UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-K

 

 

Commission file number 1-16755

 

Archstone-Smith Trust

(Exact name of Registrant as Specified in Its Charter)

 

 

9200 E. Panorama Circle, Suite 400

Englewood, Colorado 80112

(Address of principal executive office)

 

(303) 708-5959

(Registrant’s telephone number, including area code)

 

Securities registered pursuant to Section 12(b) of the Act: None

 

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the securities Act.  Yes þ     No o

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes o     No þ

 

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.  Yes þ     No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated filer þ     Accelerated filer o     Non-accelerated filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o     No þ

 

Based on the closing price of the registrant’s Common Shares on June 30, 2005, the aggregate market value of the voting common equity held by non-affiliates of the registrant was approximately $7,675,943,000.

 

At March 1, 2006 there were approximately 213,308,000 of the registrant’s Common Shares outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the registrant’s definitive proxy statement for the 2006 annual meeting of its shareholders are incorporated by reference in Part III of this report.

 

 

Table of Contents

 

 

The following abbreviations, acronyms or defined terms used in this document are defined below:

 

Forward-Looking Statements

 

Certain statements in this Annual Report that are not historical facts are “forward-looking statements” as that term is defined under the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on our current expectations, beliefs, assumptions, estimates and projections about the industry and markets in which we operate. Words such as “expects,” “anticipates,” “intends,” “plans,” “believes,” “seeks,” “estimates” and variations of such words and similar expressions are intended to identify such forward-looking statements. Information concerning expected investment balances, expected funding sources, planned investments, forecasted dates and revenue and expense growth assumptions are examples of forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions, which are difficult to predict and many of which are beyond our control. Therefore, actual outcomes and results may differ materially from what is expressed, forecasted or implied in such forward-looking statements. We undertake no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by applicable law.

 

Our operating results depend primarily on income from apartment communities, which is substantially influenced by supply and demand for apartment units, operating expense levels, property level operations and the pace and price at which we develop, acquire or dispose of apartment communities. Capital and credit market conditions, which affect our cost of capital, also influence operating results. See “Risk Factors” in Item 1 of this Annual Report for a complete discussion of the various risk factors that could affect our future performance.

 

Archstone-Smith, an S&P 500 company, is a recognized leader in apartment investment and operations. The company owns and operates an unreplicated portfolio of high-rise and garden apartment communities concentrated in many of the most desirable neighborhoods in the greater Washington, D.C. Metropolitan Area, Southern California, the San Francisco Bay Area, the New York City Metropolitan Area, Boston, Chicago, Southeast Florida and Seattle. The company strives to continually upgrade the quality of its portfolio through the selective sale of assets, using proceeds to fund investments with higher anticipated growth prospects. Through our two customer-facing brands, Archstone and Charles E. Smith, we strive to provide great apartments and great service, all backed by our unconditional Seal of Service^tm guarantees.

 

As of December 31, 2005, we owned or had an ownership position in 257 communities, representing 86,930 units, including units under construction. At year-end, our operating portfolio was concentrated in protected locations in the following core markets, based on NOI for the three months ended December 31, 2005, excluding amounts owned by Ameriton or located in Germany:

 

 

Archstone-Smith is engaged primarily in the operation, development, redevelopment, acquisition and long-term ownership of apartment communities in the United States. We have elected REIT status and are structured as an UPREIT, with all property ownership and business operations conducted through the Operating Trust. We are the

representing 1,113 units, in markets that include the Washington, D.C. Metropolitan Area, Boston and Southern California.

 

During the year, four REIT development properties achieved Stabilization, representing a Total Expected Investment of $213.3 million and adding a total of 1,113 units to Archstone-Smith’s operating portfolio.

 

We believe that our locally based development infrastructure creates a significant competitive advantage for identifying and completing very attractive investment opportunities in our core markets. As such, we expect our development capability to continue to be a key contributor to growth and to create significant value as properties are completed and stabilized at attractive yields during the next several years. Additionally, we generally utilize Guaranteed Maximum Price Contracts (GMAX) through qualified third-party contractors to reduce our development risk from a cost perspective.

 

Ameriton.  Ameriton, our wholly owned subsidiary, continues to be a highly profitable franchise for our company. Utilizing our development, acquisition and operating expertise, Ameriton identifies under-managed operating communities, as well as development and redevelopment opportunities with a short-term ownership horizon of one to three years that have the potential to produce significant profits. Ameriton sold 11 communities in 2005 (including two joint venture transactions), contributing $62.5 million or $0.269 per share to Archstone-Smith’s 2005 earnings, $56.7 million, or $0.244 per share, to its 2005 FFO, and producing an average unleveraged pre-tax internal rate of return (IRR) of 24%.

 

Ameriton’s gains in 2005 were principally driven by the sale of newly developed communities in markets that include suburban Washington, D.C. and Houston. As of December 31, 2005, Ameriton has 20 communities representing 5,016 units under construction or in planning, including joint ventures. While nearly 60% of Ameriton’s development pipeline is located in our core markets, they are in locations that we deem to be non-core for ownership by the REIT.

 

A significant component of Ameriton’s successful development program is attributable to its creation of a successful business as a relationship-based financier of new, high-quality apartment communities that are built by other capable developers with whom we have fostered relationships over the past several years. Since 2003, Ameriton has completed seven of these transactions, realizing pre-tax gains of $28.3 million, or $0.122 per share, and funds from operations (FFO) of $21.5 million, or $0.093 per share, at an average leveraged IRR of 23.2%.

 

Leveraging our relationships with third-party apartment developers, we also created a related business that offers a compelling platform for long-term value creation: mezzanine debt financing. Our Ameriton investment team sources these transactions on behalf of the REIT, as the interest income is qualifying REIT income and therefore not subject to tax. Of the $129.2 million in mezzanine loan commitments we have made through December 31, 2005, $119.3 million were originated in 2005. During the year, we had two loans repaid in the amount of $34.5 million. We are encouraged by the opportunities to selectively invest capital at very attractive returns in this incremental area of our business.

 

We believe that our long-term cash flow growth is enhanced by the Archstone and Charles E. Smith brands, our goal to build the dominant operating platform in the apartment industry, robust and scalable technology, and continued investment in our associates.

 

Powerful brands.  An essential component of our strategy is to consistently offer a higher level of service at our apartment communities. Through our Seal of Service^tm, we offer our residents convenience and flexibility all backed by written guarantees. We believe we are the only public apartment REIT with an established track record of offering customers flexible lease terms from two to 12 months as standard practice — and the only apartment company in the nation to offer fully transactional online leasing through Online Lease, our proprietary automated online leasing system.

 

Our expansion in the New York City Metropolitan Area underscores the embedded value of our customer-focused operating and branding strategy. We believe we are the only apartment owner and manager in Manhattan to provide all of the following services: (i) leasing offices that are open seven days a week; (ii) we will show

apartments without an appointment or a broker; (iii) we can process applications in 48 hours, compared to one week process time at most competitors; (iv) we offer innovative services and unconditional service guarantees through our Seal of Service^tm; and (v) we provide a technology platform that makes it easy for people to do business with us through online rent payment, online service requests and our Online Lease. Customers have demonstrated an overwhelming acceptance of this approach, allowing us to achieve a 15% increase in new move-in rents in our same-store operating communities in Manhattan in the fourth quarter of 2005 as compared to the same period in 2004.

 

Investing in technology.

 

Web-based property management system.  We invest in technology to improve our core operations and make it easier for our customers to do business with us. In 2005, we completed the roll-out of MRI, our web-based property management system that provides the platform for virtually all of our customer-facing technology products. In addition, MRI’s automated work order solution allows us to manage and execute service requests more efficiently, in line with our 1-day Service Guarantee, through which we promise to respond to service requests within 24 hours. Equally important, MRI gives us the ability to accurately track resident histories to better understand and serve our customers.

 

Revenue management.  In 2000, we pioneered the use of a sophisticated revenue management product, Lease Rent Options (LRO). LRO brings a tremendous amount of discipline to the pricing process, enabling us to more precisely forecast demand to optimize pricing and occupancy across our portfolio, thereby increasing revenues. In 2005, we continued to refine and improve LRO to better manage pricing, occupancy and lease expirations to make us less vulnerable to seasonal shifts in customer traffic.

 

We believe that pricing in the apartment industry is too reliant on on-site individuals who often use “gut instinct” to make what are ultimately arbitrary pricing decisions. To bring discipline and sophistication to pricing in the apartment industry, we began to actively market LRO to other apartment owners, making sales to two large apartment companies; several other apartment owners are currently pilot testing the software.

 

Resident web sites.  MRI provides a seamless online presence with our customers via resident-only web sites, which we rolled out nationally in 2005, allowing customers 24/7 access to us to pay rent online, submit and track service requests, participate in periodic feedback surveys, review and update account information and more. In 2005, we collected approximately 115,000 online rent payments, representing revenue of $126.6 million and 11.2% of total rent collected. Online rent payments continued to accelerate throughout the year, with online rent payments in December 2005 totaling 18.1% of all rent collected.

 

Online Lease.  We believe that we are the only national apartment company to be able to complete leases fully online through Online Lease, our proprietary automated online leasing system. Using Online Lease, customers can log on to any computer to search for a specific apartment, view real-time pricing and availability, select rentable amenities such as garages or additional storage, complete their credit application and finalize their lease — all online.

 

Fully launched in June of 2005, Online Lease has been well-accepted by our customers, representing approximately 9% of all leases transacted in the fourth quarter. Of those apartments that were leased online for the full year of 2005, 28% were leased sight-unseen by customers and 39% were leased by customers who only visited an Archstone-Smith community once. We believe Online Lease provides us with a meaningful competitive edge to better serve customers and improve our operating margins.

 

Internet marketing and lead management.  Approximately 36% of all of our leases for the year ended December 31, 2005, were sourced through the Internet, with the vast majority of our customers beginning their apartment search online through third-party search vehicles such as Google and Yahoo! or Internet Listing Services (ILS) that include Apartments.com and RentNet.com as well as our branded web sites, ArchstoneApartments.com and SmithApartments.com. Because the acquisition cost for customers sourced through the Internet is dramatically lower than traditional marketing channels such as print advertising — we estimate the cost-per-lead is approximately $100 for those sourced through the Internet compared with an average of approximately $900 for traditional

print advertising — we continue to focus our marketing efforts on improving our online presence and lead management system.

 

In 2005, we established an Internet Lead Management (ILM) system in MRI, partnering with six ILSs with whom we have national contracts to provide customer lead information, which is automatically incorporated into MRI. Activated nationally in the third quarter of 2005, the ILM allows our site teams to be far more attentive and responsive to online customers, which we believe is critical to converting more customer leads into leases.

 

Driving renewals and referrals.  We believe that we can create a distinct competitive advantage by identifying and implementing the best practices for our most critical processes and standardizing them at each of our communities to deliver a consistently superior resident experience that drives loyalty. We believe that loyalty is a key indicator of a resident’s likelihood to renew his or her lease or refer our apartment communities to friends and co-workers as a place to live.

 

To gain an understanding of our customers’ loyalty — and the drivers that would increase their potential to renew and refer — we engaged Satmetrix, a leading customer experience management company, to conduct and analyze random periodic online feedback surveys among existing residents as well as online surveys to new residents two weeks after move-in.

 

The principal objective of these surveys is to determine what actions are needed to improve renewals and referrals. The Satmetrix system also provides immediate feedback to correct specific resident issues before they impact brand satisfaction; compares our communities to identify best practices; and provides the mechanism by which to recognize excellent managers and provide development to those who need it.

 

In addition, our Core Process Project (CPP) team, established in 2004, focuses on three important customer touch-points that we believe are critical to customer acquisition, renewal and referral: (i) customer inquiries and leasing, (ii) the move-in experience, and (iii) renewal, transfer or move-out. To capture best practices, the CPP team conducts extensive field research with front-line associates to translate proven tactics into scalable tools that ensure consistency in our day-to-day customer interactions.

 

In 2005, the CPP team completed the roll-out of the Move-in Tracker, a tool that allows community teams to track all the customer-critical steps needed for a smooth move-in. As a result of the Move-in Tracker, we have received extremely favorable feedback from our customers via Satmetrix surveys about their move-in experiences. We believe that a smooth move-in increases the likelihood of a positive first impression of our company and our brands, helping to drive customer renewals and referrals. Other current projects led by the CPP team include improvements to our make-ready process and renewal program.

 

Investing in our associates.  A critical component to ensuring the integrity of our brand offering is attracting, training and retaining the best professionals in our industry — and giving them the support and tools to provide an exceptional customer experience.

 

Associate engagement.  In 2005, we contracted with Kenexa, a leading associate engagement consultancy, to measure our associates’ engagement and identify key drivers of engagement. It is our belief that associates who are fully engaged in their roles tend to contribute at a much higher level to the company and stay with us longer. Our initial results were extremely encouraging, with 75% of our associates taking part in the survey. Our results place us in the top quartile of responses among the companies with whom Kenexa works, including many of the “best in class” corporations in the United States, such as Home Depot, Kraft Foods, Molson Coors, REI, Starwood, FedEx Kinko’s and Blockbuster.

 

Incentive-based compensation.  We made significant progress during the year on our incentive-based compensation (IBC) program, through which leasing associates take on a more traditional sales role, earning the majority of their compensation through leases “sold.” Previously, approximately 20% of our leasing associates’ income was based on leasing activity; with the IBC program, 65% of a leasing associate’s income is generated through leases they put in place. We believe that providing this performance-based income potential allows us to attract higher-caliber sales associates who are more vested in delivering a superior experience to our customers. Currently, the IBC program is in place at 83 of our larger communities with full roll-out expected in 2006.

Developing our leaders.  In 2005, another 239 corporate and community managers attended The Practice of Leadership, our feedback-based training program for corporate managers, and Leading Teams at Archstone-Smith, a comparable three-day program for our on-site teams. These three-day programs focus on six leadership practices consistent with our company culture and values that we believe drive our success. This program is complemented by a feedback component, through which direct reports and peers evaluate corporate managers to identify strengths and opportunities for improvement to enhance their effectiveness as team leaders. To date, a total of 671 managers have participated in the program.

 

One of our primary financial objectives is to structure our balance sheet to enhance our financial flexibility in order to have access to capital when others in the industry do not. Archstone-Smith has a significant equity base, with equity market capitalization of $10.4 billion, including the value of the A-1 Common Units, as of December 31, 2005. Our investment-grade debt ratings from Standard & Poor’s (BBB+), Moody’s Investors Service (Baal) and Fitch, Inc. (BBB+) are indicative of our solid financial position.

 

In September 2005, we sold approximately 12.1 million Common Shares under our existing shelf registration statement filed with the Securities and Exchange Commission. The $500 million of gross proceeds was initially used to pay down our credit facilities, which had a total outstanding balance of $690 million when the transaction was announced. This equity offering, together with the incremental debt capacity it gave the company, provides the financial flexibility to fund approximately $1.0 billion needed to complete our $2.8 billion development pipeline.

 

In 2005, we increased our unencumbered asset base to $7.7 billion as of the end of the year. As of March 1, 2006, we had approximately $363.3 million of liquidity, including cash on hand, restricted cash in escrows and capacity on unsecured credit facilities. We believe this financial flexibility allows us to act more quickly on new investment opportunities as they arise. We also repurchased $56.5 million of our Common Shares in 2005, at prices ranging from $33.61 to $35.54 per share and at an average price of $34.31 per share.

 

We have structured our long-term debt maturities in a manner designed to avoid unmanageable repayment obligations in any year. We have only $92.5 million of long-term debt maturing in 2006, representing 0.6% of our total market capitalization. The following summarizes our long-term debt maturity profile for 2006 through 2010, and thereafter, as of December 31, 2005 (dollar amounts in millions):

 

 

 

 

Consistent dividend growth.  We raised our anticipated 2006 distribution level to $1.74 per share, marking our 15th consecutive annual common share dividend increase and a total increase of 172% since 1991.

 

We have several senior executives who possess the leadership, operational, investment and financial skills and experience to oversee the overall operation of our Company. We believe several of our senior officers could serve as the principal executive officer and continue our strong performance. Our management team emphasizes active

training and organizational development initiatives for associates at all levels of our Company in order to build long-term management depth and facilitate succession planning.

 

Certain Senior Officers, including all Executive Officers, of Archstone-Smith are:

 

 

 

 

Biographies of Senior Officers

 

R. Scot Sellers – 49 — Chairman and Chief Executive Officer from June 1997 to July 1998 and from December 1998 to the present, with overall responsibility for Archstone-Smith’s strategic direction, investments and operations; Co-Chairman and Chief Investment Officer from July 1998 to December 1998; Managing Director of Archstone-Smith from September 1994 to June 1997, where he had overall responsibility for investment strategy and implementation; Senior Vice President of Archstone-Smith from May 1994 to September 1994; member of the Executive Committee of the Board of Governors and current Chairman of NAREIT; member of the Executive Committee of the Board of Directors of the National Multi Housing Council; Director of the Christian International Scholarship Foundation; Director of CEO Forum; and Director of the Alliance for Choice in Education.

 

J. Lindsay Freeman – 60 — Chief Operating Officer since September 2002, with responsibility for managing all investment and operating activities for Archstone-Smith; President-East Division of Archstone-Smith from October 2001 to September 2002, with responsibility for all investments and operations of the East Division; from July 1998 to October 2001, Managing Director of Archstone-Smith, with responsibility for investments and operations in the East and Central Regions; Managing Director of Security Capital Atlantic Incorporated from December 1997 to July 1998; Senior Vice President of Security Capital Atlantic Incorporated from May 1994 to November 1997; previously, Senior Vice President and Operating Partner of Lincoln Property Company in Atlanta, Georgia, where he was responsible for acquisitions, financing, construction and management of apartment communities within the Atlantic region and oversaw operations of 16,000 apartment units.

 

Charles E. Mueller, Jr. – 42 — Chief Financial Officer of Archstone-Smith since December 1998, with responsibility for the planning and execution of the Company’s financial strategy, balance sheet management and corporate operations; Mr. Mueller oversees the Company’s accounting/financial reporting, corporate finance, investor relations, corporate and property tax, due diligence, risk management, human resources, national marketing and ancillary services functions. Vice President of Archstone-Smith from September 1996 to December 1998; prior thereto, he held various financial positions with Security Capital, where he provided financial services to Security Capital and its affiliates. He is a member of the National Multi-Housing Council Executive Committee and Board of Directors, the Real Estate Roundtable President’s Council and a Director of Denver K-Life.

 

Alfred G. Neely – 60 — President — Charles E. Smith Residential Division since February 2005; Chief Development Officer of Archstone-Smith since April 2003, with responsibility for the oversight and direction of all Archstone-Smith residential development projects; Executive Vice President of Archstone-Smith or Charles E. Smith Residential Realty, Inc. from April 1989 to April 2003 with responsibility for oversight and direction of

High-Rise residential development projects; Executive Vice President and Managing General Partner of the New Height Group from August 1981 to April 1989 with responsibility for the development and management of 2.5 million square feet of mixed-use property; General Manager of a 1,100-acre mixed-use business park from October 1973 to April 1981 where he managed the development of 3.5 million square feet of corporate user buildings.

 

Dana K. Hamilton – 37 — Managing Director — Europe with responsibility for research and development of European investment and operational opportunities since, February 2005; Executive Vice President-National Operations for Archstone-Smith from May 2001 to February 2005, with responsibility for corporate services, including human resources, training and development, marketing and corporate communications, and new business development; Senior Vice President of Archstone-Smith from December 1998 to May 2001; Vice President from December 1996 to December 1998, with responsibility for new product development and revenue enhancement through portfolio-wide initiatives.

 

Caroline Brower – 57 — General Counsel and Secretary of Archstone-Smith since September 1999, with responsibility for legal and corporate governance; from September 1998 to September 1999, President of Ameriton Properties Incorporated; prior thereto, Ms. Brower was a partner of Mayer, Brown & Platt (now Mayer, Brown, Rowe & Maw, LLP) where she practiced transaction and real estate law.

 

Daniel E. Amedro – 49 — Chief Information Officer of Archstone-Smith since January 1999, with primary responsibility for the Company’s information technology functions and initiatives; Chief Information Officer and Vice President from May 1998 to January 1999; from September 1996 to March 1998, Vice President of Information Services for American Medical Response, the largest private ambulance operation in the United States; prior thereto, Vice President of Information Services for Hyatt Hotels and Resorts, where he was responsible for all strategic information systems including Spirit, Hyatt’s worldwide reservation system, which supported over 50,000 users and was recognized as the leading reservations system in the hospitality industry.

 

Mark A. Schumacher – 47 — Chief Accounting Officer of Archstone-Smith since December 2004 and Senior Vice President and Controller of Archstone-Smith from January 2002 to December 2004, with principal responsibility for accounting and financial reporting; prior thereto, Vice President and Corporate Controller of Qwest Communications International (“Qwest”) from December 2000 to December 2001 where he had principal responsibility for accounting and financial reporting; from April 1991 to December 2000, held various senior and executive level positions in the accounting and financial reporting departments of US West; from April 1984 to April 1991 he held various managerial level positions in the accounting and financial reporting department of US West. On March 15, 2005, the Securities and Exchange Commission entered an administrative order and settled civil proceedings against Mr. Schumacher relating to his work at Qwest. The Securities and Exchange Commission alleged, among other things, that Mr. Schumacher was a cause of Qwest failing to properly record and report certain transactions in accordance with generally accepted accounting principles in violation of the Securities Exchange Act of 1934 (the “Exchange Act”). Pursuant to the terms of the consent decree, Mr. Schumacher settled all claims against him, agreed to cease and desist from violating various provisions of Section 13 of the Exchange Act and related rules thereunder, agreed not to engage in the future in any activity in violation of such provisions and paid a fine of $40,000.

 

We currently employ approximately 2,703 individuals, of whom approximately 2,106 are focused on the site-level operation of our garden communities and high-rise properties. Of the site-level associates, approximately 126 are subject to collective bargaining agreements with four unions in Illinois and New York. The balance are professionals who manage corporate and regional operations, including our investment program, property operations, financial activities and other support functions. We consider our relationship with our employees to be very good.

 

We carry comprehensive general liability coverage on our owned communities, with limits of liability customary within the industry to insure against liability claims and related defense costs. Similarly, we are insured

against the risk of direct physical damage in amounts necessary to reimburse the company on a replacement cost basis for costs incurred to repair or rebuild each property, including loss of rental income during the reconstruction period. Our property policies for all operating and development communities include coverage for the perils of flood and earthquake shock with limits and deductibles customary in the industry. We also obtain title insurance policies when acquiring new properties, which insure fee title to our real properties. We currently have coverage for losses incurred in connection with both domestic and foreign terrorist-related activities. The terms of our property and general liability policies may exclude certain mold-related claims or other types of claims based on the specific circumstances and allegations. Should an uninsured loss arise against the company, we would be required to use our own funds to resolve the issue, including litigation costs. In addition, we self-insure certain portions of our insurance program through a wholly-owned captive insurance company, and therefore use our own funds to satisfy those limits, when applicable.

 

There are numerous commercial developers, real estate companies and other owners of real estate that we compete with in seeking land for development, apartment communities for acquisition and disposition and residents for apartment communities. All of our apartment communities are located in developed areas that include other apartment communities. The number of competitive apartment communities in a particular area could have a material adverse effect on our ability to lease units and on the rents charged. In addition, single-family homes and other residential properties provide housing alternatives to residents and potential residents of our apartment communities.

 

Our web site is http://www.archstonesmith.com. We make available free of charge, on or through our web site, our annual, quarterly and current reports, as well as any amendments to these reports, as soon as reasonably practicable after electronically filing these reports with the Securities and Exchange Commission. The reference to our web site does not incorporate by reference the information contained in the web site and such information should not be considered a part of this report. We have adopted a code of ethics and business conduct applicable to our Board and officers and employees, including our principal executive officer, principal financial officer and principal accounting officer or controller. A copy of our code of ethics and business conduct is included as an exhibit to this report and is available through our web site. In addition, copies of the code of ethics and business conduct can be obtained, free of charge, upon written request to Investor Relations, 9200 East Panorama Circle, Suite 400, Englewood, Colorado 80112. Any amendments to or waivers of our code of ethics and business conduct that apply to the principal executive officer, principal financial officer and principal accounting officer or controller and that relate to any matter enumerated in Item 406(b) of Regulation S-K, will be disclosed on our web site. Any reference to our website in this Annual Report does not incorporate by reference the information contained in the website and such information should not be considered a part of this Annual Report.

 

The following factors could affect our future financial performance:

 

We have restrictions on the sale of certain properties.

 

A taxable sale of any of the properties acquired in the Smith Merger prior to January 1, 2022, could result in increased costs to us in light of the tax-related obligations made to the former Smith Partnership Unitholders. Under the shareholders’ agreement between Archstone-Smith, the Operating Trust, Robert H. Smith and Robert P. Kogod, we are restricted from transferring specified high-rise properties located in the Crystal City area of Arlington, Virginia until October 31, 2016, without the consent of Messrs. Smith and Kogod, which could result in our inability to sell these properties at an opportune time and at increased costs to us. However, we are permitted to transfer these properties in connection with a non-taxable sale or a sale of all of the properties in a single transaction or pursuant to a bona fide mortgage of any or all of such properties in order to secure a loan or other financing.

We have similar restrictions with respect to the properties acquired from Oakwood Worldwide in 2005. The restrictions last until the earlier of (a) such time as 99% of the contributing partners have sold, redeemed or otherwise disposed of their A-1 Common Units in a taxable event and (b) the later to occur of (x) 10 years from the closing of the contribution of such properties and (y) the last to die of Howard Ruby and Ed Broida.

 

We depend on our key personnel.

 

Our success depends on our ability to attract and retain the services of executive officers, senior officers and company managers. There is substantial competition for qualified personnel in the real estate industry and the loss of several of our key personnel could have an adverse effect on us.

 

Debt financing could adversely affect our performance.

 

We are subject to risks associated with debt financing and preferred equity. These risks include the risks that we will not have sufficient cash flow from operations to meet required payments of principal and interest or to pay distributions on our securities at expected rates, that we will be unable to refinance current or future indebtedness, that the terms of any refinancing will not be as favorable as the terms of existing indebtedness, and that we will be unable to make necessary investments in new business initiatives due to lack of available funds. Increases in interest rates could increase interest expense, which would adversely affect net earnings and cash available for payment of obligations. If we are unable to make required payments on indebtedness that is secured by a mortgage on our property, the asset may be transferred to the lender with a consequent loss of income and value to us.

 

Additionally, our debt agreements contain customary covenants which, among other things, restrict our ability to incur additional indebtedness and, in certain instances, restrict our ability to engage in material asset sales, mergers, consolidations and acquisitions. These debt agreements also require us to maintain various financial ratios. Failure to comply with these covenants could result in a requirement to repay the indebtedness prior to its maturity, which could have an adverse effect on our operations and ability to make distributions to shareholders.

 

Some of our debt instruments bear interest at variable rates. Increases in interest rates would increase our interest expense under these instruments and would increase the cost of refinancing these instruments and issuing new debt. As a result, higher interest rates would adversely affect cash flow and our ability to service our indebtedness.

 

We had $5.3 billion in total debt outstanding as of December 31, 2005, of which $2.4 billion was secured by real estate assets and $1.4 billion was subject to variable interest rates, including $394.6 million outstanding on our short-term credit facilities.

 

We may not have access to equity capital.

 

A prolonged period in which we cannot effectively access the public equity markets may result in heavier reliance on alternative financing sources to undertake new investment activities. These alternative sources of financing may be more costly than raising funds in the public equity markets.

 

We could be subject to acts of terrorism.

 

Periodically, we receive alerts from government agencies that apartment communities could be the target of both domestic and foreign terrorism. Although we currently have insurance coverage for losses incurred in connection with terrorist-related activities, losses could exceed our coverage limits and have a material adverse affect on our operating results.

 

We are subject to risks inherent in ownership of real estate.

 

Real estate cash flows and values are affected by a number of factors, including changes in the general economic climate, local, regional or national conditions (such as an oversupply of communities or a reduction in rental demand in a specific area), the quality and philosophy of management, competition from other available properties and the ability to provide adequate property maintenance and insurance and to control operating costs. Real estate cash flows and values are also affected by such factors as government regulations, including zoning,

usage and tax laws, interest rate levels, the availability of financing, property tax rates, utility expenses, potential liability under environmental and other laws and changes in environmental and other laws. Although we seek to minimize these risks through our market research and property management capabilities, they cannot be totally eliminated.

 

We are subject to risks inherent in real estate development.

 

We have developed or commenced development on a substantial number of apartment communities and expect to develop additional apartment communities in the future. Real estate development involves risks in addition to those involved in the ownership and operation of established communities, including the risks that financing, if needed, may not be available on favorable terms, construction may not be completed on schedule, contractors may default, estimates of the costs of developing apartment communities may prove to be inaccurate, the costs and availability of materials may be adversely affected by global supply and demand, and communities may not be leased or rented on profitable terms or in the time frame anticipated. Timely construction may be affected by local weather conditions, local moratoria on construction, local or national strikes and local or national shortages in materials, building supplies or energy and fuel for equipment. These risks may cause the development project to fail to perform as expected.

 

Real estate investments are relatively illiquid and we may not be able to recover our investments.

 

Equity real estate investments are relatively illiquid, which may tend to limit our ability to react promptly to changes in economic or other market conditions. Our ability to dispose of assets in the future will depend on prevailing economic and market conditions. Furthermore, our mezzanine loans to real estate investors may not be recoverable if those investors are unable to monetize the underlying asset at underwritten amounts.

 

Compliance with laws and regulatory requirements may be costly.

 

We must comply with certain accessibility, environmental, building, and health and safety laws and regulations related to the ownership, operation, development and acquisition of apartments. Under those laws and regulations, we may be liable for, among other things, the costs of bringing our properties into compliance with the statutory and regulatory requirements. Non-compliance with certain of these laws and regulations may impose liability without regard to fault, and could give rise to actions brought against us by governmental entities and/or third parties who claim to be or have been damaged as a consequence of an apartment not being in compliance with the subject laws and regulations. As part of our due diligence procedures in connection with the acquisition of a property, whether it is an apartment community or land to be developed, we conduct an investigation of the property’s compliance with known laws and regulatory requirements with which we must comply once we acquire a property, which investigation includes performing a Phase I environmental assessment of the property and a Phase II assessment if recommended in the Phase I report. We cannot, however give any assurance that our investigations and these assessments have revealed all potential non-compliance issues or related liabilities.

 

Costs associated with moisture infiltration and resulting mold remediation may be costly.

 

As a general matter, concern about indoor exposure to mold continues as such exposure has been alleged to have a variety of adverse effects on health. As a result, there have been a number of lawsuits in our industry against owners and managers of apartment communities relating to moisture infiltration and resulting mold. We have implemented guidelines and procedures to address moisture infiltration and resulting mold issues if and when they arise. We believe that these measures will minimize the potential for any adverse effect on our residents. The terms of our property and general liability policies after June 30, 2002, may exclude certain mold-related claims. Should an uninsured loss arise against the company, we would be required to use our own funds to resolve the issue, including litigation costs. We can make no assurance that liabilities resulting from moisture infiltration and the presence of or exposure to mold will not have a future material impact on our financial results.

Changes in laws may result in increased cost.

 

We may not be able to pass on increased costs resulting from increases in real estate taxes, income taxes or other governmental requirements, such as the enactment of regulations relating to internal air quality, directly to our residents. Substantial increases in rents, as a result of those increased costs, may affect the ability of a resident to pay rent, causing increased vacancy.

 

Archstone-Smith’s failure to qualify as a REIT would have adverse consequences.

 

We believe that we have qualified for taxation as a REIT under the Internal Revenue Code and we plan to continue to meet the requirements for taxation as a REIT. We cannot, however, guarantee that we will continue to qualify in the future as a REIT. We cannot give any assurance that new legislation, regulations, administrative interpretations or court decisions will not significantly change the requirements relating to Archstone-Smith’s qualification. If we fail to qualify as a REIT, we would be subject to federal income tax at regular corporate rates. Also, unless the Internal Revenue Service granted us relief, we would remain disqualified as a REIT for four years following the year in which we failed to qualify. In the event that we failed to qualify as a REIT, we would be required to pay significant income taxes and would have less money available for operations and distributions to shareholders. This would likely have a significant adverse effect on the value of our securities and our ability to raise additional capital. In order to maintain our qualification as a REIT under the Internal Revenue Code, our declaration of trust limits the ownership of our shares by any person or group of related persons to 9.8%, unless special approval is granted by our Board.

 

  The Operating Trust intends to qualify as a partnership, but we cannot guarantee that the Operating Trust will qualify.

 

The Operating Trust intends to qualify as a partnership for federal income tax purposes. However, the Operating Trust will be treated as an association taxable as a corporation for federal income tax purposes if it is deemed to be a publicly traded partnership, unless at least 90% of its income is qualifying income as defined in the tax code. Qualifying income for the 90% test generally includes passive income, such as real property rents, dividends and interest. The income requirements applicable to REITs and the definition of qualifying income for purposes of this 90% test are similar in most respects. We believe that the Operating Trust will meet this qualifying income test, but cannot guarantee that it will. If the Operating Trust were to be taxed as a corporation, it will incur substantial tax liabilities, Archstone-Smith would fail to qualify as a REIT for tax purposes and Archstone-Smith’s and the Operating Trust’s ability to raise additional capital would be impaired.

 

We are subject to losses that may not be covered by insurance.

 

There are certain types of losses (such as from war) that may be uninsurable or not economically insurable. Additionally, many of our communities in California are located in the general vicinity of active earthquake fault lines and many of our Southeast Florida assets are in coastal locations and subject to hurricanes. Although we maintain insurance to cover most reasonably likely risks, including earthquakes and hurricanes, if an uninsured loss or a loss in excess of insured limits occurs, we could lose both our invested capital in, and anticipated profits from, one or more communities. We may also be required to continue to repay mortgage indebtedness or other obligations related to such communities. The terms of our property and general liability policies after June 30, 2002, may exclude certain mold-related claims. We can make no assurance that liabilities resulting from moisture infiltration and the presence of or exposure to mold will not have a future material impact on our financial results. Should an uninsured loss arise against the company, we would be required to use our own funds to resolve the issue, including litigation costs. Any such loss could materially adversely affect our business, financial condition and results of operations.

 

We have a concentration of investments in certain markets.

 

As shown in the Geographic Distribution table below in “Item 2. Properties,” our most significant investment concentrations are in the Washington, D.C. Metropolitan Area, Southern California and the San Francisco Bay Area. Southern California is the geographic area comprising the Los Angeles County, San Diego, Orange County,

the Inland Empire, and Ventura County markets. We are, therefore, subject to increased exposure (positive or negative) from economic and other competitive factors specific to markets within these geographic areas.

 

Our business is subject to extensive competition.

 

There are numerous commercial developers, real estate companies and other owners of real estate that we compete with in seeking land for development, apartment communities for acquisition and disposition and residents for apartment communities. All of our apartment communities are located in developed areas that include other apartment communities. The number of competitive apartment communities in a particular area could have a material adverse effect on our ability to lease units and on the rents charged. In addition, single-family homes and other residential properties provide housing alternatives to residents and potential residents of our apartment communities.

 

Not Applicable.

 

At December 31, 2005, the geographic distribution for our eight core markets based on NOI for the three months ended December 31, 2005, excluding properties owned by Ameriton or located in Germany, was as follows:

 

The following table summarizes the geographic distribution for 2005, 2004 and 2003, based on NOI:

 

 

 

We are a leading multifamily company focused on the operation, development, redevelopment, acquisition, management and long-term ownership of apartment communities in protected markets throughout the United States. The following information summarizes our wholly owned real estate portfolio as of December 31, 2005 (dollar amounts in thousands). Additional information on our real estate portfolio is contained in “Schedule III, Real Estate and Accumulated Depreciation” and in our audited financial statements contained in this Annual Report:

 

 

 

 

During the second quarter of 2005, we entered into a full and final settlement in the United States District Court for the District of Maryland with three national disability organizations and agreed to make capital improvements in a number of our communities in order to make them fully compliant with the Fair Housing Act and Americans with Disabilities Act. The litigation, settled by this agreement, alleged lack of full compliance with certain design and construction requirements under the two federal statutes at 71 of the company’s communities. As part of the settlement, the three disability organizations all recognized that Archstone-Smith had no intention to build any of its communities in a manner inconsistent with the FHA or ADA.

 

The amount of the capital expenditures required to remediate the remaining communities named in the settlement is estimated at $47.2 million and was accrued as an addition to real estate during the fourth quarter of 2005. The settlement agreement approved by the court allows us to remediate each of the designated communities over a three year period, and also provides that we are not restricted from selling any of our communities during the remediation period. We agreed to pay damages totaling $1.4 million, which included legal fees and costs incurred by the plaintiffs. We accrued other expenses of $4.0 million during 2005, which included the settlement and all related legal and other expenses paid in 2005 or expected to be paid during 2006.

 

We are subject to various claims filed in 2002 and 2003 in connection with moisture infiltration and resulting mold issues at certain high-rise properties we once owned in Southeast Florida. These claims generally allege that water infiltration and resulting mold contamination resulted in the claimants having personal injuries and/or property damage. Although certain of these claims continue to be in various stages of litigation, with respect to the majority of these claims, we have either settled the claims and/or we have been dismissed from the lawsuits that had been filed. With respect to the lawsuits that have not been resolved, we continue to defend these claims in the normal course of litigation.

We are a party to various other claims and routine litigation arising in the ordinary course of business. We do not believe that the results of any such claims or litigation, individually or in the aggregate, will have a material adverse effect on our business, financial position or results of operations.

 

None

 

Our Common Shares are listed on the NYSE under the symbol “ASN.” The following table sets forth the high and low sales prices of our Common Shares, as reported on the NYSE Composite Tape, and cash distributions per Common Share for the periods indicated.

 

 

As of March 1, 2006, we had approximately 213,308,000 Common Shares outstanding, approximately 3,234 record holders of Common Shares and approximately 27,650 beneficial holders of Common Shares.

 

To qualify as a REIT, we are required to make annual shareholder distributions of 90% of our taxable income. The payment of distributions is also subject to the discretion of the Board and is dependent upon our strategy, financial condition and operating results. Our long-term objective is to increase annual distributions per Common Share while maximizing the amount of internally generated cash flow from operations to fund future investment opportunities.

 

We announce the following year’s projected annual distribution level after the Board’s annual budget review and approval. In January 2006 the Board announced an increase in the annual distribution level from $1.73 to $1.74 per Common Share and declared the first quarter 2005 distribution of $0.435 per Common Share payable on February 28, 2006, to shareholders of record on February 15, 2006. This dividend marks our 122nd consecutive quarter of dividends declared and paid. All future Common Share distributions are subject to approval by our Board of Trustees.

 

We are restricted from declaring or paying any distribution with respect to our Common Shares unless cumulative distributions on all Preferred Shares have been paid and sufficient funds have been set aside for Preferred Share distributions that have been declared and not paid. All of our declared distributions have been paid on schedule.

 

For federal income tax purposes, distributions may consist of ordinary income, capital gains, non-taxable return of capital or a combination thereof. Distributions that exceed our current and accumulated earnings and profits constitute a return of capital rather than ordinary income and reduce the shareholder’s basis in the Common

Shares. To the extent that a distribution exceeds both current and accumulated earnings and profits and the shareholder’s basis in the Common Shares, it will generally be treated as a gain from the sale or exchange of that shareholder’s Common Shares. We notify our shareholders annually of the taxability of distributions paid during the preceding year. The following table summarizes the taxability of cash distributions paid on the Common Shares in 2005 and 2004:

 

 

For federal income tax purposes, the following summaries reflect the taxability of dividends paid on our Preferred Shares:

 

 

 

 

 

Our tax return for the year ended December 31, 2005 has not been filed, and the taxability information for 2005 is based upon the best available data we have. Our tax returns for prior years have not been examined by the Internal Revenue Service and, therefore, the taxability of the dividends may be subject to change.

 

In 2005, 2004 and 2003 we issued 11,289,070, 374,921 and 1,955,908 A-1 Common Units of the Operating Trust as partial consideration for real estate, respectively. All units were issued in transactions exempt from registration under Section 4(2) of the Securities Act of 1933 and the rules thereunder.

 

The following table summarizes repurchases of our Common Shares (amounts in thousands):

 

 

 

 

The following table provides selected financial data relating to our historical financial condition and results of operations as of and for each of the years ending December 31, 2001 to 2005. This data is qualified in its entirety by, and should be read in conjunction with, “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the financial statements and related notes that have been included or incorporated by reference in this Annual Report. Prior years amounts have been restated for amounts classified within discontinued operations. (in thousands, except per share data):

 

 

 

 

 

 

 

 

Executive Summary

 

During the three years covered by this Form 10-K, we have continued to focus on two of our most important goals: (i) managing our invested capital through the selective sale of apartment communities in non-core locations and redeploying the proceeds to fund investments with higher anticipated growth prospects in outstanding locations in our core markets; and (ii) building the dominant operating platform in the apartment industry. The following graph illustrates the major redeployment of capital that has occurred during this time period, excluding properties owned by Ameriton, properties located in Germany and REIT joint ventures in which our economic interest is less than 50% (dollar amounts in millions).

 

ASN Capital Redeployment

 

 

 

 

 

Although the full measure of success related to this strategy will be more fully reflected in future results, the increase in our diluted earnings per share, which includes gains from dispositions, have been encouraging.

 

Diluted Earnings Per Share

 

Other major factors that influenced our operating results over the last three years include the following:

 

 

Reconciliation of Quantitative Summary to Consolidated Statements of Earnings

 

The following schedule is provided to reconcile our consolidated statements of earnings to the information presented in the “Quantitative Summary” provided in the next section: