds raised on the date of issue. Our ongoing offering of units, consisting of one share of Series A Redeemable Preferred Stock, or Series A Preferred Stock, and one warrant, or Warrant, to purchase 20 shares of Common Stock, or Units, generally closes on a bimonthly basis in variable amounts. Such offering is referred to herein as the Primary Series A Offering, pursuant to our registration statement on Form S-11 (registration number 333-176604), as may be amended from time to time. Deferred offering costs related to the Primary Series A Offering are reclassified to the stockholders’ equity section of the consolidated balance sheet as a reduction of proceeds raised on a pro-rata basis equal to the ratio of total Units issued to the maximum number of Units that may be issued.

Non-controlling Interest

Non-controlling interest represents the equity interest of the Operating Partnership that is not owned by the Company. Non-controlling interest is adjusted for contributions, distributions and earnings or loss attributable to the non-controlling interest in the consolidated entity in accordance with the Agreement of Limited Partnership of the Operating Partnership, as amended.

Redeemable Preferred Stock

Shares of the Series A Preferred Stock issued pursuant to the Primary Series A Offering (further described in note 5) are redeemable at the option of the holder, subject to a declining redemption fee schedule. Redemptions are therefore outside the control of the Company. However, the Company retains the right to fund any redemptions of Series A Preferred Stock in either Common Stock or cash at its option. Therefore, the Company records the Series A Preferred Stock as a component of permanent stockholders’ equity.

Mandatorily Convertible Preferred Stock

Shares of the Company's Series B Mandatorily Convertible Preferred Stock, or Series B Preferred Stock, are mandatorily convertible to shares of Common Stock, subject to approval by the current holders of Common Stock. Upon the occurrence of a change of control of the Company, holders of Series B Preferred Stock may require the Company to redeem the shares for cash. Because of the existence of this provision, the Company does not control all circumstances under which the shares may be redeemed for cash. Therefore, the aggregate stated value net of offering costs, which approximates fair value, of the Series B Preferred Stock transaction are classified as temporary equity on the Consolidated Balance Sheet until such time as the conversion to Common Stock is approved.

Revenue Recognition

Rental revenue is recognized when earned from residents, which is over the terms of rental agreements, typically of 13 months’ duration. Differences from the straight-line method, which recognize the effect of any up-front concessions and other adjustments ratably over the lease term, are not material. The Company evaluates the collectability of amounts due from residents and maintains an allowance for doubtful accounts for estimated losses resulting from the inability of residents to make required payments then due under lease agreements. The balance of amounts due from residents are generally deemed uncollectible 30 days beyond the due date, at which point they are fully reserved.

Interest income on real estate loans and notes receivable is recognized on an accrual basis over the lives of the loans using the effective interest method. Direct loan origination fees and origination or acquisition costs applicable to real estate loans are amortized over the lives of the loans as adjustments to interest income. The accrual of interest on all these instruments is stopped when there is concern as to the ultimate collection of principal or interest, which is generally a delinquency of 30 days in required

8

Preferred Apartment Communities, Inc.
Notes to Consolidated Financial Statements – (continued)
March 31, 2013
(Unaudited)

payments of interest or principal. Any payments received on such non-accrual loans are recorded as interest income when the payments are received. Real estate loan assets are reclassified as accrual-basis once interest and principal payments become current. Certain real estate loan assets include limited purchase options and exit fees or additional interest payments that are due the Company at maturity or in the event of a sale of the property or refinancing of the loan by the borrower to a third party. If the Company purchases the subject property, any accrued and unpaid exit fee will be treated as additional consideration for the acquired project.

Promotional fees received from service providers at the Company’s properties are deferred and recognized on a straight-line basis over the term of the agreement.

The PAC Rewards program, implemented in the first quarter of 2012, allows residents to accumulate reward points on a monthly basis for actions such as resident referrals and making rent payments online. A resident must rent an apartment from the Company for at least 14 months before reward points may be redeemed for services or upgrades to a resident’s unit. The Company accrues a liability for the estimated cost of these future point redemptions, net of a 35% breakage fee, which is the Company’s current estimate of rewards points that will not be redeemed. In accordance with Staff Accounting Bulletin 13.A.3c, the Company deems its obligations under PAC Rewards as inconsequential to the delivery of services according to the lease terms. Therefore, the expense related to the PAC Rewards Program is included in property operating and maintenance expense on the consolidated statements of operations.

Stock-Based Compensation

The Company accounts for stock-based compensation in accordance with guidance provided by ASC 505, Equity-Based Payments to Non-Employees and ASC 718, Stock Compensation. We calculate the fair value of equity compensation instruments at the date of grant based upon estimates of their expected term, the expected volatility of and dividend yield on our Common Stock over this expected term period and the market risk-free rate of return. We will also estimate forfeitures of these instruments and accrue the compensation expense, net of estimated forfeitures, over the vesting period(s). We record the fair value of restricted stock awards based upon the closing stock price on the trading day immediately preceding the date of grant.

Acquisition Costs

The Company expenses property acquisition costs as incurred, which include costs such as due diligence, legal, certain accounting, environmental and consulting, when the acquisition constitutes a business combination. The Company capitalizes these costs for transactions deemed to be asset acquisitions.
    
Capitalization and Depreciation

The Company capitalizes replacements of furniture, fixtures and equipment, as well as carpet, appliances, air conditioning units, certain common area items, and other assets. Significant repair and renovation costs that improve the usefulness or extend the useful life of the properties are also capitalized. These assets are then depreciated on a straight-line basis over their estimated useful lives, as follows:

Buildings                    30 - 40 years
Furniture, fixtures & equipment            5 - 10 years
Improvements to buildings and land        5 - 10 years    

Operating expenses related to unit turnover costs, such as carpet cleaning, mini-blind replacements, and minor repairs are expensed as incurred.

Income Taxes

The Company has elected to be taxed as a REIT under the Code. To continue to qualify as a REIT, the Company must meet certain organizational and operational requirements, including a requirement to distribute at least 90% of the Company's annual REIT taxable income to its stockholders (which is computed without regard to the dividends paid deduction or net capital gain which does not necessarily equal net income as calculated in accordance with GAAP). As a REIT, the Company generally will not be

9

Preferred Apartment Communities, Inc.
Notes to Consolidated Financial Statements – (continued)
March 31, 2013
(Unaudited)

subject to federal income tax to the extent it distributes qualifying dividends to its stockholders. If the Company fails to qualify as a REIT in any taxable year, it will be subject to federal income tax on its taxable income at regular corporate income tax rates and generally will not be permitted to qualify for treatment as a REIT for federal income tax purposes for the four taxable years following the year during which qualification is lost unless the Internal Revenue Service grants the Company relief under certain statutory provisions. Such an event could materially adversely affect the Company's net income and net cash available for distribution to stockholders. The Company intends to operate in such a manner as to maintain its election for treatment as a REIT.

Since the Company made its REIT election effective with its tax year ended December 31, 2011 (See Note 10), it was subject to U.S. federal and state income taxes for the period prior to that date. The provision for income taxes is based on income before taxes reported for financial statement purposes after adjustment for transactions that do not have tax consequences. Deferred tax assets and liabilities are realized according to the estimated future tax consequences attributable to differences between the carrying value of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using the enacted tax rates as of the date of the balance sheet. The effect of a change in tax rates on deferred tax assets and liabilities is reflected in the period that includes the statutory enactment date. A deferred tax asset valuation allowance is recorded when it has been determined that it is more likely than not that deferred tax assets will not be realized. If a valuation allowance is needed, a subsequent change in circumstances in future periods that causes a change in judgment about the realization of the related deferred tax amount could result in the reversal of the deferred tax valuation allowance.

The Company recognizes a liability for uncertain tax positions. An uncertain tax position is defined as a position taken or expected to be taken in a tax return that is not based on clear and unambiguous tax law and which is reflected in measuring current or deferred income tax assets and liabilities for interim or annual periods. The Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The Company measures the tax benefits recognized based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate resolution. The Company recognizes interest and penalties related to unrecognized tax benefits in its provision for income taxes.

Earnings (Loss) Per Share

Basic earnings (loss) per share is computed by dividing net income or loss available to common stockholders by the weighted average number of shares of Common Stock outstanding for the period. Diluted earnings (loss) per share is computed by dividing earnings or net loss available to common stockholders by the weighted average number of shares of Common Stock outstanding adjusted for the effect of dilutive securities such as share grants or warrants. No adjustment is made for potential Common Stock equivalents that are anti-dilutive during the period.

Recent Adoption of Accounting Pronouncements

In December 2011, the FASB issued ASU 2011-10, Property, Plant and Equipment (Topic 360): Derecognition of in Substance Real Estate – a Scope Clarification. This new standard clarifies the guidance concerning deconsolidation of a subsidiary that is in substance real estate upon the event of default of that subsidiary’s nonrecourse debt. Generally, deconsolidation of a subsidiary in this circumstance is not appropriate until the collateral is legally transferred to the lender and the indebtedness is extinguished. This guidance is effective for annual and interim periods beginning after June 15, 2012. Our adoption of this guidance did not have a material effect on our financial position or results of operations.

3. Real Estate Assets
On January 23, 2013, the Company completed the acquisition of the following three entities from Williams Multifamily Acquisition Fund, LP, a Delaware limited partnership, an entity whose properties were also managed by Preferred Residential Management LLC.

Ashford Park REIT, Inc, the fee-simple owner of a 408-unit multifamily community located in Atlanta, Georgia, or Ashford Park, for a total purchase price of approximately $39.6 million, exclusive of assumed mortgage debt, acquisition-related and financing-related transaction costs.


10

Preferred Apartment Communities, Inc.
Notes to Consolidated Financial Statements – (continued)
March 31, 2013
(Unaudited)

Lake Cameron REIT, Inc, the fee-simple owner of a 328-unit multifamily community located in suburban Raleigh, North Carolina, or Lake Cameron, for a total purchase price of approximately $30.5 million, exclusive of assumed mortgage debt, acquisition-related and financing-related transaction costs.

McNeil Ranch REIT, Inc, the fee-simple owner of a 192-unit multifamily community located in Austin, Texas, or McNeil Ranch, for a total purchase price of approximately $21.0 million, exclusive of assumed mortgage debt, acquisition-related and financing-related transaction costs.

The purchase price for each of these three underlying properties was established by the 95% unaffiliated third party equity investor in WMAF, pursuant to terms of the WMAF partnership agreement. The Company allocated the purchase prices of the three properties to the acquired assets and liabilities based upon their fair values, as follows:
 
Ashford Park
 
Lake Cameron
 
McNeil Ranch
 
Total
Land
$
10,600,000

 
$
4,000,000

 
$
2,100,000

 
$
16,700,000

Buildings and improvements
23,067,264

 
21,248,442

 
15,962,582

 
60,278,288

Furniture, fixtures and equipment
3,226,260

 
3,195,131

 
1,593,637

 
8,015,028

Intangible assets
2,821,176

 
2,101,427

 
1,576,276

 
6,498,879

Restricted cash
405,437

 
110,019

 
528,659

 
1,044,115

Prepaids, reserves and other assets
71,117

 
41,609

 
36,153

 
148,879

Mortgage debt
(38,700,000
)
 
(17,500,000
)
 
(13,228,389
)
 
(69,428,389
)
Intangible liabilities
(164,700
)
 

 
(112,495
)
 
(277,195
)
Accounts payable, accrued expenses and other
 
 
 
 
 
 
 
 liabilities
(424,526
)
 
(196,556
)
 
(711,281
)
 
(1,332,363
)
 
 
 
 
 
 
 
 
Net assets acquired
$
902,028

 
$
13,000,072

 
$
7,745,142

 
$
21,647,242

The weighted average remaining useful life of acquired assets and liabilities was approximately 24.4 years . The Company recorded depreciation and amortization of tangible and intangible assets on all its multifamily communities as follows:
 
 
Three months ended March 31,
 
 
2013
 
2012
Depreciation:
 
 
 
 
Buildings and improvements
 
$
858,035

 
$
411,800

Furniture, fixtures, and equipment
 
870,832

 
564,451

 
 
1,728,867

 
976,251

Amortization:
 
 
 
 
Acquired intangible assets
 
2,382,285

 

Website development costs
 
1,151

 
1,151

Total depreciation and amortization
 
$
4,112,303

 
$
977,402

Amortization of acquired intangible assets for the three-month period ended March 31, 2013 commenced from January 23, 2013, the date of acquisition of the three newly-acquired communities. The intangible assets will be amortized in full during 2013 over a period ranging from the average remaining lease term, which was approximately six months, to the average remaining lease term plus the average estimated renewal period. See note 15 for pro forma operating results of the Company, including the newly-acquired properties.

11

Preferred Apartment Communities, Inc.
Notes to Consolidated Financial Statements – (continued)
March 31, 2013
(Unaudited)


4.     Real Estate Loans, Notes Receivable, and Line of Credit

Lely

On March 28, 2013, the Company made a mezzanine loan of up to $12,713,242 to Lely Apartments LLC, or Lely, a Georgia limited liability company, to partially finance the construction of a 308-unit multifamily community located in Naples, Florida. At March 31, 2013, Lely had drawn $2,169,087 of the loan amount.

The Lely mezzanine loan matures on February 28, 2016, with options to extend until February 28, 2018, and pays current monthly interest of 8% per annum. The loan accrues an additional 6% interest which will be due at maturity or if the property is sold to, or refinanced by, a third party. There are no contingent events that are necessary to occur for the Company to realize the additional interest. The Company also has an option, but not an obligation, to purchase the property between and including April 1, 2016 and August 30, 2016 for a pre-negotiated purchase price of $43,500,000. If the Company exercises the purchase option and acquires the property, the additional accrued interest will be treated as additional consideration for the acquired project.

The mezzanine loan is collateralized by a pledge of 100% of the membership interests of Aster Lely Apartments, LLC, a Georgia limited liability company, a wholly owned subsidiary of Lely, and the ultimate owner of the property, and by unconditional guaranties of payment and performance by Clark Butler and Jeff D. Warshaw, unaffiliated third parties and principals of the borrower. Prepayment of the mezzanine loan is permitted in whole, but not in part, without the Company’s consent. The mezzanine loan is subordinate to a senior loan of up to an aggregate amount of approximately $25.0 million that is held by an unrelated third party. Messrs. Butler and Warshaw have guaranteed the completion of the project in accordance with the plans and specifications and have entered into joint and several repayment guaranties of the mezzanine loan through receipt of a certificate of occupancy of the property. All of the guaranties are subject to the rights held by the senior lender pursuant to a standard intercreditor agreement.

In connection with the closing of the Lely mezzanine loan, the Company received a total loan fee of 2% of the aggregate amount of the loan, or $254,265, net of the $9,133 in acquisition fees paid from the preceding bridge loan that was financed into the mezzanine loan, and paid a cumulative acquisition fee of 1% of the aggregate amount of the mezzanine loan, or $127,133, to the Manager out of these funds (See note 6).

Crosstown Walk

On October 29, 2012, the Company amended the real estate acquisition bridge loan it made on June 29, 2012 to Iris Crosstown Apartments LLC, or Crosstown Walk, a Florida limited liability company, for Crosstown Walk to acquire a parcel of land located in suburban Tampa, Florida, upon which a multifamily community is to be constructed. The amendment increased the aggregate amount of the loan to $4,685,000. The amount drawn under the loan at March 31, 2013 was $4,680,439. See note 17 for details regarding the repayment of the bridge loan and the issuance of a new mezzanine loan to Crosstown Walk in April 2013.

Madison-Rome

On September 28, 2012, the Company made a land acquisition bridge loan in the amount of $5,360,042 to Madison Retail - Rome LLC, or Madison-Rome, a Delaware limited liability company, to partially finance the construction of an 88,351 (unaudited) square foot retail complex located in Rome, Georgia. On November 13, 2012, the loan was converted to a mezzanine construction loan and at March 31, 2013, Madison-Rome had drawn $5,165,764 of the loan amount.

The Madison-Rome loan matures on September 20, 2015, with no option to extend and pays current monthly interest of 8% per annum. An additional exit fee equal to the difference between the 8% interest paid and a 14% cumulative annual simple interest return will be due and payable to the Company if Madison-Rome refinances the loan with a third party or when the loan balance is repaid. There are no contingent events that are necessary to occur for the Company to realize the exit fee.

The Madison-Rome loan is collateralized by a pledge of 100% of the membership interests of Madison-Rome. Prepayment is permitted in whole, but not in part, without our consent. The Madison-Rome loan is subordinate to a senior loan up to an aggregate amount of approximately $11.5 million which is held by an unrelated third party and is subject to the rights held by the senior lender pursuant to a standard intercreditor agreement.


12

Preferred Apartment Communities, Inc.
Notes to Consolidated Financial Statements – (continued)
March 31, 2013
(Unaudited)

The Madison-Rome loan is secured by unconditional guaranties of payment and performance by Stephen H. Whisenant and Charles N. Worthen, unaffiliated third parties and principals of the borrower. In connection with the closing of the Madison-Rome loan, the Company received a loan fee of 2% of the aggregate loan amount, or $107,201 and paid an acquisition fee of 1% of the aggregate amount of the loan, or $53,600 ,to the Manager out of these funds.

City Park    

On September 6, 2012, the Company made a mezzanine loan of up to $10,000,000 to Oxford City Park Development LLC, or City Park, a Georgia limited liability company, to partially finance the construction of a 284-unit multifamily community located in Charlotte, North Carolina. At March 31, 2013, City Park had drawn $7,556,482 of the loan amount.

The City Park mezzanine loan matures on September 5, 2017, with no option to extend and pays current monthly interest of 8% per annum. The loan accrues an additional 6% interest which will be due at maturity or if the property is sold to, or refinanced by, a third party. There are no contingent events that are necessary to occur for the Company to realize the additional interest. The Company also has an option, but not an obligation, to purchase the property between and including November 1, 2015 and March 31, 2016 for a pre-negotiated purchase price of $30,945,845. If the Company exercises the purchase option and acquires the property, the additional accrued interest will be treated as additional consideration for the acquired project.

The mezzanine loan is collateralized by a pledge of 100% of the membership interests of City Park. Prepayment of the mezzanine loan is permitted in whole, but not in part, without the Company’s consent. The mezzanine loan is subordinate to a senior loan of up to an aggregate amount of approximately $18.6 million that is held by an unrelated third party. W. Daniel Faulk, Jr. and Richard A. Denny have guaranteed the completion of the project in accordance with the plans and specifications. In addition, Messrs. Faulk and Denny have entered into joint and several repayment guaranties of the mezzanine loan. All of the guaranties are subject to the rights held by the senior lender pursuant to a standard intercreditor agreement.

In connection with the closing of the City Park mezzanine loan and subsequently in connection with future drawn amounts on the loan, the Company received a total loan fee of 2% of the amount drawn on the loan, or $148,505, and paid a cumulative acquisition fee of 1% of the aggregate amount of the mezzanine loan, or $74,253, to the Manager out of these funds. Additional loan fees will be recorded on subsequent drawn amounts up to the full aggregate amount of the loan.

City Vista

On August 31, 2012, the Company made a mezzanine loan of up to $12,153,000 to Oxford City Vista Development LLC, or City Vista, a Georgia limited liability company, to partially finance the construction of a 272-unit multifamily community located in Pittsburgh, Pennsylvania. At March 31, 2013, City Vista had drawn $8,200,463 of the loan amount.

The City Vista mezzanine loan matures on June 1, 2016, with an option to extend until July 1, 2017 and pays current monthly interest of 8% per annum. The loan accrues an additional 6% interest which will be due at maturity or if the property is sold to, or refinanced by, a third party. There are no contingent events that are necessary to occur for the Company to realize the additional interest. The Company also has an option, but not an obligation, to purchase the property between and including February 1, 2016 and May 31, 2016 for a pre-negotiated purchase price of $43,560,271. If the Company exercises the purchase option and acquires the property, the additional accrued interest will be treated as additional consideration for the acquired project.

The mezzanine loan is collateralized by a pledge of 100% of the membership interests of City Vista. Prepayment of the mezzanine loan is permitted in whole, but not in part, without the Company’s consent. The mezzanine loan is subordinate to a senior loan of up to an aggregate amount of approximately $28.4 million that is held by an unrelated third party. W. Daniel Faulk, Jr. and Richard A. Denny, unaffiliated third parties and principals of the borrower, have guaranteed the completion of the project in accordance with the plans and specifications. In addition, Messrs. Faulk and Denny have entered into joint and several repayment guaranties of the mezzanine loan. All of the guaranties are subject to the rights held by the senior lender pursuant to a standard intercreditor agreement.

In connection with the closing of the City Vista mezzanine loan and subsequently in connection with future drawn amounts on the loan, the Company received a total loan fee of 2% of the amount drawn on the loan, or $159,618 and paid a cumulative acquisition fee of 1% of the aggregate amount of the mezzanine loan, or $79,809, to the Manager out of these funds. Additional loan fees will be recorded on subsequent drawn amounts up to the full aggregate amount of the loan.

13

Preferred Apartment Communities, Inc.
Notes to Consolidated Financial Statements – (continued)
March 31, 2013
(Unaudited)


Summit II

On May 7, 2012, the Company made a mezzanine loan in the amount of $6,103,027 to Oxford Summit Apartments II LLC, or Summit II, a Georgia limited liability company, to partially finance the construction of a 140-unit multifamily community located adjacent to the Company’s existing Summit Crossing multifamily community in suburban Atlanta, Georgia.

The Summit II mezzanine loan matures on May 8, 2017, with no option to extend and pays current monthly interest of 8% per annum. The loan accrues an additional 6% interest which will be due at maturity or if the property is sold to, or refinanced by, a third party. Under the terms of a purchase option agreement entered into in connection with the closing of the mezzanine loan, we have an option, but not an obligation, to purchase the property for a period of five months following completion of construction, lease up and stabilization for $19,254,155. If the property is sold to, or refinanced by, a third party before or after the option period, we will be entitled to receive an exit fee equal to the amount required to provide us with a 14% simple interest return on the loan, in addition to loan fees received at closing, which totaled 2% of the loan amount. Since the minimum exit fee, assuming the purchase option is not exercised, is the amount needed to provide a 14% simple interest return, the Company is accruing each period the additional exit fee earned based on the 14% rate assuming the loan was paid off at period end. There are no contingent events that are necessary to occur for the Company to realize the additional interest. The accrued exit fee is recorded as interest income in the consolidated statements of operations. If the Company exercises the purchase option and acquires the property, the additional accrued interest will be treated as additional consideration for the acquired project.

The mezzanine loan is collateralized by a pledge of 100% of the membership interests of Oxford Summit II. Prepayment of the mezzanine loan is permitted in whole but not in part without the Company’s consent. The mezzanine loan is subordinate to a senior loan of up to an aggregate amount of $12,384,000 that is held by an unrelated third party. W. Daniel Faulk, Jr. and Richard A. Denny have guaranteed the completion of the project in accordance with the plans and specifications. In addition, Messrs. Faulk and Denny have entered into joint and several repayment guaranties of the mezzanine loan. The repayment guaranties expire at the completion of construction of the property. All of the guaranties are subject to the rights held by the senior lender pursuant to a standard intercreditor agreement.

In connection with the closing of the Summit II mezzanine loan, the Company received a loan fee of 2% of the loan amount, or $122,061 and paid an acquisition fee of 1% of the aggregate amount of the mezzanine loan, or $61,030, to the Manager out of these funds, of which WOF received $610 through its special limited liability company interest in our Manager.
Trail II
On June 30, 2011, the Company made a mezzanine loan of $6.0 million to Oxford Hampton Partners LLC, or Hampton Partners, a Georgia limited liability company and a related party, to partially finance the construction of a 96-unit multifamily community located adjacent to the Company’s existing Trail Creek multifamily community in Hampton, Virginia, or Trail II. Hampton Partners was required to fully draw down the mezzanine loan on the closing date. Hampton Partners paid $302,300 to Williams Realty Fund I, LLC, or WRF, from the proceeds of the mezzanine loan to retire an outstanding short term loan that matured on the closing date of the Trail II mezzanine loan. Approximately 100% of the membership interest in Hampton Partners is owned by WRF.

The Trail II mezzanine loan matures on June 29, 2016, with no option to extend and pays interest at a fixed rate of 8% per annum. Interest will be paid monthly with principal and any accrued but unpaid interest due at maturity. Under the terms of a purchase option agreement entered into in connection with the closing of the mezzanine loan, the Company has an option, but not an obligation, to purchase the property between and including April 1, 2014 and June 30, 2014 for $17,825,600, which is the amount of the aggregate project costs as set forth in the approved construction budget on the closing date. If the property is sold to, or refinanced by, a third party before July 1, 2014, the Company will be entitled to receive an exit fee equal to the amount required to provide it with a 14% cumulative internal rate of return on the loan. If the property is sold to, or refinanced by, a third party on or after July 1, 2014, then the Company will be entitled to receive an exit fee equal to the amount required to provide it with a 12% cumulative internal rate of return on the loan. There are no contingent events that are necessary to occur for the Company to realize the exit fee. The calculation of the cumulative internal rate of return will include the loan’s fees received at closing. Since the minimum exit fee, assuming the purchase option is not exercised, is the amount needed to provide a 12% cumulative internal rate of return, the Company is accruing each period the additional exit fee earned based on the 12% rate assuming the loan was paid off at period end as the borrower cannot control whether the option is exercised. The accrued exit fee is recorded as interest

14

Preferred Apartment Communities, Inc.
Notes to Consolidated Financial Statements – (continued)
March 31, 2013
(Unaudited)

income in the consolidated statements of operations. If the Company exercises the purchase option and acquires the property, any accrued and unpaid exit fee will be treated as additional consideration for the acquired project.

The Trail II mezzanine loan is collateralized by a pledge of 100% of the membership interests of Hampton Partners. Partial prepayment of the mezzanine loan is not permitted without the Company’s consent. The mezzanine loan is subordinate to a senior loan of up to an aggregate amount of $10.0 million that is held by an unrelated third party.

In connection with the closing of the Trail II mezzanine loan, the Company received a loan fee of 2% of the loan amount, or $120,000, and a loan commitment fee of $14,333. The Company paid an acquisition fee of 1% of the aggregate amount of the mezzanine loan, or $60,000, to its Manager out of these funds.
Notes Receivable
On March 20, 2013, the Company made a bridge loan in the amount of $500,000 to 360 Residential, LLC, a Georgia limited liability company. The loan bears interest at 8% per annum and interest only payments are due on a monthly basis until the maturity date of March 20, 2014. The loan may be prepaid at any time, in whole or in part, without penalty and accrues a cumulative compounded 6% exit fee which is due at repayment or maturity. The amounts payable under the terms of the loan are backed by guaranties of payment and performance by Clark Butler and Jeff D. Warshaw, unaffiliated third parties and principals of the borrower.

On January 24, 2013, the Company was issued a promissory note in the amount of $1,500,000 by Pecunia Management, LLC, or Pecunia, a Florida limited liability company. The loan bears interest at 10% per annum and interest only payments are due on a monthly basis until the maturity date of January 23, 2015. The loan may be prepaid at any time, in whole or in part, without penalty. The amounts payable under the terms of the loan are backed by an assignment of Pecunia's rights to dealer manager fees payable by the Company to International Assets Advisory, LLC, or IAA, a wholly-owned subsidiary of Pecunia,  pursuant to the Dealer Manager Agreement between the Company and IAA, dated November 18, 2011, with respect to the Primary Series A Offering.

On December 17, 2012, the Company made a loan in the amount of $1,300,000 to Riverview Associates, Ltd., or Riverview, a Georgia limited partnership, in the form of a promissory note. The loan bears interest at 8% per annum and interest only payments are due on a monthly basis until the maturity date of June 16, 2013, with an extension at the Company's option available until December 16, 2013. The loan may be prepaid at any time, in whole but not in part, without penalty. The amounts payable under the terms of the loan are backed by an assignment of project documents and by a guaranty of payment and performance by Stephen H. Whisenant, an unaffiliated third party and principal of the borrower.

On November 15, 2012, the Company made a loan in the amount of $650,000 to International Assets Advisory, LLC, or IAA, in the form of a subordinated loan. The loan bears interest at 10% per annum and interest only payments are due on a monthly basis until the maturity date of November 15, 2013. The loan may not be prepaid prior to maturity. The amounts payable under the terms of the loan are backed by rights of withholding commissions due IAA by the Company in connection with securing placements of the Primary Series A Offering. As of March 31, 2013, the Company has retained certain accrued dealer manager fees totaling $375,000 as additional security on this loan.

On September 14, 2012, the Company made a loan in the amount of $500,000 to Newport Development, LLC, or Newport, a Georgia limited liability company and unaffiliated third party, in the form of a promissory note. The full amount of the loan was drawn as of March 31, 2013, and the balance of the loan plus accrued interest was repaid on May 8, 2013.
On March 26, 2012, the Company made a loan in the amount of $650,000 to Oxford Properties, LLC, a Georgia limited liability company, or Oxford, in the form of a promissory note. The loan bore interest at 15% per annum and interest only payments were due beginning May 1, 2012, and continued on a monthly basis until the repayment of the loan, which occurred on September 6, 2012.
Line of Credit
On August 21, 2012, the Company extended a revolving line of credit to its Manager in an aggregate amount of up to $1.0 million, in order to provide liquidity to the Manager in support of its ongoing business operations. The credit line bears interest at 8.0%

15

Preferred Apartment Communities, Inc.
Notes to Consolidated Financial Statements – (continued)
March 31, 2013
(Unaudited)

per annum, with interest payable monthly, and matures on July 31, 2013. The loan is secured by a collateral assignment of the Manager's right to fees under the third amended and restated management agreement between the Company and the Manager, or the Management Agreement. At March 31, 2013, the amount drawn on the line of credit by the Manager was $926,221. On January 3, 2013, the Company amended the revolving line of credit to increase the amount available to $1.5 million.
The Company recorded interest income and other revenue from these instruments as follows:

 
 
Three months ended March 31,
 
 
2013
 
2012
Interest income:
 
 
 
 
Real estate loans:
 
 
 
 
Summit II
 
$
122,061

 
$

Trail II
 
120,000

 
120,000

Crosstown Walk
 
93,327

 

City Park
 
137,934

 

City Vista
 
155,007

 

Lely
 
1,902

 

Madison-Rome
 
101,949

 

 
 
 
 
 
Total
 
732,180

 
120,000

 
 
 
 
 
Accrued exit fees
 
442,989

 
13,070

Net loan fee revenue recognized
 
27,311

 
4,325

 
 
 
 
 
Total interest income on real estate loans
 
1,202,480

 
137,395

 
 
 
 
 
Total interest income on notes and line of credit
 
109,450

 
1,603

 
 
 
 
 
Total interest income
 
$
1,311,930

 
$
138,998


The Company extends loans for purposes such as to partially finance the development of multifamily residential communities, to acquire land in anticipation of developing and constructing multifamily residential communities, and for other real estate or real estate related projects. Certain of these loans include characteristics such as exclusive options to purchase the project at a fixed price within a specific time window following project completion and stabilization, the rights to incremental exit fees over and above the amount of periodic interest paid during the life of the loans, or both. These characteristics can cause the loans to create variable interests to the Company and require further evaluation as to whether the variable interest creates a variable interest entity, or VIE, which would necessitate consolidation of the project. The Company considers the facts and circumstances pertinent to each entity borrowing under the loan, including the relative amount of financing the Company is contributing to the overall project cost, decision making rights or control held by the Company, and rights to expected residual gains or obligations to absorb expected residual losses that could be significant from the project. If the Company is deemed to be the primary beneficiary of a VIE, consolidation treatment would be required.
The Company has evaluated its real estate loans, where appropriate, for accounting treatment as loans versus real estate development projects, as required by ASC 310. For each loan, the majority of the characteristics and the facts and circumstances indicate that loan accounting treatment is appropriate.
The Company's real estate loans partially finance the development activities of the borrowers' associated legal entities. Each of these loans create variable interests in each of these entities, and according to the Company's analysis, are deemed to be VIEs. Due to the combined factors of the sufficiency of the borrowers' investment at risk, the existence of payment and performance guaranties provided by the borrowers, as well as the limitations on the fixed-price purchase options on the Trail II, Summit II, City Park, City Vista, and Lely loans, the Company has concluded that it is not the primary beneficiary of the borrowing entities. It has no decision making authority or power to direct activity, except normal lender rights, which are subordinate to the senior loans on the projects. Therefore, since the Company has concluded it is not the primary beneficiary, it has not consolidated these entities in its consolidated financial statements. The Company's maximum exposure to loss from these loans is their carrying value as of March 31, 2013 of approximately $39.9 million. The maximum aggregate amount of loans to be funded as of March 31, 2013 was approximately $57.0 million.

16

Preferred Apartment Communities, Inc.
Notes to Consolidated Financial Statements – (continued)
March 31, 2013
(Unaudited)

The Company is subject to a concentration of credit risk that could be considered significant with regard to the Trail II, Summit II, Crosstown Walk, City Park and City Vista real estate loans, as identified specifically by the two named principals of the borrowers, W. Daniel Faulk, Jr. and Richard A. Denny, and as evidenced by repayment guaranties offered in support of these loans. These loans total approximately $32.5 million and in the event of a total failure to perform by the borrowers and guarantors, would subject the Company to a total possible loss of that amount. The Company generally requires secured interests in one or a combination of the membership interests of the borrowing entity or the entity holding the project, guaranties of loan repayment, and project completion performance guaranties as credit protection with regard to its real estate loans, as is customary in the mezzanine loan industry. The Company has performed assessments of the guaranties with regard to the obligors' ability to perform according to the terms of the guaranties if needed and has concluded that the guaranties reduce the Company's risk and exposure to the above-described credit risk in place as of March 31, 2013.

The borrowers and guarantors behind these real estate loans (excluding the Madison-Rome and Lely loans) collectively qualify as a major customer as defined in ASC 280-10-50, as the revenue recorded from this customer exceeded ten percent of the Company's total revenues. The Company recorded revenue from transactions with this major customer for the three-month period ended March 31, 2013 of approximately $1.0 million.

5. Redeemable Preferred Stock
On November 18, 2011, the Securities and Exchange Commission declared effective our registration statement on Form S-11 (registration number 333-176604) for our Primary Series A Offering of up to a maximum of 150,000 Units, with each Unit consisting of one share of Series A Preferred Stock and one Warrant to purchase 20 shares of our Common Stock, which is being offered and sold by IAA on a "reasonable best efforts" basis. Each share of Preferred Stock ranks senior to Common Stock and carries a cumulative annual 6% dividend of the stated per share value of $1,000, payable monthly as declared by the Company’s board of directors. Dividends begin accruing on the date of issuance. The Preferred Stock is redeemable at the option of the holder beginning two years following the date of issue subject to a 10% redemption fee. After year three the redemption fee decreases to 5%, after year four it decreases to 3%, and after year five there is no redemption fee. Any redeemed shares of Preferred Stock are entitled to any accrued but unpaid dividends at the time of redemption and any redemptions may be in cash or Common Stock, at the Company’s discretion. The Warrant is exercisable by the holder at an exercise price of 120% of the current market price per share of the Common Stock on the date of issuance of such warrant with a minimum exercise price of $9.00 per share. The current market price per share is determined using the volume weighted average closing market price for the 20 trading days prior to the date of issuance of the Warrant. The Warrants are not exercisable until one year following the date of issuance and expire four years following the date of issuance.
On August 16, 2012, the Company filed a registration statement on Form S-11 (registration number 333-183355) for a follow-on offering of an additional 850,000 Units, or Follow-On Offering, which registration statement has not yet been declared effective by the Securities and Exchange Commission. The terms of the Follow-On Offering and features of the Units in the Follow-On Offering are substantially the same as the Primary Series A Offering.

As of March 31, 2013, offering costs specifically identifiable to Unit offering closing transactions, such as commissions, dealer manager fees, and other registration fees, totaled approximately $1.3 million. These costs are reflected as a reduction of stockholders' equity at the time of closing. In addition, the costs related to the offering not related to a specific closing transaction totaled approximately $3.7 million. As of March 31, 2013, the Company had issued 41,522 Units and collected net proceeds of approximately $37.1 million from the Primary Series A Offering after commissions.  A total of 30 shares of Series A Preferred Stock were subsequently redeemed. The number of Units issued was approximately 4.2% of the maximum number of Units to be issued under the Primary Series A Offering and the Follow-On Offering. Consequently, the Company cumulatively recognized approximately 4.2% of the approximate $3.7 million deferred to date, or approximately $85 thousand as a reduction of stockholders' equity.  The remaining balance of offering costs not yet reflected as a reduction of stockholder's equity, approximately $3.5 million, are reflected in the asset section of the consolidated balance sheet  as deferred offering costs at March 31, 2013.  The remainder of current and future deferred offering costs related to the Primary Series A Offering will likewise be recognized as a reduction of stockholders' equity in the proportion of the number of Units issued to the maximum number of Units available to be issued. Offering costs not related to a specific closing transaction are subject to an overall cap of 1.5% of the total gross proceeds raised during the Unit offerings.

On January 17, 2013, the Company issued 40,000 shares of its Series B Preferred Stock at a purchase price of $1,000 per share through a private placement transaction. The net proceeds totaled approximately $37.6 million after commissions. On May 9, 2013, the common stockholders approved the issuance of Common Stock upon the conversion of the Series B Preferred Stock.

17

Preferred Apartment Communities, Inc.
Notes to Consolidated Financial Statements – (continued)
March 31, 2013
(Unaudited)

As a result of such approval, the Series B Preferred Stock will be converted into 5,714,274 shares of Common Stock on May 16, 2013.
The conversion price of the Series B Preferred Stock created a deemed beneficial conversion feature ("BCF") as a result of the conversion price being less than the market price of the Common Stock on Januarty 16, 2013. The BCF of approximately $7.1 million was not recorded until the Series B Preferred Stock became convertible in May 2013. As required by ASC 480, upon conversion, the deemed BCF and the associated issuance costs of approximately $3.0 million will be recorded as an increase in accumulated deficit, with a corresponding increase in additional paid-in capital, with no net effect on total stockholders' equity. The increase in accumulated deficit will also be recorded as a deemed non-cash preferred dividend in the Company's future earnings per share calculations.
Because the Company did not control all possible circumstances under which it may have been required to redeem the Series B Preferred Stock for cash, the proceeds from the transaction of $40.0 million, net of offering costs of approximately $3.0 million, is presented as mezzanine or temporary equity on the consolidated balance sheet. For periods subsequent to the approval of the conversion of the Series B Preferred Stock, which occurred on May 9, 2013, the net proceeds will be classified as a component of permanent equity.

6. Related Party Transactions
John A. Williams, the Company's Chief Executive Officer and Chairman of the Board, and Leonard A. Silverstein, the Company's President and Chief Operating Officer and a member of the Board, are also executive officers and directors of NELL Partners, Inc., which controls the Manager. Mr. Williams is the Chief Executive Officer and President and Mr. Silverstein is the President and Chief Operating Officer of the Manager.

Mr. Williams, Mr. Silverstein and Michael J. Cronin, the Company's Executive Vice President, Chief Accounting Officer and Treasurer are executive officers of Williams Realty Advisors, LLC, or WRA.

The Management Agreement entitles the Manager to receive compensation for various services it performs related to acquiring assets and managing properties on the Company's behalf:

 
 
 
 
Three months ended
Type of Compensation
 
Basis of Compensation
 
March 31, 2013
 
March 31, 2012
 
 
 
 
 
 
 
Acquisition fees
 
1% of the gross purchase price of real estate assets acquired or loans advanced
 
$
1,062,574

 
$
28,685

Asset management fees
 
Monthly fee equal to one-twelfth of 0.50% of the total book value of assets, as adjusted
 
265,801

 
127,892

Property management fees
 
Monthly fee equal to 4% of the monthly gross revenues of the properties managed
 
187,642

 
100,013

General and administrative expense fees
 
Monthly fee equal to 2% of the monthly gross revenues of the Company
 
118,067

 
52,663

 
 
 
 
 
 
 
 
 
 
 
$
1,634,084

 
$
309,253


In addition to property management fees, the Company incurred the following reimbursable on-site personnel salary and related benefits expenses at the properties, which are included in property operating and maintenance expense on the Consolidated Statements of Operations:
Three months ended March 31,
2013
 
2012
$
479,887

 
$
252,621


18

Preferred Apartment Communities, Inc.
Notes to Consolidated Financial Statements – (continued)
March 31, 2013
(Unaudited)


The Manager utilizes its own personnel and certain personnel of its affiliates to accomplish certain tasks related to raising capital that would typically be performed by third parties, including, but not limited to, legal and marketing functions. As permitted under the Management Agreement, the Manager has requested reimbursement of $70,485 and $45,149 for the three-month periods ended March 31, 2013 and 2012, respectively. These costs are recorded as deferred offering costs until such time as additional closings occur on the Unit offerings, at which time they are reclassified on a pro-rata basis as a reduction of offering proceeds within stockholders’ equity.

In addition to the fees described above, the Management Agreement also entitles the Manager to other potential fees, as follows:

Disposition fees - Based on the lesser of (A) one-half of the commission that would be reasonable and customary; and (B) 1% of the sale price of the asset
Construction, development, and landscaping fees - Customary and competitive market rates in light of the size, type and location of the asset
Special limited partnership interest in the Operating Partnership - distributions from the Operating Partnership equal to 15% of any net proceeds from the sale of an asset and prior operations that are remaining after the payment of (i) the capital and expenses allocable to all realized investments (including the sold asset), and (ii) a 7% priority annual return on such capital and expense; provided that all accrued and unpaid dividends on the Series A Preferred Stock have been paid in full

The Company did not incur any of these other potential fees during the three-month periods ended March 31, 2013 or 2012.

7. Dividends and Distributions

The Company declares and pays monthly cash dividend distributions on its Series A Preferred Stock in the amount of $5.00 per share per month, prorated for partial months at issuance as necessary. The Company declared and paid cash dividends on its Series B Preferred Stock at the same rate and frequency as those dividends declared on the Common Stock, equal to 5,714,274 as-converted shares of Common Stock.

The Company's dividend activity on its Common Stock and Preferred Stock for the three-month period ended March 31, 2013 was:
 
 
Three month period ended March 31,
 
 
2013
 
2012
 
 
per share
 
aggregate
 
per share
 
aggregate
Common
 
$
0.145

 
$
771,923

 
$
0.13

 
$
673,181

Preferred Stock:
 
 
 
 
 
 
 
 
 Series A
 
$
5.00

 
360,039

 
$
5.00

 
718

 Series B
 
$
17.26

 
690,476

 

 

 
 
 
 
 
 
 
 
 
 Total
 
 
 
$
1,822,438

 
 
 
$
673,899


The holders of Class A units in the Operating Partnership are entitled to equivalent distributions as those declared on the Common Stock. At March 31, 2013, the Company had 106,988 Class A partnership units outstanding, which are exchangeable on a one-for-one basis for shares of Common Stock. On February 7, 2013, the Operating Partnership declared cash distributions to its Class A unitholders totaling $15,513, which were paid on April 25, 2013.


19

Preferred Apartment Communities, Inc.
Notes to Consolidated Financial Statements – (continued)
March 31, 2013
(Unaudited)

8. Equity Compensation
Stock Incentive Plan
On February 25, 2011, the Company’s board of directors adopted, and the Company’s stockholders approved, the Preferred Apartment Communities, Inc. 2011 Stock Incentive Plan, or, as amended, the 2011 Plan, to incentivize, compensate and retain eligible employees, consultants, and non-employee directors. A maximum of 567,500 shares of Common Stock may be issued under the 2011 Plan. Awards may be made in the form of issuances of Common Stock, restricted stock, stock appreciation rights (“SARs”), performance shares, incentive stock options, non-qualified stock options, or other forms. Eligibility for receipt of, amounts, and all terms governing awards pursuant to the 2011 Plan, such as vesting periods and voting and dividend rights on unvested awards, are determined by the Compensation Committee of the Company’s Board of Directors.

Equity compensation expense by award type for the Company was:
 
 
Equity compensation expense
 
 
 
 
for the three-month periods ended March 31,
 
Unamortized Expense as of
 
 
2013
 
2012
 
March 31, 2013
 
 
 
 
 
 
 
Quarterly board member committee fee grants
$
18,168

 
$
18,287

 
$

Class B Unit awards:
 
 
 
 
 
Executive officers - 2012
2,580

 
237,184

 

Executive officers - 2013
213,237

 

 
646,664

Vice chairman of board of directors
10,249

 

 
15,374

Restricted stock grants:
 
 
 
 
 
2011
 

 
64,109

 

2012
 
64,687

 

 
21,562

 
 
 
 
 
 
 
Total
 
$
308,921

 
$
319,580

 
$
683,600


Restricted Stock Grants

On April 5, 2011, the Company granted a total of 26,000 shares of restricted Common Stock to its non-employee board members, in payment of their annual retainer fees. The Company records the fair value of restricted stock awards based upon the closing stock price on the trading day immediately preceding the date of grant. The fair value per share was deemed to be $10.00 per share (the IPO offering price) by Board resolution. Compensation cost in the amount of $260,000 was recognized on a straight-line basis over the period ending on the first anniversary of the grant date and all 26,000 shares vested on April 5, 2012.

On May 10, 2012, the Company granted a total of 33,046 shares of restricted Common Stock to its non-employee board members, in payment of their annual retainer fees. The per-share fair value was $7.83 and total compensation cost in the amount of $258,750 will be recognized on a straight-line basis over the period ending on the earlier of first anniversary of the grant date or the next annual meeting of the Company's stockholders. All 33,046 unvested shares were outstanding at March 31, 2013.

Directors’ Stock Grants

On February 2, 2012, the Company granted 2,988 shares of Common Stock to its independent board members, in payment of their quarterly meeting fees. The per-share fair value of this immediate-vesting award was $6.12, which was the closing price of the Common Stock on the prior business day. The total compensation cost of 18,287 was recorded in full at the grant date.

On February 7, 2013, the Company granted 2,115 shares of Common Stock to its independent board members, in payment of their quarterly meeting fees. The per-share fair value of this immediate-vesting award was $8.59, which was the closing price of the Common Stock on the prior business day. The total compensation cost of $18,168 was recorded in full at the grant date.


20

Preferred Apartment Communities, Inc.
Notes to Consolidated Financial Statements – (continued)
March 31, 2013
(Unaudited)

Class B Units

On January 3, 2012, pursuant to its Third Amended and Restated Agreement of Limited Partnership of the Operating Partnership, the Company granted 106,988 Class B Units, representing ownership interests in the Operating Partnership, to certain of its executive officers as compensation for service in 2012. On January 3, 2013, the Company granted 142,046 Class B Units for service during 2013.

The Class B Units become Vested Class B Units at the Initial Valuation Date, which is one year from the date of grant. For each grant, on the Initial Valuation Date, the market capitalization of the number of shares of Common Stock at the date of grant is compared to the market capitalization of the same number of shares of Common Stock at the Initial Valuation Date. If the market capitalization measure results in an increase which exceeds the target market threshold, the Vested Class B Units become Earned Class B Units and automatically convert into Class A Units of the Operating Partnership, which are henceforth entitled to distributions from the Operating Partnership and become exchangeable for Common Stock on a one-to-one basis at the option of the holder. Vested Class B Units may become Earned Class B Units on a pro-rata basis should the result of the market capitalization test be an increase of less than the target market threshold. Any Vested Class B Units that do not become Earned Class B Units on the Initial Valuation Date are subsequently remeasured on a quarterly basis until such time as all Vested Class B Units become Earned Class B Units or are forfeited due to termination of continuous service as an officer of the Company due to an event other than as a result of a qualified event, which is generally the death or disability of the holder. Continuous service through the final valuation date is required for the Vested Class B Units to qualify to become fully Earned Class B Units.

On August 15, 2012, the Company granted 6,128 Class B Units to its Vice Chairman of the Company's Board of Directors, as additional compensation for acting in an expanded capacity related to board oversight of the Company's capital raising efforts. The vesting conditions, conversion rights and other features are identical to the Class B Unit grants described above, and differ only by the amount of the market capitalization threshold.
 
Because of the market condition determining the transition of the Vested Class B Units to Earned Class B Units, a Monte Carlo simulation was utilized to calculate the total fair values, which will be amortized as compensation expense over the one-year periods beginning on the grant dates through the Initial Valuation Dates. On December 30, 2012, the 2011 Class B Unit awards became fully vested and earned, and a total of 107,164 Class B Units automatically converted to Class A Units of the Operating Partnership on that date. On December 31, 2012, all Class A Unit holders elected to convert their Class A Units into Common Stock. On January 3, 2013, the 106,988 outstanding Class B Units for 2012 became fully vested and earned and automatically converted to Class A Units of the Operating Partnership. As Class A Units, they became entitled to pro-rata distributions of profit and allocations of loss as non-controlling interests of the Operating Partnership, as follows:

 
 
Three months ended March 31, 2013
Net loss attributable to the Company
$
(3,124,343
)
Decrease in equity for vesting of Class B Units and Conversion to Class A Units
(479,841
)
Change from net loss attributable to the Company and net transfers to non-controlling interest
$
(3,604,184
)

All unvested 2013 Class B Units, as well as the unvested Class B Units issued on August 15, 2012 were outstanding at March 31, 2013.

The underlying valuation assumptions and results for the Class B Unit awards were:


21

Preferred Apartment Communities, Inc.
Notes to Consolidated Financial Statements – (continued)
March 31, 2013
(Unaudited)

Grant dates
 
1/3/2012
 
8/15/2012
 
1/2/2013
Stock price
 
$
6.05

 
$
8.30

 
$
7.88

Dividend yield
 
8.6
%
 
6.75
%
 
7.36
%
Expected volatility
 
35.23
%
 
31.35
%
 
32.1
%
Risk-free interest rate
 
2.83
%
 
2.72
%
 
2.91
%
 
 
 
 
 
 
 
Derived service period (years)
 
1.0

 
1.0

 
1.0

 
 
 
 
 
 
 
Number of Units granted
 
106,988

 
6,128

 
142,046

Calculated fair value per Unit, assuming:
 
 
 
 
 
 
50% vesting
 
$
4.50

 
$
6.69

 
$

100% vesting
 
$
4.47

 
$
6.68

 
$
6.07

 
 
 
 
 
 
 
Total fair value of Units
 
$
479,841

 
$
40,996

 
$
862,219

 
 
 
 
 
 
 
Target market threshold increase
 
$
650,000

 
$
50,000

 
$
1,150,000

The expected dividend yield assumptions were derived from the Company’s closing prices of the Common Stock on the grant dates and the projected future quarterly dividend payments of $0.13 per share for the 2012 annual awards, $0.14 per share for the August 15, 2012 award, and $0.145 for the 2013 annual awards.

Since the Company has a limited amount of operating history in the public equity market, the expected volatility assumption was derived from the observed historical volatility of the common stock prices of a select group of peer companies within the REIT industry that most closely approximate the Company’s size, capitalization, leverage, line of business and geographic focus markets.

The risk-free rate assumptions were obtained from the Federal Reserve yield table and were calculated as the interpolated rate between the 20 and 30 years year yield percentages on U. S. Treasury securities on the grant dates.

Since the likelihood of attainment of the market condition for each of the Class B Units to become earned is believed to be high and the vesting period is one year, the forfeiture rate assumption for these Class B Units was set to 0%.

Since the Class B Units have no expiration date, a derived service period of one year was utilized, which equals the period of time from the grant date to the initial valuation date.

Warrant

On March 31, 2011, as partial compensation for services rendered for the IPO, the Company issued to IAA a warrant to purchase up to 150,000 shares of Common Stock. The exercise price is $12.50 per share, which is 125% of the gross IPO price of $10.00 per share. The warrant is exercisable, at IAA’s option, in whole or in part, by either payment of the aggregate exercise price for the number of shares exercised, plus applicable transfer taxes, or by a cashless net share settlement. Upon exercise of the warrant, shares of Common Stock will be issued from authorized but unissued Common Stock. The warrant is currently exercisable and expires on March 31, 2015.

9. Indebtedness

Mortgage Notes Payable

The Company partially financed the acquisitions of its first three acquisitions, as well as the McNeil Ranch, Lake Cameron, and Ashford Park multifamily communities (which were each refinanced on January 24, 2013), with non-recourse mortgage notes collateralized only by the associated real estate assets for each community with no cross-collateralization of any other properties.

22

Preferred Apartment Communities, Inc.
Notes to Consolidated Financial Statements – (continued)
March 31, 2013
(Unaudited)

Each mortgage requires monthly payments of interest only from the dates of closing through May 1, 2014 for the Trail Creek, Stone Rise, and Summit Crossing mortgages and through February 28, 2018 for the Ashford Park, Lake Cameron, and McNeil Ranch mortgages, beyond which time payments of principal and interest calculated on a 30-year amortization schedule are due through the date of maturity of each instrument. Variable monthly interest rates are capped at 7.25% and 6.85% for Stone Rise and Trail Creek, respectively. The embedded interest rate caps on the Stone Rise and Trail Creek mortgages were deemed to be clearly and closely related to the debt host instruments.

Since the three acquired mortgages were approaching their maturity dates, the Company refinanced the three newly-acquired properties with seven-year, nonrecourse mortgage financing, as shown in the table below. Interest expense on the mortgages for our properties was:
 
Acquisition/
 
Principal balance as of
 
 
 
 
 
 
 
 
Three months ended March 31,
 
refinancing date
 
 March 31, 2013
 
December 31, 2012
 
Maturity date
 
Interest rate
 
2013
 
2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Trail Creek
4/29/2011
 
$
15,275,000

 
$
15,275,000

 
5/1/2018
 
1 month LIBOR +
2.8%
 
$
114,722

 
$
118,458

Stone Rise
4/15/2011
 
19,500,000

 
19,500,000

 
5/1/2018
 
1 month LIBOR+
2.77%
 
144,991

 
149,744

Summit Crossing
4/21/2011
 
20,862,000

 
20,862,000

 
5/1/2018
 
Fixed
4.71%
 
245,650

 
248,379

Ashford Park
1/24/2013
 
25,626,000

 
N/A

 
2/1/2020
 
Fixed
3.13%
 
155,675

 

McNeil Ranch
1/24/2013
 
13,646,000

 
N/A

 
2/1/2020
 
Fixed
3.13%
 
83,784

 

Lake Cameron
1/24/2013
 
19,773,000

 
N/A

 
2/1/2020
 
Fixed
3.13%
 
117,966

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total
 
 
$
114,682,000

 
$
55,637,000

 
 
 
 
 
 
$
862,788

 
$
516,581


The Company paid loan origination costs to secure the three new mortgages of $907,477. In addition, the Company recorded amortization of deferred loan costs related to mortgages of $137,761 and $21,493 for the three months ended March 31, 2013 and March 31, 2012, respectively. The interest expense and deferred loan cost amortization for the Company's newly-acquired multifamily properties began with the closing dates of the refinancing transactions and so do not reflect a full quarterly period of expense.
Credit Facility
On August 31, 2012, the Company and the Operating Partnership entered into a credit agreement with Key Bank National Association, or Key Bank, to obtain a $15.0 million senior secured revolving credit facility, or the Credit Facility. The permitted uses of the Credit Facility are to fund investments, capital expenditures, dividends (with consent), working capital and other general corporate purposes on an as needed basis. Amounts drawn under the Credit Facility bear interest at a variable rate of the 1 month LIBOR index plus 500 basis points, or approximately 5.2% per annum at March 31, 2013, as well as a commitment fee on the average daily unused portion of the Credit Facility of 0.50% per annum. Accrued interest and commitment fees are payable monthly and principal amounts owed may be repaid in whole or in part without penalty. The Credit Facility has a maturity date of August 31, 2013. See note 17 for details regarding the expansion and amendment of the Credit Facility in April 2013.

Borrowings under the Credit Facility are collateralized by, among other things, pledges of 100% of the ownership of each of the current and future mezzanine loan subsidiaries, and 49% of the ownership of each of the current and future real estate subsidiaries, as well as by joint and several repayment guaranties.

The Credit Facility contains certain affirmative and negative covenants including negative covenants that limit or restrict secured and unsecured indebtedness, mergers and fundamental changes, investments and acquisitions, liens and encumbrances, dividends, transactions with affiliates, burdensome agreements, changes in fiscal year and other matters customarily restricted in such agreements. As of March 31, 2013, the Company was in compliance with all covenants related to the Credit Facility, as follows:


23

Preferred Apartment Communities, Inc.
Notes to Consolidated Financial Statements – (continued)
March 31, 2013
(Unaudited)

Covenant (1)
 
Requirement
 
Result
 
Senior leverage ratio
 
Maximum 65%
 
50%
 
Net worth
 
Minimum $50,000,000
 
$101,775,345
(2) 
Debt yield
 
Minimum 7.75%
 
11.19%
 
Payout ratio
 
Maximum 95%
 
88.8%
 
Total leverage ratio
 
Maximum 70%
 
50%
 
Debt service coverage ratio
 
Minimum 1.50x
 
3.03x
 

(1) All covenants are as defined in the credit agreement for the Credit Facility.
(2) Includes the $37.0 million net proceeds of the Series B Preferred Stock, which was classified as temporary equity
on the consolidated balance sheet at March 31, 2013.

At March 31, 2013, the Company and the Operating Partnership had fully repaid the balance due under the Credit Facility. Loan fees and closing costs for the establishment of the Credit Facility totaled $323,918, which are amortized over the life of the loan. Amortization expense related to these costs was $81,079 in addition to interest expense for the Credit Facility of $141,385 for the three-month period ended March 31, 2013. The weighted average interest rate was 5.19% for the three-month period ended March 31, 2013.

LIBOR was 0.209% on March 31, 2013. Based upon this current rate, the Company’s estimated future principal payments due on its debt instruments as of March 31, 2013 were:
Period
 
Future principal payments
2013
 
$

2014
 
609,133

2015
 
1,073,717

2016
 
1,112,173

2017
 
1,152,079

thereafter
 
110,734,898

 
 
 
Total
 
$
114,682,000

10. Income Taxes

The Company elected to be taxed as a REIT effective with its tax year ended December 31, 2011, and therefore, the Company will not be subject to federal and state income taxes after this effective date. For the period preceding this election date, the Company's operations resulted in a tax loss. As of December 31, 2010, the Company had deferred federal and state tax assets totaling approximately $298,100, none of which were based upon tax positions deemed to be uncertain. These deferred tax assets will most likely not be used since the Company elected REIT status, therefore, management has determined that a 100% valuation allowance is appropriate as of March 31, 2013 and 2012.

11. Commitments and Contingencies

The Company is not currently subject to any known material commitments or contingencies from its business operations, nor any material known or threatened litigation.

12.    Segment Information

The Company evaluates the performance of its business operations and allocates financial and other resources by assessing the financial results and outlook for future performance across two distinct segments: multifamily communities and real estate related financing.


24

Preferred Apartment Communities, Inc.
Notes to Consolidated Financial Statements – (continued)
March 31, 2013
(Unaudited)

Multifamily Communities - consists of owned residential multifamily communities.

Financing - consists of the Company's portfolio of mezzanine loans, bridge loans, and other instruments deployed by the Company to partially finance the development, construction, and prestabilization carrying costs of new multifamily communities and other real estate and real estate related assets.

The Company monitors net operating income (“NOI”) on a segment and a consolidated basis as a key performance measure for its operating segments. NOI is defined as rental and other property revenue from real estate assets plus interest income from its loan portfolio less total property operating and maintenance expenses, property management fees, real estate taxes, property insurance, and general and administrative expenses. The Company believes that NOI is an important supplemental measure of operating performance because it provides a measure of the core operations, rather than factoring in depreciation and amortization, financing costs, acquisition expenses, and other expenses generally incurred at the corporate level. The Company's definition of NOI is believed by the Company to be a widely accepted measure of comparative operating performance in the real estate investment community. The Company believes that NOI is a useful supplement to, but not a substitute for, its closest GAAP-compliant measure, which the Company believes to be the line on the Company's consolidated statement of operations entitled “net loss”.

The following tables present the Company's assets, revenues, and NOI results by reportable segment, as well as a reconciliation from NOI to net loss. The assets attributable to 'Other' primarily consist of deferred offering costs recorded but not yet reclassified as reductions of stockholders' equity and cash balances at the Company and Operating Partnership levels.

 
 
March 31, 2013
 
December 31, 2012
 
 
 
 
 
Assets:
 
 
 
 
Multifamily communities
 
$
166,941,769

 
$
77,292,922

Financing
 
45,862,101

 
39,222,062

Other
 
8,960,241

 
6,776,946

Consolidated assets
 
$
221,764,111

 
$
123,291,930

 
For the three-month period ended March 31, 2013, the Company's total expenditures for long-lived assets were $21,736,069, all of which were attributable to the multifamily communities segment. This amount consisted of recurring and non-recurring capital expenditures and the purchase of the three newly-acquired communities, net of mortgage debt assumed.
 
 
 
 
Three months ended:
 
 
 
 
March 31, 2013
 
March 31, 2012
Revenues
 
 
 
 
 
 
 
 
 
 
 
 
 
Multifamily communities
 
 
 
$
4,679,029

 
$
2,495,903

Financing
 
 
 
1,311,930

 
138,998

Consolidated revenues
 
 
 
$
5,990,959

 
$
2,634,901

 
 
 
 
 
 
 
Segment net operating income (Segment NOI)
 
 
 
 
 
 
 
Multifamily communities
 
 
 
$
2,808,462

 
$
1,560,624

Financing
 
 
 
1,311,930

 
138,968

Consolidated segment net operating income
 
4,120,392

 
1,699,592

 
 
 
 
 
 
 
Interest
 
 
 
1,141,935

 
538,075

Depreciation and amortization
 
4,112,303

 
977,402

Professional fees
 
165,323

 
83,182

Management fees
 
383,868

 
180,555

Acquisition costs
 
 
 
1,107,011

 
912

Equity compensation to directors and executives
 
308,921

 
319,580

Other
 
 
 
86,860

 
76,523

 
 
 
 
 
 
 
Net loss
 
$
(3,185,829
)
 
$
(476,637
)

25

Preferred Apartment Communities, Inc.
Notes to Consolidated Financial Statements – (continued)
March 31, 2013
(Unaudited)


13. Loss Per Share

The following is a reconciliation of weighted average basic and diluted shares outstanding used in the calculation of loss per share of Common Stock:
 
 
 
Three months ended March 31,
 
 
 
2013
 
2012
Numerator:
 
 
 
 
 
Net loss
 
$
(3,185,829
)
 
$
(476,637
)
 
Net loss attributable to non-controlling interests
 
61,486

 

 
Net income (loss) attributable to the Company
 
(3,124,343
)
 
(476,637
)
 
Dividends on Series A Redeemable Preferred Stock (See Note A below)
 
(360,039
)
 
(718
)
 
Dividends on Series B Redeemable Preferred Stock
 
(690,476
)
 

 
Earnings attributable to unvested restricted shares (See Note B below)
 
(4,792
)
 
(3,380
)
 
 
 
 
 
 
 
Net loss attributable to common stockholders
 
$
(4,179,650
)
 
$
(480,735
)
 
 
 
 
 
 
Denominator:
 
 
 
 
 
Weighted average number of shares of Common Stock - basic
 
5,289,690

 
5,151,164

 
Effect of dilutive securities (See Note C below):
 
 
 
 
 
Warrants
 

 

 
Class B Units
 

 

 
Weighted average number of shares of Common Stock - diluted
 
5,289,690

 
5,151,164

 
 
 
 
 
 
 
Loss per weighted average share - basic and diluted
 
$
(0.79
)
 
$
(0.09
)

(A) The Company’s 41,492 shares of Series A Preferred Stock outstanding accrue dividends at an annual rate of 6% of the stated value of $1,000 per share, payable monthly.

(B) The Company's unvested restricted share awards (33,046 and 26,000 shares of Common Stock at March 31, 2013 and 2012, respectively) contain non-forfeitable rights to distributions or distribution equivalents. The impact of the unvested restricted share awards on earnings per share has been calculated using the two-class method whereby earnings are allocated to the unvested restricted share awards based on dividends declared and the unvested restricted shares' participation rights in undistributed earnings. Given the Company has incurred net losses, the dividends declared for the three-month periods ended March 31, 2013 and 2012 are adjusted in determining the calculation of loss per share of Common Stock since the unvested restricted share awards are defined as participating securities.

(C) Potential dilution from 150,000 shares of Common Stock that would be outstanding due to the hypothetical exercise of a warrant issued by the Company to IAA on March 31, 2011 and warrants outstanding from issuances of Units from our Primary Series A Offering that are potentially exercisable into 830,440 shares of Common Stock, 106,988 Class A Units of the Operating Partnership, and a total of 148,174 unvested Class B Units issued on January 2, 2013 and August 15, 2012 were excluded from the diluted shares calculation because the effect was antidilutive.

15. Pro Forma Financial Information (unaudited)

The Company’s condensed pro forma financial results, assuming the acquisitions of McNeil Ranch, Lake Cameron, and Ashford Park were hypothetically completed on January 1, 2012 were:

26

Preferred Apartment Communities, Inc.
Notes to Consolidated Financial Statements – (continued)
March 31, 2013
(Unaudited)

 
 
 
 
Three months ended
 
 
 
 
March 31, 2013
 
March 31, 2012
Pro forma:
 
 
 
 
 
 
Revenue
 
 
$
6,660,770

 
$
5,362,862

 
Operating expenses:
 
 
 
 
 
Property operating and maintenance
 
1,268,884

 
1,260,470

 
Property management fees to related party
 
214,434

 
204,512

 
Real estate taxes
 
536,740

 
510,480

 
General and administrative
 
127,760

 
136,559

 
Equity compensation to directors and executives
 
308,921

 
319,580

 
Depreciation
 
2,003,982

 
2,135,523

 
Amortization of intangible assets
 

 
2,707,866

 
Acquisition costs
 

 
1,107,923

 
Management fees to related party
 
423,689

 
348,889

 
Insurance, professional fees, and other expenses
 
312,423

 
213,077

 
Total operating expenses
 
5,196,833

 
8,944,877

 
 
 
 
 
 
 
 
Operating income (loss)
 
1,463,937

 
(3,582,015
)
 
 
 
 
 
 
 
 
Less interest expense
 
1,246,537

 
1,033,391

 
 
 
 
 
 
 
 
Net income (loss)
 
 
217,400

 
(4,615,406
)
 
 
 
 
 
 
 
 
Less consolidated net loss attributable
 
 
 
 
 
to non-controlling interests
 
(4,196
)
 

 
 
 
 
 
 
 
 
Net income (loss) attributable to the Company
 
213,204

 
(4,615,406
)
 
 
 
 
 
 
 
 
Dividends to preferred stockholders
 
(1,188,609
)
 
(743,574
)
 
Earnings attributable to unvested restricted stock
 
(4,792
)
 
(3,380
)
 
 
 
 
 
 
 
 
Net loss attributable to common stockholders
 
$
(980,197
)
 
$
(5,362,359
)
 
 
 
 
 
 
 
 
Net loss per share of Common Stock
 
 
 
 
 
attributable to common stockholders, basic and diluted
 
$
(0.19
)
 
$
(1.04
)
 
 
 
 
 
 
 
 
Weighted average number of shares of Common
 
 
 
 
 
Stock outstanding, basic and diluted
 
5,289,690

 
5,151,164


These pro forma results are not necessarily indicative of what historical performance would have been had these business combinations been effective January 1, 2012, nor should they be interpreted as expectations of future results.

16. Fair Values of Financial Instruments

Fair value is defined as the price at which an asset or liability is exchanged between market participants in an orderly transaction at the reporting date. The Company’s cash equivalents, notes receivable, accounts receivable and payables and accrued expenses all approximate fair value due to their short term nature. The Company does not have any assets or liabilities measured at fair value on a recurring basis.

The following tables provide estimated fair values of the Company’s financial instruments. The carrying values of the Company's real estate loans and notes receivable include deferred interest receivable from additional interest or exit fee provisions and are presented net of deferred loan fee revenue, where applicable.


27

Preferred Apartment Communities, Inc.
Notes to Consolidated Financial Statements – (continued)
March 31, 2013
(Unaudited)

 
As of March 31, 2013
 
 
 
 
 
Fair value measurements
using fair value hierarchy
 
Carrying value
 
Fair Value
 
Level 1
 
Level 2
 
Level 3
Financial Assets: