12. FAIR VALUE OF DERIVATIVES AND FINANCIAL INSTRUMENTS

Fair value is based on the price that would be received to sell an asset or the exit price that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date. A three-level valuation hierarchy prioritizes observable and unobservable inputs used to measure fair value. The fair value hierarchy consists of three broad levels, which are described below:

Level 1 — Quoted prices in active markets for identical assets or liabilities that the entity has the ability to access.

Level 2 — Observable inputs other than prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated with observable market data.

Level 3 — Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets and liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.

The estimated fair values of the Company’s financial instruments either recorded or disclosed on a recurring basis as of December 31, 2018 and 2017 are summarized as follows (dollars in thousands):


					Fair Value at December 31, 2018, Using
	Total				Quoted
	Carrying				Prices in
	Amount in				Active
	Statement of				Markets		Significant
	Financial		Fair Value		for Identical		Other		Significant
	Position at		Estimate at		Assets or		Observable		Unobservable
	December 31,		December 31,		Liabilities		Inputs		Inputs
	2018		2018		(Level 1)		(Level 2)		(Level 3)
Description:
Notes receivable (a)	$	42,259	$	45,026	$	—	$	—	$	45,026
Derivatives - Interest rate contracts (b)		4,757		4,757		—		4,757		—
Total assets	$	47,016	$	49,783	$	—	$	4,757	$	45,026

Derivatives - Interest rate contracts (b)	$	356	$	356	$	—	$	356	$	—
Secured debt instruments - fixed rate: (c)
Mortgage notes payable		417,989		416,314		—		—		416,314
Fannie Mae credit facilities		90,000		90,213		—		—		90,213
Secured debt instruments - variable rate: (c)
Tax-exempt secured notes payable		94,700		94,700		—		—		94,700
Unsecured debt instruments: (c)
Working capital credit facility		16		16		—		—		16
Commercial paper program		101,115		101,115		—		—		101,115
Unsecured notes		2,861,842		2,829,390		—		—		2,829,390
Total liabilities	$	3,566,018	$	3,532,104	$	—	$	356	$	3,531,748

Redeemable noncontrolling interests in the Operating Partnership and DownREIT Partnership (d)	$	972,740	$	972,740	$	—	$	972,740	$	—


					Fair Value at December 31, 2017, Using
	Total				Quoted
	Carrying				Prices in
	Amount in				Active
	Statement of				Markets		Significant
	Financial		Fair Value		for Identical		Other		Significant
	Position at		Estimate at		Assets or		Observable		Unobservable
	December 31,		December 31,		Liabilities		Inputs		Inputs
	2017		2017		(Level 1)		(Level 2)		(Level 3)
Description:
Notes receivable (a)	$	19,469	$	19,567	$	—	$	—	$	19,567
Derivatives - Interest rate contracts (b)		5,743		5,743		—		5,743		—
Total assets	$	25,212	$	25,310	$	—	$	5,743	$	19,567

Secured debt instruments - fixed rate: (c)
Mortgage notes payable	$	395,611	$	397,386	$	—	$	—	$	397,386
Fannie Mae credit facilities		285,836		292,227		—		—		292,227
Secured debt instruments - variable rate: (c)
Tax-exempt secured notes payable		94,700		94,700		—		—		94,700
Fannie Mae credit facilities		29,034		29,034		—		—		29,034
Unsecured debt instruments: (c)
Working capital credit facility		21,767		21,767		—		—		21,767
Commercial paper program		300,000		300,000		—		—		300,000
Unsecured notes		2,561,122		2,611,458		—		—		2,611,458
Total liabilities	$	3,688,070	$	3,746,572	$	—	$	—	$	3,746,572

Redeemable noncontrolling interests in the Operating Partnership and DownREIT Partnership (d)	$	948,138	$	948,138	$	—	$	948,138	$	—

(a)

See Note 2, Significant Accounting Policies.

(b)

See Note 13, Derivatives and Hedging Activity.

(c)

See Note 6, Secured and Unsecured Debt, Net.

(d)

See Note 11, Noncontrolling Interests.

There were no transfers into or out of any of the levels of the fair value hierarchy during the year ended December 31, 2018.

Financial Instruments Carried at Fair Value

The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts). The variable cash payments (or receipts) are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. The fair values of interest rate options are determined using the market standard methodology of discounting the future expected cash receipts that would occur if variable interest rates rise above the strike rate of the caps. The variable interest rates used in the calculation of projected receipts on the cap are based on an expectation of future interest rates derived from observable market interest rate curves and volatilities.

The Company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Company has considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees.

Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of December 31, 2018 and 2017, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives. As a result, the Company has determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy. In conjunction with the FASB’s fair value measurement guidance, the Company made an accounting policy election to measure the credit risk of its derivative financial instruments that are subject to master netting agreements on a net basis by counterparty portfolio.

Redeemable noncontrolling interests in the Operating Partnership and DownREIT Partnership have a redemption feature and are marked to their redemption value. The redemption value is based on the fair value of the Company’s common stock at the redemption date, and therefore, is calculated based on the fair value of the Company’s common stock at the balance sheet date. Since the valuation is based on observable inputs such as quoted prices for similar instruments in active markets, redeemable noncontrolling interests in the Operating Partnership and DownREIT Partnership are classified as Level 2.

Financial Instruments Not Carried at Fair Value

At December 31, 2018, the fair values of cash and cash equivalents, restricted cash, accounts receivable, prepaids, real estate taxes payable, accrued interest payable, security deposits and prepaid rent, distributions payable and accounts payable approximated their carrying values because of the short term nature of these instruments. The estimated fair values of other financial instruments, which includes notes receivable and debt instruments, are classified in Level 3 of the fair value hieracrchy due to the significant unobservable inputs that are utilized in their respective valuations.

We record impairment losses on long-lived assets used in operations when events and circumstances indicate that the assets might be impaired and the undiscounted cash flows estimated to be generated by the future operation and disposition of those assets are less than the net book value of those assets. Our cash flow estimates are based upon historical results adjusted to reflect our best estimate of future market and operating conditions and our estimated holding periods. The net book value of impaired assets is reduced to fair value. Our estimates of fair value represent our best estimate based upon Level 3 inputs such as industry trends and reference to market rates and transactions.

We consider various factors to determine if a decrease in the value of our Investment in and advances to unconsolidated joint ventures, net is other-than-temporary. These factors include, but are not limited to, age of the venture, our intent and ability to retain our investment in the entity, the financial condition and long-term prospects of the entity, and the relationships with the other joint venture partners and its lenders. Based on the significance of the unobservable inputs, we classify these fair value measurements within Level 3 of the valuation hierarchy. The Company did not incur any other-than-temporary impairments in the value of its investments in unconsolidated joint ventures during the years ended December 31, 2018, 2017, and 2016.

After determining an other-than-temporary decrease in the value of an equity method investment has occurred, we estimate the fair value of our investment by estimating the proceeds we would receive upon a hypothetical liquidation of the investment at the date of measurement. Inputs reflect management’s best estimate of what market participants would use in pricing the investment giving consideration to the terms of the joint venture agreement and the estimated discounted future cash flows to be generated from the underlying joint venture assets. The inputs and assumptions utilized to estimate the future cash flows of the underlying assets are based upon the Company’s evaluation of the economy, market trends, operating results, and other factors, including judgments regarding costs to complete any construction activities, lease up and occupancy rates, rental rates, inflation rates, capitalization rates utilized to estimate the projected cash flows at the disposition, and discount rates.