Fair Value of Derivatives and Financial Instruments

6 Months Ended

Jun. 30, 2011

FAIR VALUE OF DERIVATIVES AND FINANCIAL INSTRUMENTS

10. 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 June 30, 2011 and December 31, 2010 are summarized as follows (dollars in thousands):

			Fair Value at June 30, 2011 Using
			Quoted Prices in
			Active Markets		Significant
			for Identical		Other		Significant
			Assets or		Observable		Unobservable
			Liabilities		Inputs		Inputs
	June 30, 2011		(Level 1)		(Level 2)		(Level 3)
Description:
Derivatives- Interest rate contracts (c)	$	148	$	—	$	148	$	—
Total assets	$	148	$	—	$	148	$	—
Derivatives- Interest rate contracts (c)	$	9,979	$	—	$	9,979	$	—
Contingent purchase consideration (d)		5,402		—		—		5,402
Secured debt instruments- fixed rate: (a)
Mortgage notes payable		597,645		—		—		597,645
Fannie Mae credit facilities		931,648		—		—		931,648
Secured debt instruments- variable rate: (a)
Mortgage notes payable		177,201		—		—		177,201
Tax-exempt secured notes payable		94,700		—		—		94,700
Fannie Mae credit facilities		260,451		—		—		260,451
Unsecured debt instruments: (b)
Commercial bank		5,000		—		—		5,000
Senior Unsecured Notes		1,778,649		97,099		—		1,681,550
Total liabilities	$	3,860,675	$	97,099	$	9,979	$	3,753,597

			Fair Value at December 31, 2010 Using
			Quoted Prices in
			Active Markets		Significant
			for Identical		Other		Significant
			Assets or		Observable		Unobservable
			Liabilities		Inputs		Inputs
	December 31, 2010		(Level 1)		(Level 2)		(Level 3)
Description:
Available-for-sale equity securities	$	3,866	$	3,866	$	—	$	—
Derivatives- Interest rate contracts (c)		514		—		514		—
Total assets	$	4,380	$	3,866	$	514	$	—
Derivatives- Interest rate contracts (c)	$	6,597	$	—	$	6,597	$	—
Contingent purchase consideration (d)		5,402		—		—		5,402
Secured debt instruments- fixed rate: (a)
Mortgage notes payable		306,515		—		—		306,515
Tax-exempt secured notes payable		13,885		—		—		13,885
Fannie Mae credit facilities		927,413		—		—		927,413
Secured debt instruments- variable rate: (a)
Mortgage notes payable		405,641		—		—		405,641
Tax-exempt secured notes payable		94,700		—		—		94,700
Fannie Mae credit facilities		260,450		—		—		260,450
Unsecured debt instruments: (b)
Commercial bank		31,750		—		—		31,750
Senior Unsecured Notes		1,625,492		264,849		—		1,360,643
Total liabilities	$	3,677,845	$	264,849	$	6,597	$	3,406,399

(a)	See Note 6, “Secured Debt”
(b)	See Note 7, “Unsecured Debt”
(c)	See Note 11, “Derivatives and Hedging Activity”
(d)	In the first quarter of 2010, the Company accrued a liability of $6 million related to a contingent purchase consideration on one of its properties. The contingent consideration was determined based on the fair market value of the related asset which is estimated using Level 3 inputs utilized in a third party appraisal. During the year ended December 31, 2010, the Company paid approximately $635,000 of the liability, and the outstanding balance is due January 2012.

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 June 30, 2011 and 2010, 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.

We estimate the fair value of our Convertible Senior Unsecured Notes based on Level 1 inputs which utilize quoted prices in active markets where we have the ability to access value for identical liabilities.

Redeemable non-controlling interests in the Operating Partnership have a redemption feature and are marked to its 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 non-controlling interests in the Operating Partnership are classified as Level 2.

Financial Instruments Not Carried at Fair Value

At June 30, 2011, the fair values of cash and cash equivalents, restricted cash, notes receivable, 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 were determined by the Company using available market information and appropriate valuation methodologies. Considerable judgment is necessary to interpret market data and develop estimated fair values. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Company would realize on the disposition of the financial instruments. The use of different market assumptions or estimation methodologies may have a material effect on the estimated fair value amounts.

We estimate the fair value of our debt instruments by discounting the remaining cash flows of the debt instrument at a discount rate equal to the replacement market credit spread plus the corresponding treasury yields. Factors considered in determining a replacement market credit spread include general market conditions, borrower specific credit spreads, time remaining to maturity, loan-to-value ratios and collateral quality (Level 3).

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 investments in an unconsolidated joint venture 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 decrease in the value of its other investments in unconsolidated joint ventures during the three and six months ended June 30, 2011 and 2010, respectively.

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.

United Dominion Reality.L.P [Member]

FAIR VALUE OF DERIVATIVES AND FINANCIAL INSTRUMENTS

7. 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 Operating Partnership’s financial instruments either recorded or disclosed on a recurring basis as of June 30, 2011 and December 31, 2010 are summarized as follows (dollars in thousands):

			Fair Value at June 30, 2011 Using
			Quoted Prices in
			Active Markets
			for Identical		Significant Other		Significant
			Assets or		Observable		Unobservable
			Liabilities		Inputs		Inputs
	June 30, 2011		(Level 1)		(Level 2)		(Level 3)
Description:
Derivatives- Interest rate contracts (b)	$	108	$	—	$	108	$	—
Total assets	$	108	$	—	$	108	$	—
Derivatives- Interest rate contracts (b)	$	5,436	$	—	$	5,436	$	—
Contingent purchase consideration (c)		5,402		—		—		5,402
Secured debt instruments- fixed rate: (a)
Mortgage notes payable		467,855		—		—		467,855
Fannie Mae credit facilities		564,988		—		—		564,988
Secured debt instruments- variable rate: (a)
Mortgage notes payable		69,317		—		—		69,317
Tax-exempt secured notes payable		27,000		—		—		27,000
Fannie Mae credit facilities		175,948		—		—		175,948
Total liabilities	$	1,315,946	$	—	$	5,436	$	1,310,510

			Fair Value at December 31, 2010 Using
			Quoted Prices in
			Active Markets
			for Identical		Significant Other		Significant
			Assets or		Observable		Unobservable
			Liabilities		Inputs		Inputs
	December 31, 2010		(Level 1)		(Level 2)		(Level 3)
Description:
Derivatives- Interest rate contracts (b)	$	376	$	—	$	376	$	—
Total assets	$	376	$	—	$	376	$	—
Derivatives- Interest rate contracts (b)	$	5,111	$	—	$	5,111	$	—
Contingent purchase consideration (c)		5,402		—		—		5,402
Secured debt instruments- fixed rate: (a)
Mortgage notes payable		205,750		—		—		205,750
Tax-exempt secured notes payable		13,885		—		—		13,885
Fannie Mae credit facilities		576,069		—		—		576,069
Secured debt instruments- variable rate: (a)
Mortgage notes payable		100,590		—		—		100,590
Tax-exempt secured notes payable		27,000		—		—		27,000
Fannie Mae credit facilities		175,948		—		—		175,948
Total liabilities	$	1,109,755	$	—	$	5,111	$	1,104,644

(a)	See Note 5, Debt
(b)	See Note 8, Derivatives and Hedging Activity
(c)	During the first quarter of 2010, the Operating Partnership accrued a liability of $6.0 million related to a contingent purchase consideration on one of its properties. The contingent consideration was determined based on the fair market value of the related asset which is estimated using Level 3 inputs utilized in a third party appraisal. During the year ended December 31, 2010, the Company paid approximately $635,000 of the liability, and the outstanding balance is due January 2012.

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

Although the Operating Partnership 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 June 30, 2011 and December 31, 2010, the Operating Partnership 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 Operating Partnership has determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.

Financial Instruments Not Carried at Fair Value

At June 30, 2011, 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 were determined by the Operating Partnership using available market information and appropriate valuation methodologies. Considerable judgment is necessary to interpret market data and develop estimated fair values. Accordingly, the estimates presented herein are not necessarily indicative of the amounts the Operating Partnership would realize on the disposition of the financial instruments. The use of different market assumptions or estimation methodologies may have a material effect on the estimated fair value amounts.

The General Partner estimates the fair value of our debt instruments by discounting the remaining cash flows of the debt instrument at a discount rate equal to the replacement market credit spread plus the corresponding treasury yields. Factors considered in determining a replacement market credit spread include general market conditions, borrower specific credit spreads, time remaining to maturity, loan-to-value ratios and collateral quality (Level 3).

The Operating Partnership records 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. Cash flow estimates are based upon historical results adjusted to reflect management’s 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. The General Partner’s estimates of fair value represent management’s estimates based upon Level 3 inputs such as industry trends and reference to market rates and transactions.