Investments in Real Estate Entities

Investments in Unconsolidated Real Estate Entities

The Company accounts for its investments in unconsolidated real estate entities under the equity method of accounting, as discussed in Note 1, “Organization, Basis of Presentation and Significant Accounting Policies,” under Principles of Consolidation. The significant accounting policies of the Company's unconsolidated real estate entities are consistent with those of the Company in all material respects.

As of December 31, 2016, the Company had investments in the following real estate entities:

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AvalonBay Value Added Fund II, L.P. (“Fund II”)—In September 2008, the Company formed Fund II, a private, discretionary real estate investment vehicle which acquired and operates communities in the Company's markets. Fund II served as the exclusive vehicle through which the Company acquired investment interests in apartment communities, subject to certain exceptions, through the close of its investment period in August 2011. Fund II has six institutional investors, including the Company. One of the Company's wholly owned subsidiaries is the general partner of Fund II and at December 31, 2016, excluding costs incurred in excess of equity in the underlying net assets of Fund II, the Company has an equity investment of $19,737,000 (net of distributions), representing a 31.3% combined general partner and limited partner equity interest.

During 2016, Fund II sold three communities containing an aggregate of 1,514 apartment homes:


•	Eaves Rancho San Diego, located in El Cajon, CA, for $158,000,000,


•	Eaves Tustin, located in Tustin, CA, for $163,550,000, and


•	Eaves Rockville, located in Rockville, MD, for $61,400,000.

The Company's proportionate share of the gain in accordance with GAAP for the three dispositions was $41,501,000. In conjunction with the disposition of these communities, Fund II repaid $156,248,000 of related secured indebtedness in advance of the scheduled maturity dates. This resulted in charges for prepayment penalties and write-offs of deferred financing costs, of which the Company’s portion was $1,768,000 and was reported as a reduction of equity in income of unconsolidated real estate entities on the accompanying Consolidated Statements of Comprehensive Income.

The Company has an equity interest of 31.3% in Fund II, and upon achievement of a threshold return the Company has a right to incentive distributions for its promoted interest representing the first 20.0% of further Fund II distributions, which are in addition to its share of the remaining 80.0% of distributions. During the year ended December 31, 2016, the Company recognized income of $7,985,000 for its promoted interest, which is reported as a component of equity in income of unconsolidated real estate entities on the accompanying Consolidated Statements of Comprehensive Income.

Subsidiaries of Fund II have four loans secured by individual assets with aggregate amounts outstanding of $128,008,000, with maturity dates that vary from November 2017 to April 2019. The mortgage loans are payable by the subsidiaries of Fund II from operating cash flow or disposition proceeds from the underlying real estate. The Company has not guaranteed repayment of this debt, nor does the Company have any obligation to fund this debt should Fund II be unable to do so.

•

Archstone Multifamily Partners AC LP (the “U.S. Fund”)—The U.S. Fund was formed in July 2011 and is fully invested. The U.S. Fund has a term that expires in July 2023, assuming the exercise of two, one-year extension options. The U.S. Fund has six institutional investors, including the Company. The Company is the general partner of the U.S. Fund and, at December 31, 2016 excluding costs incurred in excess of equity in the underlying net assets of the U.S. Fund, the Company has an equity investment of $49,693,000 (net of distributions), representing a 28.6% combined general partner and limited partner equity interest. The Company acquired its interest in the U.S. Fund as part of the Archstone Acquisition.

During 2016, the U.S. Fund sold two communities containing an aggregate of 461 apartment homes:


•	Archstone Boca Town Center, located in Boca Raton, FL, for $56,300,000, and


•	Avalon Kips Bay, located in New York, NY, for $173,000,000.

The Company's proportionate share of the gain in accordance with GAAP for the two dispositions was $16,568,000. In conjunction with the disposition of these communities, the U.S. Fund repaid $94,822,000 of related secured indebtedness in advance of the scheduled maturity dates. This resulted in charges for prepayment penalties and write-offs of deferred financing costs, of which the Company’s portion was $2,003,000 and was reported as a reduction of equity in income of unconsolidated real estate entities on the accompanying Consolidated Statements of Comprehensive Income.

Subsidiaries of the U.S. Fund have eight loans secured by individual assets with aggregate amounts outstanding of $274,255,000, with maturity dates that vary from February 2019 to November 2022. The mortgage loans are payable by the subsidiaries of the U.S. Fund with operating cash flow or disposition proceeds from the underlying real estate. The Company has not guaranteed the debt of the U.S. Fund, nor does the Company have any obligation to fund this debt should the U.S. Fund be unable to do so.

•

Multifamily Partners AC JV LP (the “AC JV”)—The AC JV is a joint venture that was formed in 2011 and has four institutional investors, including the Company. Excluding costs incurred in excess of equity in the underlying net assets of the AC JV, at December 31, 2016 the Company has an equity investment of $50,674,000 (net of distributions), representing a 20.0% equity interest. The Company acquired its interest in the AC JV as part of the Archstone Acquisition.

The AC JV partnership agreement contains provisions that require the Company to provide a right of first offer (“ROFO”) to the AC JV in connection with additional opportunities to acquire or develop additional interests in multifamily real estate assets within a specified geographic radius of the existing assets, generally one mile or less. The ROFO restriction expires in 2019.

As of December 31, 2016, subsidiaries of the AC JV have eight unsecured loans outstanding in the aggregate of $162,300,000 which mature in August 2021, and which were made by the investors in the venture, including the Company, in proportion to the investors' respective equity ownership interest. The unsecured loans are payable by the subsidiaries of the AC JV with operating cash flow from the venture. The Company has not guaranteed the debt of the AC JV, nor does the Company have any obligation to fund this debt should the AC JV be unable to do so.

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MVP I, LLC—In December 2004, the Company entered into a joint venture agreement with an unrelated third-party for the development of Avalon at Mission Bay II. Construction of Avalon at Mission Bay II, a 313 apartment-home community located in San Francisco, California, was completed in December 2006. The Company holds a 25.0% equity interest in the venture. The Company is responsible for the day-to-day operations of the community and is the management agent subject to the terms of a management agreement.

During 2015, the Company received $20,680,000 from the joint venture partner associated with MVP I, LLC, upon agreement with the partner to modify the joint venture agreement to eliminate the Company's promoted interest from associated distributions for future return calculations. Before this modification to the joint venture agreement, the Company had the right to 45.0% of distributions after achievement of a threshold return, which was achieved in 2015, up to the date the joint venture agreement was modified, as well as in 2014. Subsequent to the modification, earnings and distributions are based on the Company's 25.0% equity interest in the venture.


•	Brandywine Apartments of Maryland, LLC (“Brandywine”)—Brandywine owns a 305 apartment home community located in Washington, D.C. The community is managed by a third party. Brandywine is comprised of five members who hold various interests in the joint venture. The Company holds a 28.7% equity interest in Brandywine.

Brandywine has an outstanding $23,307,000 fixed rate mortgage loan that is payable by the venture. The Company has not guaranteed the debt of Brandywine, nor does the Company have any obligation to fund this debt should Brandywine be unable to do so.

•

Residual JV—Through subsidiaries, the Company and Equity Residential entered into three limited liability company agreements (collectively, the “Residual JV”) through which the Company and Equity Residential acquired (i) certain assets of Archstone that the Company and Equity Residential have substantially divested (the “Residual Assets”), and (ii) various liabilities of Archstone that the Company and Equity Residential agreed to assume in conjunction with the Archstone Acquisition (the “Residual Liabilities”). The Residual Assets included a 20.0% interest in Lake Mendota Investments, LLC and Subsidiaries (“SWIB”), a joint venture which disposed the last of its communities in 2015, as well as various licenses, insurance policies, contracts, office leases and other miscellaneous assets.

The Residual Liabilities include most existing or future litigation and claims related to Archstone’s operations for periods before the close of the Archstone Acquisition, except for (i) claims that principally relate to the physical condition of the assets acquired directly by the Company or Equity Residential, which generally remain the sole responsibility of the Company or Equity Residential, as applicable, and (ii) certain tax and other litigation between Archstone and various equity holders in Archstone related to periods before the close of the Archstone Acquisition, and claims which may arise due to changes in the capital structure of Archstone that occurred prior to closing, for which the seller has agreed to indemnify the Company and Equity Residential. The Company and Equity Residential jointly control the Residual JV and the Company holds a 40.0% economic interest in the Residual JV.

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Legacy JV—As part of the Archstone Acquisition the Company entered into a limited liability company agreement with Equity Residential, through which it assumed obligations of Archstone in the form of preferred interests, some of which are governed by tax protection arrangements (the “Legacy JV”). The Company has a 40.0% interest in the Legacy JV. During the years ended December 31, 2016, 2015 and 2014, the Legacy JV redeemed certain of the preferred interests and paid accrued dividends, of which the Company's portion was $1,960,000, $14,410,000 and $6,300,000, respectively. At December 31, 2016, the remaining preferred interests had an aggregate liquidation value of $39,921,000, the Company's share of which is included in accrued expenses and other liabilities in the accompanying Consolidated Balance Sheets.

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Sudbury Development, LLC—During 2015, the Company entered into a joint venture agreement to purchase land and pursue entitlements and pre-development activity for a mixed-use development project in Sudbury, MA, including multifamily apartment homes, retail, senior housing and age-restricted housing. The Company has a 60.0% ownership interest in the venture. The venture is considered a VIE, though the Company is not considered to be the primary beneficiary because the Company and its third party partner share control of the joint venture as approval from both parties is required for all significant aspects of the venture's activities including, but not limited to, changes in the ownership or capital structure of the partnership, acquisitions or dispositions by the venture and decisions about the pre-development and related activities to be performed by the venture. At December 31, 2016, the Company has an equity investment of $6,680,000 in the venture, representing the Company's share of land acquisition and pre-development costs, net of distributions of proceeds from land sales by the venture.

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Avalon Clarendon—In May 2016, the Company entered into a joint venture agreement to facilitate the acquisition of Avalon Clarendon, located in Arlington, VA. Avalon Clarendon is part of a mixed-use development containing residential, retail, office and public parking. The Company contributed $120,300,000 to the venture for the Company's share of the purchase price. The Company had shared control of the overall venture with its partner, but had all of the rights and obligations associated with the residential component of Avalon Clarendon, containing 300 apartment homes. The joint venture partner had all of the rights and obligations associated with the retail, office and public parking components of the mixed-use development. In September 2016, the Company and its venture partner established separate legal ownership of the residential and retail, office and public parking components of the venture, and the Company retained all of the rights and obligations associated with the residential component. After this legal separation, the Company began reporting the operating results of Avalon Clarendon as part of its consolidated operations. In conjunction with the consolidation of Avalon Clarendon, the Company recorded the consolidated assets at fair value applying the framework discussed below under “Investments in Consolidated Real Estate Entities” for valuation, resulting in a gain of $4,322,000 for the difference between the fair value of Avalon Clarendon and the Company's equity interest at the date of consolidation of $115,848,000, primarily attributable to depreciation recognized during the period the community was owned in the joint venture. The Company has included this gain as a component of gain on sale of communities on the accompanying Consolidated Statements of Comprehensive Income.

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North Point II JV, LP—During 2016, the Company entered into a joint venture to develop, own, and operate AVA North Point, an apartment community located in Cambridge, MA, which is currently under construction and expected to contain 265 apartment homes upon completion. The Company owns a 55.0% interest in the venture, and the venture partner owns the remaining 45.0% interest. The venture is considered to be a VIE, though the Company is not considered to be the primary beneficiary because the Company and its third party partner share control of the venture. The Company and its venture partner share decision making authority for all significant aspects of the venture's activities including, but not limited to, changes in the ownership or capital structure, the original capital budget and any changes to the budget to construct AVA North Point and the future operating budget for the community upon completion. AVA North Point is the third phase of a master planned development, the other phases of which are owned through the AC JV. During 2016, the Company provided the partners of the AC JV the opportunity to acquire the AVA North Point land parcel owned by the Company as required in the ROFO provisions for the AC JV. After certain partners of the AC JV declined to participate, the Company entered into the new joint venture and sold the land parcel to the venture in exchange for a cash payment and a capital account credit, and is overseeing the development in exchange for a developer fee. Upon sale of the land parcel, the Company recognized a gain of $10,621,000, included in gain on sale of other real estate on the accompanying Consolidated Statements of Comprehensive Income. At December 31, 2016, excluding costs incurred in excess of equity in the underlying net assets of North Point II JV, LP, the Company has an equity investment of $12,398,000.

The following is a combined summary of the financial position of the entities accounted for using the equity method as of the dates presented, excluding amounts associated with development joint ventures, the Residual JV and Legacy JV (dollars in thousands):



	12/31/16		12/31/15
Assets:
Real estate, net	$	954,493	$	1,392,833
Other assets	49,519		57,044
Total assets	$	1,004,012	$	1,449,877
Liabilities and partners' capital:
Mortgage notes payable, net and credit facility	$	689,573	$	947,205
Other liabilities	16,537		20,471
Partners' capital	297,902		482,201
Total liabilities and partners' capital	$	1,004,012	$	1,449,877

The following is a combined summary of the operating results of the entities accounted for using the equity method, for the years presented, excluding amounts associated with development joint ventures, Avalon Clarendon, the Residual JV and Legacy JV (dollars in thousands):



	For the year ended
	12/31/16			12/31/15			12/31/14
Rental and other income	$	131,901		$	173,578		$	198,939
Operating and other expenses	(50,945		)	(67,962		)	(80,301		)
Gain on sale of communities	196,749			98,899			333,221
Interest expense, net (1)	(45,886		)	(45,517		)	(61,458		)
Depreciation expense	(34,471		)	(45,324		)	(52,116		)
Net income	$	197,348		$	113,674		$	338,285

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(1)	Amounts for the years ended December 31, 2016, 2015 and 2014 includes charges for prepayment penalties and write-offs of deferred financing costs of $12,659, $4,481 and $10,528, respectively.

In conjunction with the formation of Fund II and AVA North Point, and the acquisition of the U.S. Fund, AC JV and Brandywine, the Company incurred costs in excess of its equity in the underlying net assets of the respective investments. These costs represent $38,015,000 and $40,978,000 at December 31, 2016 and 2015, respectively, of the respective investment balances. These amounts are being amortized over the lives of the underlying assets as a component of equity in income of unconsolidated real estate entities on the accompanying Consolidated Statements of Comprehensive Income.

The following is a summary of the Company's equity in income of unconsolidated real estate entities for the years presented (dollars in thousands):



	For the year ended
	12/31/16			12/31/15			12/31/14
Fund I (1)	$	87		$	871		$	475
Fund II (2)	49,882			32,211			24,808
U.S. Fund (3)	15,635			2,052			342
AC JV	1,445			511			1,579
MVP I, LLC (4)	1,627			22,453			1,651
Brandywine	10			(1,474		)	828
CVP I, LLC (5)	9			1,812			113,127
Residual JV	(1,374		)	11,582			3,547
Avalon Clarendon (6)	(2,359		)	—			—
Arna Valley View LP (1)	—			—			2,406
Juanita Village (1)	—			—			3
Total	$	64,962		$	70,018		$	148,766

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(1)	The Company's equity in income for this entity represents its residual profits from the sale of the community, or liquidation of the venture.


(2)	Equity in income for the years ended December 31, 2016, 2015 and 2014 includes the Company's proportionate share of the gain on the sale of Fund II assets of $41,501, $29,726, and $21,624 respectively. In addition, equity in income for the year ended December 31, 2016 includes $7,985 relating to the Company's recognition of its promoted interest.


(3)	Equity in income for the year ended December 31, 2016 includes the Company's proportionate share of the gain on the sale of U.S. Fund assets of $16,568.


(4)	Equity in income for the years ended December 31, 2015 and 2014 includes $21,340 and $930, respectively, relating to the Company's recognition of its promoted interest. For 2015, $20,680 was from the joint venture partner upon agreement to modify the joint venture agreement to eliminate the Company's promoted interest from associated distribution for future return calculations.


(5)	Equity in income for the years ended December 31, 2015 and 2014 includes $1,289 and $61,218, respectively, relating to the Company's recognition of its promoted interest. Amount for 2014 also includes $50,478 related to the disposition of Avalon Chrystie Place.


(6)	In September 2016, the Company and its venture partner established separate legal ownership of Avalon Clarendon, after which the Company reported the operating results of Avalon Clarendon as part of its consolidated operations.

Investments in Consolidated Real Estate Entities

During the year ended December 31, 2016, in addition to Avalon Clarendon discussed above, the Company acquired four consolidated communities:


•	Avalon Hoboken, located in Hoboken, NJ, contains 217 apartment homes and was acquired for a purchase price of $129,700,000. In conjunction with the acquisition, the Company assumed a fixed rate secured mortgage note with a principal balance of $67,904,000 and a contractual interest rate of 4.18% maturing in December 2020.


•	Avalon Potomac Yard, located in Alexandria, VA, contains 323 apartment homes and was acquired for a purchase price of $108,250,000.


•	Avalon Columbia Pike, located in Arlington, VA, contains 269 apartment homes and was acquired for a purchase price of $102,000,000. In conjunction with the acquisition, the Company assumed a fixed rate secured mortgage note with a principal balance of $70,507,000 and a contractual interest rate of 3.38% maturing in November 2019.


•	Studio 77, located in North Hollywood, CA, contains 156 apartment homes and was acquired for a purchase price of $72,100,000.

These acquisitions occurred prior to the adoption of ASU 2017-01 as discussed in Note 1, “Organization, Basis of Presentation and Significant Accounting Policies,” and therefore the Company accounted for these acquisitions as business combinations and recorded the acquired assets and assumed liabilities, including identifiable intangibles, at their fair values. The Company used third party pricing or internal models for the values of the land, a valuation model for the values of the buildings and debt, and an internal model to determine the fair values of the remaining real estate assets and in-place leases. Given the heterogeneous nature of multifamily real estate, the fair values for the land, debt, real estate assets and in-place leases incorporated significant unobservable inputs and therefore are considered to be Level 3 prices within the fair value hierarchy.

Expensed transaction costs associated with the acquisitions made by the Company in 2016 and 2015, all of which were accounted for as business combinations, totaled $5,139,000 and $3,806,000, respectively. These amounts are reported as a component of expensed acquisition, development and other pursuit costs on the accompanying Consolidated Statements of Comprehensive Income. To the extent the Company received amounts related to acquired communities for periods prior to their acquisition, the Company reported these receipts, net with expensed acquisition costs. In 2014, the Company received amounts related to communities acquired in the Archstone Acquisition, for periods prior to the Company’s ownership, in excess of acquisition costs incurred, resulting in a net recovery of $7,681,000. These amounts are primarily comprised of property tax and mortgage insurance refunds.

On February 27, 2013, pursuant to an asset purchase agreement dated November 26, 2012, the Company, together with Equity Residential, acquired, directly or indirectly, all of the assets owned by Archstone Enterprise LP (“Archstone,” which has since changed its name to Jupiter Enterprise LP), including all of the ownership interests in joint ventures and other entities owned by Archstone, and assumed Archstone’s liabilities, both known and unknown, with certain limited exceptions. Under the terms of the purchase agreement, the Company acquired approximately 40.0% of Archstone's assets and liabilities and Equity Residential acquired approximately 60.0% of Archstone’s assets and liabilities (the “Archstone Acquisition”).

In conjunction with the development of Avalon Sheepshead Bay, the Company entered into a joint venture agreement to construct a mixed-use building that will contain rental apartments, for-sale residential condominium units and related common elements. The Company owns a 70.0% interest in the venture and will have all of the rights and obligations associated with the rental apartments, and the venture partner owns the remaining 30.0% interest and will have all of the rights and obligations associated with the for-sale residential condominium units. The Company is responsible for the development and construction of the structure, and is providing a loan to the venture partner for the venture partner's share of costs. As of December 31, 2016, the Company has a receivable from the venture partner in the form of a variable rate mortgage note, secured by the for-sale residential condominium units in the amount of $27,241,000 for outstanding principal and interest, reported as a component of prepaid expenses and other assets on the Consolidated Balance Sheets. The Company recognizes interest income on the accrual basis. The loan will be repaid by the venture partner with the proceeds the partner receives from the sales of the residential condominium units which are expected to occur during 2017 and 2018. The venture is considered a VIE, and the Company consolidates its interest in the rental apartments and common areas.