The accompanying unaudited condensed consolidated financial statements present the accounts of Essex Property Trust, Inc. (the “Company”), which include the accounts of the Company and Essex Portfolio, L.P. (the “Operating Partnership,” which holds the operating assets of the Company) and are, prepared in accordance with U.S. generally accepted accounting principles for interim financial information and in accordance with the instructions to Form 10-Q.  In the opinion of management, all adjustments necessary for a fair presentation of the financial position, results of operations and cash flows for the periods presented have been included and are normal and recurring in nature.  These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements included in the Company's annual report on Form 10-K for the year ended December 31, 2011.2012.

All significant intercompany balances and transactions have been eliminated in the condensed consolidated financial statements.

The unaudited condensed consolidated financial statements for the three and nine months ended September 30,March 31, 2013 and 2012 and 2011 include the accounts of the Company and the Operating Partnership.  The Company is the sole general partner in the Operating Partnership, with a 94.1%94.5% general partnership interest as of September 30, 2012.March 31, 2013.  Total Operating Partnership units outstanding were 2,234,3932,154,510 and 2,229,2302,122,381 as of September 30, 2012March 31, 2013 and December 31, 2011,2012, respectively, and the redemption value of the units, based on the closing price of the Company’s common stock totaled $331.2$324.4 million and $313.2$311.2 million, as of September 30, 2012March 31, 2013 and December 31, 2011,2012, respectively.

As of September 30, 2012,March 31, 2013, the Company owned or had ownership interests in 164166 apartment communities, aggregating 33,63734,343 units, excluding the Company’s ownership in preferred interest co-investments,  (collectively, the “Communities”, and individually, a “Community”), five commercial buildings and nineeight active development projects (collectively, the “Portfolio”).  The Communities are located in Southern California (Los Angeles, Orange, Riverside, San Diego, Santa Barbara, and Ventura counties), Northern California (the San Francisco Bay Area) and the Seattle metropolitan area.

Marketable Securities

The Company reports its available for sale securities at fair value, based on quoted market prices (Level 2 for the unsecured bonds and Level 1 for the common stock and investment funds, as defined by the Financial Accounting Standards Board (“FASB”) standard for fair value measurements as discussed later in Note 1), and any unrealized gain or loss is recorded as other comprehensive income (loss).  Realized gains and losses, interest and dividend income, and amortization of purchase discounts are included in interest and other income on the condensed consolidated statement of operations and comprehensive income.

As of September 30, 2012March 31, 2013 and December 31, 2011,2012, marketable securities consisted primarily of investment-grade unsecured bonds, common stock, investments in mortgage backed securities and investment funds that invest in U.S. treasury or agency securities.  As of September 30, 2012March 31, 2013 and December 31, 2011,2012, the Company classified its investments in mortgage backed securities, which mature in November 2019 and September 2020, as held to maturity, and accordingly, these securities are stated at their amortized cost.  The estimated fair values of the mortgage backed securities (Level 2 securities) are approximately equal to the carrying values.

 

The Company uses the specific identification method to determine the cost basis of a security sold and to reclassify amounts from accumulated other comprehensive income for securities sold.  For the three months ended September 30, 2012 and 2011, the Company did not sell any securities in the periods.  For the nine months ended September 30, 2012 and 2011,March 31, 2013, the proceeds from sales of available for sale securities totaled $6.3$20.3 million and $28.0 million, respectively, which resulted in gainsa realized gain of $0.5 million and $4.5 million, respectively.$1.8 million.  For the three months ended March 31, 2012, there were no sales of available for sale securities.

Variable Interest Entities

The Company consolidates 19 DownREIT limited partnerships (comprising twelve communities) since the Company is the primary beneficiary of these variable interest entities (“VIEs”).  Total DownREIT units outstanding were 1,057,8481,033,474 and 1,063,8481,039,431 as of September 30, 2012March 31, 2013 and December 31, 2011,2012, respectively, and the redemption value of the units, based on the closing price of the Company’s common stock totaled $156.8$155.6 million and $149.5$152.4 million, as of September 30, 2012March 31, 2013 and December 31, 2011,2012, respectively.  The consolidated total assets and liabilities related to these VIEs, net of intercompany eliminations, were approximately $202.7$202.4 million and $176.7$181.1 million, respectively, as of September 30, 2012March 31, 2013 and $199.8$201.1 million and $171.5$178.6 million, respectively, as of December 31, 2011.2012.  Interest holders in VIEs consolidated by the Company are allocated income equal to the cash payments made to those interest holders.  The remaining results of operations are generally allocated to the Company.  As of September 30, 2012March 31, 2013 and December 31, 2011,2012, the Company did not have any other VIEs of which it was deemed to be the primary beneficiary.

Equity Based Compensation

The Company accounts for equity based compensation using the fair value method of accounting.  The estimated fair value of stock options granted by the Company is being amortized over the vesting period of the stock options.  The estimated grant date fair values of the long term incentive plan units (discussed in Note 13, “Equity Based Compensation Plans,” in the Company’s Form 10-K for the year ended December 31, 2011)2012) are being amortized over the expected service periods.

Stock-based compensation expense for options and restricted stock totaled $0.4$0.6 million and $0.3$0.4 million for the three months ended September 30,March 31, 2013 and 2012, and 2011, respectively and $1.2 million and $1.0 million for the nine months ended September 30, 2012 and 2011, respectively.  The intrinsic value of the stock options exercised during the three months ended September 30,March 31, 2013 and 2012 and 2011 totaled $0.5$0.9 million and $0.6$1.1 million, respectively and $2.4 million and $3.6 million for the nine months ended September 30, 2012 and 2011, respectively.  As of September 30, 2012,March 31, 2013, the intrinsic value of the stock options outstanding totaled $13.6$14.6 million.  As of September 30, 2012,March 31, 2013, total unrecognized compensation cost related to unvested share-based compensation granted under the stock option and restricted stock plans totaled $4.3$5.8 million.  The cost is expected to be recognized over a weighted-average period of 1 to 65 years for the stock option plans and is expected to be recognized straight-line over a period of 1 to 7 years for the restricted stock awards.

The Company has adopted an incentive program involving the issuance of Series Z-1 Incentive Units of limited partnership interest in the Operating Partnership.  Stock-based compensation expense for Z-1 Units totaled $0.5 million and $0.2$0.6 million for the three months ended September 30, 2012March 31, 2013 and 2011, respectively and $1.6 million and $0.7 million for the nine months ended September 30, 2012 and 2011, respectively.2012.  Stock-based compensation for Z-1 units capitalized totaled $0.1 million for the three months ended September 30,March 31, 2013, and 2012, and 2011, and $0.4 million and $0.3 million for the nine months ended September 30, 2012 and 2011, respectively.  As of September 30, 2012,March 31, 2013, the intrinsic value of the Z-1 Units subject to future vesting totaled $22.0$16.1 million.  As of September 30, 2012,March 31, 2013, total unrecognized compensation cost related to Z-1 Units subject to future vesting totaled $7.9$6.8 million.  The unamortized cost is expected to be recognized over the next sixup to fourteen14 years subject to the achievement of the stated performance criteria.

Fair Value of Financial Instruments

Management believes that the carrying amounts of its amounts outstanding under lines of credit, notes receivable and notes and other receivables approximate fair value as of September 30, 2012March 31, 2013 and December 31, 2011,2012, because interest rates, yields and other terms for these instruments are consistent with yields and other terms currently available for similar instruments.  Management has estimated that the fair value of the Company’s $2.13$2.12 billion of fixed rate debt, including unsecured bonds, at September 30, 2012March 31, 2013 is approximately $2.26$2.21 billion and the fair value of the Company’s $402.1$551.6 million of variable rate debt, excluding borrowings under the lines of credit, at September 30, 2012March 31, 2013 is $380.9$632.7 million based on the terms of existing mortgage notes payable, unsecured bonds and variable rate demand notes compared to those available in the marketplace.  Management believes that the carrying amounts of cash and cash equivalents, restricted cash, accounts payable and accrued liabilities, construction payables, other liabilities and dividends payable approximate fair value as of September 30, 2012March 31, 2013 due to the short-term maturity of these instruments.  The fair values of the Company’s investments in mortgage backed securities are approximately equal to the amortized cost carrying value of these securities.  Marketable securities and derivatives are carried at fair value as of September 30, 2012.

The Company capitalizes all direct and certain indirect costs, including interest and real estate taxes, incurred during development and redevelopment activities. Interest is capitalized on real estate assets that require a period of time to get them ready for their intended use.  The amount of interest capitalized is based upon the average amount of accumulated development expenditures during the reporting period.  Included in capitalized costs are management’s accounting estimates of the direct and incremental personnel costs and indirect project costs associated with the Company's development and redevelopment activities.  Indirect project costs consist primarily of personnel costs associated with construction administration and development, including accounting, legal fees, and various office costs that clearly relate to projects under development.  The Company’s capitalized internal costs related to development and redevelopment projects totaled $1.5$1.6 million and $1.3$1.5 million during the three months ended September 30,March 31, 2013 and 2012, and 2011, respectively, and $4.5 million for each of the nine months ended September 30, 2012 and 2011, respectively, most of which relates to development projects.  These totals include capitalized salaries of $0.5$0.6 million and $0.6$0.7 million for the three months ended September 30,March 31, 2013 and 2012, and 2011, respectively, and $1.9 million and $1.7 million for nine months ended September 30, 2012 and 2011, respectively.

The Company owns investments in joint ventures (“co-investments”) in which it has significant influence, but its ownership interest does not meet the criteria for consolidation in accordance with the accounting standards.  Therefore, the Company accounts for these investments using the equity method of accounting.  Under the equity method of accounting, the investment is carried at the cost of assets contributed, plus the Company’s equity in earnings less distributions received and the Company’s share of losses.  The significant accounting policies of the Company’s co-investments entities are consistent with those of the Company in all material respects.  For preferred equity investments the Company recognizes its preferred interest as equity in earnings.

Upon the acquisition of a controlling interest of a co-investment, the co-investment entity is consolidated and a gain or loss is recognized upon the remeasurement of co-investments in the consolidated statement of operations equal to the amount by which the fair-value of the co-investment interest the Company previously owned exceeds its carrying value.

A majority of the co-investments, excluding the preferred equity investments, compensate the Company for its asset management services and may provide promote distributions if certain financial return benchmarks are achieved.  Asset management fees are recognized when earned, and promote fees are recognized when the earnings events have occurred and the amount is determinable and collectible.

Accounting Estimates and Reclassifications

The preparation of condensed consolidated financial statements, in accordance with U.S. generally accepted accounting principles, requires the Company to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and related disclosures of contingent assets and liabilities. On an on-going basis, the Company evaluates its estimates, including those related to acquiring, developing and assessing the carrying values of its real estate portfolio, its investments in and advances to joint ventures and affiliates, its notes receivables and its qualification as a Real Estate Investment Trust (“REIT”). The Company bases its estimates on historical experience, current market conditions, and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may vary from those estimates and those estimates could be different under different assumptions or conditions.

In January 2013, the Company acquired Annaliese, a 56 unit community located in Seattle, Washington for discontinued operations$19.0 million.  The property was built in 2009 and costis located in the South Lake Union submarket.

In February 2013, the Company purchased Fox Plaza, a 444 unit property located in San Francisco, California, for $135.0 million. Built in 1968, the property is a 29 story high rise tower with Fox Plaza apartments located on floors 14 through 29. The purchase price did not include floors 1 through 12 of managementcommercial office space but did include an adjacent two-story building comprised of approximately 37,800 square feet of space leased to retail and other fees have been madeoffice tenants and a two story underground parking garage comprised of 405 stalls.

During the first quarter, the Company sold 817,445 shares of common stock for $122.9 million, net of commissions, at an average per share price of $151.82.  Subsequent to prior year statementsquarter end, the Company has not sold any shares of operations balances in order to conform to current year presentation.  Such reclassifications have no impactcommon stock.

In April 2013, the Company issued $300 million aggregate principal amount of its 3.25% Senior Notes due on reported earnings, cash flows, total assets or total liabilities.May 1, 2023 (the "Notes").  The net proceeds from the issuance of Notes were approximately $295.2 million, after deducting the underwriters' discounts and estimated offering expenses.

The combined summarized balance sheet and statements of operations for co-investments which are accounted for under the equity method, are as follows (dollars in thousands).

 

 

Notes receivable secured by real estate, and other receivables consist of the following as of September 30, 2012March 31, 2013 and December 31, 20112012 (dollars in thousands):

 

Management and other fees from affiliates include management, development and redevelopment fees from co-investments of $2.9$2.8 million and $1.8$2.3 million during the three months ended September 30,March 31, 2013 and 2012, and 2011, respectively, and $7.9 million and $4.2 million for the nine months ended September 30, 2012 and 2011, respectively.  All of these fees are net of intercompany amounts eliminated by the Company.

The Company’s Chairman and founder, Mr. George Marcus, is the Chairman of The Marcus & Millichap Company (“TMMC”), which is a holding company for certain real estate brokerage services and other subsidiary companies including Pacific Urban Residential (“PUR”).  During July 2012,companies.  As described in Note 3, the Company invested $14.0$8.6 million as a preferred equity interest investment in an entity affiliated with PURTMMC that owns an apartment communitydevelopment in Cupertino,Redwood City, California.  The investment has a preferred returnIndependent members of 9.5% and matures in May 2016.  The Company will invest an additional $4.0 million in preferred equity to fund renovation costs.  Independent directors on the Company’s Board of Directors that serve on the Nominating and Corporate Governance and Audit Committees approved the investment in this entity.

Also during July 2012, the Company acquired Montebello, a 248 unit apartment communityAs described in Kirkland, Washington for $52.0 million from an entity affiliated with PUR.Note 4, The Company assumedprovided a $26.5$26.0 million mortgageshort-term bridge loan secured by the property at a fixed rate of 5.6% for eight years.  The interest rate on the loan was unfavorable compared to currently available market rates for mortgage loans, and thus in conjunctionWesco III to assist with the purchase price allocation,of Haver Hill which was repaid during the Company recorded a $4.1 million loan premium to reflect the debt at fair value. This results in an effective interest rate for this loan of 3.1%.  Independent directors on the Company’s Board of Directors approved the acquisition of this apartment community.

 

The Company defines its reportable operating segments as the three geographical regions in which its apartment communities are located: Southern California, Northern California and Seattle Metro.  Excluded from segment revenues are properties classified in discontinued operations, management and other fees from affiliates, and interest and other income.  Non-segment revenues and net operating income included in the following schedule also consist of revenue generated from commercial properties.  Other non-segment assets include co-investments, real estate under development, co-investments, cash and cash equivalents, marketable securities, notes receivable,and other receivables, prepaid expenses and other assets and deferred charges.

The revenues, net operating income, and assets for each of the reportable operating segments are summarized as follows for the three and nine months ended SeptemberMarch 30, 20122013 and 20112012 (dollars in thousands):