EQUITY BASED AWARD PLANS

On May 4, 2011, our shareholders approved the Associated Estates Realty Corporation 2011 Equity-Based Award Plan (the "2011 Plan") which had been adopted by our Board of Directors (the "Board") on February 23, 2011, subject to shareholder approval.

A total of 1,726,608 common shares were made available for awards under the 2011 Plan, which included 1,500,000 newly authorized common shares and 226,608 common shares that remained available for awards under our 2008 Equity-Based Award Plan (the "2008 Plan") and our 2001 Equity Incentive Plan (the "2001 Plan"), both of which were approved by our shareholders. The 2011 Plan provides for the grant to our officers, other employees and directors of options to purchase our common shares, rights to receive the appreciation in value of common shares, awards of common shares subject to vesting and restrictions on transfer, awards of common shares issuable in the future upon satisfaction of certain conditions and other awards based on common shares. At December 31, 2013, we had 638,418 common shares available for awards under this plan.

Our 2001 and 2008 Plans were discontinued in May 2011 in conjunction with the shareholder approval of our 2011 Plan. Additionally, our Equity-Based Incentive Compensation Plan (the "Omnibus Plan") expired on February 20, 2005. Outstanding stock options awarded under these plans will remain in effect according to their original terms and conditions. Options were granted with per share exercise prices not less than fair market value at the date of grant and must be exercised within ten years thereof. Options outstanding and exercisable at December 31, 2013, were as follows:



	Options	Options
	Outstanding	Exercisable
2011 Plan	125,000	41,667
2008 Plan	—	—
2001 Plan	366,270	351,270
Omnibus Plan	18,750	18,750
	510,020	411,687

During 2013, 2012 and 2011, our share-based compensation awards consisted primarily of restricted shares. We award share-based compensation to our officers and employees as a performance incentive and to align individual goals with those of the Company. Certain of our share-based awards require only continued service with the Company to vest. These awards vest either at the end of the specified service period or in equal increments during the service period on each anniversary of the grant date. We recognize compensation cost on these awards on a straight-line basis. In addition to awards containing only service conditions, we issue certain awards in which the number of shares that will ultimately vest is dependent upon the achievement of specified performance goals and/or market conditions. Compensation cost for awards with performance conditions is recognized based on our best estimate of the number of shares that will vest. Compensation cost for awards dependent upon market conditions is recognized based on the estimated fair market value of the award on the date granted, as described below, and the vesting period. We estimate the amount of expected forfeitures when calculating compensation costs. The forfeiture rates we use were calculated based on our historical forfeiture activity, adjusted for activity that we believe is not representative of expected future activity. During the years ended December 31, 2013, 2012 and 2011, we recognized share-based compensation cost in "General and administrative expense" of $4.6 million, $3.7 million and $3.3 million, respectively. Additionally, during the years ended December 31, 2013, 2012 and 2011, we recognized $400,000, $200,000 and $80,000 of share-based compensation in capitalized payroll, respectively. See Note 2 for additional information related to capitalized payroll.

Restricted Shares. Restricted shares generally have the same rights as our common shares, except for transfer restrictions and forfeiture provisions. Cash distributions paid during the period of restriction on shares that are expected to vest are recorded as a charge to "Accumulated distributions in excess of accumulated net income." Cash distributions paid during the period of restriction on shares that are expected to be forfeited are recorded as a charge to expense.

We have two compensation plans under which our officers and directors may elect to defer the receipt of restricted shares. These plans are more fully discussed in Note 18. Restricted share awards deferred under these plans are reflected as deferred restricted share equivalent units ("DRSUs") in an individual bookkeeping account maintained for each participant. The vesting of such DRSUs occurs on the same schedule as the restricted shares made subject to the deferral election, and the valuation and attribution of cost in our consolidated financial statements are also the same as the restricted shares made subject to the deferral election.

The following table represents restricted share and DRSU activity for the year ended December 31, 2013:



		Weighted			Weighted
	Number of	Average			Average
	Restricted	Grant-Date		Number of	Grant-Date
	Shares	Fair Value		DRSUs	Fair Value

Nonvested at beginning of period	525,406	$	9.23	58,825	$	14.13
Granted	758,193	$	10.44	25,848	$	17.44
Vested	466,906	$	9.19	48,011	$	13.94
Forfeited	81,509	$	8.48	1,865	$	8.38
Nonvested at end of period	735,184	$	10.52	34,797	$	17.15

The weighted average grant-date fair value of restricted shares granted during the years ended December 31, 2012 and 2011 was $16.48 and $15.19, respectively. The total fair value of restricted shares vested during the years ended December 31, 2013, 2012 and 2011 was $7.6 million, $2.9 million and $2.7 million, respectively. The total fair value of RSUs vested during the years ended December 31, 2013, 2012 and 2011 was $669,000, $715,000 and $1.0 million, respectively, recognized as "Paid-in-capital." At December 31, 2013, there was a total of $5.4 million of unrecognized compensation cost related to non-vested restricted share awards and RSUs that we expect to recognize over a weighted average period of 2.5 years.

During 2013, we issued restricted share awards in which the number of shares that will ultimately vest is subject to market conditions over a three-year period and service conditions over a four-year period. The total estimated grant-date fair value of these awards, including the awards that were deferred, was $4.3 million. We used the Monte Carlo method to estimate the fair value of these awards. The Monte Carlo method, which is similar to the binomial analysis, evaluates the award for changing stock prices over the term of vesting, and uses random situations that are averaged based on past stock characteristics. There were one million simulation paths used to estimate the fair value of these awards. The expected volatility for the awards granted in 2013 was based upon a 50/50 blend of historical and implied volatility. The historical volatility was based upon changes in the weekly closing prices of our shares over a period equal to the expected life of the restricted shares granted. The implied volatility was the trailing month average of daily implied volatilities calculated by interpolating between the volatilities implied by stock call option contracts that were both closest to the expected life and the exercise price of the restricted shares. The risk-free interest rate used was based on a yield curve derived from U.S. Treasury zero-coupon bonds on the date of grant with a maturity equal to the market condition performance periods. The expected life used was the market condition performance period.

The following table represents the assumption ranges used in the Monte Carlo method during 2013:



Expected volatility - AERC		18.1% to 22.5%
Expected volatility - peer group		14.7% to 29.5%
Risk-free interest rate		0.1% to 0.5%
Expected life (performance period)		3 years

Stock Options. We use the Black-Scholes option pricing model to estimate the fair value of stock options awarded. There were no options granted in 2013 and 2011, and 125,000 options granted in 2012. The weighted average Black-Scholes assumptions and fair value for 2012 were as follows:



Expected volatility	33.9		%
Risk-free interest rate	1.3		%
Expected life of options	7 years
Dividend yield	4.7		%
Grant-date fair value	$	2.97

The expected volatility was based upon a 50/50 blend of historical and implied volatility. The historical volatility based upon changes in the weekly closing prices of our shares over a period equal to the expected life of the options granted. The implied volatility was the trailing month average of daily implied volatilities calculated by interpolating between the volatilities implied by stock call option contracts that were both closest to the expected life and the exercise price of the options. The longest terms of such options over the trailing month averaged 7.1 months. The risk-free interest rate used was the yield from U.S. Treasury zero-coupon bonds on the date of the grant with a maturity equal to the expected life of the options. The expected life was derived using our historical experience for similar awards. The dividend yield was derived using our annual dividend rate as a percentage of the price of our shares on the date of grant.

The following table represents stock option activity for the year ended December 31, 2013:



				Weighted-
	Number of	Weighted-		Average
	Stock	Average		Remaining
	Options	Exercise Price		Contract Life
Outstanding at beginning of period	769,184	$	10.81
Exercised	259,164	$	9.53
Outstanding at end of period	510,020	$	11.47	3.6

Exercisable at end of period	411,687	$	10.73	2.6

The aggregate intrinsic value of stock options outstanding and stock options exercisable at December 31, 2013, was $2.4 million and $2.2 million, respectively.